Exporters and Trade-Based Money Laundering

March 19th, 2015

The following article was written by Stephen Wagner for the Export Compliance Training Institute. Mr. Wagner is a faculty member for the Institute, and frequently lectures and writes on export compliance and enforcement matters. We repost Mr. Wagner’s article here with the Institute’s permission.

You arrived at work today to find the perfect storm of export issues: a shipment of mobile phones to one of your most established South American customers has been detained by the Commerce’s Office of Export Enforcement (OEE); the federal government has seized $40,000 from your company’s checking account; and the banks have frozen all of your accounts. The only clue you have to this mess is from your freight forwarder. When the OEE seized your merchandise, one of the agents told your shipper that the merchandise was being seized, because it is “involved in money laundering.”

You are now afraid to make any other shipments, your company can no longer receive or send payments and that $40,000 is a huge hit to your revenues. And what do they mean by money laundering? You deal only with established customers and you have great relationships with them. They pay their invoices promptly, usually in cash or wire transfers (so no credit card fees), and they order thousands of phones per month. In fact, they send you so much business that you even give them significant discounts off of the regular invoice prices for most of the products you sell.

Where do you even begin to sort out this mess?

In the “old days” (like 10-15 years ago), illicit organizations such as drug cartels, terrorist networks and crime syndicates used to move their ill-gotten dollars, euros and pesos in cash by using couriers in cross-border travel. When law enforcement largely shut down those traditional systems, these criminals turned to a more potent option: trade-based money laundering (TBML). Through export (and import) transactions, criminals can move and launder incredibly large sums of money just by buying and selling merchandise in international markets.

According to the Financial Action Task Force (FATF), an intergovernmental body formed in the late 1980s to combat money laundering and other financial crimes, anywhere from $590 billion to $1.5 trillion in illegally obtained money was laundered world-wide in 2012 through TBML. There are four basic techniques for laundering money through trade:

  • over- and under-invoicing of goods and services;
  • multiple invoicing of goods and services;
  • over- and under-shipments of goods and services; and
  • falsely described goods and services.

To bring “clean” money into a country, a company need only undervalue its imports or overvalue its exports. To move money out of a country, the opposite would occur. For example, a U.S. company could sell $2 million in products to a cartel-linked company or customer in Latin America. The U.S. company then invoices these products upon export for only $1 million. The foreign customer obtains the products – for which they paid only $1 million – and resells them in country for the full $2 million. This creates $1 million in laundered money. The problem of import-export invoice discrepancy is so large, that the Global Financial Integrity and the International Monetary Fund estimate that the difference between the declared value of Mexican exports to the United States in 2013 was almost $40 billion higher than the declared value of those same imports into the U.S.

The company in this scenario may have unwittingly triggered several “red flags” that would indicate an involvement in TBML. According to U.S. Immigration and Customs Enforcement (ICE), indictors of TBML include:

  • Payments to vendors by unrelated third parties;
  • False reporting, such as commodity misclassification, commodity over- or under-valuation;
  • Commodities being traded that do not match the business involved;
  • Unusual shipping routes or transshipment points;
  • Packaging inconsistent with the commodity or shipping method;
  • Double-invoicing;

and many more. The Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) have identified other “red flags” that you can read about here.

In this case, the “significant discounts” to customers could appear as undervaluations, depending on how invoices are prepared. Additional factors may also contribute to exports being labeled as trade-based money laundering transactions; for example, accepting payments in cash, receiving wire transfers from unrelated parties and customer orders for products or in quantities that law enforcement officials may believe are unreasonable, given the customer.

When enforcement comes in money laundering cases, it can take several forms and come from several fronts. Enforcement measures include seizure and forfeiture of merchandise, seizure of funds that can be traced to the money laundering activity, civil penalties and/or criminal charges. These measures are being used by the federal government, state governments and even local governments which take part in multi-jurisdictional task forces (which are often funded by the seizures they make). In addition, banks and credit card companies may suspend accounts to avoid being seen by law enforcement as being complicit in money laundering activities. In 2013, banking giant HSBC agreed to pay $1.92 billion to U.S. authorities in fines for its complacency in laundering drug money for Mexican cartels; no bank wants that to happen to them.

Now understanding what the situation may be, the challenge is responding quickly and appropriately to the seizures. “Red flags” which otherwise could indicate money laundering may also have completely legal business rationales. For example, is the South American company that is buying the large quantities of mobile phones the largest reseller of mobile phones in that country? If so, such sales volume may be reasonable. Did you perform due diligence on the customer to ensure they are who they say they are? Are the discounts properly noted on invoices and in keeping with discounts offered by other industry leaders? Do the funds represented by the seized bank deposits line up perfectly with invoices for shipments? These are the types of arguments that must be made in negotiations with law enforcement and in petitions seeking return of seized property. The real key is assembling and presenting strong documentary evidence demonstrating that money laundering is not taking place; merely professing innocence usually will not result in mitigation of the seizures.

Money laundering charges are notoriously difficult to fight; however, a company’s best practice to keep itself from unwittingly participating in a money laundering violation is to have a strong anti-money laundering (AML) program. An AML program is a set of procedures designed to guard against someone using your company to launder money. It derives from requirements for financial institutions under the Bank Secrecy Act and the USA PATRIOT ACT (Title 31 of the United States Code), and includes such features as a customer identification or “know your customer” (KYC) program. [These requirements are akin to verifying the consignee and end-user of an export against denied party lists and understanding the intended end use of merchandise before export.] Though not technically required for most exporters, any company selling products into high-risk regions or receiving payments from third parties would be advised to have an AML program in place.

Assuming you have vigilantly and rigorously implemented and maintained your AML program (and your export compliance program), your company should be able to identify and avoid those situations which may result in your company inadvertently becoming involved in a money laundering transaction. If your company exports its products from the United States and does not have an effective AML compliance program, your company faces an enhanced risk of enforcement measures that could put it out of business for good.

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Federal Marijuana Regulation: Why is Flexibility Critical in the Dawn of Legalization?

January 28th, 2015

Attorneys Andrew Ittleman and Jessika Tuazon of Fuerst Ittleman David & Joseph published their article, “Federal Marijuana Regulation: Why is Flexibility Critical in the Dawn of Legalization?” in the December 2014 issue of the Food and Drug Law Institute’s Food and Drug Policy Forum. A copy of the article is available here.

In the article, Mr. Ittleman and Ms. Tuazon confront “the complex question of how the federal government should go about the process of ending its decades-old prohibition of cannabis and bring about a regulatory regime designed to address the wide array of risks and opportunities presented by legalization.” After describing the history of the federal government’s prohibition of marijuana, as well as the efforts of various states to legalize it in various forms, the article recommends that “rather than attempting to devise a statutory scheme for cannabis in an echo chamber, Congress should be carefully studying the successes and failures of the individual states’ efforts to regulate marijuana, as they are the perfect ‘social and economic experiments’ encouraged by traditional notions of federalism.” The article further suggests that instead of “starting from scratch in developing regulations for marijuana, the government could – and should – borrow elements from regulatory regimes already in place for analogous products.” The article also describes how existing federal agencies – including the FDA, the Alcohol and Tobacco Tax and Trade Bureau (“TTB”), and

the Bureau of Alcohol, Tobacco, Firearms, and Explosives (“ATF”) – could all be delegated jurisdiction by Congress to regulate marijuana, as all three agencies

are well suited to handle the added task of regulating and enforcing laws overseeing the manufacture, distribution, and sale of marijuana.

Most importantly, Mr. Ittleman and Ms. Tuazon recommend that in undertaking the regulation of marijuana, the federal government should proceed flexibly, giving due regard to the marijuana industries already developing in numerous jurisdictions in the United States, as well as regulatory regimes already in place for analogous articles, including alcohol and tobacco. The article concludes with the following recommendations:

First, we respectfully submit that Congress should carefully study the marijuana industries already developing in numerous jurisdictions in the United States, and should likewise invite the individual states to participate in Congress’s legislative process. Additionally, because of the value of the data currently being developed

in states which have legalized marijuana in one way or another, the federal government should support the states in their efforts to regulate marijuana by providing regulatory guidance and law enforcement resources as requested by the states. The federal government should also continue to loosen restrictions on banks and other federally regulated financial institutions wishing to do business with licensed marijuana related companies, as the all-cash business model of the typical dispensary will only lead to security risks and the tainting of the information needed by Congress when considering how to govern the interstate market for cannabis.

