Archive for November, 2011



Tax Court holds that use of foreign bank accounts provides basis for fraud exception to statute of limitations

Monday, November 14th, 2011

In Browning v. Commr, T.C. Memo 2011-261, Judge Halpern in a 55 page opinion sustained most of the IRS assessments of additional tax, penalties and interest.

The facts are as follows:

In December 1995, Mr. Browning, the principal shareholder, president, and CEO of SBE, a Vermont-based manufacturing corporation, on the advice of its promoters and his own tax adviser, entered into an offshore employee leasing (OEL) arrangement whereby he agreed to lease his services to an Irish corporation that subleased his services to a U.S. employee leasing company that subleased his services back to SBE. During the audit years (1995-2000), in consideration of Mr. Brownings services, SBE paid the leasing company annual amounts equivalent to what SBE had paid Mr. Browning as wages in prior years. The leasing company paid a portion of those amounts to Mr. Browning, who reported those payments as wages. The leasing company remitted the balance after deducting certain amounts, including the payroll taxes owed with respect to its payments to Mr. Browning, to the Irish corporation for deposit in a deferred compensation or retirement account for Mr. Brownings benefit (the retirement account). The retirement account was opened in the name of a Bahamas subsidiary of the Irish corporation. Mr. Browning and his wife received and used, during 1998-2000, credit cards in the name of the Irish subsidiary. Money from Mr. Brownings retirement account funded the bank account used to pay the credit card charges, many of which Mr. Browning recognized were personal. During all of the audit years, Mr. Browning continued to represent himself to third parties as an employee and president of SBE, and he acted on behalf of SBE in the same manner as before adoption of the OEL arrangement. He also determined the amounts to be deposited in the retirement account and he effectively controlled the manner in which the assets in the account were invested. During 1998-2000, he exercised his unrestricted access to the funds in the account by means of the Bahamas bank credit cards.

Both the 3- and 6-year periods of limitations on assessment under I.R.C. sec. 6501(a) and (e) had expired before the IRS issued the notices of deficiency (the notices) to Mr. Browning. However, the IRS alleged that the notices were timely issued by reason of the application of I.R.C. sec. 6501(c), which permits assessment of tax at any time in the case of a false or fraudulent return. The IRS also alleged that, for all open audit years, Mr. Browning (1)underreported his income, (2) is liable for the I.R.C. sec. 6663 fraud penalty, and (3) alternatively, is liable for the I.R.C. sec. 6662 accuracy-related penalty.

The Tax Court held as follows:

1. For all audit years, Mr. Browning was in constructive receipt of (1) amounts equal to the excess of SBEs payments to the leasing company for his services on behalf of SBE over the sum of the amounts he reported as wages plus the employer portions of the Social Security and Medicare taxes that the leasing company paid with respect to those reported wages and (2) the capital gains and investment income generated by the assets in the retirement account.

2. Mr. Brownings 1998-2000 returns were fraudulent by reason of Mr. Brownings concealment of the Bahamas bank account and associated credit cards by means of which he had, and intended to exercise, his unrestricted access to the constructively received amounts described in holding 1.

3. Mr. Brownings 1995-97 returns were not fraudulent with the result that IRSs determinations and adjustments regarding those years are barred.

4. Mr. Browning is subject to the I.R.C. sec. 6663 fraud penalties for 1998-2000 with respect to all the constructively received amounts described in holding 1.

5. Finally, the I.R.C. sec. 6663 fraud penalties to Mr. Brownings total underpayments for 1998-2000, and the I.R.C. sec. 6662 accuracy-related penalties do not apply for those years.

The significance of this case is that for those taxpayers who may have used offshore (non-domestic) accounts, especially in tax haven jurisdictions (such as the Bahamas, the British Virgin Islands, the Cayman Islands, and Switzerland), the IRS may be able to avoid both the 3 year statute of limitations provision against assessment, and the extended 6 year statute of limitations provision against assessment for those that understated income by more than 25%, by asserting that the taxpayers use of the offshore bank accounts was fraudulent and, as a result, there is no statute of limitations provision protecting the taxpayers from additional tax, penalties, and interest.

The full opinion can be found here.

