Precedent-setting decision upholds $4M OFAC penalty
Alert
The Office of Foreign Assets Controls (OFAC) within United States Department of the Treasury regularly imposes substantial fines for economic sanctions laws violations, often against multinational corporations and global financial service providers. More recently, however, the agency has engaged in an increasing number of enforcement actions against small and medium sized businesses, levying heavy penalties against family owned manufacturers and service providers.
One such company, Epsilon Electronics Inc. (Epsilon), a California-based electronic components manufacturer, took the rare step of refusing to settle and pay the $4.07 million assessed penalty. Instead, the company challenged OFAC’s fine in federal court. On March 7, 2016, the United States District Court for the District of Columbia issued its ruling in the case, finding against Epsilon. This precedent setting decision underscores the type of sanctions due diligence measures that are necessary to avoid the risk of similar fines and penalties.
Epsilon argued that OFAC’s fine was disproportionate and excessive, violating both the Administrative Procedures Act and the Eighth Amendment. The company reasoned that OFAC should have taken several mitigating factors into account, including the unsophisticated nature of the family-owned business, ASRA’s sales into countries other than Iran, the fact that only 2 percent of Epsilon’s overall sales went to ASRA, and management’s belief that the company’s products were only being exported to the United Arab Emirates, not Iran. The company further claimed that its sales to ASRA were covered by the so-called “inventory exception,” established in a 2002 OFAC publication entitled “Guidance on Transshipments to Iran,” which permits U.S. persons to export goods to a third country knowing that such goods may be subsequently shipped to Iran, provided that the goods are not subject to the Commerce Control List of the U.S. Export Administration Regulations, that the U.S. person is filling a general inventory order rather than a specific order for export to Iran, and the majority of the buyer’s business and sales are not to Iran. The scope of this purported exception has long been debated by sanctions law experts.
The court further determined that Epsilon’s argument that OFAC had traditionally permitted “transshipment of goods to Iran when the items are not sold to [a] third-country party for the specific purpose of being reexported to Iran and the third-country party’s sales are not predominantly to a sanctions target,” constituted a misreading of the agency’s guidance. The court pointed to agency language stating that the inventory exception does not apply “where the seller had reason to know that the goods were specifically intended for Iran, including when the third party deals exclusively or predominantly with Iran . . .”
In response to Epsilon’s claims that the fine was excessive and that the agency failed to properly consider mitigating factors, the court again ruled in favor of OFAC. The court found that the agency had acted rationally and in compliance with its guidelines in imposing the large penalty, pointing to the company’s failure to file a voluntary self-disclosure of the violations and the company’s continued shipments to ASRA despite a cautionary letter. The court further held that OFAC had the discretion to determine that other factors - including Epsilon’s “reckless disregard toward the Iran sanctions program,” and the fact that it “had no program in place to ensure compliance with the Regulations” - outweighed any mitigation that might have been warranted by the company’s status as a small business. Given that the potential maximum penalty OFAC could have awarded was over $12.8 million, the court held that the $4.07 million penalty did not violate the Eighth Amendment’s protection against excessive fines.
The opinion highlights the importance of performing adequate due diligence on customers, suppliers, and distributors, as “reason to know” can be established by information available on a website – whether or not you actually view it. In light of the decision, in addition to screening third parties to ensure that they do not appear on sanctions lists, businesses would likewise be advised to, at minimum, review such parties’ websites for possible indications of activity that would violate sanctions laws.
A company’s small size, lack of sophistication, and/or limited amount of international sales will not serve as protection from a substantial OFAC penalty or any of its collateral reputational and business consequences. The decision shows that it is always best to rely on the advice of expert counsel before attempting to invoke one of the many complicated exceptions to sanctions laws and regulations.
For questions regarding economic sanctions laws and the role our attorneys can play in developing effective compliance strategies individually tailored for your company’s needs, please contact the attorney listed below.
One such company, Epsilon Electronics Inc. (Epsilon), a California-based electronic components manufacturer, took the rare step of refusing to settle and pay the $4.07 million assessed penalty. Instead, the company challenged OFAC’s fine in federal court. On March 7, 2016, the United States District Court for the District of Columbia issued its ruling in the case, finding against Epsilon. This precedent setting decision underscores the type of sanctions due diligence measures that are necessary to avoid the risk of similar fines and penalties.