Second, we respectfully submit that in evaluating its own regulation of medicinal and recreational cannabis, the federal government should look to regulatory regimes already in place for analogous articles, including alcohol and tobacco. By doing so, the process of writing regulations for the marijuana industry can be far more economical, and will give the regulated industry better notice and more opportunity to comply.

Third, we should all appreciate the scope of the task at hand, and understand that there is much more at issue than simply rescheduling or “legalizing” cannabis. Once prohibition has ended, marijuana may be available nationwide in the form of buds, edibles, drinks, tinctures and concentrates, potentially for medicinal and recreational purposes, and every possible variation on the manufacturing, distribution and use will be subject to regulation. It is therefore critical that Congress proceed deliberately so as to avoid a gap between the end of prohibition and the beginning of regulation, and flexibly so as to take all of the various forms and uses of cannabis into consideration.

Finally, everyone participating in the process of ending the federal government’s prohibition of cannabis should appreciate the magnitude of the black market and understand that it will not disappear overnight following a rescheduling. It is the black market, perhaps above all else, that mandates that Congress proceed deliberately when legalizing cannabis, to ensure that all possible voices are heard and seriously considered. Indeed, if federal regulation of cannabis is overly restrictive, leading to higher costs or elimination of choice for consumers, consumers will revert to the same black markets they have used for the past 40 years. A black market for cannabis – even following a federal rescheduling – will trigger all of the “Cole Memo Priorities” currently sought to be quelled by the Obama administration, including the diversion of profits to criminal enterprises, access to cannabis by children, and other adverse health consequences. Congress should thus take care to end prohibition deliberately, comprehensively, and with due regard for every interested party.

Fuerst Ittleman David & Joseph provides comprehensive representation to highly regulated businesses, including clients operating in the financial services, biotechnology, and international trade industries, and frequently lectures on these subjects for industry trade groups. The firm has more recently been called upon to combine its Food and Drug and Anti-Money Laundering practice areas in assisting marijuana-related businesses achieve financial compliance.

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Personal Liability for Export Violations: Civil Penalties for Individuals May be Trekking Toward You

January 27th, 2015

The following article was written by Stephen Wagner for the Export Compliance Training Institute. Mr. Wagner is a faculty member for the Institute, and frequently lectures and writes on export compliance and enforcement matters. We repost Mr. Wagner’s article here with the Institute’s permission.

You run a small tech company that customizes other manufacturers’ desktop and laptop computers for your customers. You can install special chipsets, encryption hardware and software, upgrade the fans and power units to make them “ruggedized” for field use-whatever your clients need. You are the sole owner of the company and, except for occasional part-time help, the only employee.

One of your customers is an American research scientist with whom you have been working for years. He is on a special project at a university in a former Soviet republic and his team liked what you had done for his computer so much, you upgraded multiple machines for them and sent them out. Today, Special Agents from the Office of Export Enforcement visited your office and told you that you may have violated export control laws, because these computers required some sort of license. From your own research after they left, you have learned that your company could be liable for hundreds of thousands of dollars in civil penalties. The Special Agents told you that they didn’t see any potentially criminal liability issues.

If your company got hit with those sorts of penalties, you would have to close it down. You’re wondering if there are any other risks that you need to consider.

Generally speaking, the owners (equity holders), directors and officers of corporations and limited liability companies do not face personal liability for their corporate actions. Under the Business Judgment Rule, there is a presumption against individual liability if decisions are made on an informed basis, in good faith and with the best interests of the corporation at heart.

However, personal liability can attach for company actions under multiple circumstances; for example, if company officials intentionally act in a criminal or fraudulent manner, breach their fiduciary duties to the company or if the company is found to be an “alter ego” of the individual. The “alter ego” doctrine is especially important for small or closely held companies. As an attorney, I recommend to my smaller, corporate clients that they strictly observe corporate formalities (have regular director and shareholder meetings, execute formal resolutions, have company bank accounts that are separate from their personal accounts, not commingle personal and company assets, etc.) as a means to avoid a court “piercing the corporate veil” and extending corporate liability to a company’s owner(s), director(s) and officers.

Until recently, I would have said taking such actions to ensure that a company is not considered to be the alter ego of its owners/operators would protect an exporter from individual civil liability in the event that a company has export violations. And then came Trek.

In United States v. Trek Leather, Inc., and Harish Shadadpuri, 781 F.Supp.2d 1306, (CT.Int’l Trade, 2011), a company had improperly imported merchandise into the United States. The U.S. government (U.S. Customs and Border Protection) brought legal action against both the company and its president, individually. The applicable customs law in Trek provides “no person by fraud, gross negligence, or negligence” may “enter, introduce or attempt to introduce any merchandise into the United States by means of” misrepresentations or omissions. 19 U.S.C. § 1592(a)(1)(A) (emphasis added). The court in the Trek case applied the laws of agency – which state that an agent who actually commits a civil wrong is generally liable for the act along with the principal, even though the agent was acting for the principal – to find that not only is the company (i.e., the principal) liable for the import violation, but the president (its agent) is personally liable as well. Further ruling that the company’s president, Harish Shadadpuri, was indeed a “person” within the meaning of the statute, and is therefore covered by the statute, the Court of International Trade found both the company and its president liable on a theory of gross negligence.

On appeal to the Federal Circuit, the court held that corporate officers may be held personally liable for civil penalties even without the government piercing the corporate veil or when the officers themselves do not act in a manner that violates the Customs statute. United States v. Trek Leather, Inc., 767 F.3d at 1288, 96-99 (Fed. Cir. 2014) (en banc).The Trek court found that to impose personal liability, the corporate officer or his or her agent must only take some action that “introduce[s]” goods into the United States.

So what does the Trek decision mean for exporters? It may mean that individuals who take actions which violate export control laws can face civil liability in the form of monetary penalties for their actions.

Just like the customs law at issue in Trek, the Export Administration Regulations (EAR) provides:

No person may engage in any conduct prohibited by or contrary to, or refrain from engaging in any conduct required by, the EAA, the EAR, or any order, license or authorization issued thereunder.

15 C.F.R. §764.2(a) (emphasis added). Similarly, under the ITAR regulations,

Any person who is granted a license or other approval or who acts pursuant to an exemption under this subchapter is responsible for the acts of employees, agents, and all authorized persons to whom possession of the defense article or technical data has been entrusted regarding the operation, use, possession, transportation, and handling of such defense article or technical data abroad.

22 C.F.R. §127.1(c). In the same manner that the court in Trek found that company’s president to be a “person” covered by the statute and, therefore, personally liable for civil penalties arising from import violations, BIS, DDTC or a court could impose civil penalties on individual persons for their company’s export violations as well.

While individuals have often been charged, convicted, fined, and imprisoned for criminal violations of export control laws, I can think of no instance in which an individual has been assessed civil penalties for export violations committed by his or her company. Trek may now open the door for such civil penalties. With federal budgets tightening and the ruling of Trek relieving the government of any obligation to pierce the corporate veil, enforcement agencies may use the ruling to increase their assessments of civil penalties against companies and their principals. On December 18, 2014, for example, the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) filed a lawsuit seeking $1 Million in civil penalties against the former compliance officer of MoneyGram for violations of the Bank Secrecy Act. This is the first attempt by this enforcement agency to hold an individual personally responsible for the anti-money-laundering failures of his employer.

It is likely that smaller exporters, and especially closely-held companies, may have a higher risk, because day-to-day operations – including export matters – are usually vested in just a few people. The fewer the people involved in an export transaction at a company, the easier it may be for government investigators and enforcement officials to affix individual liability. However, export program managers, compliance personnel, and even the “front line” employees responsible for export operations at larger exporters may also be at risk.

