The article by counsel Michael Casey and associates Brendan Hanifin and Emerson Siegle was originally published in Law360 on March 10, 2017.

On March 7, 2017, China-based telecommunications giant Zhongxing Telecommunications Equipment Corp. entered into settlement agreements with multiple U.S. regulators to resolve alleged violations of U.S. sanctions and export control laws, agreeing to pay a combined penalty of $892 million. The combined penalty, which is subject to court approval and would balloon to $1.19 billion if ZTE violates the terms of its settlement agreements, would represent the largest fine and forfeiture imposed to date in an export control case. This article provides an overview of the ZTE settlements and discusses what the combined resolution may portend for future sanctions and export control enforcement.

Background

Factual Background

Collectively, the settlements allege that, from 2010 through mid-2016, ZTE implemented a company-wide strategy to evade U.S. economic sanctions and export control laws by building, operating and servicing telecommunications networks in Iran using U.S.-origin equipment and software. ZTE ordered, transferred and facilitated the delivery of U.S.-origin goods valued at nearly $40 million, including nearly 275,000 items that were controlled for export by the Export Administration Regulations (“EAR”) for national security, encryption, regional security or anti- terrorism reasons. The U.S. Department of Commerce’s Bureau of Industry and Security (“BIS”) alleged that ZTE also sent 283 shipments of controlled items to North Korea in contravention of the EAR. ZTE took various steps to conceal its unlawful conduct, including (1) designating Chinese intermediary companies as the shippers on internal paperwork; (2) commingling U.S.- origin items with non-U.S. origin items; (3) omitting U.S.-origin items from packing lists and other shipping documentation; and (4) using code names for — and deleting references to— Iran and Iranian customers in internal communications.

In March 2012, Reuters reported on ZTE’s dealings with Iran, including the company’s contract with the Telecommunication Company of Iran (“TCI”) and a 907-page ZTE packing list that included U.S.-origin items. In addition, ZTE came under investigation by the House Select Committee on Intelligence, the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”), and other agencies. Around that time, ZTE claimed that it had ceased performance of its contract with TCI and reported that it had wound down all re-exports of U.S.- origin goods to Iran. However, the U.S. government claimed that ZTE’s suspension of activities with Iran was only temporary. In November 2013, ZTE allegedly resumed its dealings with Iran and took deliberate steps to conceal its conduct, including (1) trans-shipping goods destined for Iran via an intermediary in China; and (2) instructing IT personnel to alter or remove references to Iran in the company’s internal databases.

Overview of Settlement Agreements

To resolve its potential liability, ZTE entered into coordinated settlement agreements with BIS, OFAC and the U.S. Department of Justice.

BIS: ZTE agreed to pay a civil penalty of $661 million, with $300 million suspended during a seven-year probationary period, for violating the EAR in connection with its dealings with Iran and North Korea. This civil penalty is the largest monetary fine that BIS has ever imposed on a party for export control violations.

OFAC: ZTE agreed to pay a civil penalty of $100,871,266 for committing 251 apparent violations of the Iranian Transactions and Sanctions Regulations. The penalty amount falls just below the statutory maximum of $106,180,280 and is the largest settlement that OFAC has entered into with a nonfinancial entity for sanctions violations.

DOJ: ZTE agreed to plead guilty to one count of conspiring to violate the International Emergency Economic Powers Act (“IEEPA”), one count of obstruction of justice, and one count of making a material false statement to federal investigators. ZTE agreed to pay a fine of $286,992,532, a criminal forfeiture in the amount of $143,496,266, and a special assessment of $1,200. In addition, ZTE is required to retain an independent corporate compliance monitor to review and report on the company’s export compliance program. If approved by the court, the criminal fine of over $286 million would represent the largest criminal fine levied in connection with an IEEPA prosecution.

