By John Herzo, Senior Associate
Everyone involved in export compliance understands that the cornerstone of corporate compliance is a strong export compliance program. A sign that your export compliance program is functioning properly is the ability of your employees to identify and prevent potential export compliance violations before they occur. One essential tool for an effective export compliance program is employee training on the recognition and remediation of "red flags" in export transactions. The goal of this article is to explain what is meant by "red flags" and the forms in which the "red flags" present themselves in prospective export transactions.
Scenario - Missiles, Inc., of the U.S. (Your Company) received a purchase order from ABC GmbH of Germany for sophisticated missile engine components. Per your company's Export Compliance Manual, Missiles, Inc., performed its due diligence on the new customer ABC GmbH. The due diligence determined the following facts about ABC GmbH:
- ABC GmbH has no company website;
- ABC GmbH's purchase order was sent to you via a Gmail email account;
- ABC GmbH's asked if Missiles, Inc., would accept a cash payment for the missile engine components;
- ABC GmbH's purchase order did not request any ongoing support, which is customary for these products;
- ABC GmbH is listed on several investment websites as a book store;
- A Google Earth search identified ABC GmbH at the street address provided and the store front appears to be a book store;
- Missiles, Inc., ran a denied party screening of ABC GmbH against U.S. Government denied party lists and revealed a hit for ABC GmbH of Germany, but the address is slightly different than the address for ABC GmbH;
- ABC GmbH asked for the missile engine components to be sent to their freight forwarder in the U.S., and did not note delivery to their address in Germany; but identified for the freight forwarder to contact ABC GmbH for delivery instructions
- Lastly, ABC GmbH refused to provide an end use statement regarding its intended use of the missile engine components.
Let's analyze the information Missiles, Inc., is presented with:
Denied Party Screening
Red Flag - ABC GmbH's address is similar to one of the parties found on BIS', the Office of Foreign Assets Control's ("OFAC") or other U.S. Government agency's denied parties/persons lists.
The existence of this "red flag" means that Missiles, Inc., will need to perform additional due diligence, e.g., research, to confirm that ABC GmbH is not the party on the subject denied party list. This is a difficult "red flag" to overcome, particularly when viewed in conjunction with the other "red flags" explained below. Missiles, Inc., must have persuasive evidence, not merely a statement in writing, that ABC GmbH is an entirely different organization from the listed entity at a different address. As companies who are prohibited from receiving U.S. exports will take significant steps to conceal their "prohibited" status, Missiles, Inc., must conduct extensive due diligence to overcome this "red flag".
Red Flag - ABC GmbH refused to provide an end-use statement regarding how it will utilize the missile engine components after Missiles, Inc., requested the end-use statement.
This "red flag" is a very serious one, particularly in light of the sensitive end use and extensive controls applicable worldwide on missile components. Detailed end-use statements are absolutely essential for items like missile components given that the U.S. Government will only approve export to vetted Governmental end users in "friendly" countries. This "red flag" may also present itself in other obvious ways such as the customer providing limited information on end-use when requested. If the potential customer or purchasing agent understands U.S. export regulations and believes it knows the classification of your product, they may try and tell you that there is no licensing requirement for the export of your product to their country. Therefore, end-use information is not required. The correct response, per EAR Part 744, or the ITAR (if applicable) is that the U.S. Government prohibits sales of any item if it will be used in nuclear production or any unsafeguarded nuclear facility; or any missile or unmanned aerial vehicle capable of a range of 300km or greater; or any chemical or biological end-use. Thus, your company requires end-use information to rule out the requirement for a license per EAR Part 744.
or the ITAR
Product Capability Vs. Customer's Line Of Business
Red Flag - Your due diligence revealed that ABC GmbH is a book store, therefore the product's capabilities, sophisticated missile engine components, does not fit ABC GmbH's line of business.
This is a really impossible "red flag" to overcome. The purchase of sensitive items, like missile components by those not in the same line of business is risky, given the high possibility of diversion to unauthorized end users. The fact that ABC GmbH is a book store was corroborated by Missiles, Inc.'s Google Earth search. As a result, Missiles, Inc. needs additional information for any possibility of overcoming this "red flag".
Technical Level Of End-Use Country
Red Flag - The item ordered is incompatible with the technical level of the country to which it is being shipped.
This "red flag" did not present itself in the scenario above because ABC GmbH is from Germany a highly technical country with active missile development end users. This type of "red flag" typically presents itself when the due diligence reveals export controlled equipment is being requested for purchase and shipment to a country that has no known capability to field or use the equipment.
Payment In Cash
Red Flag - ABC GmbH asked if Missiles, Inc., would accept cash for the missile engine components. The missile engine components are very expensive and would normally call for financing.
This "red flag" is indicative of an entity not wanting a "paper trail" and a sign of possible diversion. Your company's business development and sales force should be able to identify this "red flag" during sales meetings and contract negotiations.
Payment By Another Company
Red Flag - A secondary party requests to pay for another party's purchase.
This "red flag" did not present itself in this scenario. This "red flag" will present itself during the negotiation of the sale or after the sale has been negotiated, but prior to payment. Typically, a U.S. entity requests to pay for the purchase of a foreign entity. In some cases, the foreign customer / end user is from a proscribed country, such as Venezuela. The payment through another party may be a way to avert economic sanction regulations or to otherwise avoid being a party to a transaction. This "red flag" may implicate compliance issues with the OFAC regulations and the Foreign Corrupt Practices Act.