The ruling in Trek highlights the importance of an exporter- large or small – having a strong compliance program, using robust compliance procedures and safeguards which are implemented and maintained on an on-going basis and relying on agents such as freight forwarders and attorneys with proven compliance experience. Each of these measures will help ensure that companies and their individual officers, directors and employees are remaining compliant with respect to export matters.

Trek may also highlight the need for individuals involved in a company’s export operations to seek certain protections from their employers. Such individuals may well demand proper insurance and indemnification from the company for their export activities. They may also need to review company governance documents (such as bylaws and board resolutions) to ensure that the company is adequately protecting them from possible risks.

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Complex Commercial Litigation Update: New York’s Separate Entity Rule and the Reemergence of Florida as a Potential Gateway for Judgment Creditors to Seize Debtors’ Foreign Assets in Enforcement and Collection Proceedings

January 13th, 2015

All too often a judgment-creditor hits a roadblock when a judgment-debtor attempts to evade enforcement of a money judgment by shielding the debtor’s assets located outside of the jurisdiction where the judgment was obtained, whether in other parts of the United States and/or throughout the world.  The creditor then must chase the debtor’s foreign assets around the globe, where blocking statutes and bank secrecy regimes in other countries often significantly hinder, if not halt, the chase.

International banking cities in the United States with foreign bank branches have struggled with this issue for years, especially given recent globalization and advances in centralized operational technology, which now allow financial institutions to communicate with their branches and affiliates in a matter of seconds or a few keystrokes.

Litigants, lawyers, financial regulators and the courts likewise have struggled with this issue in the context of post-judgment enforcement proceedings, where international comity and foreign interests must be balanced with the rights of creditors to collect upon their final judgments.

Several legal decisions recently emanating out of New York have clarified various important issues in the matter, making the creditor’s chase for foreign assets more difficult in certain respects but easier in others. Specifically, for nearly a century, the courts in New York employed a common law rule—known as the separate entity rule—providing that, even when a bank-garnishee with a New York branch is subject to personal jurisdiction, the bank’s other branches are to be treated as separate entities for certain purposes, including pre-judgment attachments and post-judgment freezes and turnover orders.  The separate entity rule thus required a creditor to track down and serve each and every bank branch where a debtor might be hiding assets and to successfully freeze (or enjoin) those assets before they were transferred or withdrawn by the debtor.

In 2009, the tides seemingly turned in favor of the creditors, when the New York Court of Appeals ruled that a creditor could reach beyond New York’s borders to seize assets held elsewhere.  Specifically, in Koehler v. Bank of Bermuda, the highest court in New York held that a creditor could seek the turnover of stock certificates located outside the United States if the court had personal jurisdiction over the garnishee bank.  The Koehler decision spawned a frenzy by judgment creditors viewing New York as a potential haven for collecting assets located worldwide from banks with branches in that state.

Years later in 2013, Motorola (the global telecommunications giant), after having obtained a judgment of more than $3 billion against various Turkish companies and their beneficial Turkish owners, obtained a post-judgment collection order restraining the debtors and anyone with notice of the order from transferring the debtors’ property.  Motorola served the restraining order on, among other international banks with branches in the United States, the New York branch of Standard Chartered Bank (SCB), a foreign bank existing under the laws of the United Kingdom.  SCB, which had no connection to the dispute between Motorola and the bank’s customers, did not locate any of the debtors’ assets at its New York branch, but, following a global search of its other branches, found $30 million worth of debtor-related assets in its branches located in the United Arab Emirates (UAE).  SCB froze those assets in accordance with the restraining order, but the regulatory banking authorities in the UAE and Jordon quickly intervened and unilaterally debited the $30 million from SCB’s account with the UAE’s central bank.  SCB then took the matter to court, arguing, in relevant part, that service of the restraining order on SCB’s New York branch was effective only as to assets located at that sole branch.   In other words, relying on New York’s separate entity rule, the foreign bank garnishee (SCB) argued that the judgment creditor (Motorola) could not freeze the judgment debtors’ funds located in the bank’s foreign branches by merely serving its New York branch alone.  In response, the creditor asserted that the separate entity rule was no longer valid law in light of Koehler.

The case identified above, Motorola Credit Corp. v. Standard Chartered Bank, garnered significant attention from the business and legal communities, including global financial and banking institutions, and was recently decided in October 2014.

Significantly, the same court that had previously allowed a judgment creditor to reach beyond the jurisdiction’s borders in Koehler prevented a creditor from doing this inStandard Chartered Bank.  In a 5-2 decision, with a strong dissent, the majority expressly adopted the separate entity rule for post-judgment enforcement and collection proceedings, holding that the rule precludes a creditor from ordering a garnishee bank operating branches in New York to restrain a debtor’s assets held in foreign branches of the bank.

The majority in Standard Chartered Bank preliminarily found the separate entity rule to be “a firmly established principle of New York law.”  The majority also distinguishedKoehler, noting that the rule was not expressly raised in that case; the case involved neither bank branches nor assets held in bank accounts (but stock certificates); and the foreign bank at issue there had conceded the court’s personal jurisdiction over the bank.  The Standard Chartered Bank majority also relied on various policy reasons supporting adoption of the separate entity doctrine, including that “international banks have considered the doctrine’s benefits when deciding to open branches in New York,” and that the doctrine “promotes international comity and serves to avoid conflicts among competing legal systems.”  Ultimately, the majority concluded “that abolition of the separate entity rule would result in serious consequences in the realm of international banking to the detriment of New York’s preeminence in global financial affairs.”

In sharp contrast, the dissent in Standard Chartered Bank deemed the separate entity rule to be “outmoded” and “a step in the wrong direction.”  The dissent likewise maintained that “use of the separate entity rule to address potential comity issues is akin to using a cannon to kill a fly,” and that a bank’s concerns about double-liability (between responding to a US court-order and respecting a foreign country’s blocking statutes and banking privacy laws) and other potentially conflicting exposure could be addressed on a case-by-case basis.  The Standard Chartered Bank dissent also viewed the majority’s opinion to conflict with the same court’s holding in Koehler.  According to the dissent, the foreign bank simply “ha[d] aided its fugitive customers by erecting a monumental roadblock to [the judgment creditor]’s enforcement of a staggering judgment.”

As of the writing of this article, only two reported decisions have been decided in the wake of Standard Chartered Bank’s adoption of the separate entity rule.

In Lease Finance Group, LLC v. Fiske, a New York state trial court ruled that service in Pennsylvania of a non-domesticated New York judgment upon a domestic bank with branches throughout the United States, including in Georgia and New York, does not subject the debtor’s account in Georgia to the jurisdiction of New York courts for purposes of enforcing the New York judgment.  However, the court in Fiske expressly noted that Standard Chartered Bank did not define the separate entity rule’s “scope in regard to domestic branches of banks located in foreign states.”

Additionally, in Motorola Credit Corp. v. Uzan, in post-judgment discovery proceedings related to Standard Chartered Bank, a New York federal district court addressed whether a New York judgment creditor (again, Motorola, in that case), through subpoenas issued on New York offices of international banks, could obtain discovery regarding accounts held by the judgment debtors or their agents in various foreign branches of those banks, including in France, Switzerland, Jordan and the UAE.  Conducting a particularized analysis of the respective interests of those foreign jurisdictions and a “full consideration of international comity” as set forth in the United State Supreme Court’s seminal decision in Societe Nationale Industrielle Aerospatiale v. United States District Court for the Southern District of Iowa, the court in Uzan ordered the New York branches of banks in France, Jordan and the UAE to comply with the subject subpoenas and discovery requests.  The court otherwise quashed (denied) enforcement of the subpoenas directed to the Swiss banks, concluding that the blocking statutes and bank privacy regime in Switzerland “is not merely protective of private interests, but expressive of public interest” and that Switzerland viewed its “bank secrecy as a positive social value and benefit.”

