These cases also showcase key details about international business practices that might pose "red flags," and let us learn from others' mistakes. Effective compliance requires companies to commit high-level attention and large dollar amounts, but also requires entities to critically respond to the facts and details of particular markets on the ground.
The June 5 settlement of Netherlands-based aerospace service provider Fokker Services, B.V. ("Fokker") with three different U.S. government agencies is a great learning tool. The proposed penalties against Fokker totaled $21 million for violations of U.S. economic sanctions (on Iran, Sudan, and Burma) and U.S. export controls laws, arising from Fokker's unauthorized exports of aircraft spare parts from the United States.
In a significant recent twist, on July 9, Judge Richard Leon of the U.S. District Court for the District of Columbia delayed signing off on the deal, voicing "great concerns" about certain aspects of the settlement terms. A hearing has been scheduled for July 24, 2014 to address some of these concerns.
Legal Framework. The Export Administration Regulations ("EAR"), which are administered by the U.S. Department of Commerce, Bureau of Industry and Security ("BIS"), control exports and re-exports of commercial items such as aircraft parts, for both national security and foreign policy reasons. The EAR covers all items listed on the Commerce Control List that either are in the United States or are of U.S. origin, wherever located. To export or re-export commercial aircraft parts to Iran or Sudan, a company must get appropriate licenses from BIS, or, in some cases, the U.S. Treasury Department, Office of Foreign Assets Control ("OFAC").
Under U.S. sanctions laws, which are administered by OFAC, U.S. companies and individuals are prohibited from providing virtually any goods or services to Iran, whether directly or indirectly. In addition, no U.S. company may engage in any transaction or dealing in (including selling, transporting, swapping, financing, or facilitating) or related to goods or services for exportation, re-exportation, sale, or supply, directly or indirectly, to Iran. With a few exceptions, the trade embargo on Sudan also restricts U.S. companies and individuals from doing business with Sudan. U.S. restrictions on Burma historically restricted many transactions with Burma by U.S. persons, including investment in Burma and imports of Burmese products to the United States.
There are both civil and criminal penalties for violations of the EAR and the sanctions regime: up to $1 million and 20 years in prison for criminal violations; up to $250,000 or twice the value of the prohibited transaction for each civil violation; and the potential denial of export privileges.
The Alleged Schemes. From 2005 to 2010, Fokker allegedly employed several schemes aimed at avoiding U.S. export laws and sanctions to do business in sanctioned countries. These "work-arounds," as described in court documents, allegedly included withholding aircraft tail numbers or providing false tail numbers to repair shops, and asserting falsely that U.S. parts submitted for repair were for general inventory. Fokker also allegedly maintained a separate database of end users in sanctioned countries and a "black list" of U.S. companies with whom they refused to do business, because those companies had more sophisticated export control compliance systems. Moreover, Fokker's President purportedly ignored advice of the company's export compliance manager and in-house counsel that no U.S.-origin parts should be shipped to Iran.
According to the settlement documents, Fokker voluntarily self-disclosed the matter in 2010, although whether the government knew of the violations prior to the self-disclosure is now being questioned by Judge Leon. After actually or attempting to disclose, the company conducted an in-depth internal investigation. Ultimately, the company was charged with 1,112 violations of the Iranian Transactions and Sanctions Regulations, 41 violations of the Sudanese Sanctions Regulations, and 253 violations of the EAR. Those violations included transactions involving Iranian military end users and violations of a denial order in place against Iran Air. The U.S. Attorney's Office for the District of Columbia, citing shipments to Burma in addition to Iran and Sudan, charged Fokker criminally for conspiracy to violate the International Emergency Economic Powers Act, which serves as the statutory authority for most U.S. economic sanctions programs.
Re-Exports and Non-U.S. Companies. The Fokker case serves as a reminder that U.S. export controls follow U.S.-origin goods even when they are being re-exported. This aspect of U.S. export controls essentially mandates that non-U.S. businesses who trade in U.S. goods must comply with U.S. law; the Fokker settlement highlights the willingness and ability of U.S. enforcement agencies to pursue actions against non-U.S. companies. In the past few years, we have seen the largest historical penalties involving sanctions violations in cases against non-U.S. companies, especially in the financial sector. The Fokker settlement may be seen as an extension of that trend to non-U.S. businesses outside of the financial sector.