Economic Sanctions and Export Control Enforcement In The Wake Of ZTE’s Settlement

Iran-Related Enforcement Remains a Top Priority

The ZTE settlements illustrate that the U.S. government remains committed to enforcing existing economic sanctions and export control laws targeting Iran. Despite relaxation of certain U.S. sanctions pursuant to the Joint Comprehensive Plan of Action (“JCPOA”), Iran continues to be perceived as a significant national security threat to the United States. Consistent with this sentiment, four out of the five civil penalties announced by OFAC in 2017 have involved alleged violations of the Iranian sanctions. In addition, recent reports suggest that the Trump administration specifically identified the ZTE case as an opportunity to secure a “quick win” in the weeks following President Trump’s inauguration and, possibly, to signal a new, tougher U.S. foreign policy.[1] Notably, in a press release issued by BIS, Secretary of Commerce Wilbur Ross commented that, “Under President Trump’s leadership, we will be aggressively enforcing strong trade policies with the dual purpose of protecting American national security and protecting American workers.”

Looking forward, the Trump administration is expected to actively “police” Iran’s compliance with the JCPOA as President Trump promised on the campaign trail. In addition, the Trump administration may continue to ratchet up U.S. sanctions — i.e., designate additional individuals and entities within and outside of Iran — in an effort to deter Iran’s ballistic missile testing. Based on the administration’s statements to date, companies that violate U.S. sanctions and export controls targeting Iran can expect to be pursued aggressively, particularly if the underlying conduct potentially implicates U.S. national security interests (as in the ZTE case).

The Trump Administration May Be Signaling a New Posture Toward China

The ZTE settlement also has the potential to place greater strain on the United States’ relationship with China. On March 8, 2016, during the pendency of its investigation, BIS added ZTE and several affiliates to the Entity List. As a result, a specific license was required for exports, re-exports and in-country transfers to ZTE of items subject to the EAR, and license requests were subject to a presumption of denial. Less than three weeks later, in an unprecedented step, BIS reversed course and issued a temporary general license that essentially authorized all exports and other transfers of items subject to the EAR to ZTE. At the time, some observers speculated that the reversal in policy was an attempt by the Obama administration to placate Chinese leadership.[2]

During his campaign, President Trump decried the impact of foreign interests on the U.S. economy and signaled changes to the United States’ policy toward China. For example, President Trump pledged to instruct the U.S. Trade Representative to pursue cases against China for unfair trade practices in U.S. courts and at the World Trade Organization. It is possible that the ZTE resolution marks the beginning of a new, more aggressive enforcement posture regarding dealings with China. Among other steps, the Trump administration may encourage increased scrutiny of transactions involving Chinese entities through the Committee on Foreign Investment in the United States and Defense Security Service review processes.

Multi-Agency Enforcement Actions Produce Massive Penalties

As is increasingly common in sanctions and export control enforcement actions, ZTE’s conduct was investigated over a multiyear period by a slew of federal government agencies acting in close coordination. In its press release, the DOJ noted that the ZTE resolution “is an excellent example of cooperation among multiple U.S. agencies to uncover illegal technology transfers and make those responsible pay for their actions.” The DOJ’s release cited cooperation by four different federal agencies (DOJ, BIS, FBI and the U.S. Department of Homeland Security). OFAC and the House Select Committee on Intelligence appear to have conducted their own investigations as well. These multi-agency enforcement actions tend to result in large settlements and present a host of logistical challenges to companies under investigation.

BIS Has Become Increasingly Aggressive in Bringing Enforcement Actions

The ZTE resolution is the latest in a string of high-profile enforcement actions in which BIS has played a more active role. Historically, BIS did not bring major enforcement actions or collect significant penalties from individuals or entities that violated export control laws. As recently as 2009, BIS investigations of export control violations netted only $455,409 in criminal fines, approximately $1.5 million in forfeitures, and just over $14.5 million in civil penalties.[3]

Over the last several years, BIS has become increasingly aggressive in pursuing export control violators and imposing significant penalties. For example, following a lengthy BIS investigation, Weatherford International agreed in 2013 to pay an administrative civil penalty of $50 million to resolve allegations that it had violated the EAR by exporting controlled U.S.- origin items to Cuba, Iran and Syria. At the time, Weatherford’s settlement was the largest penalty that BIS had ever levied. ZTE’s agreement to pay $661 million to BIS (with $300 million suspended) dwarfs the Weatherford settlement and sets a new high-water mark for EAR enforcement. The ZTE resolution also is unique in that a majority of the combined total penalty is earmarked for BIS, as opposed to another investigating agency.

