China: Chinese Telecom Giant ZTE Makes History With Guilty Plea And $1.19 Billion Settlement For Sending US Export-Controlled Goods To Iran And North Korea

Keywords: Chinese, Telecom, ZTE, Commerce Department

Following a five-year investigation and a scandal that threatened the loss of its supply chain, China's Zhongxing Telecommunications Equipment Corporation, its subsidiaries and affiliates (collectively "ZTE") have concluded settlement agreements with the US Departments of Justice, Commerce, and the Treasury. In total, ZTE agreed to combined civil and criminal penalties of $1.19 billion and pled guilty to shipping US-origin items illegally to Iran and North Korea, obstructing justice and making a material false statement. As part of the settlement, ZTE will remain under probation for an additional seven-year period and submit itself to active auditing and monitoring by the US government.

The settlement follows a key turning point in the case last year when the Commerce Department took a bold and aggressive action to blacklist ZTE, one of China's largest companies and one of the largest telecommunications equipment firms in the world. Faced with a crippling loss of its supply chain, ZTE was forced to negotiate with US enforcement officials regarding allegations of an elaborate and far-reaching diversion scheme involving company management. The case is just the latest example of the US government's intention to pursue and penalize both US and non-US companies that violate US export control and sanctions laws. While the case is noteworthy for both the nature of the conduct and the sheer size of the penalties involved, it also conveys important lessons for the board and management of any company that wishes to avoid a similar fate.

Background

According to ZTE's settlement agreements, over the course of more than six years, ZTE exported or reexported nearly $40 million worth of US-origin goods through China to Iran in knowing violation of US export control and sanctions laws against those countries. In addition, the company also made hundreds of shipments of controlled goods to North Korea in violation of export control laws. ZTE's practices were specifically designed to evade these laws through the use of third-party "isolation companies," were approved by the highest levels of company management and continued in secret even while the company was under investigation—a trifecta of damning actions that led to the record penalty imposed.

As ZTE bid on and secured contracts worth hundreds of millions of dollars to install cellular and landline network infrastructure in Iran, it developed an elaborate system to fulfill those contracts using US-origin items, including dual-use goods controlled by the US government for national security and anti-terrorism reasons. This evasive system included:

  • Importing US-origin goods into China with the purpose of reexporting them to Iran;
  • Using third-party "isolation companies," including a company called Beijing 8 Star, to serve as parties to contracts and to be responsible for supplying the US-origin goods while ZTE itself effectively controlled these companies throughout the process; and
  • Removing logos and other markings from shipments containing the goods and comingling them with foreign-origin goods in an effort to conceal them and evade detection.

Following press coverage in 2012 of the company's business dealings in Iran and alleged violation of US sanctions, ZTE temporarily stopped its business dealings with Iran. The coverage prompted a US government investigation into the company's dealings in Iran. Although ZTE informed the US government that it was winding down operations, leaders at the highest levels of the company decided to resume the company's business dealings with Iran, including its efforts to divert US goods to the country.

ZTE took several steps to conceal its new procurement campaign from investigators. The company sought and used a "new, more capable third-party" to serve as the isolation company in the scheme. ZTE also assembled a team of IT employees to engage in a project to "alter, process, sanitize, and/or remove references to Iran in the company's internal databases" and then had the IT team delete their emails related to the project. In addition, ZTE apparently deleted and concealed records from, and otherwise provided "incomplete and/or otherwise altered information" to, outside counsel and forensic accountants retained in the investigation, knowing that such information would eventually be shared with the US government.

In 2016, the Commerce Department placed ZTE on the Entity List, thereby prohibiting all third parties from trading in goods, software and technology originating in the United States or containing more than de minimis US content. This prohibition immediately threatened to cut off ZTE from its suppliers, prompting the Chinese company to enter into settlement discussions with the US government.

Lessons Learned

The sheer size of the penalties against ZTE has attracted the attention of companies around the world and sends a message about the seriousness with which the US government will pursue both US and non-US companies that violate its export control and sanctions laws. But the case also holds broader lessens for the boards and management of any company that wishes to avoid ZTE's fate.

