The View from Washington: Trends, Key Compliance Takeaways
2019 has already seen a multitude of settlement agreements published by the U.S. Department of the Treasury Office of Foreign Assets Control (OFAC), providing a clear indication that enforcement of economic sanctions is a top priority of the Trump administration.
Importantly, perhaps for the first time, OFAC is expressing not only that sanctions compliance is important, but more particularly its views on the elements of an effective compliance program, therefore putting companies on notice of U.S. government expectations.
In the M&A context, OFAC has indicated that not only is it important to engage in transaction due diligence and implement a compliance program covering the target, but that parties subject to U.S. jurisdiction must also ensure there is continuing monitoring of compliance post-acquisition.
The State Department has emphasized that if companies do not take seriously their responsibility to administer a bona fide export controls compliance program, the U.S. government will impose one, which will be more onerous and come at increased cost.
Legislative and Regulatory Developments
There were several regulatory developments concerning countries subject to economic sanctions.
Economic Sanctions on Venezuela and on Cuba
On Jan. 28, 2019, OFAC designated Venezuela’s state-owned oil company Petróleos de Venezuela S.A. (PdVSA), as a Specially Designated National (SDN), which ratchets up U.S. sanctions by significantly targeting Venezuela’s oil exports for the first time. The designation means all U.S. persons worldwide are required to freeze PdVSA’s assets and are cut off from all transactions and dealings with PdVSA.
Non-U.S. persons also risk “secondary sanctions” and designation as SDNs to the extent OFAC determines they provide significant support to PdVSA, and non-U.S. financial institutions are likely to carefully consider whether to continue to do business with PdVSA, lest doing so jeopardize their continued access to the U.S. financial system. OFAC issued a series of general licenses to cushion the impact on companies dealing with PdVSA and its subsidiaries, but only temporarily.
As of this writing, economic sanctions on Venezuela continue to be strengthened, including through the April 17, 2019, designation of the Central Bank of Venezuela as an SDN. These have been coupled with further economic sanctions on Cuba, specifically implementation of Title III of the Helms-Burton Act, which allows U.S. lawsuits against any person that “traffics” in Cuban property seized by the Communist government following the Cuban revolution. These actions indicate the Trump administration is targeting both direct and indirect sources of support for the Maduro regime to try to accelerate the transition of government.
In recent days, U.S. Special Representative for Venezuela Elliot Abrams has outlined U.S. expectations for changes in a post-Maduro government, including an independent military and an inclusive representative government, amid opposition leader Juan Guaidó’s escalating calls for the military to rise up in opposition to Maduro. President Trump has indicated that even stricter sanctions on Cuba could be forthcoming if Cuba does not withdraw its support for the Maduro regime, explicitly revealing the cross-connectivity of the Cuba and Venezuela sanctions programs.
Economic Sanctions on North Korea
On March 21, 2019, OFAC sanctioned Chinese shipping companies Dalian Haibo International Freight Co. Ltd. and Liaoning Danxing International Forwarding Co. Ltd. for helping North Korea evade U.S. and UN sanctions. On the same day, OFAC also issued an updated advisory warning industry about North Korea sanctions evasion methods in shipping. In the aftermath of the recent summit between President Trump and Chairman Kim, which ended abruptly, these actions affirm that the Trump administration is aggressively enforcing sanctions on North Korea by targeting its supply chains and benefactors, so that it cannot benefit from resisting denuclearization.
Economic Sanctions on Syria and on Iran
On March 25, 2019, OFAC updated its Advisory on petroleum shipping to highlight its concerns with deceptive shipping practices that facilitate exports of petroleum to the Syrian government and exports of petroleum of Iranian origin. This is especially notable given that the Trump administration has announced that it will not renew waivers the U.S. previously granted countries to continue to buy oil from Iran temporarily when they come up for renewal on May 2.
As of this writing, the U.S. has designated Iran’s Islamic Revolutionary Guard Corps (IRGC) as a Foreign Terrorist Organization, intensifying sanctions on Iran by making it a criminal offense for any person worldwide to provide the IRGC with “material support or resources.” This is a significant measure given the IRGC’s influential role in several sectors of Iran’s economy, and it is the first time such a designation has been imposed on part of the government of a foreign country.