The attorneys at Fuerst Ittleman, PL have extensive experience dealing with the IRS for taxpayers with under-reported income and undeclared foreign bank accounts. The attorneys at Fuerst Ittleman likewise have experience litigating in both the U.S. Tax Court, the U.S. District Courts, and the U.S. Circuit Courts. You can contact an attorney by emailing us at: contact@fuerstlaw.com

Congressmen Call For Investigation of Two U.S. Companies for Possible Syrian Sanctions Violations

Monday, November 14th, 2011

On November 10, 2011 several U.S. Congressmen sent letters to the Departments of State and Commerce urging them to investigate two U.S. IT companies, NetApp, Inc. and Blue Coat Systems, Inc. (“Blue Coat”), for possible violations of U.S. trade sanctions against Syria. The alleged violations stem from the exporting or re-exporting of the companies technology for use in internet surveillance projects by the Syrian government.

Generally speaking, the sanctions program in place against Syria prohibits U.S. persons from engaging in transactions with the Government of Syria and separately prohibits the exportation, reexportation, sale, or supply, directly or indirectly, by a United States person, wherever located, of any services to Syria. More information regarding the sanctions against Syria can be found on the Office of Foreign Assets Controls (“OFAC”) website here.

According to a recent Bloomberg report, Area SpA, an Italian surveillance company, is working with the Syrian government to create an internet surveillance system designed to “intercept and catalog virtually every e-mail that flows through the country.” As part of this massive project, it is alleged that Area SpA is using NetApps hardware and software technology to create four petabytes of storage for archiving e-mails. (By comparison, a database with four petabytes of storage space can store more than 15 times the amount of data stored in the online archives of the Library of Congress.) Additionally, it is alleged that the Syrian government has been using Blue Coats technology to censor and filter website content within Syria.

NetApp and Blue Coat have come under criticism not only because their activities may violate the sanctions scheme in place against Syria, but also because of concerns that the purpose of the Syrian surveillance programs is to suppress activists and dissidents opposed to the totalitarian Assad regime. Since March of 2011, the Syrian government has engaged in a brutal crackdown of dissidents resulting in the deaths of more than 3,000 Syrian citizens.

Both companies have denied wrongdoing. NetApp has stated that it is not aware of any of its products being sold to Syria. However, a November 4, 2011 Bloomberg report reported that the NetApp structured its contract in a way to avoid direct dealing with Syria or Area SpA. According to the report, NetApps Italian subsidiary sold its products to a authorized vendor which then re-sold NetApps technology to Area SpA for use in the Syrian surveillance program. Blue Coat has also denied violating U.S. sanctions claiming its products were illegally transferred to the Syrian government. Blue Coat has launched an internal investigation to determine how its web filtering technology was transferred to Syria.

This situation provides an important reminder to businesses which engage in international trade. Because of the breadth and complexity of these regulatory schemes, although businesses may not directly engage in trade with Syria, they may still unknowingly violate OFAC sanctions because of the nature of their relationships with foreign businesses who do. Examples of this can be read in our previous reports here and here. If you have questions pertaining to the OFAC sanctions on trade with Syria, the BSA, anti-money laundering compliance, or how to ensure that your business maintains regulatory compliance at both the state and federal levels, please contact us at contact@fuerstlaw.com.

Update: Court Issues Preliminary Injunction Blocking FDA’s Graphic Smoking Warning Labels From Going Into Effect

Monday, November 14th, 2011

On November 7, 2011, Judge Richard Leon of the United States District Court for the District of Columbia granted a preliminary injunction on behalf of five tobacco companies challenging the implementation of the FDAs new graphic cigarette warning labels. As a result of the injunction, the FDAs new cigarette labeling requirements, which were scheduled to take effect in September 2012, are now blocked from taking effect until fifteen months after resolution of the plaintiffs claims on the merits. A copy of the Courts opinion can be read here.

As we previously reported, on June 21, 2011, pursuant to the authority granted to it by the Family Smoking Prevention and Tobacco Control Act to regulate tobacco, the FDA released nine new graphic warning labels that were required to appear on every pack of cigarettes sold in the US and in every cigarette advertisement starting no later than September 2012. In response to the FDAs new rule, five tobacco companies (R.J. Reynolds Tobacco Company, Lorillard Tobacco Company, Commonwealth Brands, Inc., Liggett Group LLC, and Santa Fe Natural Tobacco Company, Inc.) filed a complaint in the United States District Court for the District of Columbia alleging that the FDAs new cigarette labeling rules violated the First Amendment and the Administrative Procedure Act.