Recent news reports suggest that BIS also is investigating potential export control violations involving other multinational companies. Notably, BIS’s settlement with ZTE was finalized five days after the agency’s participation in a high-profile raid of Caterpillar Inc.’s corporate offices in connection with an investigation into, inter alia, the company’s export filings involving shipments to its Swiss affiliate.

ZTE Will Incur Costs in Addition to its Settlement Payment

While the combined penalty that the U.S. government anticipates collecting from ZTE is massive, the impact (and indirect costs) of the settlement agreements’ nonmonetary requirements also are significant. Pursuant to its plea agreement with the DOJ, ZTE is required to retain an independent corporate compliance monitor for a term of up to three years. During the monitorship, ZTE will be responsible not only for its own costs (legal and otherwise), but also for the fees of the compliance monitor and his/her counsel. In addition, ZTE will be required to respond to information requests, host on-site observations and testing, and make employees available for interviews as reasonably requested by the monitor. The amount of ZTE’s combined penalty does not account for these quantifiable monitor-related expenses, much less business disruption costs.

BIS’s settlement with ZTE is arguably even more onerous. In addition to the monetary penalty levied by BIS, ZTE is subject to a seven-year probationary period, during which ZTE’s export privileges can be promptly revoked if the company fails to comply fully with all nonmonetary requirements imposed by BIS. Those nonmonetary requirements include (1) engagement of a third-party consultant to perform (and submit to BIS) six annual export control-focused audit reports; (2) agreement to comply with end use verifications, as jointly negotiated by the U.S. and Chinese governments; and (3) provision of extensive export control training to employees and affiliates (including submission of the training materials to BIS).[4]

Regulators are Eager to Punish Perceived Bad Faith by Management

The magnitude of the penalty imposed against ZTE by the U.S. government appears to be attributable to, at least in part, the efforts undertaken by historic ZTE leadership to conceal the company’s violations of U.S. sanctions and export control laws. OFAC treated the involvement of ZTE’s senior leadership and management as an aggravating factor in calculating the applicable penalty. Among other actions, OFAC alleged that ZTE leaders: (1) instructed IT personnel to sanitize references to Iran from the company’s internal records; (2) required employees to sign nondisclosure agreements related to exports to Iran that included stiff monetary penalties for violating the agreements; (3) formed a committee for the specific purpose of identifying an intermediary to facilitate indirect exports to Iran; and (4) provided incomplete information to the company’s forensic consultant, knowing that such information would eventually be shared with the U.S. government.

Cooperation Counts, and Better Late than Never

Based on the settlement agreements, it appears that ZTE did not cooperate with regulators until the late stages of the investigation. In particular, the DOJ and OFAC alleged that ZTE misled

U.S. regulators regarding the company’s resumption of dealings with Iran from early 2014 until early 2016. The DOJ and OFAC also claimed that ZTE provided incomplete information to forensic auditors engaged by the company’s outside counsel, despite knowing that the auditors’ analysis would be reported to U.S. regulators. Finally, the DOJ alleged that a ZTE in-house attorney falsely reported to U.S. regulators during a July 2015 meeting that the company was abiding by U.S. laws. Collectively, these allegations served as the basis for criminal charges for obstruction of justice and making of a material false statement, and they undoubtedly contributed to the size of the penalty sought by the U.S. government.

Even against the backdrop of these allegations of obstruction and interference, ZTE persuaded OFAC to consider the company’s cooperation as a mitigating factor in calculating the applicable penalty. In assessing ZTE’s cooperation, OFAC cited (1) the company’s agreement to enter into three tolling agreements, which collectively extended the statute of limitations for 803 days; (2) ZTE’s willingness, after March 2016, to provide documentation and make witnesses available for interviews; and (3) remedial steps taken by the company in 2016 and 2017, including implementation of a sanctions and export control compliance program.

Conclusion

The ZTE resolution demonstrates that the U.S. government is committed to active enforcement of economic sanctions and export control laws, especially where there is a perceived impact on U.S. national security interests. The Trump administration, in particular, appears interested in exhibiting American strength through regulation of non-U.S. companies, as well as aggressive enforcement of suspected violations of U.S. laws. In the current enforcement environment, companies with international operations, whether based in the United States or elsewhere, should review their economic sanctions and export compliance controls regularly, address any identified gaps, and ensure that employees possess sufficient topical familiarity to identify and report potential violations of law or company policies as they arise.