Huawei Indictment and China-Iran Policy
On January 28, 2019, defendants including Huawei Technologies Co. Ltd. (Huawei), Huawei Device USA Inc. (Huawei USA), Skycom Tech Co. Ltd. (Skycom), and Huawei’s CFO Wanzhou Meng (Meng) were charged with violating U.S. sanctions on Iran. According to the Justice Department, Huawei and its affiliates offered to sell U.S. computer equipment to Iran’s largest mobile phone operator, actually sold similar equipment to Iran, and defrauded HSBC and other banks by misrepresenting Huawei’s relationship with Skycom, which was actually a suspected front company for Huawei to do business with Iran.
The Trump administration has taken an aggressive posture in terms of enforcing the sanctions regimes, particularly the Iranian sanctions. Huawei is likewise becoming persona non grata in the U.S. due to national security concerns about Huawei’s products in telecommunications infrastructure and trade war concerns that China is gaining on the U.S. with respect to cutting-edge technologies.
Supply Chain Risk
On Jan. 31, 2019, OFAC announced that e.l.f. Cosmetics Inc. (ELF) had agreed to a $996,080 settlement for violations of the North Korea Sanctions Regulations (NKSR) for indirect dealings in North Korean goods. OFAC found that ELF committed 156 apparent NKSR violations between April 2012 and January 2017 by importing from two Chinese suppliers approximately $4 million of fake eyelash kits that contained materials from North Korea.
The statutory maximum civil penalty was $40,833,633, but OFAC determined that the violations were non-egregious; that employees did not know of the violative conduct; and that ELF had voluntarily self-disclosed.
However, OFAC also determined that that ELF’s compliance program was “either non-existent or inadequate” given ELF did not review its imports for sanctioned country materials and did not discover for nearly five years that 80% of the eyelash kits contained materials from North Korea. As part of the voluntary self-disclosure and settlement, ELF implemented changes to its compliance procedures, including conducting regular supply chain audits. The settlement indicates that OFAC can impose meaningful fines even when the products at issue do not pose national security concerns.
Post-Acquisition Monitoring and Conduct of Foreign Affiliates
On Feb. 7, 2019, OFAC announced a $13,381 settlement with Kollmorgen Corporation (Kollmorgen) for six alleged violations of the Iranian Transactions and Sanctions Regulations (ITSR).
According to OFAC, Kollmorgen’s Turkish affiliate, Elsim Elektroteknik Sistemler Sanayi ve Ticaret Anonim Sirketi (Elsim), knowingly provided products and services destined for Iranian end-users and serviced certain machines located in Iran between July 2013 and July 2015. Kollmorgen acquired Elsim in 2013, at which point Elsim became subject to the ITSR’s prohibition on engaging in business in Iran.
After the acquisition, though Kollmorgen implemented procedures to terminate Elsim’s existing business in Iran and prevent Elsim from providing future services or products to Iran, OFAC found that Elsim’s management purposefully ignored these procedures; asked employees to falsify documentation related to business conducted in Iran; repeatedly lied to Kollmorgen about the ongoing business in Iran; and later obstructed an internal company investigation concerning it.
Though the statutory maximum civil penalty was $1.5 million and OFAC determined the violations were not egregious, OFAC still imposed penalties because Elsim management’s conduct was egregious and its sales to Iran prior to the acquisition raised its risk profile.
In a similar vein, on March 27, 2019, OFAC announced a $1,869,114 settlement with Stanley Black & Decker (SBD) for 23 apparent violations of the ITSR committed by Jiangsu Guoqiang Tools Co. Ltd. (GQ), a Chinese subsidiary in which SBD acquired a 60 percent controlling interest in May 2013. From June 29, 2013, through Dec. 30, 2014, GQ exported or attempted to export 23 shipments of power tools and spare parts, valued at $3,201,647.73, to Iran or to a third country with knowledge that the goods would be directly or indirectly supplied, re-exported, or transhipped to Iran.