The five companies also sought an injunction to prohibit the rules from going into effect until fifteen months after a final decision has been rendered on the merits of their case. More background information involving this case can be read in our prior report here. In order for a court to grant a preliminary injunction, it must determine the following: 1) whether there is a substantial likelihood of success on the merits for the moving party; 2) whether the movant will suffer irreparable harm if the injunction is not granted; 3) whether the injunction will substantially injure other interested parties; and 4) whether the public interest would be furthered by the injunction. See Mova Pharm. Corp. v. Shalala, 140 F.3d 1060, 1066 (D.C. Cir. 1998). However, “the party seeking a preliminary injunction need not prevail on each factor.” R.J. Reynolds Tobacco Company, Inc. v. U.S. Food and Drug Administration, 11-1482, at 9 (November 7, 2011 D.D.C.). Rather, the court “appl[ies] the factors on a sliding scale.” Id. As a result, “if the arguments for one factor are particularly strong, an injunction may issue even if the arguments in the other areas are rather weak.” Id.

More specifically, the tobacco companies alleged that the requirement to place graphic images on its labels unconstitutionally compels speech. Generally speaking, compelled speech is presumptively unconstitutional and will only be upheld if it passes “strict scrutiny,” i.e.: 1) the government has a compelling interest it seeks to protect; and 2) the regulation is narrowly tailored to achieve that interest. However, as explained by the Court, narrow exceptions apply in the area of commercial speech. The government may require disclosure of only “purely factual and uncontroversial information” to protect consumers from “confusion or deception,” unless such a disclosure is “unjustified or unduly burdensome.” A lower level of scrutiny applies in cases where government- compelled speech meets this narrow exception.

In this case, the Court determined that the FDAs rule did meet the narrow exception for compelled commercial speech for several reasons. First, the Court found that the images could not be considered purely factual because must were either digitally enhanced or manipulated to depict the negative consequences of smoking. Second, the Court found that the FDAs argument that the images chosen by the rule were uncontroversial and purely factual was undermined by the fact that the FDAs selected graphic images were designed to evoke viewers emotions. Finally, the Court found that when the graphic images were combined with the textual warnings and the mandatory display of the 1-800-QUIT-NOW smoking cessation hotline, the goal was to induce the viewer to quit or never start smoking. Thus, the Court found that the FDAs labels were neither purely factual nor uncontroversial. Therefore, strict scrutiny and not a lower, more-deferential level of scrutiny applied.

In evaluating whether the FDAs labeling rule passed constitutional muster, the Court found that regardless of whether the governments interest in providing information to consumers is compelling, the FDAs rule is not narrowly tailored to achieve such a purpose. The Court noted that the size and display requirements of the rule — the top 50% of the front and back panels of all cigarette packages and the top 20% of printed advertising — is not narrowly designed to achieve an informative purpose. Rather, the Court found that such dimensions promote a government sponsored anti-smoking message. Additionally, the Court found that the graphic warnings when combined with the textual messages and the 1-800 number result in the FDA “conscript[ing] tobacco manufacturers into an anti-smoking brigade.” Thus, the Court found that the tobacco manufacturers have a substantial likelihood of success on the merits because the FDAs labeling requirements are likely to be found violative of the First Amendment.

The Court also found that the plaintiffs satisfied the other prongs necessary to be granted a preliminary injunction. The Court found that because of the plaintiffs likelihood of success on the merits and the fact that litigation would likely continue well beyond the September 2012 effective date, the plaintiffs would suffer irreparable harm if an injunction was not issued. Additionally, the Court found that injunctive relief would not harm any interested third parties because, based on the record, Congress did not demonstrate that such rules were urgent. In so finding, the Court noted that the Tobacco Act established a mutli-stage timeline in which the FDA was given two years to promulgate a Final Rule and a 15 month implementation period before the Final Rule took effect. Therefore, the Court found no prejudice to other third parties. Finally, the Court found that the “public interest will be served by ensuring that plaintiffs First Amendment rights are not infringed before the constitutionality of the regulation has been definitively determined.” As such, the Court granted the tobacco companies injunction.

