On March 7, 2017, China’s Zhongxing Telecommunications Equipment Corporation and ZTE Kangxun Telecommunications Limited, and their subsidiaries and affiliates, (collectively, ZTE), reached a historic combined $1.19 billion settlement with the US government. The settlement resolves export controls and sanctions violations related to shipments of US-origin equipment to Iran and North Korea. The company pled guilty to criminal charges, including obstruction of justice, and reached settlements with the US Department of the Treasury’s Office of Foreign Assets Control (OFAC), the US Department of Commerce’s Bureau of Industry and Security (BIS), and the US Department of Justice (DOJ), ending a long-running investigation into ZTE by the US government.
The investigation had resulted in ZTE entities being placed on the BIS Entity List in March of 2016 (on which we previously advised), which was notable due to ZTE’s size and international trading presence. ZTE is one of the world’s largest telecommunications equipment makers with operations in 160 countries and significant business relationships with major US companies. As a result of their inclusion on the Entity List, a license was required to export, re-export, or transfer (in-country) items subject to the Export Administration Regulations (EAR) to the listed ZTE entities. A license was also required for any transaction in which one of the named entities, “act[ed] as purchaser, intermediate consignee, ultimate consignee, or end user of items subject to the EAR.” However, BIS issued, and extended several times, a temporary general license to ZTE while settlement negotiations took place (on which we have also previously written). The US government used the Entity List designations, along with the temporary general license, as additional leverage to gain the company’s cooperation in resolving the matters under investigation.
The $1.19 billion penalty includes $661 million to be paid to the BIS (with $300 million suspended during a probationary period), $100.9 million to OFAC, and $430.5 million in criminal fines and forfeiture to the DOJ ($287 million in fines and $143.5 million in forfeiture). The penalty is the largest ever imposed by the BIS, the largest ever imposed by OFAC against a non-financial entity, and the largest criminal fine ever imposed by the DOJ for a prosecution under the International Emergency Economic Powers Act.
The BIS settlement agreement also requires ZTE to:
- Submit a series of audit reports on its compliance with US export controls law
- Hire an independent compliance auditor for three years
- Conduct annual meetings between representatives of ZTE and BIS
- Allow US government verification of the end-uses of items ZTE procures
- Provide enhanced compliance training to management and employees
- Operate under a suspended denial order for a period of seven years
- Continue to cooperate fully with regulators and the DOJ
The OFAC settlement agreement requires ZTE to establish and maintain a compliance program designed to minimize the risk of similar future violations.
The DOJ plea agreement requires:
- A three-year corporate probation period
- Maintenance of a compliance and ethics program aimed at preventing similar violations
- Continued cooperation with law enforcement and regulators
- An independent compliance monitor during the probation period
- Annual certifications that ZTE is in compliance with the agreement during the probation period
- The removal of four ZTE employees
From early 2010 to March 2016, ZTE allegedly engaged in a complex scheme designed to evade US export controls and sanctions and ship hundreds of millions of dollars’ worth of US-origin equipment to Iran and North Korea, including routers, microprocessors, and servers controlled under the EAR for reasons of national security, encryption, regional security, and anti-terrorism. These allegations first came to light in 2012 through media reporting. At that time, ZTE reportedly stated that it had halted these shipments, but instead allegedly began a scheme to continue this business while it remained under investigation by the US government.
Obstruction of Justice and False Statements
According to the settlement agreements, ZTE knowingly misled investigators by claiming the shipments in question had been permanently discontinued. ZTE also deleted documents and emails, and concealed information from investigators as well as their outside counsel and the forensic accounting firm that had been hired. These actions included the creation of a special team within ZTE tasked with sanitizing all materials related to Iran transactions. The responsible employees’ emails were deleted on a nightly basis and the employees were required by the company to sign non-disclosure agreements.
High-Level Executive Involvement
This scheme was known to and orchestrated by individuals at the highest level of leadership within ZTE. In early 2011, senior management directed a special project team to review ZTE’s export control risks and recommend an approach to better conceal the scheme and minimize the chance of legal repercussions. In September 2011, four ZTE senior managers drafted a memorandum laying out the company’s plan to use shell companies, or so-called “isolation companies,” to ship US items to embargoed countries. The isolation companies were designed to conceal ZTE’s involvement in the scheme and to insulate the company from legal risk. The scheme continued until March 2016 when the BIS added ZTE to the Entity List, suspending its export privileges.
Aggressive Enforcement Under the Trump Administration The ZTE settlements set a new high-water mark for financial penalties for export controls and sanctions violations. While the investigations began under the Obama administration, Trump administration officials have signaled that companies should expect to see robust enforcement efforts going forward.
The record penalty assessed in this case was due, in part, to the nature of the underlying facts. As described above, ZTE’s violations were found to be the product of a willful scheme designed by officials at the highest levels of the company. The US Government also concluded that ZTE intentionally misled investigators for years and renewed their illegal transactions even after an initial investigation began. The penalty clearly reflected that US regulators and prosecutors will crack down particularly harshly when there are findings of willful and evasive conduct, especially when such findings include obstruction of justice (i.e., evasive conduct directed at US government investigators).
Importance of Cooperation with Outside Counsel and Accounting Firms According to the US Department of Commerce (DOC) press release, ZTE hired outside counsel and a forensic accounting firm who became unwitting participants in the company’s scheme. ZTE is alleged to have deleted and concealed documents and other information in order to have their outside counsel and accounting firm affirmatively mislead US government investigators. This serves as a cautionary tale for those who hire counsel and auditors to investigate potential infractions, but who fail to cooperate in an internal investigation.
The ZTE settlements mark the end of a long and groundbreaking investigation. The case is notable due to the underlying factual findings, the manner in which the DOC used the Entity List designation and temporary license to support a resolution of the investigation, and the record-setting penalties assessed. The settlements underline the importance of having a robust compliance program that reaches the highest levels of the corporate structure. They also serve as a warning to avoid evasive behavior when dealing with federal prosecutors and regulators, as well as counsel and consultants engaged to ferret out illegal action.