Canada-U.S. Blog Trade Lawyers Cyndee Todgham Cherniak and Susan K. Ross

Poof Goes the Rule of Law!

Posted in Anti-Trust/Competition Law, Corporate Counsel, Cross-border deals, Cross-border trade, Customs Law, Export Controls & Economic Sanctions, Exports, Legal Developments, Trade Remedies

Originally published by the Journal of Commerce in June 2018.

There was a strong temptation to title this column – What the Football!  President Trump has spent a good deal of his time recently excoriating professional football players about their actions when it comes to the nation anthem. He seems to have not spent even a fraction of that time addressing the implications of the recent settlement with ZTE China.

For those who have not followed the case, ZTE China faced both criminal charges and civil fines for its actions in circumventing U.S. export laws related to the sale of products to Iran, and to a lesser extent, Sudan,  North Korea, Syrian and Cuba (more background can be found below).  The original settlement with the Dept. of Justice resulted in ZTE China (two related entities) pleading guilty and being subject to the largest criminal fine/civil penalty then imposed, along with three years of corporate probation. Additionally, the company agreed to put in place a monitor who was to report to the court about the success of ZTE China’s newly upgraded compliance program.

ZTE China also agreed to pay fines to the Bureau of Industry and Security (BIS) and the Office of Foreign Assets Control (OFAC) pursuant to settlement agreements with those agencies. BIS suspended an additional $300,000,000 fine which would be imposed if ZTE China violated its settlement with the agency. The total overall forfeiture and fine amount that ZTE China was to pay the U.S. Government was $1.19 billion with $300,000,000 suspended.

Five (5) weeks later, BIS issued a denial order in which the following statements were made by the then Acting Assistant Secretary of Commerce for Export Enforcement: “[ZTE agreed to the record-high combined civil and criminal penalties after]  engaging in a multi-year conspiracy to violate the U.S. trade embargo against Iran to obtain contracts to supply, build, operate, and maintain telecommunications networks in Iran using U.S.-origin equipment, and also illegally shipping telecommunications equipment to North Korea .. .”  In the face of “ZTE ‘s Pattern of Deception, False Statements, and Repeated Violations of U.S. Law,” BIS found ZTE had violated the terms of the settlement, and imposed the denial order.  Given U.S. sanctions laws apply directly (barring the acquisition of U.S. parts from U.S. sellers) and indirectly (barring the acquisition of U.S. parts from third parties, even those outside the U.S.), ZTE China was effectively put out of business

Secretary Ross issued a statement at the time saying “ZTE made false statements to the U.S. Government when they were originally caught and put on the Entity List, made false statements during the reprieve it was given, and made false statements again during its probation … ZTE misled …  Commerce … This egregious behavior cannot be ignored.”

Then, last month, it was announced that at the request of Chinese President Xi, President Trump instructed Commerce Secretary Ross to find a different solution, one that would allow ZTE China to stay in business. The outcome we learned last Thursday June 7th was a new deal was struck wherein ZTE China will now pay an even larger fine and accept other conditions.

Based on the press release issued by Secretary Ross on the 7th, ZTE will now pay an additional $1 billion on top of the $892 million previously paid. Plus, an additional $400 million must be posted into a “suspended penalty” escrow account before “BIS will remove ZTE from the Denied Persons List” Secretary Ross went on to say: “ZTE will also be required by the new agreement to retain a team of special compliance coordinators selected by and answerable to BIS for a period of 10 years. Their function will be to monitor on a real-time basis ZTE’s compliance with U.S. export control laws. … ZTE is also required under the new agreement to replace the entire board of directors and senior leadership for both entities [i.e., Zhongxing Telecommunications Equipment Corporation and ZTE Kangxun Telecommunications Ltd].  Finally, the new agreement once again imposes a denial order that is suspended, this time for 10 years, which BIS can activate in the event of additional violations during the ten-year probationary period. These collectively are the most severe penalty BIS has ever imposed on a company …  The purpose of this settlement is to modify ZTE’s behavior while setting a new precedent for monitoring to assure compliance with U.S. law. Embedding compliance officers into the company vastly improves the speed with which the Department of Commerce can detect and deal with any violations.”

One is left to ask, what did the U.S. really get?  If money alone was the cure for bad actors, fines of large sizes would have been imposed years ago. If replacing executives and boards would do the trick when dealing with a Chinese company, that, too, would have been done a long time ago. Ironically, last Thursday, the CEO of Qualcomm was quoted as hoping the deal with NXP in China would now finally be approved by the Chinese authorities!  Was that the quid pro quo? If so, one has to ask – who got the better deal?

When you consider the behavior that originally led BIS, OFAC and Justice to proceed involved a long history by ZTE of bad and intentional actions, were these terms enough?   Does anyone think the new team can’t figure out a more sophisticated means to get U.S. telecom equipment sold to Iran or North Korea?

ZTE knew the items it was acquiring in the U.S. could not be shipped or sold to Iran, North Korea or any other embargoed country. So elaborate plans were hatched that involved subterfuge, evasion, outright lies and destruction of evidence, including to the American subsidiary’s lawyers and consultants who were trying to help the company address the allegations against it! Just how convinced are you the U.S. got a “good deal”?

Knowing it was under investigation, ZTE took steps to mislead the U.S. government, which included having the involved individuals sign non-disclosure agreements. ZTE management gave false statements to the company’s counsel knowing they would be shared with the U.S. government, including that sales to Iran had ended and thereby stating the company was now in compliance with U.S. law.  Further, existing data was hidden from the forensic accounting firm hired by defense counsel to conduct an internal investigation.  The withheld data was omitted from reports prepared and given to the U.S. government, thereby ZTE provided false statements.  To further avoid detection, ZTE formed a “contract data induction team” of about 13 people with the goal to “sanitize the databases” of all relevant information. To further cover their tracks, emails by team members were subject to a 24 hour auto-delete function.

When you listen to the relevant U.S. government representatives, you are left wondering – What the Firetruck? The violations by ZTE were export related and so the activities of BIS, OFAC and Justice were law enforcement in nature.  Do you really deal with violators who rub their noses at U.S. law by upping the fine and changing management and board members?  In a curious coincidence of timing, on June 7th, the current Assistant Secretary of Commerce for Export Administration spoke at the annual meeting of an international trade association. His point was that BIS does not set policy, but rather enforces the law. He went on to also say: “We don’t negotiate national security.”  So, when the regulatory consequence / rule of law states if you violate the law, get fined, agree to a settlement and then lie about your level of compliance, that means you are placed on the denied parties list, how does changing that long-standing law enforcement / rule of law outcome not amount to setting a new policy? Whether it also means the U.S. negotiated national security remains to be seen.  As this column is published, President Trump is in Singapore to meet with Supreme Leader Kim of North Korea. Maybe that was the quid pro quo with the Chinese government?

Anyone who deals regularly with China will not be in the least surprised to hear in the future that American telecommunications equipment ended up in Iran or in the hands of other questionable end users, and that result can be traced back to a ZTE affiliate, perhaps this time through more sophisticated schemes than the ones reported in the settlement documents publicly filed. In the end, most international traders who attended the referenced annual conference were left wondering – did the U.S. get enough in return to make the deal with ZTE worthwhile?