In sum, the foregoing decisions—Standard Chartered Bank, Fiske and Uzan—have provided creditors with new tools and strategies to chase and seize a debtor’s foreign assets, including the important discovery tools endorsed in Uzan.  The decisions, while adopting the separate entity rule, also have left open numerous important legal questions, including the applicability of the rule to branches located outside of the jurisdiction of the judgment but within the United States and its territories; the extent that the corporate relationship between a bank and its affiliates distinguishes the rule’s application; and the degree to which a banking branch or affiliate conducts business within a jurisdiction for jurisdictional purposes, such as the foreign bank in Koehler, where the creditor was allowed to obtain foreign assets by serving a local branch over which the court had personal jurisdiction.

The analysis in this context is also subject to forum-specific considerations, as the policy interests underlying the separate entity rule as applied in New York City might differ from those in other important banking cities in the United States, such as Miami, Atlanta, Chicago, San Francisco, Boston, Philadelphia, Dallas, Los Angeles, Minneapolis and so forth.  Those differences, of course, as well as the different laws in those respective jurisdictions, can lead to strategies that favor creditors’ enforcement efforts or, conversely, debtors’ asset-protection efforts.

For example, the separate entity rule is not the law in Florida, as affirmed in Tribie v. United Development Group International LLC.  Notably, the court in Tribie rejected the bank’s (there, Wells Fargo’s) reliance on the separate entity rule to quash a writ of garnishment seeking discovery regarding the debtor’s assets at all of the bank’s branches, describing the rule as “a somewhat dated and seldom-cited legal doctrine.”  The court thus required the bank to respond to the subject discovery by identifying, in relevant part, “whether Wells Fargo knows of other persons [or entities] indebted to [the debtor]” (emphasis added), including, presumably, the bank’s other branches holding the debtor’s assets.  Similarly, in a case involving a judgment creditor’s request for an order directing a bank’s disbursement of a judgment debtor’s (there, the American Samoa Government’s) garnished funds under Hawaiian law, the court in Marisco, Ltd. v. American Samoa Government  “predict[ed] that the Hawai’i Supreme Court would decline to adopt the separate entity rule” and directed the bank to disburse the debtor’s (a government entity’s) garnished funds.

Whether a creditor is attempting to seize foreign assets or a debtor is attempting to protect its assets in any jurisdiction, the individuated analyses in Tribie and Mariscounderscore the importance of the specific factual circumstances at issue and of the applicable authority where the dispute is focused and/or litigated.

The recent case law regarding financial institutions as a means of seizing foreign assets also underscores the reemergence of jurisdictions with important banking ties—such as Miami, Florida—as potential gateways for not only litigation in this area but the resolution of all types of global legal disputes, including international arbitrations.  Indeed, Miami already promotes its relatively lower costs (as compared to other major banking cities, like New York, Los Angeles and San Francisco in the United States, and Paris and London abroad), multi-lingual professional force and central-location easily reachable from South America, Europe and Asia, among its unique benefits for handling international business and legal matters.  Florida law regarding the separate entity rule, especially when compared to New York law as addressed in the recent cases cited in this article, now provides yet another feather in Miami’s cap as an ideal destination for litigation regarding the seizure of foreign assets, international arbitrations, the confirmation of arbitration awards and all garnishment and other collection proceedings related thereto.

The attorneys at Fuerst Ittleman David & Joseph have extensive experience in all areas of complex civil and criminal litigation, pre-litigation and arbitration, including international and domestic business disputes.  The firm also provides wealth preservation and asset protection services designed to form the foundation for continued, protected wealth-creation (both domestically and offshore).  Please contact us by email at contact@fuerstlaw.com or telephone at 305.350.5690 with any questions.

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FDA Regulatory Update: Forecasting FDA Regulation of Laboratory Developed Tests (LDTs) in 2015

January 7th, 2015

2015 is proving to be a landmark year for FDA’s regulation of laboratory developed tests. As we have previously discussed (see our blog here), the U.S. Food and Drug Administration (FDA) has been expressing its intention to begin exercising regulatory authority over laboratory developed tests (LDTs) for years. In the Federal Register, FDA has defined LDTs as “a class of in vitro diagnostics that are manufactured, including being developed and validated, and offered, within a single laboratory.” Examples of these tests include genetic tests, emerging diagnostic tests, and tests for rare conditions. While FDA has claimed authority to regulate LDTs under the Food, Drug, and Cosmetics Act (FDCA), it has not drafted applicable regulations. Consequently, the primary federal regulation of laboratories and LDTs has been under the Clinical Laboratory Amendments of 1988 (“CLIA”).

While historically FDA has continued to claim authority to regulate LDTs, the agency consistently maintained the position that it would not enforce regulations regarding LDTs. FDA began departing from its “enforcement discretion” position on June 10, 2010, when it issued five Untitled Letters to companies stating that their tests did not qualify as LDTs as they were “not developed by and used in a single laboratory.” (To read the FDA’s Untitled Letters to Industry, please click herehereherehere, and here.) In those instances, FDA determined that it would regulate those tests as medical devices and require premarket approval. In June 2010, FDA stated that increased regulation of LDTs may be necessary due to the changing nature of LDTs from “generally relatively simple, well-understood pathology tests” to tests that “are often used to assess high-risk but relatively common diseases and conditions and to inform critical treatment decisions.” (To read the full text of the Federal Register notice regarding federal oversight of LDTs, please click here.)

In 2012, the Food and Drug Administration Safety and Innovation Act (“FDASIA”) was signed into law requiring that FDA notify Congress if it intended to issue guidance on the regulation of LDTs. On July 31, 2014, in compliance with FDASIA, FDA notified Congress that it would issue two draft guidance documents pertaining to its regulation of LDTs. Shortly thereafter, FDA issued these guidance documents entitled “Framework for Regulatory Oversight of Laboratory Developed Tests (LDTs)” (hereinafter FDA’s “Framework Guidance”) and “FDA Notification and Medical Device Reporting for Laboratory Developed Tests (LDTs)” (hereinafter FDA’s “Notification Guidance”). (For the full text of FDA’s notification and the two anticipated draft guidance documents, please click here.)

FDA’s Framework Guidance adopts the same definition of LDTs that FDA proposed in 2010, “an IVD that is intended for clinical use and designed, manufactured and used within a single lab.” It also identifies three groups of LDT: (1) LDTs that are subject to full enforcement discretion, (2) LDTs that are subject to partial enforcement discretion, and (3) LDTs that are subject to complete FDA regulation. Essentially, FDA explains how it will regulate these different types of LDTs under the current framework of medical devices. For example, low-risk LDTs are classified as class I medical devices and will be subject to partial enforcement discretion. FDA has grouped LDTs that are moderate- to high-risk into tests that FDA intends to fully regulate. Moderate-risk LDTs are those classified as class II devices, which will be required to gain clearance or approval through submissions to FDA. High-risk LDTs are those with the same intended use as a cleared or approved companion diagnostic, LDTs with the same intended use as a class III device approved by FDA, and LDTs for determining safety and effectives of blood or blood products.

The anticipated Notification Guidance describes how laboratories must notify FDA if they intend to “manufacture, prepare, propagate, compound or process” an LDT. FDA also plans to exercise enforcement discretion when it comes to establishment registration and devices listing for LDTs, as long as the laboratories notify FDA that they are manufacturing an LDT within six months after the final Framework Guidance is finalized by FDA. After notification, FDA will issue a notification confirmation number to the laboratory. The Notification Guidance also goes on to explain the types of record keeping, procedures, and reporting requirements the laboratories will need to incorporate into their procedures.

While the two guidance documents place a very high burden on the developers of LDTs, it is important to note that the guidance documents are themselves neither laws nor regulations. FDA specifically states that “[g]uidance documents represent FDA’s current thinking on a topic.  They do not create or confer any rights for or on any person and do not operate to bind FDA or the public.  You can use an alternative approach if the approach satisfies the requirements of the applicable statutes and regulations.” However, FDA does utilize such guidance documents regularly in its oversight of industry.

Most recently, the House Energy and Commerce Committee has issued a white paper regarding its 21st Century Cure Initiative in which it requests input related to FDA’s proposed LDT regulatory framework. This white paper sets forth eleven questions related to the proposed LDT guidance documents to which the committee seeks answers. These questions relate to a range of issues including: the clarification between the practice of medicine and developing these types of tests, the delineation between what constitutes a device and what constitutes a test not subject to device regulation, how will FDA determine the risk in its “risk-based” approach, the implementation of post-market processes to reduce hurdles to patient access to tests, and separation of CLIA and FDA regulation of LDTs, among others. The Committee requested that all comments be submitted by last week, so we should have a better idea of the reaction to these comments and FDA’s proposed guidance documents in the next few weeks.