Background
In 2014, OFAC imposed a $4,073,000 penalty against Epsilon on the basis that between 2008 and 2012, the company issued 39 invoices for car audio and video equipment valued at $3.41 million to ASRA International Corp. LLC (ASRA), an auto-parts distributor located in the United Arab Emirates that OFAC claimed “reexports most, if not all, of its products to Iran and has offices in Tehran.” The Iranian Transactions and Sanctions Regulations (ITSR) prohibit the export, re-export or supply directly or indirectly from the United States, or by a U.S. person, wherever located, of any goods, services or technology to a person in a third country with knowledge or reason to know that such goods are specifically intended for Iran. OFAC further alleged that despite sending a letter to Epsilon in 2012, warning the company that the ITSR “prohibit virtually all direct or indirect commercial financial or trade transactions with Iran by U.S. persons or within the United States unless authorized by OFAC or exempted by statute,” the company proceeded to issue five new invoices to ASRA for products that Epsilon knew or had reason to know were intended for ASRA’s resale in Iran.Epsilon argued that OFAC’s fine was disproportionate and excessive, violating both the Administrative Procedures Act and the Eighth Amendment. The company reasoned that OFAC should have taken several mitigating factors into account, including the unsophisticated nature of the family-owned business, ASRA’s sales into countries other than Iran, the fact that only 2 percent of Epsilon’s overall sales went to ASRA, and management’s belief that the company’s products were only being exported to the United Arab Emirates, not Iran. The company further claimed that its sales to ASRA were covered by the so-called “inventory exception,” established in a 2002 OFAC publication entitled “Guidance on Transshipments to Iran,” which permits U.S. persons to export goods to a third country knowing that such goods may be subsequently shipped to Iran, provided that the goods are not subject to the Commerce Control List of the U.S. Export Administration Regulations, that the U.S. person is filling a general inventory order rather than a specific order for export to Iran, and the majority of the buyer’s business and sales are not to Iran. The scope of this purported exception has long been debated by sanctions law experts.
Decision
The federal district court’s opinion illustrates the deference typically granted by the judicial branch to administrative agencies such as OFAC, which operate in the realm of foreign affairs and national security. The court found no fault with the agency’s conclusion that Epsilon had reason to know that ASRA distributed equipment “exclusively or predominantly” into Iran, based on the fact that the distributor’s website (a) listed a location in Tehran, Iran, (b) touted the company’s success in the Iranian car audio and video market and listed dealers located exclusively in Iran, and (c) displayed photographs of what appeared to be car shows in various Iranian cities.The court further determined that Epsilon’s argument that OFAC had traditionally permitted “transshipment of goods to Iran when the items are not sold to [a] third-country party for the specific purpose of being reexported to Iran and the third-country party’s sales are not predominantly to a sanctions target,” constituted a misreading of the agency’s guidance. The court pointed to agency language stating that the inventory exception does not apply “where the seller had reason to know that the goods were specifically intended for Iran, including when the third party deals exclusively or predominantly with Iran . . .”
In response to Epsilon’s claims that the fine was excessive and that the agency failed to properly consider mitigating factors, the court again ruled in favor of OFAC. The court found that the agency had acted rationally and in compliance with its guidelines in imposing the large penalty, pointing to the company’s failure to file a voluntary self-disclosure of the violations and the company’s continued shipments to ASRA despite a cautionary letter. The court further held that OFAC had the discretion to determine that other factors - including Epsilon’s “reckless disregard toward the Iran sanctions program,” and the fact that it “had no program in place to ensure compliance with the Regulations” - outweighed any mitigation that might have been warranted by the company’s status as a small business. Given that the potential maximum penalty OFAC could have awarded was over $12.8 million, the court held that the $4.07 million penalty did not violate the Eighth Amendment’s protection against excessive fines.
Key takeaways
The court’s decision has a number of implications for businesses that have products in the international market, whether sales are made directly or indirectly through a sales agent or distributor. As the Epsilon case makes clear, OFAC will take enforcement action against a company for the action of an unrelated third party that the company merely has “reason to know” may be violating sanctions laws.The opinion highlights the importance of performing adequate due diligence on customers, suppliers, and distributors, as “reason to know” can be established by information available on a website – whether or not you actually view it. In light of the decision, in addition to screening third parties to ensure that they do not appear on sanctions lists, businesses would likewise be advised to, at minimum, review such parties’ websites for possible indications of activity that would violate sanctions laws.
A company’s small size, lack of sophistication, and/or limited amount of international sales will not serve as protection from a substantial OFAC penalty or any of its collateral reputational and business consequences. The decision shows that it is always best to rely on the advice of expert counsel before attempting to invoke one of the many complicated exceptions to sanctions laws and regulations.
For questions regarding economic sanctions laws and the role our attorneys can play in developing effective compliance strategies individually tailored for your company’s needs, please contact the attorney listed below.