In Brief

• Where goods bearing a genuine trademark are altered and resold without altering the mark itself, such conduct does not constitute trafficking in counterfeit goods. Actual use of a counterfeit mark is a necessary element of the offense under federal law.

Intellectual property crime takes numerous forms, including trafficking in counterfeit goods and counterfeit labeling. The use of fake or altered trademarks is a common problem that can be addressed under both the criminal and civil laws, as there is significant overlap between the two in this context. Surprisingly, however, the use of a genuine trademark on altered goods does not create criminal liability under current federal law. The Fourth Circuit recently held that where goods bearing a manufacturer’s genuine trademark are altered and resold without altering the mark itself, such conduct does not constitute trafficking in counterfeit goods under the Trademark Counterfeiting Act, 18 U.S.C. § 2320(a). United States v. Cone, Nos. 11-4888, 11-4934, 2013 WL 1502007 (4th Cir. Apr. 15, 2013).

United States v. Cone

Cone concerned a conspiracy to import and resell sophisticated computer networking equipment manufactured by Cisco Systems, Inc. (“Cisco”). Defendant Chun-Yu Zhao and her co-defendant, Donald Cone, operated JDC Networking, Inc. (“JDC”) as a licensed distributor of Cisco products. Cisco prohibits its licensed distributors from purchasing Cisco products outside the United States for resale within the United States. From 2004 through 2010, however, JDC imported from China and Hong Kong more than 200 shipments of counterfeit equipment as well as genuine Cisco equipment. JDC sold the imported equipment to resellers and to consumers at a significant markup over the low prices it paid for the products by purchasing them outside the United States.

Zhao and Cone were convicted on several counts of conspiracy and trafficking in counterfeit goods and labels, importation and sale of improperly declared goods, and wire fraud based on their operation of JDC. The objects of the trafficking conspiracy, according to the government, were threefold:

(1) the sale of “pure” counterfeit products, which were never made with Cisco’s authorization;

(2) the sale of relabeled or mislabeled Cisco products; and

(3) the sale of legitimate Cisco products that Zhao and Cone converted into different Cisco products but without altering the original labels (the “material alteration” theory).

The Fourth Circuit agreed with the District Court that the first two theories satisfied all the elements of criminal trafficking. The court rejected the material alteration theory, however, and vacated Zhao’s conviction for the underlying offense. The case was remanded for resentencing as to both defendants.

Section 2320 requires proof that the defendant “(1) trafficked . . . in goods or services; (2) did so intentionally; (3) used a counterfeit mark on or in connection with such goods and services; and (4) knew the mark was counterfeit.” United States v. Lam. A mark is counterfeit under Section 2320 if it is a “spurious mark,” meaning it is “identical with, or substantially indistinguishable from, a [registered] mark . . . the use of which is likely to cause confusion, to cause mistake, or to deceive.” The Lanham Act’s definition of counterfeit is similar to the definition of counterfeit in Section 2320. The government therefore urged the Fourth Circuit to apply civil precedents holding that a genuine mark transforms into a counterfeit mark when the product to which the genuine mark has been applied is altered without authorization.

The Fourth Circuit, however, recognized that in the civil context, “‘the important test is whether the practice of the defendant is likely to cause confusion, not whether the defendant duplicated the plaintiff’s mark.’” Westinghouse Elec. Corp. v. General Circuit Breaker & Elec. Supply, Inc. By contrast, Section 2320 makes duplication or alteration of the genuine mark an element of the offense, which the court could not ignore even if material alteration would support a finding of civil liability. Moreover, the appellate court emphasized that unlike the Lanham Act, Section 2320 contains an exception for authorized use. Under that exception, a spurious mark does not include a mark that the manufacturer was authorized to use at the time the goods were manufactured. Because criminal statutes must be narrowly construed, these distinctions between the civil and criminal laws were critical to the Fourth Circuit’s holding.

Notes for Practitioners

Combating intellectual property (“IP”) crime is currently a high priority for the Department of Justice (“DOJ”), the Department of Homeland Security (“DHS”) and several federal agencies and task forces. In 2012, DOJ brought 178 cases and DHS brought 334 cases related to IP crimes. DHS seized more than $1.26 billion in counterfeit and pirated goods, as measured by manufacturer’s suggested retail prices (“MSRP”). With the rapid increase in IP crime facilitated through the Internet and the current administration’s focus on increasing IP enforcement, it is likely these statistics will increase in 2013. Civil efforts to stem counterfeiting are also likely to increase as the economic impact of counterfeiting continues to grow.

Given the government’s heightened focus on combating IP crime, both criminal and civil practitioners should be aware of the parallels between civil and criminal IP laws. Cone illustrates that there are gaps between those laws that create opportunities for the defense where the government’s theories are based on civil standards. Trademark owners also should take note and implement a strategy to routinely monitor unauthorized use of their brands. Where authorized use becomes unauthorized but without alteration of the owner’s genuine mark, only civil remedies may be available to stop infringement or obtain compensation for the unauthorized sales.

Defense practitioners in particular should be aware that penalties for trafficking in counterfeits are stiff. As currently in effect, Section 2320 provides penalties for first-time individual offenders of up to 10 years in prison and a $2 million fine, or for a corporation or other entity, up to a $5 million fine. The penalties and fines for repeat offenders are substantially higher. In addition, a defendant can be ordered to pay restitution to anyone directly or proximately harmed by the defendant’s conduct. If measured by the MSRP of the goods and a 1:1 substitution ratio between counterfeit and genuine goods is assumed, the total restitution can be staggering. As civil practitioners are aware, however, a 1:1 substitution ratio can be difficult to prove. While not addressed in Cone, practitioners should keep informed of developments in this area.