Perils Of The Global Supply Chain Series, Part 3: Groundbreaking ‘Honey Laundering’ Sting Signals New Era In Supply Chain Enforcement

http://www.perkinscoie.com/files/ImageControl/50ea3c09-e852-4016-8c73-e51913d7492b/7483b893-e478-44a4-8fed-f49aa917d8cf/Presentation/Image/CSR.jpgSupply chain compliance is on the government’s enforcement radar like never before.  If the recent Executive Order on Trafficking in Government Contracts and final SEC Conflict Minerals Rules were not notice enough, the Department of Justice’s  (DOJ’s) February 20, 2013 announcement of headline-grabbing charges against the two largest domestic honey processing companies eliminates any doubt that companies must carefully examine the effectiveness of their existing supply chain compliance programs.

As the DOJ press release noted, Texas-based Honey Holdings, doing business as Honey Solutions, and Michigan-based Groeb Farms, as well as five individuals, were charged criminally following an interagency global “honey laundering” sting.  The detailed charges allege not only the record-breaking illegal importation of honey from China without paying antidumping import duties, but also the introduction into commerce of adulterated honey.  As of today, the two charged companies entered into Deferred Prosecution Agreements (DPAs); of the five charged individuals, three defendants have pled guilty and are awaiting sentencing, one is a fugitive and one is awaiting trial.

This exceptional case is not only the largest anti-dumping case in U.S. history, but also the nation’s largest food-fraud case, shattering the prior record of about $80 million set by the same enforcement team some two years earlier.  Not only did the defendants allegedly mislabel honey to avoid more than $180 million in antidumping duties, but they also imported and sold honey adulterated with unapproved antibiotics. But the real story may be what this case signals about the federal government’s amplified focus on supply chain compliance—and the lengths it will go to in its efforts to bring a case.

Import Restrictions on Foreign Honey

In 2001, the U.S. Department of Commerce determined that honey from China was being sold in the U.S. at less than fair market value.  In response, the government implemented antidumping laws imposing hefty duties on Chinese-origin honey

Some companies, however, sought to illegally work around the antidumping laws, using one or more of three separate strategies: (1) mislabeling honey as sugar, molasses or another similar product; (2) mislabeling honey coming directly from China as coming from another country; or (3) transshipping honey from China through another country and claiming it as the country of origin.  (Notably, Honey Solutions and Groeb Farms are charged with knowingly buying honey that illegally entered the country in avoidance of applicable antidumping duties under all three of these strategies.) 

Meanwhile, in 2002 the Food and Drug Administration issued an alert for honey containing the antibiotic Chloramphenicol, which is used to treat serious infection in humans, but is not approved for use in honey.  Honey containing the antibiotic is considered to be “adulterated.”  (Honey Holdings is charged with knowingly importing and distributing such adulterated honey from Poland.) 

Key Points from the Government’s Honey Laundering Sting

  • Supply Chain Audits Were Performed . . . and Corporate Executives’ Failure to Adequately Address the Results Led to Corporate Criminal Liability.

The two charged companies—Groeb Farms and Honey Solutions—rank among the world’s largest honey processors, selling honey to the industrial, retail and foodservice sectors.  The individual defendants, in turn, are executive-level food brokers and distributors.  The government alleges that from 2008 through 2012, Groeb Farms implemented first-party onsite supply chain audits and inspections of manufacturers and suppliers to insure compliance with all laws, including honey import laws.  The government says these detailed audits raised substantial concerns that honey from overseas suppliers was illegally transshipped and misdeclared.  One supplier even refused auditors access to facilities (a classic supply chain “red flag”).

Despite these clear warning signs signaling significant supply chain problems, Groeb Farms continued to buy honey sourced from these suppliers.  Executives, indeed, even went so far as to knowingly provide false information to their Board of Directors and to market and promote the company’s business practices as compliant with applicable laws.   

The company’s failure to conduct meaningful supply chain due diligence, its executives’ willful blindness toward evidence of illegality, and the resulting cover-up, resulted in the current charges. 

  • Responsible Corporate Executives Were Charged Individually.

In a rare move, the government, as noted above, entered into two deferred prosecution agreements with Groeb Farms and Honey Holdings (and only assessed $2 million and $1 million, respectively, in fines based on both companies’ ability to pay) while simultaneously charging five individuals (one of whom is a Canadian citizen) for their roles in the illegal business schemes. 

