Every few months we hear the news reports about the United States Department of the Treasury’s Office of Foreign Assets Control(“OFAC”) imposing heavy fines, or coming to massive settlements, for violations of the economic sanctions programs they administer. Typically, these are settlements of investigations that have been ongoing for years and for which the parties have cooperated at least at some point in the investigation. In the end, OFAC gets the big press release and the violator of sanctions takes it on the chin and moves on with their business. Until now.
On New Year’s Eve, Epsilon Electronics, Inc. (“Epsilon”), a California corporation, who was fined earlier in 2014 for violations of the Iranian Transactions and Sanctions Regulations (“ITSR”) filed a lawsuit against OFAC seeking a ruling from the United States District Court for the District of Columbia that the penalty imposed was unlawful and excessive, and for Writ of Mandamus to remove or reduce the penalty. By way of background, OFAC made a finding that Epsilon exported approximately $3.4 million worth of car audio and video equipment to Iran without an OFAC license and accordingly imposed a penalty of $4,073,000.00. In their complaint, Epsilon contends that the goods were sold to a Dubai, U.A.E. corporation and reexported to Iran without Epsilon’s permission.
Epsilon contends that OFAC failed to specify the basis of its penalty assessment and disregarded a number of mitigating factors that were, in Epsilon’s words, mandated by OFAC’s Enforcement Guidelines. More interestingly, however, Epsilon contends that OFAC disregarded the “inventory exception”, a rule whose existence sanctions practitioners have long debated, and which has its roots in OFAC guidance published in 2002 entitled “Guidance on Transshipments to Iran”). In stating its case, Epsilon contends that despite the prohibition contained in 31 C.F.R. 560.204 on exports and reexports of U.S. origin goods, services, and technology to Iran, that U.S. persons can freely export goods to a third country knowing that such goods may go to Iran provided that the goods are not subject to the Export Administration Regulations, that the U.S. person is not filling a specific order for export to Iran, and the majority of the buyer’s business and sales are not to Iran. If nothing else comes out of this case, we may finally get a judicial ruling on whether or not the “inventory exception” actually exists, and even if we don’t, OFAC will surely comment in their answer–and likely their forthcoming Motion for Summary Judgment–as to whether or not they consider the 2002 guidance to have actually created such an exception.
Further, Epsilon’s complaint relies heavily upon a few factors: 1) that OFAC was not specific in citing instances of unlawful conduct, and/or Epsilon’s knowledge of unlawful conduct, prior to issuing their Penalty Notice; and 2) that OFAC failed to properly consider mitigating factors to reduce Epsilon’s penalty. In making its cases as to the misapplication of the OFAC Enforcement Guidelines, Epsilon contends, inter alia, that:
1) Epsilon did not willfully or recklessly violate the law because its export of products was to U.A.E., and therefore not prohibited by U.S. law. Further, it was not reckless because the U.S. engages in a heavy volume of trade with U.A.E., and the company with which Epsilon was transacting exports to many other countries besides Iran;
2) Epsilon did not know that their transactions would be considered prohibited. Epsilon again cites to the “inventory exception”;
3) There was minimal benefit to the Iranian economy. Epsilon further states that their products are Chinese made and that nearly identical products are already exported to Iran, and the volume exports by Epsilon is minimal in comparison to the number of these goods already being exported to Iran by other countries;
4) There were no solid implications on U.S. policy. In making this point, Epsilon once again goes back to the “inventory exception”;
5) OFAC did not fairly, fully, and adequately account for Epsilon’s lack of commercial sophistication, despite the fact that OFAC recognized the modest size and commercial sophistication of the company;
6) The transactions only constituted 2% of Epsilon’s sales in a given period (although it’s not clear from the complaint whether they mean the given period that covered the scope of the investigation, or some other period), and that Epsilon is in substantial debt and has recently laid off eleven (11) workers in the last six months. Interestingly, Epsilon noted that upon announcement of the OFAC penalty that it’s bank reduced Epsilon’s line of credit by 50% and shortened their repayment terms. Another sign that banks, upon seeing any bad, sanctions-related news about one its customers, take drastic actions to protect themselves;
7) Epsilon has never been cited for an OFAC violation in its existence. However, Epsilon did note earlier in its complaint that it had previously received a Cautionary Letter from OFAC in January 2012. Although OFAC’s January 2012 Cautionary Letter–attached as an exhibit to the Complaint–states that it is a final enforcement response, it also stated that it is not a final agency action as to the finding of a violation;
8) Epsilon took remedial measures by retaining counsel to defend itself, disbanding its distribution agreement with Asra, and stopped further transactions;
9) Epsilon signed a tolling agreement in May 2013; and
10) Finally, Epsilon faults its prior counsel by stating that although it is a reputable firm for tax law, it was apparently unfamiliar with the subject matter, and the response they prepared in relation to OFAC’s investigation was “woefully inadequate and unduly prejudiced Epsilon.”