Although the preliminary injunction is effective as of the Courts order, the government does have the ability to file an interlocutory appeal challenging the Courts decision. If the government does appeal and is successful, then the District Courts preliminary injunction will be vacated. A similar situation arose in Sherley v. Sebelius, a case involving a challenge to federal funding for stem cell research. In that case, the plaintiffs were granted a preliminary injunction to prevent the NIH funding guidelines from taking effect. However, as we previously reported, the D.C. Circuit vacated the preliminary injunction on appeal and remanded the case to the district court for resolution on its merits.

The practical effect of a successful government appeal would be that, although tobacco companies would still be able to challenge the FDAs rule on the merits, the companies would still have to comply with the FDAs new labeling requirements starting September 2012.

Fuerst Ittleman will continue to monitor the progress of this lawsuit and the FDAs regulation of tobacco products and advertising. For more information, please contact us at contact@fuerstlaw.com.

GlaxoSmithKline Agrees to Pay $3 Billion over Avandia Marketing

Thursday, November 10th, 2011

On November 3, 2011, GlaxoSmithKline (GSK) agreed to a settlement with the U.S. Department of Justice (DOJ) for a record-breaking $3 billion. The settlement, which is expected to be finalized in early 2012, involves multiple civil and criminal claims filed against GSK for the alleged off-label marketing of its widely controversial diabetes drug Avandia. In particular, the government alleged that GSK had illegally marketed Avandia for uses that were not approved in the products labeling.

The governments prohibition of “off-label” marketing, or promoting a drug for uses other than those approved by the U.S. Food and Drug Administration (FDA), is a highly-contentious issue. While it is widely accepted that licensed practitioners may prescribe drugs for uses other than those approved by the FDA, drug manufacturers are prohibited from marketing such uses, even where the new uses show no signs of adverse events. However, although the FDA views its prohibition on off-label promotion as well-settled, challenges by drug manufacturers have called the legal grounding of this prohibition into question. Recently, various pharmaceutical manufacturers have brought challenges against the FDA regarding restrictions on off-label promotions, arguing that the prohibition violates the First Amendment. In addition, as previously reported, drug manufacturers petitioned the FDA in July 2011 requesting that the Agency solidify its stance on off-label marketing by promulgating regulations and publishing other guidance in this area.

For more information on FDA regulations and acceptable pharmaceutical marketing practices please contact us at contact@fuerstlaw.com.

Third Circuit Court of Appeals Reverses Tax Court in Sunoco Inc. v. Commissioner of Internal Revenue

Tuesday, November 8th, 2011

Last month, the Third Circuit reversed the judgment of the Tax Court which held that the Tax Court had jurisdiction over Sunoco’s claim that it was entitled to interest on tax overpayments. In reversing the decision of the Tax Court, the Third Circuit held that either the U.S. District Courts or the Court of Federal Claims have jurisdiction over claims that the United States owes interest on overpayments.

The relevant facts are as follows:  On July 1, 1997, the IRS issued a notice of deficiency to Sunoco for the tax years 1979, 1981, and 1983. The IRS claimed deficiencies of income tax in the amounts of $10,563,157.00, $5,163,449.00, and $35,916,359.00 respectively, for a total amount of $51,642.965.00. Sunoco responded to the notice of deficiency by filing a timely petition in the Tax Court in which it contested the IRS determination of deficiencies for 1979, 1981, and 1983. It also asserted that it had made income tax overpayments for those years totaling $46,100,857.00. Sunoco sought a refund of the overpayment together with interest.

Thereafter, in November of 1997, Sunoco amended its petition to add, inter alia, allegations relating to certain errors that Sunoco claimed the IRS had made in computing underpayment and overpayment interest. Sunoco alleged that for each of the disputed years, the interest the IRS had charged on underpayments pursuant to I.R.C. § 6601 was too high, and the interest the IRS had paid to Sunoco on overpayments pursuant to I.R.C. § 6611 was too low.

