On September 21, 2017, President Trump issued an Executive Order (yet to be numbered) (“EO”) imposing additional sanctions on North Korea. It took affect the next day. The general press has quoted Treasury Secretary Mnuchin as stating: “Foreign financial institutions are now on notice that going forward they can choose to do business with the United States or North Korea, but not both”. These latest changes raise the specter for even more caution on the part of companies conducting international business. The question every CFO at every company should ask is – is our due diligence program as good as it needs to be? If not, your funds could get seized and dealing with the Dept. of Justice in these types of cases can be quite challenging. The government often has information the private sector does not possess and, if your due diligence program is not deemed sufficient, you stand little chance of getting those funds released. Given the current climate, you can bet getting funds released related to the North Korea sanctions is going to be even more difficult!
The new Executive Order is broadly worded to include any person who is determined:
(i) to operate in the construction, energy, financial services, fishing, information technology, manufacturing, medical, mining, textiles, or transportation industries in North Korea;
(ii) to own, control, or operate any port in North Korea, including any seaport, airport, or land port of entry;
(iii) to have engaged in at least one significant importation from or exportation to North Korea of any goods, services, or technology;
(iv) to be a North Korean person, including a North Korean person that has engaged in commercial activity that generates revenue for the Government of North Korea or the Workers’ Party of Korea;
(v) to have materially assisted, sponsored, or provided financial, material, or technological support for, or goods or services to or in support of, any person whose property and interests in property are blocked pursuant to this order; or
(vi) to be owned or controlled by, or to have acted or purported to act for or on behalf of, directly or indirectly, any person whose property and interests in property are blocked pursuant to this order.
The text as written is obviously intended to allow the Trump Administration as much flexibility as possible, but it does raise potentially serious concerns for American companies. Note in particular the use of the undefined word “significant”, when it comes to an import from or export to North Korea. Similarly, there is the use of the undefined word “materially” when it comes to assisting, sponsoring or providing financial, material or technological support for goods or services involving North Korea. Equally noteworthy is the inclusion of services, not just goods, within the scope of this EO.
As noted above, it is often the case that U.S. government authorities have information on which they rely for enforcement purposes which is not known to the private sector and could yield seized goods, seized funds and/or penalties, despite the private sector conducting what it would consider as proper due diligence, and this is where relations with China are impacted and, equally importantly, the due diligence programs implemented by companies.
We have already seen a spate of forfeiture cases brought by the Dept. of Justice involving funds seized on the grounds they were derived from dealings with North Korea, which are already barred by existing law. To be clear, the existing cases are not limited to American companies, but rather focus on U.S. dollars and other currencies which are coming through U.S. banking channels.
Worth noting is the industries mentioned – construction, energy, financial services, fishing, information technology, manufacturing, medical, mining, textiles, or transportation. This industry list covers those most critical to North Korea, some would say their only industries. For example, any aircraft or vessel which has called a port in North Korea in the past 180 days may not call a U.S. port, measured from the date of departure from North Korea. Such a provision raises the specter that violators will attempt to evade these sanctions by turning off vessel and aircraft directional equipment in the hopes of fooling regulators. Not surprisingly, attempted and actual evasion, along with the intent to evade, are also barred by the new EO.
The extent of this latest action by the Trump Administration can perhaps best be illustrated by the provision which states:
All funds that are in the United States, that hereafter come within the United States, or that are or hereafter come within the possession or control of any United States person and that originate from, are destined for, or pass through a foreign bank account that has been determined by the Secretary of the Treasury to be owned or controlled by a North Korean person, or to have been used to transfer funds in which any North Korean person has an interest, are blocked and may not be transferred, paid, exported, withdrawn, or otherwise dealt in.