Based on this timeline, we expect 2015 to be a remarkable year for LDT regulation as FDA’s policies and regulatory framework evolves and these types of tests are subjected to heightened scrutiny. It will be interesting to see how industry responds to this development in FDA’s LDT policies. In the past, various members of industry have submitted citizen petitions urging FDA not to regulate LDTs so there will likely be a strong reaction from industry to FDA’s notice to Congress and these two draft guidance documents. Fuerst, Ittleman, David, and Joseph, PL will continue to monitor the developments in FDA’s regulation of laboratory developed tests.

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Complex Litigation Update: Bridging the Gap between Data on Causation of Lost Profits and the Admissibility of Expert Opinions

January 6th, 2015

The Eleventh Circuit recently held in Chapman v. Procter & Gamble Distributing, LLC that when determining the admissibility of medical expert causation testimony, the court, acting as the gatekeeper, must find that the expert’s opinion on novel issues of causation is based on generally accepted methodologies rather than untested hypotheses or collateral evidence.  Namely, there must be enough data, analytical evidence, and scientific literature upon which the expert can base an inference—not a hypothesis—of causation.  Here, we address the issue of how Chapman might impact expert causation testimony relating to non-scientific causation testimony, such as an expert’s valuation of a business’s alleged lost profits.

It is well settled that an expert’s testimony must be reliable and relevant to the issue at hand to be admissible.  Specifically, the court must determine that the expert’s methods in reaching his or her conclusion are sufficiently reliable.  The court cannot just take the expert’s word for it.  As set forth in a landmark case dealing with the admissibility of novel causation expert testimony, Daubert v. Merrell Dow Pharmaceuticals, Inc., when determining reliability, the court should look at: “(1) whether the expert’s methodology has been tested or is capable of being tested; (2) whether the theory or technique used by the expert has been subjected to peer review and publication; (3) whether there is a known or potential error rate of methodology; and (4) whether the technique has been generally accepted in the relevant scientific community.”  Although the law addressing the admissibility of expert testimony on causation initially developed in the medical and scientific fields, courts following theDaubert method have utilized the same analysis when dealing with the admissibility of expert testimony in commercial cases.

With the focus being on the expert’s methodology in reaching his or her ultimate conclusion, those seeking to have an expert opine on the lost profits of a business  should ensure the expert’s analysis comports with the Daubert factors.  But as we learned in Chapman, this would likely mean that the expert testifying as to the cause of the plaintiff’s lost profits would have to establish that analytical evidence, generally accepted in the relevant professional community, exists whereby this cause and effect may be inferred, not just hypothesized.  Because hypotheses can only be verified by testing, it would be improper to submit a mere hypothesis of causation to the jury for consideration.  It is not enough for the expert to say the defendant’s action or inaction may have caused the loss of profits, the expert would have to demonstrate that the method utilized in determining loss causation are generally accepted in the relevant community.  The key is to show general acceptance in the relevant professional community of the specific cause and effect, not just a generalized notion that certain acts or inactions can cause the damage.  Experts seeking to opine on the cause of a plaintiff’s alleged lost profits must be armed with evidence to demonstrate their primary methods for proving the cause and effect of the loss in that particular case.

Likewise, parties seeking to exclude an opposing expert’s testimony as to loss causation may look to Chapman for the proposition that expert testimony must establish that the lost profits were in fact cuased by the defendant and did not occur coincidentally.  Just as the court in Chapman determined that the expert seeking to establish that the plaintiff’s exposure to a particular substance was the cause of the injury was required to base his opinion on analytical evidence, an expert in a commercial case seeking to establish that a defendant caused a plaintiffs to suffer lost profits would likewise need analytical evidence to bridge the gap between the data relied upon and the lost profits alleged by the plaintiff.  Just as it was not enough for the experts in Chapman to provide plausible explanations as to the cause and effect that led to the plaintiff’s damage, it will not be enough for experts to simply speculate on untested theories of the cause of lost profits. Chapman may thus prove to be a powerful tool for those defending parties seeking to exclude speculative expert testimony.

Whether seeking to admit expert testimony on a novel issue of loss causation or seeking to have such testimony excluded, Chapman dictates that the expert’s testimony must close the analytical gap between the data and evidence of causation generally accepted in that relevant professional community with the specific opinion being offered.  Requiring experts to rely on more than just unverified methodologies reduces the speculative nature of such opinions and ensures that the jury is not misled by opinions of causation that are insufficient proof of causation.

The commercial litigation attorneys at Fuerst Ittleman David & Joseph are experienced in litigating complex matters involving expert witnesses in state and federal court. We would be happy to address any questions about these or similar legal issues. Please do not hesitate to contact us via email at contact@fuerstlaw.com or by telephone at (305) 350-5690.

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Same Surgical Procedure Exception under 21 CFR 1271.15(b): FDA Raises More Questions Than it Answers Regarding the Scope of the Exception

November 12th, 2014

The FDA has released a new draft guidance document for industry entitled “Same Surgical Procedure Exception under 21 CFR 1271.15(b): Questions and Answers Regarding the Scope of the Exception” (the Guidance Document), which can be read here. This Guidance Document is FDA’s attempt at clarifying the “same surgical procedure” exception set forth at 21 C.F.R. 1271.15. That exception allows for the use of autologous stem cell treatments without submitting to regulation under FDA’s drug or biologic regulations. As always, “FDA’s guidance documents, including this guidance, do not establish legally enforceable responsibilities.”

As background, FDA regulates human cells and tissues intended for use in transplantations, implantation, or transfer into human recipients as human cells, tissues, or cellular or tissue-based products. FDA defines “human cells, tissues, or cellular or tissue-based products” (HCT/Ps) to mean:

[A]rticles containing or consisting of human cells or tissues that are intended for implantation, transplantation, infusion, or transfer into a human recipient. Examples of HCT/Ps include, but are not limited to, bone, ligament, skin, dura mater, heart valve, cornea, hematopoietic stem/progenitor cells derived from peripheral and cord blood, manipulated autologous chondrocytes, epithelial cells on a synthetic matrix, and semen or other reproductive tissue. 21 CFR 1271.3(d).

FDA has set forth its regulations for HCT/Ps in 21 C.F.R. part 1271. In this part of the Code of Federal Regulations, FDA has divided HCT/Ps into two categories: (1) HCT/Ps regulated solely under part 1271 and section 361 of the Public Health Service Act (PHSA) (42 USC 264), and (2) HCT/Ps regulated under part 1271 and FDA’s regulations governing medical devices or drugs under the FDCA or biological products under section 351 of the PHSA (42 USC 262). However, practitioners can avoid regulation under Part 1271 if their treatment modalities fall within the “same surgical procedure” exception under 1271.15(b), which states “you are not required to comply with the requirements of this part if you are an establishment that removes HCT/Ps from an individual and implants such HCT/Ps into the same individual during the same surgical procedure.”

FDA’s new Guidance Document gives a brief overview of the history of the exception. In 1997, the FDA issued a document called “Proposed Approach to Regulation of Cellular and Tissue-Based Products” in which it stated “[t]he agency would not assert any regulatory control over cells or tissues that are removed form a patient and transplanted back into that patient during a single surgical procedure. The communicable disease risks, as well as the safety and effectiveness risks, would generally be no different than those typically associated with surgery.” After that, in 1998, FDA published a proposed rule in the Federal Register, 63 Fed Reg 26744, regulating the registration of HCT/P establishments followed by a final rule in 2001, 66 Fed Reg 5447. In the proposed rule, FDA stated that it received a comment assuming that a hospital retaining autologous tissue to be used in a subsequent application on the same patient, even if the use would occur in a future, not-yet-scheduled surgical procedure, would not be subject to registration and listing. In its final rule, FDA agreed that “so long as the hospital does not engage in any other activity encompassed with in [sic] the definition of “manufacture,” the hospital would not be required to register or comply with the other provisions to be codified in part 1271. For example, if the hospital expanded the cells or tissues, it would not meet the terms of the exception.”

