United States: Balancing Reliance on Third-Party Intermediaries with the Need for Internal Compliance

While the flow of modern international business is greatly aided by the involvement of customs brokers, freight forwarders, sales agents, foreign distributors, and other third-party intermediaries, a company cannot rely on these outside parties to meet its obligations under the growing web of International Regulatory obligations. Recent enforcement cases in each of these areas have demonstrated that companies walk a fine line when working with these third-party intermediaries: on one hand, the involvement of third-party agents adds to a company’s bottom line to the extent the company is able to rely on its services; on the other hand, reliance on third-party agents to meet compliance responsibilities could result in an enforcement investigation. This article will discuss recent case examples dealing with each of the four areas of intermediaries identified above, and will provide a brief summary of the compliance obligations which cannot be delegated to these third-parties.

In the case of United States v. Pan Pacific Textile Group, Inc., et al., Court No. 01-01022 ("Pan Pacific Textile"), Pan Pacific Textile, the importer of record, engaged a customs broker who operated several cargo transportation companies for shipments of merchandise from China to the United States. After receiving a power of attorney from Pan Pacific Textile, the broker began submitting false entry documents which mis-described track suits as plastic bags and wooden patio furniture, and which systematically undervalued the merchandise imported. The broker continued to charge Pan Pacific Textiles the proper amount of duties and provided copies of accurate invoices and entry documents, which were never submitted to Customs. After roughly a year, the customs broker approached Pan Pacific Textiles with a revised business arrangement: Pan Pacific Textiles would compensate the customs broker for its services on a flat fee basis, and the customs broker would become the importer of record. The flat fee, while lower than the previous duty amounts paid by Pan Pacific Textiles to the customs broker, was to include all freight forwarding charges, as well as Customs duties.

Pan Pacific Textile and the customs broker were able to underpay Customs duties utilizing this scheme for approximately four years before a Customs investigation revealed the wrong-doing. Pan Pacific Textile and the customs broker were subsequently criminally indicted, and while Pan Pacific Textile was ultimately acquitted of criminal liability, the Broker pleaded guilty and paid $1.4 million in restitution. Customs then filed a civil action before the United States Court of International Trade ("CIT") seeking the recovery of unpaid duties and additional unpaid duties. On August 26, 2005, the CIT found that the defendants were both liable for unpaid Customs duties and for civil damages as well, but that further hearings were necessary to determine whether the duties were unpaid because of fraud, gross negligence or mere negligence. In making this determination, the CIT specifically reaffirmed the longstanding precedent that a Principal, such as Pan Pacific Textile, is liable for the actions of its Agent, such as the customs broker, when that Agent acts with the specific or apparent authority of the Principal. The CIT further noted that this Agency relationship did not change under the flat fee arrangement, despite the fact that the customs broker was acting as the Importer of Record, because the nature of the underlying transaction had not changed in any way. Most importantly, the CIT made clear that it is irrelevant whether the Pan Pacific Textile expressly authorized any specific unlawful conduct of the customs broker, or even whether Pan Pacific Textile provided contrary instructions to the customs broker, as long as the activities undertaken were within the scope of the customs broker’s specific or apparent authority as an agent of Pan Pacific Textile.

Regardless of whether Pan Pacific Textile was aware of the wrongdoing by its customs broker, it nevertheless failed to meet its compliance obligations by ignoring key legal responsibilities which could not be delegated to its broker. Specifically, even after delivering the shipment to the broker, an importer of record is required to:

• Keep and maintain copies of all documents listed on the "(a)(1)(A)" list, including the Airway Bill or Bill of Lading, the Declaration of Entry, a Packing List or Commercial Invoice, any necessary Certificates of Origin, and Customs Bond information, for a minimum of five years. These requirements are identified in greater detail at 19 U.S.C. § 1509(a)(1)(A) or in the Appendix to 19 C.F.R. § 163.

• Review key documents filed by the broker, particularly the Customs Entry Summary, CBP Form 7501, to ensure that the information filed by the customs broker matches the item description, HTSUS classification, country of origin, and value listed on the commercial invoice accompanying the shipment.

• Maintain sufficient awareness of the import transaction to notice any information which appears to be out of place or inconsistent with earlier information, such as the falsified entry summaries referenced above, or the fact that the flat fee arrangement amounted to a lower total payment of duties than that recorded in the falsified entry summaries.