The Fokker case should also remind U.S. companies that their non-U.S. partners can pose a risk through resale of U.S.-origin items to sanctioned countries or other controlled destinations. Fokker's concealment of its activity is somewhat extraordinary, and the measures that Fokker took to conceal its transactions with sanctioned countries from U.S. companies suggest that the U.S.-parts suppliers were not complicit in the activity. Nonetheless, we would not be surprised if Fokker's suppliers received inquiries or suggestions from the Government about the need to upgrade their export controls compliance programs.
Proving the absence of knowledge in retrospect can be an uphill battle, especially in the midst of a government inquiry. As such, the Fokker settlement highlights the importance of targeted, risk-based due diligence that begins with an understanding of international diversion risks for any given market.
Using Exceptions. Fokker's apparent use of the "inventory exception" under U.S. economic sanctions is notable. As practitioners familiar with the field know, that generally recognized exception allows for shipments into general inventory of a distributor even if the distributor sells some items to sanctioned countries, provided that the U.S. person does not know that its parts are destined for the sanctioned countries.
It appears that Fokker deliberately misused this exception to justify shipments from the United States. For non-U.S. companies, the takeaway is simple: either use the exception appropriately or risk enforcement. For a U.S. supplier, the lesson is more difficult. Spotting misuse of the inventory exception by a non-U.S. distributor can be very tough; but one key step to protecting against this type of activity is training the workforce to understand red flags that may signal directed shipments in paperwork or other interactions with a non-U.S. distributor.
The Role of the Court. The recent developments in the Fokker case highlight the complications that may arise after a company is basking in the relief of a settlement announcement. It's not over until it's (really) over. More than a month after the settlement was announced, Judge Leon expressed his apprehensions about the relative leniency of the penalty amount, the lack of criminal charges against the individuals involved, and a media report raising a question of whether the government knew about the violations in 2008, long before Fokker's apparent self-disclosure. The Court has also asked that the parties submit filings comparing how Fokker's proposed settlement matches up against other deferred prosecution agreements. Last year, we discussed how Judge Leon's questioning of a proposed settlement between IBM and the Securities and Exchange Commission for alleged books and records violations possibly contributed to an expanded investigation of the Company, and may have complicated the enforcement picture. Here, there is no indication yet of additional investigations, although the Court's involvement may lead to harsher penalties.
The Role of Compliance. OFAC noted in its settlement documents that Fokker had no compliance program in place during the five-year period when the violations occurred. U.S. Attorney Ronald C. Machen said that Fokker "treated U.S. export laws as inconveniences to be 'worked around' through deceit and trickery." The company undertook several corrective actions in response to the matter, including establishing a formal compliance program.
Let's face it. Aligning business interests and compliance is tricky. While business people may understand that compliance is necessary, compliance professionals often have to persuade business development personnel to see compliance as anything other than a burden. That is especially true where, as was apparently the case with Fokker, there was not a clear tone from the top about the importance of compliance.
But Fokker may be useful in helping compliance personnel connect with their business personnel, because Fokker illustrates plainly that the consequences of non-compliance may be much greater than mere dollar values. Even assuming the penalty amount sticks, not only was the $21 million penalty roughly equal to the gross revenues for the violative shipments, but the Justice Department described the investigation conducted by outside counsel as "vast;" OFAC described it as "exhaustive." Thorough internal investigations can wreak havoc on a company's day-to-day operations (not to mention cost a lot). Prevention is always better than cure.
It is imperative to have a compliance program with clear and efficient processes that allow the business side to manage their own and their customers' expectations, and set real boundaries for results. Anything less can lead, as Fokker learned, to very significant, negative consequences.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Last Updated: July 22 2014 Article by Mark L. Jensen and Fatema K. MerchantSheppard Mullin Richter & Hampton