Epsilon contends that as result of OFAC’s failings a penalty was imposed that was “unconstitutional, excessive, and arbitrary and capricious, and grossly disproportionate…” The causes of action contained in the complaint includes alleged violations of the Administrative Procedure Act (“APA”), alleged violations of the Eighth Amendment, Excessive Fines Clause, and alleged violations of the Fifth Amendment Due Process Clause. The APA and Eight Amendment causes are based upon a belief that the penalty imposed was not warranted by the facts, and the Fifth Amendment cause is based on OFAC’s failure to provide notice as to the specific transactions which constituted the prohibited conduct until issuance of the Penalty Notice, a final agency action, and therefore, Epsilon was denied an meaningful opportunity to respond. Epsilon cites to the impact on its financial condition as to the harm caused by OFAC’s action.
As noted above, Epsilon seeks, in part, for the Court to declare the penalty unlawful and excessive in light of the APA and the Eighth Amendment, and the issuance of a Writ of Mandamus ordering OFAC to remove the fine, or reduce the fine in accordance with the “inventory exception”. Further, Epsilon seeks monetary damages for the financial harm and loss of business caused by OFAC grossly excessive fine, and an award of attorneys’ fees and costs incurred in filing the suit.
There are many interesting angles to this case, and we will be watching it closely in the coming months. As I have noted above, we will likely get a final determination, either from OFAC or the Court, as to whether the “inventory exception” exists. Another interesting angle is what standard of review the court will apply in reviewing the APA claims. APA claims are typically reviewed under the highly deferential “arbitrary and capricious” standard, which is further heightened in the national security context which is the context in which OFAC’s penalty decision was made. However, I believe an argument could be made for de novoreview in light of Citizens to Preserve Overton Park v. Volpe, 401 US 402 (1971), and National Organization for Women, Washington DC Chapter v. Social Security Administration, 736 F.2d 727 (D.C. Cir. 1984).
Those cases stand for the proposition that when a party is adversely impacted by a final agency action without an opportunity to respond to the evidence relied upon by the agency in taking that action, that a court reviewing the matter taken should engage in de novo review of the action. This is a theory that is currently being tested in the Zevallos v. Obama, OFAC SDN List Kingpin Act litigation, which is on appeal to the D.C. Circuit. While an OFAC enforcement matter and a SDN Kingpin Act reconsideration case are two very different things, if Epsilon believes that it did not have an opportunity to rebut the evidence relied upon in OFAC’s Penalty Notice, they may seek to request the Court to apply de novo review of their APA claim. This Epsilon litigation could have a major impact on the OFAC enforcement environment, and how subjects of OFAC investigations may respond to agency investigations in the future. As always, we will keep you posted on developments in this case and in other sanctions related matters.
The author of this blog is Erich Ferrari, an attorney specializing in OFAC matters. If you have any questions please contact him at 202-280-6370 or email@example.com.