Navigating the Minefield of U.S. Export Control

The complex series of regulations governing the licensing and shipping requirements for the export of U.S. goods includes separate regulations for exporting “munitions” under the U.S. Munitions List (USML) and the International Trafficking in Arms Regulations (ITAR), and others for “dual use” goods under the U.S. Department of Commerce's Control Lists and the Export Administration Regulations (EAR). Still other regulations impose restrictions upon certain prohibited destinations and ultimate end users that have been placed on the government's denied parties list under the U.S. Treasury Department's Office of Foreign Assets Control regulatory framework (referred to as OFAC).

The OFAC provisions restrict or prohibit shipment to certain locations due to U.S. foreign policy concerns, and also to certain “prohibited persons” (SDNs) when individuals have suffered past violations or have committed a violation of a regulation promulgated under the foreign policy directives (Executive Orders) that have been issued because of these foreign policy goals. The SDN list is supplemented regularly by the Treasury Department, and exporters are required to be familiar with it.

The export control law and regulation process may be especially complicated for a component parts manufacturer that ships to another entity which then incorporates the parts into a larger assembly and sells or trans-ships the completed item to a third party or even to another country. The subsequent manufacturer may not provide the component manufacturer with information concerning where the products ultimately will be sold and shipped, or to whom. Yet, the component manufacturer may not have rid itself of its legal obligations. The component manufacturer must confirm that the end use and ultimate destination of its goods is permissible before it ships the goods. It also is critical for the components manufacturer to shift the compliance risks to the subsequent entity in its distribution agreements in these circumstances.

The case of Computerlinks FZCO illustrates this point. In 2013, Computerlinks settled with the U.S. Department of Commerce's Bureau of Industry and Security (BIS) for $2.8 million when it reshipped Internet control devices to Syria, an embargoed country. Computerlinks had obtained the devices from its authorized supplier in the U.S., Blue Coat Systems Inc. of Sunnyvale, CA. Under the distribution agreement, Computerlinks was obligated to comply with all U.S. export laws in its resales in the Middle East. As a result, Blue Coat escaped liability.

The Export Documentation

Another compliance risk lurks in completing the Shippers Export Declaration (SED), the document that accompanies shipments upon export, a frequent favorite of prosecutors to charge the offense of making a false statement to the government. The SED requires the exporter to certify, among other things, the nature of the item, the identity of the intermediate consignee, the ultimate recipient and whether a license is required for the export. Knowingly making a false statement on an SED is a criminal offense, and a charge often considered by prosecutors as easier to prove than the crime of illegal diversion.

A number of recent cases illustrate the government's focus on holding companies liable for exporting goods that were ultimately diverted to prohibited locations or destinations inconsistent with what the company represented on the SED.

On Oct. 31, 2014, OFAC announced that Texas-based oil services provider Indam International Inc. agreed to pay $44,850 to settle potential civil liability for shipments sent originally to an entity in the United Arab Emirates (UAE), which were actually destined for two oil rigs in Iranian waters, in violation of the Iranian Sanction Regulations. OFAC found that Indam should have known the shipments were intended for Iran, but demonstrated “reckless disregard” by failing to conduct due diligence to determine the end users of its product.

Earlier that month, Intel subsidiary Wind River Systems agreed to a $750,000 penalty to settle allegations that it had sold encryption software to foreign government customers and entities on the U.S. Department of Commerce's Bureau of Industry and Security (BIS) Entity List without the required licenses. The penalty was approved to “serve as a reminder to companies of their responsibility to know their customers and, when using license exceptions, to ensure their customers are eligible recipients.”

Manufacturers also may face criminal penalties for the acts of subsequent manufacturers. In the same month, Robbins & Myers Belgium S.A., a subsidiary of the Texas oil firm, pleaded guilty to four counts of violating the International Emergency Economic Powers Act and the EAR. The Belgian subsidiary caused four illegal exports of drilling equipment made from steel milled in the U.S. to Syria, a prohibited destination. The company agreed to pay $1 million in criminal fines for the illegal exports, which were sold initially for only $31,716, and entered a civil settlement with BIS requiring the company to pay $600,000 in civil penalties.

While the harshest penalties are reserved for deliberate violations, even an inadvertent violation can result in the imposition of significant penalties.

Three companies misclassified their items as falling under the EAR, when in fact they were contained on the U.S. Munitions List, and thus ITAR parts requiring a license from the U.S. Department of State's Directorate of Defense Trade Controls prior to export. All paid dearly: In June 2014, Intersil Corporation agreed to pay a $10 million fine, $4 million of which was required to be used for the company to institute remedial compliance measures to prevent future violations. In 2013, Aeroflex Inc. was fined $8 million dollars following a 10-year period of similar violations. And in March 2014, aerospace and defense technology company Esterline Technologies Corporation was required to pay a $20 million fine for similar misclassification and other export violations, $10 million of which was ordered earmarked for compliance.

The Need for'a Comprehensive Compliance Program

These recent cases demonstrate the significant financial risks involved in failing to invest in a sufficient compliance program and failing to take export compliance seriously. As a result of lack of preparation or will, these companies made costly licensing and shipping mistakes, and greatly compounded the cost by failing to have a sufficient compliance program in place. Importantly, the resolutions in these cases provided that approximately half the fine amount was to be used to pay for compliance, a strong signal that authorities view sound compliance programs as essential parts of U.S. companies involved in shipments of goods abroad.

The U.S. Department of Justice (DOJ) has stated clearly that it views the company's tone and attitude toward compliance as a critical factor in assessing the extent of any fine. Indeed, on Nov. 19, 2014, at the American Conference Institute's 31st International Conference on the Foreign Corrupt Practices Act, the Division Enforcement Director of the U.S. Securities and Exchange Commission (SEC) Andrew Ceresney strongly encouraged companies to create robust compliance systems. He stated that “the SEC staff will look well on companies that have robust [compliance] programs and that the existence of such programs will pay dividends should an [enforcement] issue arise.”

From a practical perspective, a sound compliance program often will help companies prevent the costly mistakes in the first instance and thereby lessen the chance of the commencement of an enforcement action and a significant penalty thereafter.

What to Do

All companies that send products abroad, either directly or indirectly, should follow the motto that “an ounce of prevention is worth a pound of cure,” and immediately seek competent legal assistance to create a comprehensive compliance program that fits the company's business profile and its activities, while upper management must promote a tone throughout the company favoring compliance over risky business decisions.

These efforts also might include adding: 1) a capable mechanism to determine license requirements for company goods; 2) capacity to oversee and exercise quality control over licensing decisions; 3) competency to make the appropriate inquiries of the subsequent recipient of its intentions with the company's products; 4) language in invoices, correspondence, distribution agreements and shipping records that requires the subsequent manufacturer/recipient to assume the economic and financial sanctions risks and provide the proper assurances for any further sale or distribution; and 5) training on compliance to the relevant staff and employees. Failure to address these economic and compliance risks, and to adopt these measures, carries the potential for substantial losses and significant fines.

Robert Appleton is a partner in the New York and Connecticut offices of Day Pitney. Appleton is a former supervisory federal prosecutor who specialized in export control prosecutions at the U.S. Attorney's Office in Connecticut between 1995 and 2005, and also served as the export crimes coordinator, leading many of the major U.S. Department of Justice prosecutions of weapons and sensitive technology diversion to China and Iran during this time. Denise Rosenhaft , who assisted with this article, is counsel at the firm. This article also appeared in Corporate Counsel , an ALM sister publication of this newsletter

While the export control regulatory framework can present a dizzying array of requirements for exporters, companies also risk being held responsible for the activities of others, including those abroad who trans-ship their products to destinations embargoed by the United States, or in violation of U.S. licensing or regulatory requirements. Exporters may now face the doubling of fines for not having proper compliance programs in place.