In March of 2000, the IRS moved to dismiss Sunoco’s amended petition to the extent that it asked the Tax Court to order the IRS to pay additional overpayment interest under I.R.C. § 6611. The IRS contended that Sunoco’s claims for overpayment interest for the taxable years 1979, 1981, and 1983 must be dismissed for lack of jurisdiction [because] the Tax Court does not have jurisdiction to determine the amount of interest due on overpayments allowed prior to the commencement of the case.

In an opinion dated February 4, 2004, the Tax Court denied the IRS motion to dismiss, holding that it had jurisdiction to determine interest with respect to overpayments where the overpayments and interest on overpayments had been refunded to the taxpayer or otherwise credited to the taxpayer’s account before the case arrived in the Tax Court. Sunoco, Inc. and Subsidiaries v. Commr of the IRS, 122 T.C. 88 (2004). A full copy of the Tax Court decision can be found here.

In overturning the decision of the Tax Court, the Third Circuit discussed the two types of interest, interest on tax underpayment and interest on overpayments.  Interest on tax underpayments is known as deficiency interest.  See I.R.C. section 6601.  Interest on overpayments is known as overpayment interest.  See I.R.C. section 6611.  The Tax Court has jurisdiction to determine interest on underpayments (deficiency interest).  See I.R.C. section 6512(b).  However, a claim for overpayment interest is a general monetary claim against the United States, which (like all such claims) must be brought in the federal district courts or the Court of Federal Claims within the six-year limitations period set forth in 28 U.S.C. §§ 2401 (district court) and 2501 (Court of Federal Claims). Consequently, the Third Circuit reversed the Tax Court’s decision that it had the requisite decision to hear Sunoco’s claim that it was entitled to interest on tax overpayments.

The significance of this decision is that a taxpayer must properly ascertain what time of interest deficiency vs. overpayment is involved in a particular dispute.  Failure to properly bring an action in the appropriate court could lead to a case being dismissed for lack of jurisdiction.  Moreover, if a case is brought in the wrong court, by the time a decision is rendered it may be too late to refile with the appropriate court.

A full copy of the Third Circuit’s decision can be found here

The attorneys at Fuerst Ittleman, PL have extensive experience litigating against the government in the Tax Court, the District Courts, the Court of Claims, and the Circuit Courts.  You can contact at contact@fuerstlaw.com.

Office of Financial Regulation’s MSB Facilitated Workers’ Compensation Fraud Work Group Issues Report and Recommendation to Florida House; Draws Criticism from Legislators.

Friday, November 4th, 2011

On November 2, 2011, Floridas Office of Financial Regulations “MSB Facilitated Workers Compensation Fraud Workgroup” presented its much anticipated report and recommendations to the Florida House of Representatives Insurance and Banking Subcommittee. The report focused on recommendations for combating workers compensation fraud facilitated by Florida check-cashers. A copy of the report and recommendations can be read here.

As we previously reported, on August 2, 2011, the Financial Services Commission of the Florida Office of Financial Regulation (“OFR”) issued a report to Governor Rick Scott and his Cabinet regarding workers compensation fraud in the State of Florida. The cabinet report revealed that money services businesses have played an active, critical, and sometimes unknowing part in defrauding the workers compensation insurance market. A complete overview of the fraud scheme can be read here.

At that time, Florida C.F.O. Jeff Atwater announced the creation of a workgroup to study the issue of MSB facilitated workers compensation fraud and to make recommendations to combat the issue. Over the next several months, the workgroup met four times to analyze ways to combat the fraud scheme and develop comprehensive reforms. The November 2, 2011 presentation of the workgroups report and recommendations was the product of these meetings.

The workgroup provided several consensus recommendations to combat MSB facilitated workers compensation fraud. First, the workgroup called for the creation of a real-time database for check cashing transactions above $1,000. The workgroup reasoned that because shell corporations which drive workers compensation fraud incorporate and dissolve quickly, time is of the essence in detecting a fraud scheme. A real-time database would provide the OFR with the amount of the cashed check, the cashing entitys workers compensation policy number and other information currently required to be within a check cashers electronic logs. OFR would then compare this information with the amount of payroll reported to the insurer, thus indicating potential fraud schemes when reported payroll and total amounts of checks cashed differed.

