What You Don't Know Can Hurt You: OFAC's First 2019 Enforcement Cases Emphasize Global Supply Chain and Affiliate Risks
This Advisory was updated on February 15, 2019.
Shutdown, what shutdown? With less than three weeks of a fully operating Treasury Department in 2019, the Office of Foreign Assets Control (OFAC) is off to a fast start (much faster than last year) in announcing the settlement of three enforcement cases. While the cases are different in many ways, they share a common theme: namely, the need for end-to-end visibility when implementing a global compliance program; merely relying on assurances from partners may not be enough.
Do you know who your suppliers' suppliers are?
First, on January 31, 2019, OFAC announced a nearly $1 million settlement with e.l.f. Cosmetics (ELF) for alleged violations of North Korean sanctions. According to OFAC, ELF imported more than $4 million worth of fake eyelashes from suppliers in China, over five years, that contained materials from North Korea. ELF "immediately" voluntarily disclosed the violation, which appears to have contributed to an assessed penalty far below the $40 million statutory maximum.
OFAC notes that ELF's supply chain oversight focused on issues pertaining to quality and production, but did not include sufficient due diligence regarding material sourcing. The company is now taking a number of steps highlighted by OFAC that go far beyond asking its first tier suppliers to avoid sanctioned countries—suppliers now have to prove it. In particular, ELF is not only requiring certificates of compliance for its suppliers' sources, but also conducting supply chain audits related to sourcing and demanding to review payment information and supplier bank statements to back up source certificates.
The case suggests that companies should consider reviewing their supply chain programs to be sure that supply chain managers and auditors are adequately trained on US trade sanctions, export controls, and other applicable trade regulations. Dealing with these issues only in supplier agreements or representations and warranties may prove insufficient in ensuring supplier compliance and avoiding investigations and enforcement actions.
Are you sure your foreign affiliates are following your compliance program?
In a February 7, 2019 announcement, OFAC detailed the extensive diligence efforts undertaken by US company Kollmorgan Corporation (Kollmorgan) in its 2013 acquisition of Turkish company Elsim Elektroteknik Sistemler Sanayi ve Ticaret Anonim Sirketi (Elsim). When Kollmorgan acquired control of Elsim, it was apparently aware that Elsim had Iran-related contracts and took a number of steps highlighted by OFAC to block future Iran work in compliance with US Iran sanctions (which prohibit foreign companies owned or controlled by US companies from doing most business with Iran).
Nevertheless, according to OFAC's announcement, management at Elsim willfully continued Iran business, even "fraudulently" certifying to Kollmorgan that Elsim had ceased all Iran work. The violations at issue were eventually uncovered thanks to an internal complaint filed by an Elsim employee on Kollmorgan's ethics hotline. Even after Kollmorgan began investigating the matter, Elsim employees allegedly took steps to obstruct the investigation.
As a result of the investigation, Kollmorgan took a number of steps to bolster compliance even further, including additional procedures designed to monitor Elsim's operations and employee training. While OFAC did impose an approximately $13,000 penalty on the company, it noted Kollmorgan's "extensive" compliance efforts and thorough voluntary disclosure, which likely contributed to the penalty falling far below the possible $1.5 million statutory maximum.
On the other hand, on February 14, 2019, OFAC announced an over $5.5 million settlement with German company AppliChem GmbH (AppliChem). In early 2012, Illinois Tool Works, Inc. (ITW), a US company, acquired AppliChem, which manufactures chemicals and reagents for the pharmaceutical and chemical industries. Through the acquisition, AppliChem became subject to US. Cuba sanctions restrictions and was told to cease work with Cuba. Within a few months, however, ITW learned that AppliChem was continuing to engage in dealings with Cuba. ITW sent further instructions to AppliChem employees that it must cease all sales to Cuba, and ITW voluntarily disclosed the transactions to OFAC in 2013. In 2015, OFAC issued a cautionary letter only to ITW; it did not pursue any civil penalties or further enforcement.
Despite ITW's efforts to stop AppliChem's continued dealings with Cuba, AppliChem did not stop. According to OFAC, "[r]ather than ceasing sales to Cuba as ITW had directed, between February 2012 and April 2012, AppliChem designed and implemented what were called the 'Caribbean Procedures' (whereby Cuba was referred to by the code word 'Caribbean'), which made sure that no documents mentioning Cuba would be prepared or retained by AppliChem in connection with its continued business with the country." ITW discovered this in 2016 due to a call to the company's ethics hotline, and commenced a full investigation at that time. This investigation led to a second voluntary disclosure with OFAC concerning the "Caribbean Procedures" scheme.
However, the full investigation also uncovered that ITW had been put on notice in March 2013 and June 2015 that Cuba sales were continuing, but ITW only responded by seeking assurances from AppliChem that the Cuba sales had ceased and reminding the company of its obligations. ITW and AppliChem did not fully investigate the issue until 2016 despite these prior warnings. OFAC determined that this constituted an egregious case under the penalty guidelines.
Like the ELF case, the Kollmorgan and AppliChem cases highlight that global compliance requires adherence to the adage "trust, but verify." OFAC specifically noted that the Kollmorgan and AppliChem cases highlight the importance of (among other compliance efforts):
- performing heightened due diligence, particularly with regard to affiliates, subsidiaries, or counter-parties known to transact with OFAC sanctioned countries or persons, or that otherwise pose high-risks due to their geographic location, customers and/or suppliers, or products and services they offer;
- implementing proactive controls when US persons, directly or indirectly, acquire companies with preexisting relationships with sanctioned persons and jurisdictions;
- implementing risk-based controls, such as regular audits, to ensure subsidiaries are complying with their obligations under OFAC's sanctions regulations; and
- appropriately responding to derogatory information regarding the sanctions compliance efforts of foreign persons subject to the jurisdiction of the United States.
The Trump Administration has repeatedly indicated that it will take an aggressive approach towards enforcing many sanctions programs and these cases involving Iran, China, North Korea, and Cuba underscore this posture. If OFAC maintains the pace it has set in these two weeks, 2019 could indeed be a record year for enforcement cases.
© Arnold & Porter Kaye Scholer LLP 2019 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.