Despite SBD’s discovery of GQ’s Iran business during diligence in 2011, conditioning of the closing on GQ’s cessation of this business, and conducting compliance training of GQ employees after closing, SBD did not implement post-acquisition procedures to monitor or audit GQ’s operations or ensure that GQ was no longer making sales to Iran.
Once SBD learned of the potential violations, it initiated an independent internal investigation and determined that GQ’s board and management knowingly violated the ITSR, and that GQ employees concealed and facilitated these violations, including through the use of trading companies and bills of lading that omitted references to Iran. In issuing the penalty, OFAC noted: “This enforcement action highlights the importance for U.S. companies to conduct sanctions-related due diligence both prior and subsequent to mergers and acquisitions, and to take appropriate steps to audit, monitor, and verify newly acquired subsidiaries and affiliates for OFAC compliance.”
The Kollmorgen and SBD cases highlight that in addition to taking steps immediately after closing to ensure acquired entities comply with sanctions, it is essential to continually monitor ongoing compliance and ensure buy-in from management.
Concealment Through Third Parties
On Feb. 14, 2019, OFAC announced a $5.51 million civil monetary penalty against AppliChem GmbH (AppliChem) for AppliChem’s 304 violations of the Cuban Assets Control Regulations (CACR). According to OFAC, for almost four years from May 2012 to February 2016, AppliChem violated the CACR when it sold chemical reagents to Cuba on 304 occasions. AppliChem is a German company that was acquired by an Illinois company, Illinois Tool Works, Inc. (ITW) in 2012.
Though ITW filed a voluntary disclosure and cooperated in the investigation, the presence of multiple aggravating factors, including the size and sophistication of AppliChem, led OFAC to determine the case to be egregious. Most notably, AppliChem’s former owners had continued its Cuba business by creating a scheme using third parties and doctored documents to conceal this business from ITW after specifically representing to ITW that it had ceased.
Effective ITAR Empowered Officials
On Feb. 26, 2019, the U.S. Department of State Directorate of Defense Trade Controls (DDTC) executed an 18-month Consent Agreement with Darling Industries, Inc. (Darling), an Arizona-based manufacturer and exporter of rocket motor insulation and other specialty fabricated rubber and composite items, for six apparent violations of the International Traffic in Arms Regulations (ITAR). One of the apparent violations related to failure to appoint an Empowered Official with sufficient authority and substantive export controls expertise to effectively carry out the responsibilities of the function.
Darling agreed to pay a $400,000 penalty, as well as to implement remedial measures, including designation of an Internal Special Compliance Officer (ISCI) to oversee the terms of and compliance with the Consent Agreement. The ISCI will be required to review and verify the export control jurisdiction of all Darling-manufactured items within one year of the agreement, and to submit related reports to the Office of Defense Trade Controls Compliance on classification and compliance remediation. This case highlights that, if companies fail to establish and implement a bona fide compliance program on their own, the U.S. government has the authority to impose one, which is likely to be more costly and more complex.
About the Authors
Mario Mancuso is a partner at Kirkland & Ellis and leads the firm’s International Trade and National Security practice. A former member of the President’s national security team, he specializes in counselling clients on international trade and national security matters, guiding clients through the CFIUS process, and resolving crises involving economic sanctions and export control-related investigations by the U.S. government.
Sanjay Mullick, a partner in Kirkland’s Washington, D.C., office, regularly represents clients on investigative, regulatory and transactional matters related to economic sanctions, export and import controls, anti-money laundering, and anticorruption.
Anthony Rapa, a partner in Kirkland’s Washington, D.C., office, counsels companies, financial institutions, and private equity sponsors worldwide regarding U.S., UK, and EU economic sanctions and export control issues.
Abigail Cotterill, of counsel in Kirkland’s Washington, D.C. office, regularly provides legal advice to companies, financial institutions, and private equity sponsors on the regulatory and other risks of operating or investing across international borders, with a focus on economic sanctions, export controls, and anticorruption.