The workgroup also recommended that that OFR be given the authority to make unannounced visits to inspect MSBs. Currently, Florida law prohibits unannounced visits and requires that OFR provide at least 15 days notice prior to inspection. See § 560.109, Fla. Stat. As explained by the workgroup, “the announcement of an exam or investigation allows unscrupulous licensees to hide, destroy, or otherwise tamper with the evidence that the [OFR] may collect in the course of the visit.”

The workgroup also recommended that the Legislature require licensed check cashers to provide the workers compensation policy number, under which a corporate payment instrument is cashed, to the OFR. This requirement would allow the OFR to compare estimated payroll reported on the policy with the amount and number of checks that are cashed for a policyholder and will enable regulators to more readily identify premium avoidance schemes.

Other consensus workgroup recommendations included: 1) requiring the Division of Workers Compensation to include payroll information of policy holders on its proof of coverage website; 2) modifying the check cashing statute, found at § 560.303, Fla. Stat. et seq., to require licensees to maintain a depository bank account for the purpose of negotiating all cashed checks in order to simplify audit trails; and 3) eliminating the mandatory six-month examination of new licensees, but still require examination “as soon as practicable” to allow OFR to focus regulatory resources on high priority cases.

The workgroup also provided several other recommendations which were not fully supported by the workgroup. The non-consensus recommendations included: 1) eliminating the ability to cash checks when the payee is a corporate entity or a third-party or set a threshold limit for the dollar amount allowable for such checks to be eligible for cashing; and 2) changing how certificates of insurance are issued by requiring that certificates be issued by the OFR.

Although the workgroup presented a host of recommendations, its inability to reach consensus on all recommendations drew criticism from subcommittee members. Additionally, the workgroups report drew criticism from some subcommittee members because the representatives did not feel the recommendations went far enough.

Fuerst Ittleman will continue to monitor this situation with a keen eye as implementation of the workgroups recommendations could result in changes to regulatory compliance for the Florida MSB industry. If you have questions pertaining to Floridas Office of Financial Regulations, the BSA, anti-money laundering compliance, or how to ensure that your business maintains regulatory compliance at both the state and federal levels, please contact us at contact@fuerstlaw.com

Senate Bill Seeks to Reinforce Least Burdensome Provisions for Medical Device Review

Wednesday, November 2nd, 2011

On October 13, 2011, Senator Amy Klobuchar introduced a bill before the United States Senate, entitled the “Medical Device Regulatory Improvement Act.” Found here, the bill is aimed at amending the Federal Food, Drug and Cosmetic Act (FDCA) in an effort to increase efficiency in the way medical devices are reviewed by the U.S. Food and Drug Administration (FDA). In particular, the bill seeks to require the FDA to consider alternative ways of determining device safety and effectiveness, by requiring the agency to consider “alternatives to randomized, controlled clinical trials, such as the use of surrogate endpoints.” Additionally, the bill states that the FDA “shall not request information unrelated or irrelevant to a demonstration of reasonable assurance of device safety and effectiveness.” While the FDA often requests that manufacturers provide clinical data and other documentation under what it characterizes as “related to safety and effectiveness,” it is unclear how the bill would change the way the FDA reviews medical devices in practice.

As we previously reported, another bill proposing to change the way medical devices are reviewed was recently introduced before the U.S. House of Representatives. Similar to the bill proposed by Senator Klobuchar, the House bill is aimed at increasing the efficiency of FDAs review process. However, the Senate bill differs inasmuch as it focuses primarily on expediting review for devices following the premarket approval (PMA) and 510(k) clearance pathways. Although the “Least Burdensome” provisions – the portion of the FDCA that the Senate bill seeks to change – have been in place since the passage of the FDA Modernization Act of 1997, many in the industry have found that the provisions have little effect on the FDA review process. Thus, many are hoping that the passage of the Senate bill will lead to greater efficiency by lessening the burden on manufacturers during the medical device review process.

These proposals to update FDAs medical device review process are largely a result of the report recently released by the Institute of Medicine (IOM). Published on July 29, 2011, the IOM Report contained various recommendations for the FDA in relation to its medical device review process. As we previously reported, the IOM particularly took issue with FDAs 510(k) review process, recommending that the system undergo a complete overhaul.

