United States: Corporate Compliance And Regulatory Update: The U.S. Government Provides Guidance On How Companies Doing Transactions Involving China And Russia (And Certain Other Countries) May Avoid Violating The U.S. Sanctions Against North Korea

Last Updated: November 19 2018
Article by Sharie A. Brown

I. The U.S. Government Issues Advisory with a Warning for Companies

Companies that do business with supply chain links to China, Russia and certain other countries are at risk of unintentionally violating the various U.S. and United Nations sanctions against North Korea due to the deceptive practices employed by North Korea that disguise transactions involving trade with North Korea and the use of North Korean labor. As discussed below, a July 23, 2018, jointly issued advisory from the U.S. Department of State, the U.S. Department of Treasury's Office of Foreign Assets Control ("OFAC") and the U.S. Department of Homeland Security ("DHS"), Risks for Businesses With Supply Chain Links to North Korea,1 provides a warning and detailed guidance for companies with supply chain links in China and other listed countries that seek to remain in compliance with U.S. laws and restrictions on dealings with North Korea.

According to the advisory, there are two primary areas of concern for North Korea-related trade risks: i) inadvertent sourcing of goods, services or technology from North Korea; and ii) the presence of North Korean citizens or nationals working in a company's supply chain, whose labor generates revenue for the North Korean government. The U.S. government seeks to disrupt the North Korean government's ability to generate hundreds of millions of U.S. dollars in revenue from the export of North Korean labor (largely from salaries paid directly to the North Korean government by certain foreign employers). Companies should be aware of the below-described risks involving goods, services and technology.

II. Increased Risk for and Potential Indicators of Goods, Services and Technology with a North Korean Connection

The advisory provided examples of five types of trade transactions that have heightened risks for an unlawful North Korean connection or nexus:

  • Subcontracting/Consignment Firms: A Chinese or third-country factory subcontracts with a North Korean firm to provide materials or components for a product ordered from the Chinese or third-country factory.
  • Mislabeled Goods/Services/Technology: A North Korean exporter may attempt to hide the origin of goods produced in North Korea by falsely labeling an item as "Made in China" when, in fact, the item was made in North Korea.
  • Joint Ventures: North Korean exporters have formed (nonpublic) partnerships with firms from China and other countries in the areas of

    • apparel, construction, small electronics, hospitality
    • minerals, precious metals, seafood and textiles.2
  • Raw Materials or Goods Provided with Artificially Low Prices: Since North Korean exporters sell goods and raw materials at substantially below-market prices to intermediates and third parties, businesses should view pricing that is well below market as a possible "red flag" that North Korea is involved as a supplier.
  • Information Technology ("IT") Services: Since North Korean firms disguise their country of origin footprint by using front companies, aliases and third-country nationals who act as facilitators, companies should be aware that North Korea provides IT services such as website and app development, security software, and biometric identification software and take appropriate precautions to avoid the North Korean service providers.

III. Increased Risks for and Potential Indicators of North Korean Overseas Labor

A. Country Risks

The advisory identified China and Russia as the two countries that host more North Korean laborers than 39 other countries combined. The advisory provides a full list of countries hosting North Korean labor in 2017- 2018 as follows:

Algeria

Nepal

Angola

Nigeria

Bangladesh

Oman

Belarus

Peru

Cambodia

Poland

China

Qatar

Democratic Republic of the Congo

Uganda

Equatorial Guinea

Republic of Congo

Ethiopia

Russia

Ghana

Rwanda

Guinea

Senegal

Indonesia

Singapore

Kuwait

Tanzania

Kyrgyzstan

Taiwan

Laos

Thailand

Libya

United Arab Emirates

Malaysia

Uruguay

Mali

Vietnam

Mongolia

Zambia

Mozambique

Zimbabwe

Namibia

B. Industry Risks

The advisory warned that large numbers of North Korean laborers are exported to perform a huge single contract involving the following (and other) industries: apparel, construction, footwear manufacturing, hospitality, IT services, logging, medical, pharmaceuticals, restaurant, seafood processing, textiles and shipbuilding.

C. Red Flags Indicating Possible North Korean Overseas Labor

Wage Practices: The employer withholds wages; makes large, unreasonable pay deductions; pays wages late; or makes payment to workers in-kind, among other practices.

Contract Terms: North Korean laborers are generally hired on long-term two-to-five-year contracts that also require a large upfront payment to the North Korean government. The upfront payment could be as high as 30% of the total contract amount.

Poor Housing: Laborers live in unreasonably inexpensive/cheap employer-provided housing that is unsafe and unsanitary; North Korean laborers are often isolated from laborers of other nationalities.

Labor Controls: North Korean laborers typically have no access to or control over their bank accounts, passports or visas (which are controlled or held by the employer). The laborers may have little to no time off work and attend mandatory self-criticism sessions, among other controlling practices.

No Transparency: The ultimate beneficiary of the contract or financial transaction is difficult to ascertain due to contract structuring designed to hide key parties and beneficiaries. Worksite inspections are prohibited by the North Korean government and laborers cannot be interviewed without a "minder" (observer) present.

IV. Risk-Based Due Diligence Required

The advisory recommends that companies review their supply chains for possible North Korean laborers, goods, services and technology. Companies must also take into account whether their activities involve any of the above high-risk industries or countries. Companies should then implement risk-based due diligence procedures and controls commensurate with their assessed risks with respect to possible North Korean links or connections.3

V. Possible Penalties

Failure to conduct appropriate risk-based due diligence and/or engaging in or facilitating a prohibited activity could result in civil penalties of two times the value of the underlying transaction or $295,141 per violation as well as a referral for criminal prosecution, or both. OFAC can also designate a U.S. person and impose sanctions against the U.S. person for misconduct involving North Korea. Secondary sanctions could also be imposed against foreign financial institutions that knowingly conduct or facilitate significant trade with North Korea or that knowingly conduct or facilitate a significant transaction on behalf of a designated person.

VI. Conclusion

According to the advisory, companies with dealings in China, Russia and other high-risk countries in high-risk industries have a heightened exposure for a violation of U.S. and other sanctions and restrictions against North Korea. We recommend that such companies, and the investing firms that fund those companies, ensure that a risk assessment is performed and compliance reviews are conducted to determine the required due diligence actions, controls and internal procedures necessary to detect and avoid any sanctionable North Korean connections, and to prevent a violation of the sanctions against North Korea.

Footnotes

1 A copy of the advisory is available at this website address: https://www.state.gov/documents/organization/284481.pdf.

2 The advisory includes a list of known North Korean joint ventures in Annex 2.

3 For more details on the recommended due diligence standards, the advisory recommends reviewing DHS Q&As (specifically question 8), and OFAC's Economic Sanctions Enforcement Guidelines, 31 C.F. R. Part 501, Appendix A.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Sharie A. Brown
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