• Promptly follow up on any inconsistent or incorrect information with the customs broker, correct any deficiencies with Customs, and report any misconduct by the customs broker or any other third-party agent.

While the CIT has not yet tested whether similar liability would apply in the export controls context, an anecdotal scenario, actually experienced by several companies in recent years, is equally instructive. In this scenario, an unsuspecting U.S. company is visited by federal agents from the Department of Commerce, Bureau of Industry and Security’s ("BIS") Office of Export Enforcement and asked to explain certifications made on a Shipper’s Export Declaration ("SED") that proved to be incorrect once the goods were inspected. In one case, the U.S. company was able to show from its export records that it had the correct Export Control Classification Number ("ECCN") in its files, and that it had provided the freight forwarder with this correct information. In this case, no export license would have been required even if the correct ECCN number had been used on the SED, and the export had occurred recently enough that the U.S. company could not reasonably have been expected to uncover the issue on its own. As a result, the BIS agents redirected their investigation back to the freight forwarder.

However, if the correct ECCN would have required that an export license be obtained for the export at issue, if the export had been sufficiently remote in time that the fraudulent information used on the SED by the freight forwarder could have been independently discovered by the exporter, or if the exporter had been unable to document its correct instructions to the freight forwarder, this scenario could have reached a different conclusion. At the very least, these documentation errors by the freight forwarder would have led to an investigation of the exporter. Actual liability aside, even if the federal agents ultimately determined that the exporter bore no fault in the incorrect SED being filed, an exporter cannot afford to take lightly the administrative costs of a prolonged federal investigation and the distinct possibility of tertiary export enforcement actions being brought against the company.

As discussed above, exporters cannot rely on a freight forwarder to meet their export compliance responsibilities. While freight forwarders frequently assist exporters with the mechanics of export transactions, the exporter remains 100 percent responsible for all information provided to the federal government as part of the export transaction. As such, it is the responsibility of the exporter to monitor its export compliance obligations, even after providing the shipment and all associated documentation to the freight forwarder, and to undertake actions such as the following:

• Keeping and maintaining all records associated with the export of its products, including documentation supporting all product classification determinations, end-use and end-user certificates, export licenses or documentation supporting the use of export license exceptions, packing lists and other shipping records, SEDs filed by the freight forwarder (or the appropriate Automated Export System records), and invoices including the appropriate diversion control language.

• Reviewing all export records prepared by the freight forwarder to ensure that the proper end user, product classification, export license or license exception has been reported to federal officials.

• Continuing "red flags" screening post-delivery to ensure that the product was not impermissibly diverted to the incorrect party.

• Addressing promptly all compliance shortcomings which occur through the actions of third-parties, and determine whether these unauthorized transactions should be reported to federal authorities.

As reported by the U.S. Attorney’s Office for the Southern District of New York on October 6, 2005, a number of investors, including American International Group, Omega Advisors, Inc., Pharos Capital Management, L.P., and Frederic Bourke, have been charged with participating in a scheme to bribe senior government officials in the Republic of Azerbaijan in order to obtain a controlling interest in the State Oil Company of the Azerbaijan Republic ("SOCAR") once it privatized. This scheme allegedly revolved around a single agent, Viktor Kozeny, who made and promised to make a series of corrupt payments to senior officials of the Government of Azerbaijan, SOCAR, and the State Property Committee (the Azeri agency charged with administering the privatization program). The illicit payments, potentially amounting to several hundreds of millions of dollars, also included gifts of jewelry valued at more than $600,000, and travel to New York City, shopping excursions, and medical care for two of these senior officials. In exchange, these senior officials agreed to permit the investors to acquire a controlling interest in SOCAR upon its privatization. Each of the investors has been charged with conspiracy to violate the Foreign Corrupt Practices Act ("FCPA"), as well as violation of the FCPA, and certain of the investors are also charged with money laundering conspiracy, money laundering violations, and making false statements in interviews with the FBI.

While it appears that perhaps only the agent and those operating under his direction were involved in the actual corrupt payments, the charges indicate that the key employees responsible for these accounts within each of the investors were reportedly aware to some extent of the payments and promises being made to these senior officials. Although the companies identified above have not been criminally charged to date, key individuals have been charged as indicated above. In fact, in the case of Omega and Pharos, the individual responsible for this account has reportedly already pleaded guilty to the FCPA charges made against him. Even if no charges are brought against the companies involved in these transactions, the negative publicity, lost investment funds, and administrative costs associated with an ongoing government investigation will make any reprieve from the FCPA’s criminal penalties cold comfort indeed.

Companies should also undertake the following actions as part of managing their ongoing relationships with foreign agents:

• Conduct detailed due diligence of proposed foreign agents to include business references, financial references, press reviews, questions and FCPA compliance certificates.

• Conduct regular internal coordination meetings between the party assigned with responsibility over FCPA compliance and the individuals within the company who are assigned to work with individual foreign agents, where the activities being conducted by each agent should be discussed.

• Implement a reporting structure to address any questions or concerns involving the activities of foreign agents, and disciplinary actions for employees found to have been involved in or to have ignored actions by foreign agents in violation of the FCPA and/or company compliance procedures.

• Conduct regular, targeted reviews of all activities involving foreign agents to ensure that no activities contrary to the FCPA and/or company compliance procedures are occurring.

On November 22, 2005, BIS announced that Carrier Access Corporation ("Carrier") had agreed to settle charges related to the sale of telecommunications equipment to customers in Iran and the provision of technical support to those customers via telephone, email, and telnet. Carrier agreed to pay a $61,600 fine to settle the 17 violations, of which Carrier had notified BIS through a voluntary disclosure.

According to the BIS Charging Letter, Carrier exported Adit 600 Chassis, FXO Channel Cards, and ABI FXO ports on two occasions to a Canadian company with knowledge that these products would be reexported to Iran via the United Arab Emirates. While not specifically stated in the Charging Letter, it appears that Carrier had previously sold this equipment to the same Canadian company without any knowledge that it would be reexported to Iran. However, a month prior to the first of the sales mentioned above, Carrier was specifically advised by its technicians that Carrier and the Canadian company were actively servicing Carrier devices which were physically located in Iran, and that the Canadian company wished to purchase additional devices for reexport to Iran. After apparently reviewing the U.S. regulatory restrictions on sales to Iran, Carrier personnel continued with the two additional sales, and later provided service for these telecommunications parts which it had reason to know had been reexported by the Canadian company to Iran.

While it is clear that Carrier only assumed an active role in the export violations discussed above once it became aware that its Canadian customer was distributing its products into Iran, this example is illustrative of the danger of relying too heavily on distributors to be aware of and to prevent export violations. Although in this instance BIS has stated that Carrier technicians reported the Canadian company’s diversions to Iran as soon as they became aware of them, it is generally more difficult to pinpoint the precise time when a company becomes aware of export violations by a distributor. In many situations, particularly where compliance processes such as regular company-wide training and specific reporting structures are not present, individuals with no direct link to the legal or compliance management functions of a company may become aware of improper reexports by foreign distributors, but do not know how to act on this information or whether the actions at issue are contrary to U.S. law. As a result, export violations can sometimes continue for significant periods of time before coming to the attention of the appropriate company officials.

In addition to placing diversion control statements on all shipping documentation; notifying foreign distributors of any conditions associated with an export license or export license exception, including proper export-related terms and conditions in distributor agreements; and obtaining end-user information where required or practical, companies should take the following actions to ensure that the actions of their foreign distributors are not putting them at risk of committing export violations:

• Monitor all information received from the distributor for any sign of sales to second-tier distributors, freight forwarders, or trading companies which do not appear to be an actual end-user of the products being sold.

• To the extent product registration information is received from end-users for the purpose of technical service or warranties, this information should be verified for compliance with U.S. export control laws and regulations.

• In addition to company-wide training, specific training of foreign distributors at sales conferences or other company visits should also be conducted, particularly in the case of distributor operations in export-sensitive areas of the world.

• Any export compliance issues should be promptly addressed and evaluated to determine whether a disclosure to federal officials is necessary.

In summary, because modern international business transactions require the use of a number of third-party agents, it is essential that companies ensure their actions relative to third parties are compliant with import, export, FCPA and sanctions-compliance obligations. While third-party compliance efforts may require a significant investment in company resources at the outset of a major international business transaction or a new line of international business activities, the long-term gains in avoiding the kinds of penalties and negative press attention discussed in the examples above are well worth the investment. All in all, cost in and count on international regulatory compliance in all dealings with third parties.

This article is presented for informational purposes only and is not intended to constitute legal advice.