Fuerst Ittleman will continue to monitor the developments and changes to FDAs medical device review process. For more information, please contact us at contact@fuerstlaw.com.

Second Circuit Overturns Conviction for Violation of Iranian Transactions Regulations and Operation of an Unlicensed Money-Transmitting Business

Wednesday, November 2nd, 2011

On October 24, 2011, the United States Court of Appeals for the Second Circuit issued its decision in United States v. Banki overturning the conviction of Mahmoud Reza Banki for violating trade sanctions with Iran and operating an unlicensed money-transmitting business. In this case, authorities alleged that Banki violated the ITR and 18 U.S.C. § 1960, which prohibits the operation of unlicensed money-transmission businesses, for his role in 56 money transfers to Iran through the informal money transmission system known as “hawala” which is widely used throughout the Middle East and South Asia. In the hawala system funds are transferred from one country to another through a network of hawala brokers known as “hawaladars.”

As previously reported, the ITR, which are found at 31 C.F.R. part 560, were promulgated pursuant to the International Emergency Economic Powers Act and are administered by OFAC.  31 C.F.R. § 560.204 prohibits the exportation, reexportation, sale, or supply, directly or indirectly, from the United States, or by a United States persons, of any goods, technology, or services to Iran unless “otherwise authorized” in 31 C.F.R. part 560. Pursuant to 17 U.S.C. § 1705, persons who willfully violate the ITR are subject to criminal penalties.

There are numerous forms of hawala but the two discussed by the Court were the “paradigmatic” system and the “match” system. The “paradigmatic” system works as follows: person 1 located in country A who wants to send money, for example $100, to person 2 in country B would contact a hawaladar located in country A and would pay the country A hawaladar the $100. Next the country A hawaladar would contact a country B hawaladar and ask the country B hawaladar to pay $100 in country Bs currency, minus any fees, to person 2. In the future, when country B hawaladar needs to send money to country A, he will then contact the country A hawaladar, with whom he now has a credit because of the previous transaction, and the country A hawaladar will complete the transaction. Normally, a number of transactions must be completed in order to balance the books between the two hawaladars and periodic settlement of the imbalances occurs via wire transfers or more formal money transmission methods. In this way, people can remit money to others without any actual money crossing the border between country A and country B.

The “match” system works on a similar premise. Under the match system, country As hawaladar seeks out a country B hawaladar looking to transmit money to a third party in country A. Once a “match” occurs, country Bs hawaladar would pay person 2 and then, upon knowledge of payment to person 2, country As hawaladar would pay the third party. Hawaladars derive their profits from the difference in the “buy” and “sell” exchange rates on completed transactions.

The use of the hawala system in the United States to remit funds to and from Iran is problematic for several reasons. First, transferring funds through a hawala qualifies as “money transmitting” under 18 U.S.C. § 1960. Therefore, hawaladars, which typically operate without licenses, are operating illegal money transmitting businesses and are thus in violation of 18 U.S.C. § 1960. As such, U.S. patrons of hawaladars may also be charged for using hawala in the U.S. Second, because money transmission is considered a “service” under the ITR, it is a violation of the Iranian sanctions to transfer money to Iran unless the transfer arises as part of an underlying transaction that is not prohibited.

In Bankis case, authorities alleged that Bankis family members in Iran engaged in 56 money transfers using a match hawaladar to transfer assets to Banki in the United States. Authorities further alleged that for each deposit made into Bankis U.S. bank account, a corresponding payment was sent to Iran for a third party. Additionally, although the funds being transferred into Iran were not Bankis, authorities alleged that Banki knew that for each deposit he received there was a corresponding payout in Iran. Thus, based on this knowledge, authorities alleged that Banki facilitated an American hawaladar in violating the IRT and in operating an unlicensed money-transmitting business.

Authorities charged Mr. Banki with: 1) conspiring to violate the ITR and operate an unlicensed money-transmitting business; 2) violating or aiding and abetting the violation of the IRT; 3) conducting or aiding and abetting the conduct of an unlicensed money-transmitting business; and 4) two counts of making materially false representations in response to an OFAC administrative subpoena. In May of 2010, Banki was found guilty of all counts and was sentenced to 30 months imprisonment and ordered to forfeit $3.4 million.