Standards of Liability

A manufacturer that exports parts to a company abroad may be liable for an export violation if the subsequent entity does something wrong and an enforcement action subsequently finds that the original manufacturer should have been aware. A manufacturer also risks severe penalties if it does not pay proper attention to export control documentation, the parts classification issue for export licensing purposes and, importantly, the ultimate destination and recipient of the goods. These latter transgressions can be assessed under a “strict liability” theory and need not be “knowing” for an administrative violation.

The complex series of regulations governing the licensing and shipping requirements for the export of U.S. goods includes separate regulations for exporting “munitions” under the U.S. Munitions List (USML) and the International Trafficking in Arms Regulations (ITAR), and others for “dual use” goods under the U.S. Department of Commerce's Control Lists and the Export Administration Regulations (EAR). Still other regulations impose restrictions upon certain prohibited destinations and ultimate end users that have been placed on the government's denied parties list under the U.S. Treasury Department's Office of Foreign Assets Control regulatory framework (referred to as OFAC).

The OFAC provisions restrict or prohibit shipment to certain locations due to U.S. foreign policy concerns, and also to certain “prohibited persons” (SDNs) when individuals have suffered past violations or have committed a violation of a regulation promulgated under the foreign policy directives (Executive Orders) that have been issued because of these foreign policy goals. The SDN list is supplemented regularly by the Treasury Department, and exporters are required to be familiar with it.

The export control law and regulation process may be especially complicated for a component parts manufacturer that ships to another entity which then incorporates the parts into a larger assembly and sells or trans-ships the completed item to a third party or even to another country. The subsequent manufacturer may not provide the component manufacturer with information concerning where the products ultimately will be sold and shipped, or to whom. Yet, the component manufacturer may not have rid itself of its legal obligations. The component manufacturer must confirm that the end use and ultimate destination of its goods is permissible before it ships the goods. It also is critical for the components manufacturer to shift the compliance risks to the subsequent entity in its distribution agreements in these circumstances.

The case of Computerlinks FZCO illustrates this point. In 2013, Computerlinks settled with the U.S. Department of Commerce's Bureau of Industry and Security (BIS) for $2.8 million when it reshipped Internet control devices to Syria, an embargoed country. Computerlinks had obtained the devices from its authorized supplier in the U.S., Blue Coat Systems Inc. of Sunnyvale, CA. Under the distribution agreement, Computerlinks was obligated to comply with all U.S. export laws in its resales in the Middle East. As a result, Blue Coat escaped liability.

The Export Documentation

Another compliance risk lurks in completing the Shippers Export Declaration (SED), the document that accompanies shipments upon export, a frequent favorite of prosecutors to charge the offense of making a false statement to the government. The SED requires the exporter to certify, among other things, the nature of the item, the identity of the intermediate consignee, the ultimate recipient and whether a license is required for the export. Knowingly making a false statement on an SED is a criminal offense, and a charge often considered by prosecutors as easier to prove than the crime of illegal diversion.

A number of recent cases illustrate the government's focus on holding companies liable for exporting goods that were ultimately diverted to prohibited locations or destinations inconsistent with what the company represented on the SED.

On Oct. 31, 2014, OFAC announced that Texas-based oil services provider Indam International Inc. agreed to pay $44,850 to settle potential civil liability for shipments sent originally to an entity in the United Arab Emirates (UAE), which were actually destined for two oil rigs in Iranian waters, in violation of the Iranian Sanction Regulations. OFAC found that Indam should have known the shipments were intended for Iran, but demonstrated “reckless disregard” by failing to conduct due diligence to determine the end users of its product.

Earlier that month, Intel subsidiary Wind River Systems agreed to a $750,000 penalty to settle allegations that it had sold encryption software to foreign government customers and entities on the U.S. Department of Commerce's Bureau of Industry and Security (BIS) Entity List without the required licenses. The penalty was approved to “serve as a reminder to companies of their responsibility to know their customers and, when using license exceptions, to ensure their customers are eligible recipients.”