Enforcement Focus on Diversion, Transshipment and Illicit Procurement. The conduct at the heart of the case highlights a high-priority focus for US enforcement officials—the use of procurement agents and transshipment routes to divert goods to prohibited countries and end users/end uses. As the case record demonstrates, ZTE's scheme arose from its need to procure US export-controlled components in order to fulfill its contracts with Iran, as well as a belief that it could evade US law through schemes to conceal the actual intended destination and end user. Significant US government resources are focused on evaluating and monitoring customs and export declarations, parties to the transactions, end-user and end-use information and other risk factors. Indeed, the lengths to which ZTE went appear to reflect a recognition of this enforcement focus and an elaborate yet ultimately failed effort to evade scrutiny.

Extraterritorial Reach and Leverage. The case reflects the extensive reach of the US government over non-US parties that deal in goods and technology with a US nexus and the overlapping regulatory regimes governing that activity. Many non-US companies may wonder why ZTE, a non-US company, would concede US jurisdiction and settle these charges with the US government at all. When the Commerce Department designated the company on the Entity List in 2016, it effectively made it illegal for third parties, whether US or non-US, to provide critical US parts, components and related software and technology to ZTE. In addition, US banks were prohibited from clearing dollar transactions for ZTE. The threatened loss of its supply chain and dollar payments brought ZTE quickly to the negotiating table to deal with the US government and begin a process that ultimately led to this extraordinary settlement.

Aggravating Factors. The case also offers an important illustration of the aggravating factors that exacerbated ZTE's penalties and treatment in the case with respect to both civil and criminal liability. With respect to the civil penalties, both the Commerce and Treasury Departments maintain enforcement guidelines under which the primary drivers of any penalty amount are the number and value of the violative transactions, whether the violations were voluntarily self-disclosed to the agencies and whether the case involves certain aggravating factors that make it "egregious." In determining whether a particular case is "egregious," both agencies give substantial weight to (1) the willfulness or recklessness of the conduct, (2) senior management's awareness of the conduct at issue, (3) the harm to sanctions programs' objectives and (4) the individual characteristics of the party that committed the violation. In this case, the facts as publicly reported clearly supported a determination that the civil violation was "egregious," and indeed there were referrals to the Justice Department for parallel criminal prosecution.

Multi-Agency Investigations and Enforcement. ZTE was pursued aggressively over a five-year period, as multiple US agencies investigated. The case reflects the significant investigative resources that the US government brings to bear in these matters. Over the course of five years, the joint investigation involved investigative agents from the Departments of Justice, Homeland Security, Commerce, and the Treasury, as well as from the FBI. The multi-agency settlement drove higher penalties in this case. ZTE had to settle with not just one agency but three—$661 million (Commerce), $100 million (Treasury) and $430 million (Justice)—thus compounding the impact of its conduct.

Management and Board Governance Considerations. As with other notorious cases, perhaps the most significant lesson of this case relates to the critical impact that management and boards can have on the ultimate outcome of a case when violations are discovered or suspected. Much of the narrative in the settlement documents focuses not just on ZTE's initial diversion scheme or management's involvement in that scheme but on the company's subsequent cover-up (including misleading its own outside counsel and advisors) when it became clear that the US government was investigating the matter.

Rather than taking steps immediately to bring ZTE's conduct into compliance, management's elaborate effort to conceal was ultimately futile and in the end involved an expensive and years-long campaign that drained significant resources and guaranteed harsher treatment. The initial decisions a company makes in response to the discovery of violations, including those involving its own management, regarding whether, how and in what manner to manage an investigation and disclose violations are critical. Companies that wish to avoid ZTE's fate must be prepared to protect themselves by having in place appropriate and robust governance mechanisms, including appropriate board oversight and a plan to ensure independent investigation of potentially significant violations.

Originally published on 10 March 2017

Visit us at mayerbrown.com

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

© Copyright 2017. The Mayer Brown Practices. All rights reserved.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions