OFAC fines China-based ZTE $1.2 billion: Implications for Canadian companies

Author(s): Lipi Mishra, , Taylor Schappert, Riyaz Dattu

Mar 27, 2017

Introduction

On March 7, 2017, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) announced a record-breaking fine against Chinese telecommunications giant ZTE Corp. and its subsidiaries as part of a settlement following a five-year joint investigation by the Departments of Treasury, Commerce, and Justice. The US$1.192-billion penalty is the largest fine ever imposed against a non-financial institution. In this particular case, ZTE took extraordinary measures to conceal its violations, which is one of the factors that contributed to the OFAC’s decision to impose the large fine. Nonetheless, the fine levied against ZTE serves to reinforce the increasingly broad reach of OFAC regulations and their application to both U.S. and foreign companies, and the severe consequences of violating U.S. economic sanctions regulations. Canadian companies, whether in the financial sector or other sectors that have links to the U.S., that incorporate U.S. components or technology in their products, or use U.S. currency in their transactions, can be subject to investigation and possibly enforcement action under several U.S. trade and anti-terrorism laws.

The grounds for enforcement in this case was ZTE’s use of U.S.-origin components in its Chinese telecom products exporting business to both Iran and North Korea. On this basis, Canadian companies can easily become entangled under OFAC economic sanctions and U.S. export restriction-related regulations, including those administered by the Department of Commerce and the State Department, when exporting Canadian goods containing U.S. components or technology to countries subject to U.S. trade restrictions. In particular, Canadian companies that manufacture goods using NAFTA supply chains to source components and for sales overseas are particularly vulnerable. The risk arises from the fact that U.S.-originating parts, which are subject to U.S. foreign trade policies, can become part of their exports from Canada in violation of laws administered by U.S. agencies.

In this case, ZTE’s active concealment of its violations and the fact that this investigation spanned five years both contributed to the record-breaking fine.

However, the imposition of such large fines can be expected to continue under the administration of President Trump, where trade policy is framed around the America-first rhetoric. Foreign companies, whether in the financial sector or other sectors, would be prudent to take note that non-U.S. companies who ignore U.S. export control laws and economic sanctions laws may face extremely high fines and other punitive measures. Commerce Secretary Wilbur Ross announced to reporters in connection with the ZTE enforcement that, “These penalties are just the first example of the extraordinary powers Commerce will use.” His statement reaffirms similar indications provided by the new U.S. administration that it will target non-U.S. companies who violate U.S. trade laws and are seen to be competing unfairly against U.S. businesses.

OFAC

OFAC is responsible for administering and enforcing economic and trade sanctions against U.S. and non-U.S. entities based on U.S. foreign policy and national security goals. In its role, OFAC has the authority to impose trade restrictions and economic sanctions, and thereby limit what companies can sell outside the U.S. if the exported goods and technology contain U.S.-originating components or technology. OFAC also has the power to freeze assets that are within U.S. jurisdiction. OFAC is part of the U.S. Treasury Department, and it exercises jurisdiction in relation to economic and trade sanctions in conjunction with other U.S. agencies, such as the Department of Commerce, which focuses on export controls of civilian goods and technology, and the U.S. State Department which, under the International Traffic in Arms Regulations, controls the transfer of U.S. munitions and related technology.

Although OFAC’s control spans across industries, the quantum of fines levied against ZTE has historically been reserved for financial institutions accused of financing illicit trading:

• Commerzbank AG (March 11, 2015): US$258 million for use of payment practices that interfered with the implementation of U.S. economic sanctions, including deleting or omitting references to Iranian financial institutions and replacing the originating bank information with Commerzbank’s name in payment messages sent to U.S. financial institutions; and
• BNP Paribas SA (June 30, 2014): US$963 million for engaging in a systemic practice of concealing or omitting references to information about U.S.-sanctioned parties in 3,897 financial and trade transactions. The OFAC sanction was part of an $8.9-billion joint settlement with federal and state government agencies and represented the largest sanction ever issued by the U.S. government.

OFAC settlement agreement

As part of the agreement, ZTE has entered into separate settlements and plea arrangements with each of the relevant U.S. government agencies.

The OFAC settlement requires ZTE to pay $100,871,266 for its violations of the Iranian Transactions and Sanctions Regulations. In the agreed statement of facts set out in the settlement signed by ZTE, the company acknowledged that it not only knew its actions were in violation of U.S. sanction regulations, but it  knowingly developed a massive and complex scheme intended to deceive and evade U.S. detection, including using isolation companies to provide a pass-through buffer for Iran-destined goods, removing ZTE logos and markings from shipments, using code-names for goods sent to U.S. embargoed countries, and authorizing a team of IT employees to engage in a project to sanitize and delete references to the company’s improper dealings.

If ZTE’s criminal plea is approved by the federal court, an additional US$430,488,798 in combined criminal fines and forfeitures will be owed to the Department of Justice, and a US$661,000,000 penalty — of which US$300,000,000 is suspended during a seven-year probationary period — to the Department of Commerce.

Implications for Canadian Companies

The ZTE enforcement is the latest example of OFAC flexing its regulatory muscle — financial institutions are no longer the sole target for sizeable economic sanctions penalties.

With uncertainty surrounding the impending NAFTA renegotiations, the OFAC sanctions against ZTE add further risk and insecurity for Canadian companies engaging in international transactions and, in particular, those who rely on or may have to increase their reliance on NAFTA supply chains, to comply with amended NAFTA rules of origin, or depend on the U.S. financial and banking system.

The zealous enforcement actions against ZTE should serve as a reminder to Canadian companies to remain vigilant about business practices when engaging in international transactions. While Canadian companies are now becoming familiar with the requirement for compliance with anti-corruption statutes and the extra-territorial reach of the U.S. Foreign Corrupt Practices Act, there is generally less knowledge and understanding of the extra-territorial reach of wide-ranging U.S. economic sanctions and export control laws.

The following is a non-exhaustive list of trade restrictions considerations for Canadian companies engaging in overseas business:

1. Product awareness – Where does each input for my product, whether components or technology, originate from?
2. Identify relevant U.S. trade policies and laws – Are there U.S. policies and laws that relate to these types of goods and technology and the country we ship to?
3. Persons involved – Are any U.S. persons including Canadian personnel who are U.S. nationals involved in the export transactions to U.S. sanctioned countries?
4. Compliance – Is there a company compliance policy in place that assists us in ensuring that goods with U.S.-originating components or technology are not exported in breach of U.S. trade laws?
5. Self-reporting – If a breach of U.S. trade laws is detected, what steps are in place for self-reporting the breach, mitigating against potential fines, and ensuring compliance on a go-forward basis?