Manufacturers also may face criminal penalties for the acts of subsequent manufacturers. In the same month, Robbins & Myers Belgium S.A., a subsidiary of the Texas oil firm, pleaded guilty to four counts of violating the International Emergency Economic Powers Act and the EAR. The Belgian subsidiary caused four illegal exports of drilling equipment made from steel milled in the U.S. to Syria, a prohibited destination. The company agreed to pay $1 million in criminal fines for the illegal exports, which were sold initially for only $31,716, and entered a civil settlement with BIS requiring the company to pay $600,000 in civil penalties.

While the harshest penalties are reserved for deliberate violations, even an inadvertent violation can result in the imposition of significant penalties.

Three companies misclassified their items as falling under the EAR, when in fact they were contained on the U.S. Munitions List, and thus ITAR parts requiring a license from the U.S. Department of State's Directorate of Defense Trade Controls prior to export. All paid dearly: In June 2014, Intersil Corporation agreed to pay a $10 million fine, $4 million of which was required to be used for the company to institute remedial compliance measures to prevent future violations. In 2013, Aeroflex Inc. was fined $8 million dollars following a 10-year period of similar violations. And in March 2014, aerospace and defense technology company Esterline Technologies Corporation was required to pay a $20 million fine for similar misclassification and other export violations, $10 million of which was ordered earmarked for compliance.

The Need for'a Comprehensive Compliance Program

These recent cases demonstrate the significant financial risks involved in failing to invest in a sufficient compliance program and failing to take export compliance seriously. As a result of lack of preparation or will, these companies made costly licensing and shipping mistakes, and greatly compounded the cost by failing to have a sufficient compliance program in place. Importantly, the resolutions in these cases provided that approximately half the fine amount was to be used to pay for compliance, a strong signal that authorities view sound compliance programs as essential parts of U.S. companies involved in shipments of goods abroad.

The U.S. Department of Justice (DOJ) has stated clearly that it views the company's tone and attitude toward compliance as a critical factor in assessing the extent of any fine. Indeed, on Nov. 19, 2014, at the American Conference Institute's 31st International Conference on the Foreign Corrupt Practices Act, the Division Enforcement Director of the U.S. Securities and Exchange Commission (SEC) Andrew Ceresney strongly encouraged companies to create robust compliance systems. He stated that “the SEC staff will look well on companies that have robust [compliance] programs and that the existence of such programs will pay dividends should an [enforcement] issue arise.”

From a practical perspective, a sound compliance program often will help companies prevent the costly mistakes in the first instance and thereby lessen the chance of the commencement of an enforcement action and a significant penalty thereafter.

What to Do

All companies that send products abroad, either directly or indirectly, should follow the motto that “an ounce of prevention is worth a pound of cure,” and immediately seek competent legal assistance to create a comprehensive compliance program that fits the company's business profile and its activities, while upper management must promote a tone throughout the company favoring compliance over risky business decisions.

These efforts also might include adding: 1) a capable mechanism to determine license requirements for company goods; 2) capacity to oversee and exercise quality control over licensing decisions; 3) competency to make the appropriate inquiries of the subsequent recipient of its intentions with the company's products; 4) language in invoices, correspondence, distribution agreements and shipping records that requires the subsequent manufacturer/recipient to assume the economic and financial sanctions risks and provide the proper assurances for any further sale or distribution; and 5) training on compliance to the relevant staff and employees. Failure to address these economic and compliance risks, and to adopt these measures, carries the potential for substantial losses and significant fines.

Robert Appleton is a partner in the New York and Connecticut offices of Day Pitney. Appleton is a former supervisory federal prosecutor who specialized in export control prosecutions at the U.S. Attorney's Office in Connecticut between 1995 and 2005, and also served as the export crimes coordinator, leading many of the major U.S. Department of Justice prosecutions of weapons and sensitive technology diversion to China and Iran during this time. Denise Rosenhaft , who assisted with this article, is counsel at the firm. This article also appeared in Corporate Counsel , an ALM sister publication of this newsletter