After describing that historical background, FDA concludes in the new Guidance Document that “autologous cells or tissues that are removed from an individual and implanted into the same individual without intervening processing steps beyond rinsing, cleansing, or sizing, or certain manufacturing steps, raise no additional risks of contamination and communicable disease transmission beyond that typically associated with surgery.” FDA does not explain the leap from its 2001 explanation regarding hospital activities to its new decision that anyintervening steps outside of “rinsing, cleansing, or sizing” would bring a procedure outside of the “same surgical procedure” exception. What has happened between 2001 and now that has led FDA to determine that rinsing, cleansing, and sizing fit within the 1271.15 exception? This is only the first of many questions this new Guidance Document raises but does not answer. While attempting to provide some clarity to the regenerative medicine industry, FDA has, as it often does, raised additional questions and confusion as to how certain treatments and procedures will be regulated.

For instance, in addressing “[w]hen does the exception in 1271.15(b) apply?” (see Q4. of the Guidance Document),  FDA states there are three criteria that must be met to fall under the exception. These criteria are that (1) the HCT/Ps must be removed and implanted into the same individual (autologous use), (2) the HCT/Ps must be implanted within the same surgical procedure, and (3) the HCT/Ps remain “‘such HCT/Ps;’ they are in their original form.” FDA has included a footnote to the third criterion stating:

Note that the criteria of “minimal manipulation” expressed in 21 CFR 1271.10 (a) is not the standard for establishing whether an HCT/P is “such HCT/P” under § 1271.15.  Accordingly, even manufacturing steps considered minimal manipulation within § 1271.10(a), will typically cause the HCT/P to no longer be “such HCT/P” under §1271.15(b), unless the HCT/P is only rinsed, cleaned, sized, or shaped. (Emphasis added.)

This new narrower 1271.15 same surgical procedure exception leads to numerous other questions that our clients are asking in their medical practices. This footnote makes clear that the 1271 same surgical procedure exception is actually narrower than the “more than minimal manipulation” standard, which FDA has previously interpreted in guidance documents and regulatory preambles as being incredibly narrow. Would FDA consider centrifugation to be “rinsing, cleansing, sizing or shaping?” How does this Guidance Document affect the physicians in the United States who are utilizing centrifugation to work with stromal vascular fraction (SVF), many of whom using SVF in their practices under the auspices of the same surgical procedure exception? How does this interpretation affect cell separation procedures?

In attempting to clarify the types of procedures that fall within the same surgical procedure exception, FDA provides the following insights: “[P]rocedures that involve an incision or instrumentation (e.g., incision or surgical technique) during which an HCT/P is removed from and implanted into the same patient within a single operation performed at the same establishment, are considered to be the same surgical procedures.  Examples include autologous skin grafting and coronary artery bypass surgery involving autologous vein or artery grafting.” (See Q3 of the Guidance Document.) As this statement seems to encompass a fairly broad range of procedures, it will be interesting to see exactly which procedures, other than those specifically mentioned, FDA will consider “surgical.”

FDA also attempts to address whether procedures that involve more than a single operation could fall under the same surgical procedure exception and whether autologous tissue can be shipped within the exception. In the Guidance Document, FDA writes that, in most situations, more than one procedure would not qualify under this exception. However, neither time nor the number of “procedures” involved is dispositive. Instead, there may be circumstances in which “removal and future implantation may be a number of days apart” and still fall within the exception (see A4 of the Guidance Document). HCT/Ps may only be rinsed, cleansed, and/or stored during the intervening time, according to FDA, and no other “manufacturing steps beyond labeling and storage may be performed.” Accordingly, it seems that procedures performed days apart can still be deemed to be the same surgical procedure. FDA also states that shipping of HCT/Ps cannot be done at any time during the procedure to fall under this exception, no matter what the purpose of the shipment (even for storage).

Despite the new questions raised, one of the few clear conclusions that can be drawn from this new draft Guidance Document is that FDA has decided to apply the same surgical procedure exception of part 1271 very narrowly. Practitioners and professionals in the regenerative medicine industry who believe that they are currently practicing within the same surgical procedure exception should closely scrutinize their practices in light of this Guidance Document to prepare and insulate themselves from potential enforcement action that may stem from violation of FDA’s newest interpretations. As this Guidance Document is a draft, FDA has chosen to accept comments, and comments must be submitted in writing by December 22, 2014. Fuerst, Ittleman, David, and Joseph, PL will continue to monitor this policy document and all other issues relating to FDA’s regulation of the regenerative medicine industry.

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Confession: Good for the Soul, but Bad for Business?

November 11th, 2014

The following article was written by Stephen Wagner for the Export Compliance Training Institute. Mr. Wagner is a faculty member for the Institute, and frequently lectures and writes on export compliance and enforcement matters. We repost Mr. Wagner’s article here with the Institute’s permission.

A few days ago, your company filed a voluntary disclosure with the Directorate of Defense Trade Controls stating that you violated the ITAR in an export transaction. Your in-house counsel told you that you had to file quickly and that you were legally obligated to disclose your violation voluntarily. You really didn’t have time to do anything other than gather all of the documents related to the transaction and send those papers to the government along with a summary of what happened and what you had done to fix the problem.

Last night, you told this story to a friend who is a criminal defense lawyer. She shocked you by asking why you would EVER voluntarily “confess to a crime.” Your legal department told you that you would escape serious legal liability by making the voluntary disclosure to the DDTC. But now you are not so sure.

Did your company do the right thing, or did you just make a serious mistake?

The question of whether or not a company should make a disclosure to the government in any regulatory matter – including exports, imports, food and drug, anti-money laundering – should never be evaluated in normative, ethical constructs of doing the “right” or the “wrong” thing. Instead, a company should carefully consider all of the business and legal implications of disclosure and then decide. If your company did that here, then the decision would always be the “right thing,” regardless of whether you ended up making the disclosure or not.

In your particular case, however, it doesn’t sound like your company carefully evaluated all of the angles before dashing off a letter to Washington.

Federal regulations provide for the voluntary disclosure of compliance violations by exporters, and making such disclosures can be very beneficial in enforcement matters. The Office of Export Enforcement, Bureau of Industry and Security notes that a voluntary disclosure will be given “great weight” as a mitigating factor in administrative sanction decisions. The Office of Foreign Assets Control (OFAC) states that voluntary self-disclosure will result in a capping of maximum penalties at 50% of their normal level. (31 C.F.R. § 501, App. A.) U.S. Customs and Border Protection offers similar, strong mitigation of administrative penalties for voluntary disclosures in matters involving Automated Export System (AES) violations under the Census regulations (15 C.F.R. § 30.74, CBP Dec. 08-50 (“Extraordinary Mitigating Factor”)).

But these benefits of voluntary disclosures are not automatically accorded by all export enforcement agencies. DDTC regulations state, “the Department may consider a voluntary disclosure as a mitigating factor in determining the administrative penalties, if any, that should be imposed” (22 C.F.R. § 127.12(a) (emphasis added)). Therefore, it is possible that no mitigation of administrative penalties may occur upon the filing of a voluntary disclosure under the ITAR.

The fundamental truth is that a voluntary disclosure is an admission that your company has violated export control laws. A company must be aware, therefore, of the ramifications of a voluntary disclosure:

  • It will result in an investigation of the company and its export activities.
  • It most likely will result in sanctions which can range from a warning letter up to significant fines and even jail time.
  • If a disclosure (or the subsequent investigation) reveals other violations (e.g., of tax laws or securities laws), those matters will be referred to other enforcement agencies.
  • If a disclosure reveals the clear intent of a company to violate export laws and/or egregiously violative activities, the case most likely will be referred to the Justice Department for criminal prosecution (in addition to administrative sanctions).

While the voluntary disclosure can significantly mitigate sanctions and even convince an agency to proceed administratively instead of criminally in some circumstances, every effect on the company must still be considered before making the disclosure.

