Soo-Mi Rhee, Baruch Weiss, Nicholas L. Townsend, Tal R. Machnes, Tom McSorley, and Junghyun Baek*

In a time of record-high fines against companies that, even inadvertently, deal with prohibited parties in a commercial transaction, the message is clear: notwithstanding the difficulties associated with robust compliance procedures, the U.S. government expects companies to screen, identify, and refuse to deal with prohibited parties, or else risk large civil, or even criminal, fines. The authors of this article discuss recent enforcement actions that underscore the importance of knowing your customers and suppliers.

On November 25, 2019, the United States issued an enforcement action against a private company for, in part, failing to identify a prohibited counterparty in a commercial transaction; and at the same time acknowledged—in a government accountability report—the difficulties that government agencies themselves are facing in precisely the same area. In a time of record-high fines against companies that, even inadvertently, deal with prohibited parties, the message is clear: notwithstanding the difficulties associated with robust compliance procedures, the U.S. government expects companies to screen, identify, and refuse to deal with prohibited parties, or else risk large civil, or even criminal, fines.

The first of these two actions was announced by the U.S. Department of Treasury, Office of Foreign Assets Control ("OFAC"). That day, OFAC issued an enforcement action against Apple, Inc. ("Apple") based, in part, on the company's alleged failure to properly screen a commercial counterparty that had restructured itself several times, apparently to hide its connection to an OFAC-sanctioned owner.1 As a result, Apple apparently implicated OFAC sanctions regulations that prohibit companies from doing business with certain Specially Designated Nationals ("SDN") (in this case, designated narcotics traffickers), and entered into a settlement agreement that included a $466,912 civil penalty.

Second, and later that same day, the Government Accountability Office ("GAO") published a report recognizing that even the U.S. government is facing difficulty in understanding the sometimes opaque ownership structure of its own contractors. 2

Although the U.S. government appears to recognize the difficulty of screening certain counterparties, these dual actions and high enforcement activity throughout 2019 continue to suggest that the U.S. government expects end-to-end visibility into suppliers, customers, and any other counterparties for compliance with its many regulatory regimes.

THE GAO REPORT: DIFFICULTY OF UNDERSTANDING OPAQUE OWNERSHIP STRUCTURES

On November 25, 2019, the GAO published a public version of a report titled Defense Procurement: Ongoing DOD Fraud Risk Assessment Efforts Should Include Contractor Ownership (the "GAO Report"). The GAO Report discusses the national security threat posed by companies that use shell companies with opaque ownership structure to disguise the beneficial owner or owners, who own, control, or benefit financially from the business.

The GAO Report discusses the challenges that the Department of Defense ("DOD") faces in identifying and verifying contractor ownership. The GAO specifically notes the lack of centralized information source or registry on company ownership information in the United States. Although some states collect information during company formation, it is generally minimal. As a result, DOD contracting officers face "challenges in time-consuming efforts to verify contractor ownership." 3 The GAO Report also notes that "workload and resource constraints limit the extent to which they can verify contractor ownership." 4 Moreover, the difficulty in identifying and verifying contractor ownership may be amplified when "the contractor is actively seeking to misrepresent its ownership." 5

Even beyond the U.S. government's direct contractors, the GAO Report notes that there is additional risk involved further down the supply chain, given that a contractor's suppliers may use prohibited suppliers even when the contractor itself is an entirely permissible counterparty. Indeed, during this past year, OFAC, too, has highlighted potential supply chain risks in the sanctions area.

Ultimately, the GAO Report recommends that the DOD assess the "risks related to contractor ownership as part of its ongoing efforts to plan and conduct a department-wide fraud risk assessment." 6 The GAO Report further recommends that the DOD "involve relevant stakeholders with knowledge of emerging risks and use this information to help inform other types of risk assessments across the department, including for national security concerns." 7

Although the scope of the GAO Report (and its recommendations) is limited to government agencies and does not extend to private entities, it is notable that the U.S. government itself is facing the same difficulties as private companies when dealing with compliance issues.

Moreover, the GAO Report provides some indication to private companies as to what the U.S. government expects in this area. For example, the lack of centralized information source or registry on company ownership information affects not just government agencies, but also private entities.

Yet, the GAO Report illustrates that the US government expects its agencies to dig into ownership even in the absence of such centralized information. This sends a message to private companies, too, both small and large—that they must engage in "time-consuming efforts" 8 to verify the ownership structure of their counterparties. This will undoubtedly pose challenges for small companies whose "workload and resource constraints" limit their efforts to verify counterparty ownership. 9

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Footnotes

* Soo-Mi Rhee (soo-mi.rhee@arnoldporter.com), a partner at Arnold & Porter Kaye Scholer LLP, focuses her practice on economic sanctions laws, export control laws, antibribery laws, antiboycott laws, customs laws, and other foreign policy, national security, and economic policy-based trade and investment controls. Baruch Weiss (baruch.weiss@arnoldporter.com) is a partner at the firm and a trial attorney focusing on white collar, national security, and complex civil litigation. Nicholas L. Townsend (nicholas.townsend@arnoldporter.com) is counsel at the firm handling export controls, trade sanctions, cybersecurity, privacy, and aerospace industry matters. Tal R. Machnes (tal.machnes@arnoldporter.com) is a senior associate at the firm focusing her practice on international trade and national security, as well as white collar, intellectual property, and securities enforcement. TomMcSorley (tom.mcsorley@arnoldporter.com) is a senior associate at the firm advising clients on the intersection of law, technology, national security, and foreign policy. Junghyun Baek (junghyun.baek@arnoldporter.com) is an associate at the firm focusing on litigation, national security, and international trade, as well as political law compliance.

1 OFAC Enforcement Information for November 25, 2019, Apple, Inc. Settles Potential Civil Liability for Apparent Violations of the Foreign Narcotics Kingpin Sanctions Regulations, 31 C.F.R. part 598 (hereinafter "OFAC Enforcement Information Against Apple"), available at https:// www.treasury.gov/resource-center/sanctions/CivPen/Documents/20191125_apple.pdf.

2 U.S. Government Accountability Office, Report to Congressional Committees (Nov. 2019), GAO-20-106, Defense Procurement: Ongoing DOD Fraud Risk Assessment Efforts Should Include Contractor Ownership (hereinafter "GAO Report"), available at https://www. gao.gov/assets/710/702890.pdf.

3 Id. at 35.

4 Id.

5 Id.

6 GAO Report, supra note 2, at 43.

7 Id.

8 Id. at 35.

9 Id.

Originally published May 6, 2020.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Ms Soo-Mi Rhee
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