Prevent diversions to forbidden nations

Unprepared U.S.-based companies can find themselves in hot water if they don't prevent personnel or customers from diverting their products to embargoed countries. Here's how to protect against substantial civil and criminal penalties.

John Carrington, a former North Carolina state senator, and president and chief executive officer of Sirchie Fingerprints — a police and forensics equipment supply company — wanted to sell some products to Hong Kong and China. However, he had no intention of U.S. export control licensing requirements holding him up. He simply shipped the goods to an Italian associate who was quite happy — for a price — to send them to Carrington's customers in China. The U.S. government eventually caught Carrington, slapped him in 2005 with a criminal fine of $850,000, a year of supervised release and barred him from exporting anything for five years. Sirchie Fingerprints also was barred from exporting for five years and was required to pay a $400,000 civil penalty. Undaunted, Carrington continued illegally exporting through a successor company he created. The feds caught him again. In 2010, Carrington's successor company had to pay $2.5 million for 10 violations plus another $10.1 million in criminal fines and had to stop exporting for another five years.

[This case history is from the July 2014 U.S. Bureau of Industry and Security (BIS) publication, Don't Let This Happen To You!]

Increasing enforcement

Scores of U.S.-based companies either unwittingly or knowingly illegally divert products by selling them to customers in federally accepted nations only to have those customers resell the items to companies or individuals in embargoed countries — such as Syria — or nations that require rigorous government oversight through export control licensing and associated conditions and requirements — such as China.

The U.S. federal government is increasingly enforcing sanctions and export controls in pursuit of national security and foreign policy goals. As a result, U.S.-based companies must implement more effective internal controls to prevent fraudulent shipment diversions. The penalties — both criminal and civil — are severe for failing to take adequate preventive steps. The U.S. Department of Treasury's Office of Foreign Asset Control (OFAC) alone has issued recent penalties rivaling those for violations of the Foreign Corrupt Practices Act.

Other countries are also cracking down on fraudulent shipment diversions. Witness the joint European Union and U.S. imposition of sanctions against Russia related to the Ukraine crisis. And the Wassenaar Arrangement on Export Controls — implemented among 42 countries to this point — requires implementation of adequate transaction screening procedures to prevent diversion of the export/transfer to unauthorized end users or end uses.

In this article, I'll review U.S. requirements for preventing diversion, which are similar to other Wassenaar Arrangement signatory countries. I'll provide some case studies and then discuss best practices for 1) balancing incentives for sales personnel, 2) empowering international trade compliance personnel to impose transaction holds when necessary and 3) conducting proper and adequate transaction due diligence on end users and end uses.

U.S. requirements for preventing diversion

As of the publication of this article, the OFAC imposes almost total embargoes on such countries as Cuba, Crimea, Iran, North Korea, Syria and Sudan. (The embargo on Iran might change because of the July 14 announcement of the Nuclear Containment Agreement.)

Meanwhile, the Obama administration is pushing to have the Cuban embargo lifted. And Congress has begun to take action in that direction through the July 23rd Senate Committee amendments to the Senate Financial Services appropriations bill. (See the Reuters article on MSN, Senate panel passes amendment to end restrictions on travel to Cuba.)

The U.S. also imposes limited sanctions against many other countries, specially designated nationals and denied parties. (See: http://tinyurl.com/398fb4p.) Companies, of course, must ensure they aren't conducting business with any of these and other blacklisted entities.

Meanwhile, the U.S. Department of Commerce's Bureau of Industry and Security enforces export and embargo controls. (See 15 CFR Parts 744 and 746.) Among these controls is the prohibition against end-users who are proliferators of nuclear, biological and chemical weaponry and missile delivery systems. (See 15 CFR Part 744.) The law requires inclusion of a destination control statement on all relevant export documentation stating at a minimum:

"These commodities, technology, or software were exported from the United States in accordance with the Export Administration Regulations (EAR). Diversion contrary to U.S. law is prohibited." [See 15 CFR §758.6(a).]

Under the Export Administration Regulations, the government can impose criminal penalties up to $1 million and 20 years imprisonment per violation while administrative penalties can reach the greater of $250,000 per violation or twice the amount of the transaction that is the basis of the violation.

Criminal penalties for willful violations of OFAC sanctions can include fines ranging up to $20 million and imprisonment of up to 30 years. Civil penalties for violations of the U.S. Trading with the Enemy Act can range up to $65,000 for each violation. Meanwhile, civil penalties for violations of the International Emergency Economic Powers Act can range up to $250,000 or twice the amount of the underlying transaction for each violation.