Trade Compliance Flash: OFAC Imposes a $101 Million Penalty Against ZTE for Violating the Iran Sanctions as Part of $1.19 Billion Consolidated Settlement with DOJ and BIS
On March 7, 2017, the U.S. Department of the Treasury's Office of Foreign Assets Control (OFAC) imposed a substantial fine against Chinese telecommunications corporation Zhongxing Telecommunications Equipment Corporation (ZTE) and several of its subsidiaries. The fine is OFAC's largest settlement to date with a non-financial entity. At only $5.3 million below the statutory maximum, it was imposed based on allegations that ZTE engaged in 251 apparent violations of the Iranian Transactions and Sanctions Regulations (ITSR) involving approximately $40 million dollars of U.S.-origin goods. According to the settlement agreement between OFAC and ZTE, the violations persisted over a six-year period between 2010 and 2016. The OFAC settlement was announced concurrently with settlements by ZTE with the U.S. Department of Commerce’s Bureau of Industry and Security (BIS) and the U.S. Department of Justice (DOJ), which respectively imposed fines of $661 million and $430 million for a total penalty of $1.19 billion. The BIS penalty was a record and the DOJ penalty was a record for criminal actions of this kind.
Yesterday's actions were not necessarily unexpected. ZTE's history with U.S. authorities dates back to 2012, when OFAC and other U.S. government agencies launched an investigation into press reports of illegal dealings by ZTE with Iran. That investigation continued through March 7, 2017 and culminated in yesterday's penalties. During the course of that investigation, almost exactly a year ago, BIS added ZTE to its Entity List (found at Part 744 of the U.S. Export Administration Regulations (EAR)) and subsequently entered a series of temporary general licenses that effectively suspended the ZTE listing. The most recent of these temporary general licenses, entered on February 24, 2017, was only for a period of 30 days, indicating that today's settlement was likely imminent.
Nothing, however, could have foretold the size of the penalties levied against ZTE. So what is the basis for such extraordinary measures?
The OFAC settlement agreement explains that from January 2010 to March 2016, ZTE knowingly attempted to evade U.S. economic and trade sanctions against Iran by using third parties to enter into contracts with Iranian entities for the sale of U.S.-origin goods. Specifically, ZTE engaged a third party to purchase U.S.-origin goods from suppliers on its behalf and to then re-export those goods from China to Iran while attempting to "isolate" ZTE from any open connection to these companies and thus conceal any role ZTE had in the Iran transactions. In internal memos, ZTE apparently referred to these entities as "isolation" companies. According to OFAC, these "isolation companies" were "specifically intended to provide a pass-through and buffer entity for U.S.-origin goods destined for Iran and to obscure [ZTE's] involvement with Iran, thereby reducing the risk of detection by U.S. regulators . . . " Because the original "isolation company" had no track record of its own, ZTE needed to participate in the financing and negotiation of the transactions and therefore still played an open role in the transactions. As a result, ZTE looked for and found "a larger, more capable isolation company," which allowed ZTE to attempt to fade into the background and to use the third party's name on all internal paperwork in an attempt to conceal ZTE's involvement in the transactions. OFAC also highlighted other activities intended to evade U.S. export controls and economic sanctions, including the commingling of U.S.-origin goods in shipments of non-U.S.-origin goods to Iran and concealment or failure to disclose to U.S. suppliers the material fact that their products were "specifically intended for reexportation to Iran." The OFAC settlement agreement concluded that ZTE's "willingness to provide U.S.-origin goods to its Iranian customers helped it secure and win  contracts."
The OFAC settlement describes ZTE's conduct as a "company-wide scheme" that was "developed and approved at the highest levels of [ZTE's] management." Apart from the significant evasion of the Iran embargo by systematically re-exporting U.S.-origin goods to Iran over a six-plus year period (which itself was significant), several other factors about this case appear to have prompted the extraordinary penalties imposed by U.S. regulators:
- After a 2012 Reuters article provided some information on ZTE's Iran business, ZTE initially halted that business, but then reinstituted its Iran transactions and continued to use U.S.-origin goods. The biggest change in its post-Reuters business with Iran was that it engaged in additional (and extraordinary) efforts to conceal its conduct.
- In internal communications, ZTE used code names to conceal the identity of its Iranian customers, deleted references to Iran, or referred to Iran generically as the "Middle East."
- After it learned that U.S. regulators were investigating, ZTE deleted or attempted to delete any references to Iran and Iranian customers in internal documents.
- In January 2016, ZTE provided incomplete or altered information to its own forensic auditors, which sought to minimize the scope of the Iran transactions. OFAC determined that the purpose of this submission was to have that misleading information shared with U.S. regulators through defense counsel or through the forensic accountant.
- Internal documentation revealed that ZTE "was specifically aware of and considered the legal risks and consequences of violating U.S. economic sanctions and export control laws."
- Internal ZTE documents also suggested that the company had been suffering from self-described "export control crises" – close calls that did not result in enforcement actions:
- In 2005, a U.S. company discovered and conducted an investigation into ZTE's use of goods from sanctioned countries;
- Hong Kong port authorities had seized and confiscated goods that ZTE was attempting to export to banned jurisdictions; and
- In 2010, the Commerce Department inquired into ZTE's management of U.S.-procured items.
Also important to OFAC was the significant harm to the national security and policy objectives of the Iran embargo caused by providing Iran with significant access to $40 million of controlled U.S.-origin goods and technology.
Despite ZTE's unusually obstructive conduct, which continued into the early phases of its cooperation with U.S. regulators, OFAC granted the company mitigating credit based on later cooperation with OFAC's investigation. After being put on the Entity List in March 2016, ZTE responded by signing multiple tolling agreements, providing access and information to government investigators, and providing helpful information to the government from its files. OFAC also credited ZTE for its implementation of a robust sanctions compliance program. It is likely that the punishments would have been even more severe absent these important steps.
- The importance of timely, independent, counsel-directed internal investigations: ZTE had notice of the significant risks posed by its Iran business at least as early as 2012 and possibly as far back as 2005. Had its management chosen to conduct an internal investigation when it learned of the conduct, directed by independent counsel with the authority to conduct the investigation correctly, the outcome of this enforcement action would likely have been quite different and ZTE's fines would have likely been reduced substantially.
- Coordination and creativity by U.S. regulators: The amount of coordination by DOJ, BIS, and OFAC in this enforcement action is quite significant and appears to have been very effective. Especially notable is BIS's use of the Entity List powers, combined with the issuance of temporary general licenses. This novel carrot-and-stick approach – which almost certainly secured management attention and coincided with the end of ZTE's obstructive conduct – appears to have been quite successful.
- Continued U.S. enforcement risk for foreign companies doing business with Iran: Though the 2015 Iran nuclear deal, formally known as the Joint Comprehensive Plan of Action (JCPOA), increased the number of opportunities for foreign companies to lawfully trade with Iran, unlawful foreign sales of U.S.-origin goods to Iran continue to remain an enforcement priority for the U.S. government. As U.S.-origin goods still carry sanctions and export controls restrictions with them when they leave the United States, foreign companies still face significant exposure for trade with Iran, especially trade designed to circumvent these restrictions.
- Due diligence: The U.S.-origin goods that ZTE re-exported to Iran were initially supplied to ZTE by U.S. persons. This enforcement action serves as a reminder for U.S. companies that it is imperative to conduct thorough due diligence on all third parties and that this due diligence should include reasonable measures to address the risk of "isolation" companies and customers operating in jurisdictions like China, which pose a higher risk of re-export to embargoed destinations, including Iran.
- Tone at the top: OFAC's settlement agreement is peppered with references to the involvement of ZTE senior management in all aspects of the violations. Senior managers are well-advised to remember the importance of communicating and modeling compliant behavior and, as noted above, to secure an early, independent, counsel-directed investigation when the circumstances warrant one (as they clearly did here).
- Cooperation: The importance of cooperation with a government investigation cannot be overstated. OFAC granted some cooperation credit to the target of its historic penalties here, despite initially obstructive conduct, but the credit would have likely been more substantial had ZTE cooperated at a much earlier stage.
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