On appeal, Banki argued his conviction should be overturned for several reasons. First, Banki argued that executing money transfer to Iran on behalf of others only violates the ITR if undertaken for a fee. Second, he argued that even if hawala transfers are considered a service, non-commerical remittances, including family remittances like the ones in this case, are exempt from the service ban. Third, Banki argued his aiding and abetting of an unlicensed money transmitting business should be overturned because the trial court failed to instruct the jury that participation in a single, isolated transmission of money does not constitute a money transmission business.

In its decision, the Second Circuit provided a detailed analysis of Bankis arguments which will guide future IRT and 18 U.S.C. § 1960 cases. First, the Court found that because the IRT was designed to be a broad and overinclusive sanctions scheme designed to isolate Iran, “the transfer of funds on behalf of another constitutes a Ëœservice even if not performed for a fee.”

Although money transmittal for no fee is still considered a “service” under the ITR, the Court went on to find that 31 C.F.R. § 560.516, which provides that non-commercial remittances, such as family remittances, are exempt from the services ban, is ambiguous as to whether it applies to all instances of non-commercial remittances or only those which take place in depository institutions. In so holding, the Court found that the governments argument that U.S. depository institutions have exclusive authority to process family remittances is inconsistent with the language of the regulation. However, the Court also found that, based on the statutory and regulatory sanctions scheme in place, Bankis argument that anyone, including hawalas, could process a non-commercial remittance is inconsistent with the ITR scheme as a whole. Thus, based on the ambiguity of the breadth of the non-commercial remittance exemption, the Court overturned Bankis convictions for conspiracy and violations of the ITR.

The Court also vacated Bankis conspiracy and aiding and abetting of an unlicensed money transmitting business and remanded for a new trial. In so ruling, the Court agreed with Banki and stated that “to find a defendant liable for operating [or aiding and abetting] an unlicensed money transmitting business, a jury must find that he participated in more than a Ëœsingle, isolated transmission of money.” The Court found that because the evidence presented at trial only showed Bankis knowledge of “match” funds moving to Iran in one transaction, a jury instruction stating that participation in a single, isolated transmission of money does not constitute a money transmission business was appropriate. The trial courts failure to provide the jury with such an instruction was reversible error.

The Second Circuit further held that the lower court also erred in instructing the jury that hawala is both an informal money transfer system and a money transmitting business. The Court found that by so instructing the jury, the district court relieved the government of its burden of proving that Banki had knowledge that more than one transmission had occurred. As explained by the Court, “by later instructing the jury that Ëœa hawala is a money transmission business, the district court arguably was instructing the jury that if it found that Banki operated a hawala, then he necessarily operated a money transmitting business, thereby taking the latter issue away from the jury.” Thus, the Second Circuits opinion distinguishes between the use of a system of money transmission and the operation of a money transmission business.

Although the Court overturned Bankis convictions for conspiracy and aiding and abetting, it disagreed with Bankis argument that he was entitled to an “mere customer or beneficiary” instruction. In his appeal, Banki argued that he should not be held liable for conspiracy or adding and abetting because he was “mere customer or beneficiary” and thus exempt from criminal liability. However, the Court found that Banki was charged with aiding and abetting the facilitation of funds to Iran and not with receiving funds from Iran. Thus, because Banki was charged as the facilitator of the transfer he was an intermediary, not a customer, and thus the instruction would be inappropriate. As explained by the Court, “put simply, where the crime charged is transmitting money to Iran without a license, the Ëœcustomer is the wire originator and/or the intended recipient” not the intermediary.

The opinion is noteworthy not only because it is illustrative of the potential criminal charges Iranian sanction violators may face, but also because of the Courts detailed analysis of the Iranian Transactions Regulations (“ITR”) and the federal money transmitting laws. If you have questions pertaining to the OFAC sanctions on trade with Cuba and Iran, the BSA, anti-money laundering compliance, or how to ensure that your business maintains regulatory compliance at both the state and federal levels, please contact us at contact@fuerstlaw.com.