Know Your Customer: OFAC, BIS Penalize Companies for Sales of “EAR99” Items and Services to Prohibited Parties Through Distributors

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The U.S. government recently took action in two cases against companies for exports to distributors that resold their products to prohibited parties. The products at issue in both cases are designated "EAR99," which is a broad catch-all category for commercial items that are not specifically listed on any U.S. export control list. As explained below, the regulatory agencies imposed significant penalties even though the items at issue were not sensitive and the sales were made through distributors.

Commerce Penalizes Semiconductor Industry Supplier

The U.S. Commerce Department's Bureau of Industry and Security (BIS) entered into an agreement with Dynatex International, Inc. (Dynatex), a California-based semiconductor equipment and materials company, to settle a charge of conspiracy to illegally export a scribe and break tool (used in semiconductor manufacturing to dice materials), as well as associated consumables and accessories, to two Chinese entities that are on BIS's "Entity List." (15 C.F.R. Part 744, Supp. 4.)

The Entity List is a list of foreign businesses, government entities, other public and private organizations, and individuals that BIS has identified as engaging in activities contrary to U.S. national security and/or foreign policy interests. BIS has recently increased its use of the Entity List as a foreign policy tool to address Chinese human rights abuses and "destabilizing military modernization efforts," among other issues.1 Listed entities are subject to stringent export licensing requirements for even the most basic items.

According to the settlement agreement, Dynatex was informed that at least one of the Chinese entities was on a "black list," but erroneously believed that they could continue with the transaction because they were selling the products to a distributor rather than directly to the listed entity. Dynatex also reportedly believed that license requirements would not apply to consumables and accessories. Dynatex therefore neither applied for nor obtained the required export licenses.

Under the settlement agreement, Dynatex was assessed a penalty of $469,060, which is twice the value of the exported commodities. Dynatex is required to pay $50,000 within 30 days of the order. The remainder of the penalty is suspended on condition that Dynatex commit no other export violations for one year or is acquired by a company that has a robust export compliance program.

OFAC Penalizes Video Technology Company

A Texas company that sells video production technology and services has settled charges related to violations of the U.S. Iranian Transactions and Sanctions Regulations (ITSR). The U.S. Treasury Department's Office of Foreign Assets Control (OFAC) announced last week that NewTek, Inc. agreed to pay $189,483 to settle potential civil penalties relating to sales to third-country distributors that it knew or had reason to know were specifically intended for companies and individuals in Iran. NewTek reportedly entered into agreements with distributors in France and the UAE that authorized sales to an Iranian reseller. NewTek also reportedly provided software updates, reseller training, or other support to customers in Iran.

The ITSR are part of the set of regulations that impose comprehensive sanctions on Iran. Among other things, the ITSR generally prohibit direct or indirect sales to Iran, including sales to a person in a third country if you know that the items are destined for Iran. (See 31 C.F.R. Pt. 560.)

If NewTek had not voluntarily disclosed these violations, OFAC could have imposed a penalty of over $15 million. As a result of the self-disclosure and the overarching facts of the case, OFAC considered this case to be "non-egregious," with a maximum penalty of just under $300,000. OFAC further reduced the penalty because NewTek is a relatively small company, had not previously been penalized by OFAC, fully cooperated in the investigation, and took several remedial actions. Most notably, NewTek established an export controls and sanctions compliance program, provided training to its employees, implemented restricted party list screening for its product registrants and distributors, and implemented geo-IP blocking measures to prevent persons in sanctioned countries from downloading or registering its products.

Conclusion

The key takeaway from these cases is the importance of knowing your customers, including the ultimate end-users of your products, even when your products are not particularly sensitive. The items exported by NewTek and Dynatex are not subject to licensing requirements unless they are exported to an embargoed or sanctioned country or person, or for a prohibited end-use or to a prohibited end-user. The exports in both cases nevertheless required a license because the transactions involved prohibited parties. These cases also highlight the importance implementing an export compliance program. NewTek's penalty was substantially reduced because it implemented a compliance program. Similarly, Dynatex can avoid the bulk of the suspended penalty if it is acquired by a company with a robust compliance program.

In sum, companies should tread carefully when expanding their business to global markets. Before you start exporting, make sure you understand with whom you can do business and what processes you need to put in place to be compliant with export control regulations.


[1] See, e.g., Commerce Department Adds 34 Entities to the Entity List to Target Enablers of China’s Human Rights Abuses and Military Modernization, and Unauthorized Iranian and Russian Procurement (July 9, 2021); Commerce Adds Seven Chinese Supercomputing Entities to Entity List for their Support to China’s Military Modernization, and Other Destabilizing Efforts (Apr. 8, 2021); Commerce Department Further Restricts Huawei Access to U.S. Technology and Adds Another 38 Affiliates to the Entity List (Aug. 17, 2020); Commerce Addresses Huawei’s Efforts to Undermine Entity List, Restricts Products Designed and Produced with U.S. Technologies (May 15, 2020); Addition of Entities to the Entity List, 84 Fed. Reg. 22,961-68 (May 21, 2019) (revising 15 C.F.R. Pt. 744 to add Huawei Technologies Co., Ltd. and its non-US affiliates to the Entity List).

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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