This case, therefore, stands in stark contrast to the DOJ’s trend of entering into deferred prosecution agreements with companies while leaving the individuals who actually engaged in the illegal conduct uncharged.  

  • The Government Used an Undercover Agent Inside a Company.

In 2011, Honey Holdings began cooperating with the government in its efforts to identify others engaged in illegal importing.  This included the placement of an undercover law enforcement officer in Honey Holdings as its “Director of Procurement.”  But unlike other cases, this undercover officer was not inserted in a government-created undercover company.  Rather, the undercover officer was placed into a real operating company unaffiliated with the government. 

This style of sophisticated, aggressive and proactive investigation was once the sole province of narcotics and organized crime cases.  If this case is any indication, this may well be a sign of things to come in this area. 

  • Mandatory Corporate Compliance Program for the Corporate Defendants Parallel SEC Conflict Mineral Rules.   

In addition to other significant concessions common in a white collar case—such as promising to cooperate fully with the federal government, producing all documents requested, making employees available for testimony, voluntarily disposing of the illegal honey and paying millions of dollars in fines—Groeb Farms and Honey Holding agreed to implement corporate compliance programs as part of their respective deferred prosecution agreements.  

More specifically, under the agreed-to compliance programs, the companies must conduct “reasonable country-of-origin and supply chain inquiries” —thereby adopting a standard similar to the SEC’s recently released final Conflict Minerals Rules. Significantly, as part of its risk assessment—and in what appears to be a first-of-its-kind provision—the companies are required to conduct diligence on their suppliers by performing supply chain audits.  Key criteria of the audits include “the willingness and extent of access granted for the audits; thoroughness, scope, and frequency of the audits; and the training, expertise, and credibility of the auditor.” 

The mandated compliance program also requires the companies to educate their customers regarding (1) their policies on traceability and (2) food laws—requirements evocative of the disclosures required by other “hot topic” supply chain compliance laws and regulations, including the president’s September 25, 2012, Executive Order on Trafficking in Federal Contracting, the California’s Transparency and Supply Chains Act, and the pending Business Transparency on Trafficking and Slavery Act (H.R. 2759).  

The Lesson: Supply Chain Compliance Is Serious Business—and the Government Is Starting to Treat it as Such

As previous client Updates have advised, companies should understand and mitigate the various subject-specific risks their supply chains expose them to.  Because responsible, practical solutions to these challenges are as varied as the companies that must adopt them, companies should consult with experienced counsel to:

  1.  Understand (and Begin to Reduce) Your Risk Profile

Conduct an initial mapping and risk-based analysis of your supply chain.

Understand your responsibility.  Transaction/business partners such as suppliers, distributors, agents, consultants and customs expediters are responsible for the bulk of compliance risks (particularly in the developing world). 

Be aware of your supply chain.  Suppliers who engage in trafficking or bribery likely also violate other human rights, social and environmental laws and regulations and will deceive customers.

Identify, rank and address discrete areas of greatest subject-specific vulnerability.

Conduct targeted due diligence on, and vetting of, potential “risk-aggravating” transaction partners to help avoid problems at the outset.

Root out bad actors through professional vetting and due diligence.

Control “marginal” actors through effective and focused training.

Bring your code and tailored executive oversight and training in line with best practices.

Remove bad employees and educate those on the margins.

Conduct targeted predeal due diligence.  

          2.  Be Prepared to Address Problems

Understand and respond to the spectrum of significant risks: governmental intervention; consumer boycotts; class actions; and advocacy group pressure.

Be able to demonstrate effectiveness of efforts to government(s), consumers, shareholders and advocates.

Have a sound hotline reporting system in place.

Have experienced counsel available 24/7 to answer questions and hotline reports, address time-sensitive issues and appropriately escalate any more serious issues.

Develop an integrated crisis response approach.

Respond to allegations of serious misconduct by conducting a practical phased internal investigation.

The DOJ’s honey-laundering indictments provide companies with complex supply chains an even greater incentive to conduct appropriate due diligence and ensure that their audit results are taken seriously.  The government has put companies on notice that supply chain audits originally intended as corporate shields to liability may now serve as the government’s sword to convict the corporation if the audit results are ignored or not taken seriously.

Topics:  Antidumping Duties, China, Compliance, Deferred Prosecution Agreements, DOJ, Food Contamination, Illegal Imports, Risk Assessment, Supply Chain

Published In: Business Organization Updates, General Business Updates, Criminal Law Updates, International Trade Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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