Foreign subsidiary trading with Iran? OFAC really means STRICT liability

On February 7, 2019, OFAC fined a Virginia-based company, Kollmorgen Corporation, for business that its recently-acquired Turkish subsidiary allegedly conducted in Iran after determining that Kollmorgen had undertaken “extensive preventative and remedial conduct” both before and after the acquisition in an effort to ensure the subsidiary complied with US sanctions.  OFAC also found that Kollmorgen had “conduct[ed] an effective and extensive internal investigation and submit[ed] a comprehensive voluntary self-disclosure to OFAC.”  Why, then, would OFAC fine this company, if it sounds like they did everything right?  The answer is strict liability.  OFAC’s civil enforcement authority applies on a strict liability basis, meaning if the prohibited conduct occurs, the agency can impose civil penalties, even if there is no negligence, intent, or other finding of fault.  Attorneys often advise their clients that as a technical matter OFAC penalties can apply even if the company does everything that’s feasible to comply with the law, underscoring the potential risk in dealing with sanctioned countries or sanctioned parties.  But OFAC frequently declines to penalize companies under such circumstances, and instead often closes out such cases with a “warning letter”.  While the amount of the fine here was very small ($13,381, quite a downward departure from the statutory maximum of $1,500,000) due to the mitigating conduct of the US parent, other costs of the enforcement process and a finding of violation can still be significant. The individual at the foreign subsidiary who was found to be culpable for this conduct was added to OFAC’s Foreign Sanctions Evaders (FSE) list under Executive Order 13608, which imposes a broad restriction similar to the Specially Designated Nationals (SDN) list.  This is an interesting approach to sanction an individual employee of a foreign subsidiary of a US company while providing a high degree of leniency to the cooperating US company.  Very likely Kollmorgen provided significant information about this individual’s conduct to OFAC as part of its voluntary disclosure.  OFAC provided some detail about the individual’s role in “directing” the Iran-related violations and attempting to “conceal” that activity, with a senior Treasury official remarking “This action is a clear warning that anyone in supervisory or managerial positions who directs staff to provide services, falsify records, commit fraud, or obstruct an investigation into sanctions violations exposes themselves to serious personal risk.”   OFAC remarked that this coupling of an FSE designation with a civil enforcement action was “unprecedented.” The following factual summary from OFAC provides good context:

Despite the US Company’s extensive efforts, for two years after the acquisition, Kayakiran — in his role as the managing director of the Turkish Company — directed employees to service machinery located in Iran.  Employees were threatened with termination if they refused to travel to Iran to provide the services, and upon returning from the trips, employees were directed to falsify corporate records by listing the travel as vacation rather than business.  Kayakiran also regularly and fraudulently certified to the US Company that no products or services were being sent to Iran.  It was only after an employee filed an internal complaint with the US Company via the company’s ethics hotline in late October 2015 that the violations and associated conduct came to light.  The US Company subsequently investigated the matter. Upon being notified of the US Company’s internal investigation, Kayakiran attempted to obstruct the investigation by instructing the Turkish Company’s employees to delete references to Iran in company records and misled the US Company’s attorneys.  Finally, Kayakiran attempted to delete emails related to Iran.

This summary of the US parent company’s compliance efforts shows that even fairly extensive efforts are no guarantee of protection:

Prior to the acquisition, Kollmorgen hired an external law firm and an external auditing and consulting company to perform sanctions due diligence on Elsim [the Turkish subsidiary]. The due diligence results demonstrated that Elsim made sales to, and had customers in, Iran prior to its acquisition by Kollmorgen. Based on these results, Kollmorgen determined it would need to take steps to prevent such sales from occurring in the future and educate Elsim on the applicability of US sanctions. Kollmorgen subsequently implemented a wide range of pre- and post-acquisition compliance measures designed to ensure Elsim complied with US sanctions, which included but were not limited to the following:

(i) conducting a comprehensive review of Elsim’s customer database in order to identify any sales or customers located in, or with connections to, countries or regions subject to US economic and trade sanctions;

(ii) identifying Elsim’s Iran-related customers and applying controls to block those customers from making future orders;

(iii) drafting and circulating a memorandum to all Elsim employees notifying them of US sanctions against Iran, the legal requirement for Elsim to comply with the ITSR, and Elsim’s obligation to not sell products or services to Iran;

(iv) conducting in-person trainings for Elsim’s employees regarding Kollmorgen’s trade compliance policies (specifically including Iran), which included a requirement that employees promptly report any and all violations of the law;

(v) on a proactive and continuing basis, performing additional manual reviews of Elsim’s customer database to identify any sanctions-related customers;

(vi) requiring Elsim customers to agree to modified terms and conditions of sale prohibiting the resale of any Elsim products, directly or indirectly, to Iran;

(vii) requiring Elsim’s senior management to certify, on a quarterly basis, that no Elsim products or services were being sent or provided to Iran;

(viii) ordering Elsim’s senior management to immediately cease transactions with Iran, including any technical support; and

(ix) implementing an ethics hotline for reporting violations of law.

. . .

After the Apparent Violations were uncovered, Kollmorgen took a series of remedial actions designed to rectify the situation and discourage ongoing violative conduct, which included:

(i) terminating the Elsim managers responsible for, and involved in, the Apparent Violations;

(ii) implementing new procedures to educate Elsim employees on compliance with US economic and trade sanctions;

(iii) requiring Elsim to seek pre-approval from an officer based outside of Turkey for all foreign after-sales service trips; and

(iv) requiring Elsim to inform its major Turkish customers that Elsim cannot provide goods or services to Iran.

OFAC justified its enforcement response as follows: “Notwithstanding Kollmorgen’s extensive compliance efforts, OFAC determined a penalty was the appropriate administrative response to the Apparent Violations due to Elsim’s egregious conduct and specific risk profile, including that Elsim had previously engaged in business with Iran.” One other noteworthy point is that the US parent was fined for the actions of its foreign subsidiary.  OFAC’s Iranian Transactions and Sanctions Regulations (ITSR) apply to “US persons” and to non-US entities “owned or controlled” by US persons.  If a non-US entity owned or controlled by a US person violates the ITSR, the US person itself can be fined.  See the note to Sec. 560.215 of the ITSR. What’s the takeaway here for US companies?  First, Iran is a high-risk country, even for companies with extensive compliance measures in place, and anything that falls through the cracks can lead to enforcement action.  Second, and more broadly, OFAC pre-acquisition due diligence and post-acquisition compliance integration and monitoring should not be a “check-the-box” undertaking – reasonable efforts are not a safe harbor.  Foreign entities with actual or suspected links to Iran should be investigated and overseen carefully.  Finally, if a potential violation is discovered, consider a voluntary disclosure – Kollmorgen’s extensive cooperation with OFAC earned it a 99% reduction in penalty.