What Should Companies Consider?

Given the significant risks and benefits involved in voluntary disclosures, what should companies consider when evaluating whether to make such a disclosure? There are myriad factors and many are particular to the company, its compliance history and the particular facts of the violation(s); however, the following are some important elements that must be considered by every exporter:

  • Is Disclosure Required? Under some circumstances, voluntary disclosure is not just a good idea, but is required by law. For example, under 22 C.F.R. §126.1(e) (ITAR), “Any person who knows or has reason to know of such a final or actual sale, export, transfer, reexport or retransfer of such articles, services or data [to certain listed, embargoed countries] must immediately inform the Directorate of Defense Trade Controls” (Emphasis added). In fact, the ITAR regulation’s general policy statement would seem almost to compel voluntary disclosure: “Failure to report a violation may result in circumstances detrimental to U.S. national security and foreign policy interests, and will be an adverse factor in determining the appropriate disposition of such violations” (22 C.F.R. § 127.12(a) (emphasis added)).
  • Will the Government find out about the violation anyway? A company must ask itself whether, absent disclosure, the Government will likely find the violation on its own. If your company has aggressive competitors or disgruntled employees who may learn of the violation and contact enforcement officials, the odds of discovery increase. Similarly, if the violation involved a recurring transaction or an item that may be returned for repair or replacement, the Government is more likely to find out about the violation eventually. If the chance for discovery is higher, you might as well disclose the violation(s) to take advantage of potential mitigation of sanctions. Voluntary disclosure can also avoid an inference of a company’s intent to violate export control laws (in a potential criminal investigation) when the violation was, in fact, an accident or unintended.
  • Is this an isolated or recurring issue? Does it involve potentially criminal activity? Before making a disclosure of an export violation, a company needs to know all of the facts surrounding the issue. Since the Government will launch a complete investigation upon receiving the voluntary disclosure, your company needs to thoroughly investigate the transaction(s) and audit its export compliance program to determine if there is a systemic problem, or if criminal activity is present. Factors such as these could significantly increase penalties and even result in prison sentences for company employees; all things you will want to know before making the disclosure.
  • What are the effects of disclosure on other aspects of my business? Voluntary disclosures can result in public pronouncements (charging letters, consent agreements) that can adversely affect a company’s goodwill (and revenues). Moreover, disclosures of export violations may implicate potential issues in import transactions, tax returns, accounting records, shareholder and Securities and Exchange Commission (SEC) disclosures. Making a voluntary disclosure without a complete understanding of the nature of the violation(s) and the ripple effects on your business is playing Russian roulette with your company’s future.

The fact of the matter is that voluntary disclosure is a double-edged sword. It can be a powerful way for an exporter to “clean the slate” of its violations and greatly mitigate penalties. It can also launch a Government investigation (of a matter the Government may never have found on its own) and serve as your signed confession to a federal crime. However, for these reasons, even if your company has an in-house attorney, you may want to consult with an unbiased outside counsel before deciding whether to make a prior disclosure.

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Money Laundering in the News: Los Angeles Fashion District Raid Puts Trade-Based Money Laundering and Black Market Peso Exchange in Spotlight

November 11th, 2014

On September 10, 2014, federal and local law enforcement officials raided the Los Angeles Fashion District in an effort to combat alleged money laundering for Mexican drug cartels which was occurring within the District. The raid, part of “Operation Fashion Police,” focused on the Fashion District due to the high potential for vendors to launder cartel money through a technique known as trade-based money laundering.

Law enforcement and financial institutions have seen an increase in trade-based money laundering since June of 2010 when the Mexican government announced regulations limiting deposits of U.S. cash in Mexican banks. (More information on Mexico’s deposit regulations can be found in the FinCEN Advisory entitled: “Newly Released Mexican Regulations Imposing Restrictions on Mexican Banks for Transactions in U.S. Currency” found here.)

A. Defining Trade-Based Money Laundering and understanding its common techniques.

Generally speaking, trade-based money laundering can be broadly defined as the process of disguising illicit proceeds and moving the value of such proceeds through a series of trade transactions in an attempt to disguise and legitimize their origin.

The basic premise of trade-based money laundering is as follows: Foreign drug traffickers who have an abundance of U.S. currency in the U.S. need a technique to move that money, the source of which is illicit drug profits, overseas. To accomplish this objective, traffickers, with the assistance of conspiring importers/exporters, arrange for the purchase of goods in U.S. dollars. Those goods are then shipped to foreign destinations, usually but not necessarily the home countries of the traffickers. Once these goods arrive, they are sold in the local currency. Thus, the traffickers have now moved their proceeds across the border, converted the U.S. dollars into local currency which traffickers use for day-to-day operations, and legitimized their income as the funds appear to be derived from legitimate trade and business transactions.

Trade-based money laundering can take several forms ranging from the very basic to the incredibly complex. While a complete list of trade-based money laundering techniques is beyond the scope of this article, some of the more common forms of trade-based money laundering include:

  • Over/Under invoicing goods and services: This technique involves the misrepresentation of the price of a good or service in order to transfer additional value between the importer and exporter. By invoicing the goods below fair market value, an exporter can transfer monetary value to an importer because the importer will be paying less for the good than the importer will receive when the good is sold. Alternatively, by invoicing at an amount above fair market value, the exporter receives added value as the goods have been purchased by the importer at a price higher than the value the importer will receive when they sell the goods.
  • Multiple invoicing of goods and services: This technique involves the issuance of more than one invoice for the same transaction. Through the issuance of multiple invoices, a money launderer can make multiple payments for the same goods, thus enabling more money to move in each transaction. Further, unlike over/under invoicing, these multiple payments can be made at fair market value. In order to increase difficulty in detection and avoid possible BSA reporting requirements, parties will often make payments for multiple invoices through different financial institutions.
  • Over/Under shipment of goods and services: This technique involves the misrepresentation of the amount of goods being shipped or services being provided. By shipping a greater quantity of goods than was paid for, an exporter can transfer addition value to an importer who will then sell these extra goods in the local market.
  • Falsely described goods and services: This technique involves the misrepresentation of the type or quality of the good being shipped or the service being provided. The false description creates a discrepancy between the listed invoice value and the actual market value of the good. For example, an exporter ships gold worth $3 per unit but falsely describes the shipment on its invoice as silver worth $2 per unit. The importer would pay the exporter $2 per unit for the goods shipped and then sell the higher valued product on the local market for $3 per unit and obtain the extra money as laundered profits.

The Financial Action Task Force, a 35 member inter-governmental policy-making body of which the U.S. is a member and whose purpose is to establish international standards to combat money laundering, has developed a comprehensive guide regarding the various trade-based money laundering techniques used to launder money. This informative guide can be read here.

B. The Black Market Peso Exchange

One advanced trade-based money laundering technique is known as the “Black Market Peso Exchange.” While the particular details of any Black Market Peso Exchange operation will vary on a case by case basis, the basic operation of any black market peso exchange arrangement usually follows the same steps.

To demonstrate, let’s use a hypothetical involving a Mexican drug cartel and apply their activities to the outline of trade-based money laundering provided by the Financial Action Task Force in its guide. In such a case, the black market exchange would operate as follows:

1) Drug traffickers smuggle drugs into the United States which are sold for U.S. dollars;

2) The drug cartel arranges to sell the U.S. dollars at a discount (i.e. a rate cheaper than that paid on the forex) in exchange for currency of the trafficker’s home country (in this example Mexican pesos) to a third party known as a “peso broker;”

3) The peso broker pays the cartel in pesos from his account located in Mexico;

4) The peso broker will then structure deposits of the U.S. dollars into the broker’s U.S. bank accounts, known to as “funnel accounts” in an effort to avoid triggering BSA reporting requirements;

5) The peso broker then locates Mexican importers who import goods from the U.S. and need to pay for these goods with U.S. Dollars;

6) Once located, the broker will arrange to pay the U.S. exporter on behalf of the Mexican importer in U.S. dollars from the broker’s U.S. bank account;

7) Goods are then shipped to the Mexican importer; and finally,

8) The importer sells the goods in Mexico, pays the broker his arranged discounted exchange fee in pesos deposited in the broker’s Mexican bank account, and thus replenishes the broker’s account with the pesos the broker needs to begin the cycle again with a new laundering transaction.