For the sake of clarity, a North Korean person is defined as:
… any North Korean citizen, North Korean permanent resident alien, or entity organized under the laws of North Korea or any jurisdiction within North Korea (including foreign branches)… the term “North Korean person” shall not include any United States citizen, any permanent resident alien of the United States, any alien lawfully admitted to the United States, or any alien holding a valid United States visa;
In last month’s Alert, we discussed the impact of H.R. 3364, the “Countering America’s Adversaries Through Sanctions Act”- see http://www.msk.com/newsroom-alerts-2608 for the full text. In that publication, we made the point:
The latest round of sanctions now demands that American companies seek many more details from their Chinese buyers and sellers. The key is clearly understanding both who owns the party with whom you are dealing, but also who are that party’s customers/suppliers …
While having the most robust due diligence program possible remains a key factor, it is now doubly important that financial institutions make sure they know with whom they are dealing, and businesses, too. Financial institutions already are subject to “know your customer” rules under the Patriot Act and other laws and regulations. This new EO is likely going to lead to many more questions from financial institutions before agreeing to fund letters of credit, otherwise accept funds from foreign parties or transmit funds payable to foreign parties. The more robust your due diligence program, the more likely you are ready with satisfactory answers.
The reach of this EO is in line with similar actions by the U.S. in the sense its impacts both those within the borders of the U.S. and beyond. Some refer to this as secondary sanctions, but whatever you call it, American companies with foreign operations and companies headquartered outside the U.S. with operations within U.S. borders are equally affected. The old rule “if you can’t make the deal when an American company is involved, you can’t make the deal if you cut out the American company” still applies. With other countries targeted by other sanctions provisions, there are typically very distinct ways in which compliance can be accomplished when foreign parents or affiliates are involved, but that is no longer the case with North Korea. You can get into equal difficulty if the deal is made by the foreign entity as with the U.S. entity, and frankly, it should raise questions for companies as to the source of any U.S. dollars, even if they do not transit the American financial system.
Any U.S. person (individual or entity) who knowingly conducts or facilitates a significant transaction with North Korea is in violation. The definition of “knowingly” is the same as typically appears in other sanctions laws – “… a person has actual knowledge, or should have known, of the conduct, the circumstance or the result”. While knowingly is defined, “facilitate” is not, so again, the U.S. government retains the utmost flexibility. Any missing definitions will undoubtedly be filled in from existing criminal law decisions and laws.
Foreign companies want to be particularly cautious in how they proceed. It is worth bearing in mind the $12 million penalty which was imposed in July 2017 on CSE Global Limited (“CSE Global”) and its subsidiary, CSE TransTel Pte. Ltd. (“TransTel”), which are both based in Singapore. The fine resulted from the use of American dollars maintained in a Singapore-based bank to conduct business with Iran. The U.S. chose to exercise jurisdiction because the funds transited the U.S. financial system causing multiple financial institutions to violate U.S. sanctions by engaging in the prohibited processing of U.S. dollar payments from the United States to Iran or for the benefit of Iran. As reported by the relevant enforcement agency – OFAC – the Office of Foreign Assets Controls – these violations involved 104 funds transfers amounting to more than $11 million, and all were paid to Iranian third parties which aided the companies to provide the goods and services needed to fulfill a telecommunications contract.
The elephant in the room is how are Chinese banks going to respond. It is common knowledge that China is North Korea’s main trading partner. Rumors abound that China has already told its central bank to stop dealing with North Korea, but that does not help American institutions or traders. They still need greater visibility into the supply chain, i.e., the real parties in interest in a given transaction. The new EO is described as “forward looking” meaning it will be imposed on deals after it became effective. However, that still means traders should be asking more questions, and so, too, should financial institutions. Given the rules are different in other countries, how likely is it that Chinese partners are going to willingly admit they are using North Korean inputs or have North Koreans on staff? How likely is it Chinese buyers are going to freely admit they are taking American content (even intellectual property) and putting it into products sold/traded/bartered to/with North Korea? Without accurate relationship details, goods could be seized, funds frozen and penalties imposed. And those accurate details are not likely to come without Chinese government cooperation, which trickles down to its domestic business community.
A real test of the international trading system for goods and services is upon us and how the Chinese respond to the EO will be a telling sign of whether we are facing the beginnings of a trade war with China, or whether China has the same goal as the U.S., at least when it comes to North Korea, and, therefore, encourages its business community to freely provide needed details so that due diligence conducted by U.S. businesses (and others who trade in American dollars) yields a meaningful outcome.