The Department of Treasury’s Office of Foreign Asset Control (“OFAC”) recently announced the settlement of the Epsilon enforcement action.  (Here).  This case requires a theme song and there is none better than Truckin (here) from Grateful Dead’s second compilation album — What a Long Strange Trip its Been.

This case involved two separate OFAC investigations for violations of the Iran Sanctions Program, an appeal to the US District Court for the District of Columbia (here), and an appeal at the U.S. District Court of Appeals for the District of Columbia Circuit (here).  The case is important because it confirms a broad reading of third party risks for companies when dealing with the Iran Sanctions Program (and the Cuba Sanctions Program).

As we all know, companies can be held liable for a sanctions violation when they ship a product to a third-party in another country and know or have reason to know that the third party intends to reship the product to Iran.  Consequently, companies have to conduct due diligence and document appropriate assurances that the third party is not intending to ship the goods to Iran.

The legal question here boils down to what does OFAC have to prove – that the products actually ended up in Iran or that the company had “reason to know” that the third party intended to ship the goods to Iran.  There is a big difference here between the two levels of proof.

The Facts

Let’s review the facts – OFAC learned in 2008 that Power Acoustik (a subsidiary of Epsilon) sent a shipment to an address in Iran and OFAC issued a subpoena.  OFAC eventually closed the investigation with a cautionary letter dated January 26, 2012.

In a separate investigation, OFAC learned that between September 2010 and October 2011, Power Acoustik received wire transfers totaling more than $1.1 million from a commercial bank in Dubai on behalf of Asra International, and that these payments may have been for products destined to Iran.  OFAC issued another subpoena.

Power Acoustik confirmed that they had 41 sales of audio and video equipment to Asra International between August 2008 and May 2012.  OFAC found that 5 of these transactions post-dated its initial cautionary letter, Dated January 26, 2012.

OFAC did not identify any direct evidence that Power Acoustik’s shipments were transported to Iran, but they located a website for Asra International which indicated that Asra, through an affiliated entity, distributed car audio and video products in Iran.  The Iran affiliate’s address was the same as the address in the original 2008 illegal shipment to Iran.  OFAC also noticed that photos from the Asra International website revealed that Asra International distributed Acoustik Power’s products (from a related party) were being distributed in Iran.

OFAC issued a pre-penalty notice concluding that Power Acoustik should pay $4,073,000, based on 34 non-egregious violations (which occurred before the January 26, 2012 cautionary letter), and 5 egregious violations (which occurred after the cautionary letter).  After hearing Power Acoustik’s objections, OFAC affirmed its penalty notice.

Power Acoustik’s Appeals

The district court affirmed the OFAC determination.  The US Court of Appeals, however, reversed in part and affirmed OFAC’s decision with remand instructions.  The Court of Appeals affirmed OFAC’s enforcement action with respect to the 34 non-egregious cases but reversed on the 5 transactions that occurred after the January 26, 2012 cautionary letter.

The Court of Appeals affirmed that an exporter may be found liable if it ships goods from the United States to a third country, with reason to know that those goods are specifically intended for reexport to Iran, even if the goods never arrive in Iran.  OFAC affirmed this finding as to the total 39 transactions.

The “reason to know” requirement can be established “through a variety of circumstantial evidence,” including “course of dealing, general knowledge of the industry or customer preferences, working relationships between the parties, or other criteria far too numerous to enumerate.”

Up until December 2011, Asra International in Dubai distributed to Iran exclusively.  The evidence concerning Asra International’s website and marketing document confirmed its exclusive distribution arrangement involving an Iran  affiliate.  For this time period, Power Acoustik could reasonably infer that Asra in Dubai only distributed its products to Iran.

For the final five shipments, however, the Court of Appeals found that the evidence did not satisfy the “reason to know” standard.  Specifically, the Court of Appeals noted that OFAC failed to address several email conversations between Acoustik’s sales team and the Asra Dubai manager during the period of September 2011 to July 2012, which indicated that the products were going to be sold from Asra International’s new retail store in Dubai.

Based on this review, the Court of Appeals re-calculated OFAC’s penalty by excluding the 5 egregious transactions.  The Court of Appeals remanded the case back to OFAC for recalculation of the penalty based on the change in the 5 transactions.

The End of the Road.

OFAC and Epsilon agreed to pay $1,500,000 to settle the enforcement matter.