C. Trade-Based Money Laundering and Black Market Exchange Red Flags and Financial Institution Reporting Obligations

Pursuant to the Bank Secrecy Act (“BSA”), financial institutions are required to create reports and records in order to combat fraud, money laundering, and protect against criminal and terrorist activity. More specifically, federal law requires that financial institutions file Suspicious Activity Reports (“SARs”) if the financial institution “knows, suspects, or has reason to suspect” that an attempted or fully conducted transaction: 1) involves funds derived from illegal activities or is an attempt to disguise or hide such funds; 2) is designed to evade the requirements of the BSA and its implementing regulations; or 3) lacks an apparent lawful or business purpose. See 31 C.F.R. § 1020.320see also 12 C.F.R. § 21.11; (more information on BSA requirements can be found on the Office of the Comptroller of the Currency’s website here).

Due to the complexity of many black market peso exchange arrangements, FinCEN has issued several Advisories regarding potential “red flag” indicators of trade-based money laundering or black market peso exchange activities that financial institutions must be aware of. Such red flags include in part:

  • Third party payments for goods and services made by an intermediary apparently unrelated to the seller or purchaser of good;
  • Wires where no apparent business relationship appears to exist between the originator and the beneficiary;
  • Funds transferred into U.S. domestic accounts that are subsequently transferred out of the account in the same or nearly the same amounts, especially those originating from or destined to high risk jurisdictions;
  • A foreign import business with U.S. accounts receiving payments from locations outside the areas of their customer base;
  • In the case of a business account, the deposits take place in a different geographic region from where the business operates. For example, an account for a company operating locally in Florida receives numerous small deposits, all below the threshold reporting requirement, at bank branches in Texas, Virginia, and Tennessee;
  • In the case of a business account receiving out-of-state deposits, the debits do not appear to be related to the stated business activity of the account holder;
  • If questioned, the individuals opening or depositing funds into these “business accounts” have no detailed knowledge about the state business activity of the account holder or the source of the cash deposited.

Should any of the above red flags be spotted, FinCEN urges financial institutions to submit a Suspicious Activity Report indicating possible trade-based money laundering or black market peso exchange activity. A more complete list of trade-based money laundering red flags can be found in FinCEN’s Advisory FIN-2010-A001, entitled: “Advisory to Financial Institutions on Filing Suspicious Activity Reports regarding Trade-Based Money Laundering” found here. More detailed information regarding funnel account specific red flags can be read in FinCEN’s more recent Advisory, FIN-2014-A005, issued on May 28, 2014 here.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of administrative law, anti-money laundering, regulatory compliance, customs, import and trade law, white collar criminal defense and litigating against the U.S. Department of Justice. If you are a financial institution, or if you seek further information regarding the steps which your business must take to remain compliant, you can reach an attorney by emailing us at contact@fuerstlaw.com or by calling us at 305.350.5690.

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Upstream Assessment of Downstream Export Issues

October 21st, 2014

The following article was written by Stephen Wagner for the Export Compliance Training Institute. Mr. Wagner is a faculty member for the Institute, and frequently lectures and writes on export compliance and enforcement matters. We repost Mr. Wagner’s article here with the Institute’s permission.

Your company is a midsize manufacturer of computer network hardware and software, some of which is really cutting-edge technology. A significant portion of your products is exported overseas, either by you directly or by your U.S. distributors. For these U.S. distributors, you ensure that product labeling and literature is in the language of the final user.

You just received a phone call from one of your distributors in Los Angeles. Their customer in Hong Kong just called and told them that officials from the U.S. Department of Commerce just conducted an “end-use check” there in Hong Kong and found “major problems” involving your products. Your distributor is letting you know, so that you can take what your distributor called “appropriate action.”

You don’t know what to do. If there are any problems in Hong Kong, it’s not your problem, right? Especially because this distributor is here in the United States. Should your company be doing something?

Your company needs to take immediate action as a result of this reported “problem.”

If you do nothing, when – not “if,” but “when” – special agents from the Office of Export Enforcement, Bureau of Industry and Security (BIS/OEE) come calling, you will not be prepared and that could result in higher sanctions if they find any export compliance issues at your company.

What risks and/or liabilities do you face?

End-use checks are physical, on-location verifications with the recipient of exported U.S. goods to determine if the party is a reliable recipient of those goods and that items are, or will be, used in accordance with the Export Administration Regulations (EAR). These checks are conducted by the Departments of Commerce, State and Defense, and take place every day in dozens of countries around the world.

If an end-use check found a “major problem” with respect to your company’s merchandise, it could arise from numerous sources. For example, the end-user may have misrepresented itself to the seller or may be transshipping the merchandise illegally. Provided that your company did everything it was supposed to do under the regulations – including investigating red flags, knowing your customer, etc. – you may face little-to-no scrutiny. However, an end-use check could unearth one or more export violation(s) that your company – the manufacturer – may be committing. Depending upon how you manufacture, describe and sell the product, there may be issues with commodity classifications (through CCATS), licenses, etc. Is your company publishing inaccurate Export Control Classification Number (ECCN) or license information on its website and inviting your distributors and customers to rely on such data? This could lead to problems for you.

Moreover, you state that you are aware that your products are being exported. Remember that under export regulations, “All parties that participate in transactions subject to the EAR must comply with the EAR” (15 C.F.R. § 758.3). Are you taking the steps required to ensure that your distributors and customers are compliant with export regulations? Furthermore, if your company is the exporter of record (aka, the U.S. Principal Party in Interest or “USPPI”), you are ultimately responsible for the electronic export information (EEI) that is being filed through the Automatic Export System (AES) and for all classification and license matters.

What should your company do?

Knowing that there is a downstream problem with your exports, it is highly prudent that your company conducts an immediate self-assessment of its export compliance activities-but remember that time is of the essence; if BIS is aware of issues with your exports, it is only a matter of time before they come to call.

You should start by examining the particular transaction(s) involved with this customer. You should be looking to ensure that any export information (e.g., ECCNs, license information) you provided to the customer and/or the distributor was accurate and complete. Expanding your assessment radially, you should examine any and all transactions with this customer, this distributor, and the product(s) involved to ensure that transaction is being performed in accordance with your export compliance management program (ECMP). Then, as time allows, you can review your overall ECMP and perform audits on other, randomly selected export transactions to ensure compliance. An excellent resource to help organize and conduct your company’s self-assessment is the audit module tool developed by BIS. (Click here to view the tool.)

Once you have conducted a thorough self-assessment, you will know if there are any issues with your export compliance program and the export of this product, through this distributor, to this end-user. At that point, you can assess whether any issues you find are systematic problems with your export compliance plan or anomalies that need to be isolated. Regardless of their nature, any issues you find need to be well documented and fixed at once.

As you are remediating any issues you find, your company can decide whether it wants to make any voluntary self-disclosures (VSDs) to BIS. BIS strongly encourages VSDs from exporters, and such disclosures usually result in significant mitigation of any monetary penalties or other sanctions. That said, there are risks to a company making a voluntary self-disclosure and these risks need to be weighed against the benefits.

Also, because your company’s technology is “cutting edge,” your products may embody proprietary, “trade secret” information (such as product materials, designs, and algorithms). Moreover, the end-user and/or your distributor may have commercially sensitive information belonging to your company, such as pricing, training and use information. Because some of this trade secret or commercially sensitive information could be made public during the course of an investigation, you may need to notify BIS/OEE of the need to protect this information from disclosure. Generally, BIS can take steps to help ensure that any disclosure of protected information is tightly controlled. But certainly, the more your company propounds the need for confidential treatment with BIS, the more likely it is that such information will be protected to your satisfaction.

In short, when it comes to export transactions, whether you are the manufacturer, the distributor, the freight forwarder, any other “middle man” or the end-user, compliance with export regulations is always your responsibility, and any “problems” in these transactions should always be addressed as if they were your problems.

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