Little Or No Business Background
Red Flag - The customer has little or no business background.
This "red flag" also did not directly present itself in the scenario above. This "red flag" will typically present itself during the negotiation of the sale. Your company's business development personnel or sales force should be able to identify this "red flag" readily through bid and proposal discussions.
Unfamiliar With Product's Performance Characteristics
Red Flag - The customer is unfamiliar with the product's performance characteristics but still wants the product.
This "red flag" did not present itself in our scenario above. This "red flag" typically presents itself during the negotiation of the sale. Your company's business development personnel or sales force should also be able to identify this "red flag" as performance characteristics are essential for applications like missiles.
Decline Of Routine Installation, Training, Or Maintenance Services
Red Flag - ABC GmbH's purchase order did not request maintenance information or a warranty.
This "red flag" presented itself in ABC GmbH's email that contained its purchase order for the missile engine components. The failure to request installation, training or maintenance support where it is ordinarily requested can be a "red flag" indicating diversion to a prohibited end use as the ultimate end user would be denied the ability to receive this support, as well as the parts. This "red flag" typically presents itself during the negotiation of the sale. Your company's business development personnel or sales force should also be able to identify this "red flag".
Red Flag - Delivery dates are vague, or deliveries are planned for out of the way destinations.
This "red flag" did not present itself in the scenario above. Typically, this "red flag" will present itself during the negotiation of the sale. Your company's business development personnel or sales force should be able to differentiate between vague delivery dates for valid business reasons as opposed to vague delivery dates that are "red flags". Deliveries to out of the way destinations will present themselves during the due diligence phase when your company is screening the potential customer. For instance, the customer's address is in the United Arab Emirates, but they are asking for delivery to Uganda. This is a "red flag" that is often able to be overcome when the purchaser is able to explain the logical reasoning behind its request. This "red flag" will need to be addressed in the export license application as verification of address is important.
Delivery To Freight Forwarder
Red Flag - ABC GmbH requested that the missile engine components be delivered to its freight forwarder in the U.S. and did not state to deliver to ABC GmbH in Germany.
Is this a "red flag"? It is often customary for the foreign customer to identify the freight forwarder if they pay the freight charge. This can be a red flag if the purchase order doesn't identify to make the shipment from the U.S. direct to ABC GmbH in Germany. In this scenario, the requirement for the freight forwarder to get instructions for delivery information at a later time is another red flag. Is this a routed transaction, where the responsibility for licensing of controlled exports is placed on the U.S. freight forwarder? If yes, receive and review a copy of their export license before you make delivery to the freight forwarder. This allows you to verify the bona fides of the parties to the export transaction. This "red flag" should be identified by your company's business development personnel, sales force or shipping department as it is not typical to ship missile engine components to only the U.S. freight forwarder without knowledge of direct shipment to the foreign customer.
Red Flag - The shipping route is abnormal for the product and destination.
This "red flag" did not present itself in the scenario above. This "red flag" presents itself during the negotiation of the sale and the shipping process. Your company's business development personnel, sales force and shipping department should be able to identify this "red flag". This is a risk of diversion when the product is transported on an unusual route.
Red Flag - Packaging is inconsistent with the stated method of shipment or destination.
This "red flag" did not present itself in our scenario above. The "red flag" presents itself during the shipping process. Your company's shipping department should be able to identify this "red flag". This "red flag" often indicates a product will be diverted and party maybe used to obfuscate the country of export.
Red Flag - When questioned, the buyer is evasive and especially unclear about whether the purchased product is for domestic use, for export, or for reexport.
This "red flag" did not specifically present itself in the scenario above. However, ABC GmbH did refuse to provide an end-use statement, which is a form of evasiveness. This "red flag" may arise during the negotiation of the sale. This is very serious given the strict rules on end use of these types of items. Your company's business development personnel or sales force should also be able to identify this "red flag".
Red Flag - Missiles, Inc.'s due diligence into the bona fides of ABC GmbH revealed that ABC GmbH does not have a company website. While not every company has a website, most companies involved in the use of missile engine components have a website. The failure of your customer to have a website is a "red flag" that your company should perform additional due diligence to determine the bona fides of the customer.
This "red flag" presented itself in the scenario during the performance of Missiles, Inc.'s due diligence. Your company's business development personnel or sales force should also be able to identify this "red flag".
Red Flag - ABC GmbH's email to Missiles, Inc., came from a gmail email account as opposed to an ABC GmbH corporate email account. While not every customer will have a corporate email account, most companies involved in the use of missile engine components have a corporate email account. Your customer's failure to have a corporate email account is a "red flag" that your company should perform additional due diligence to determine the bona fides of the customer.
This "red flag" presents itself at the inquiry stage of the sales process. This "red flag" is easily identifiable by your company's customer service, business development and sales personnel.
With the preponderance of red flags present in this scenario, should Missiles, Inc., proceed with the order? What would your company do?
There can be many different "red flags" to export transactions that should put your company on notice that a given transaction has the potential to lead to an export violation and diversion of goods. It is your company's responsibility to address these "red flags" as they present themselves to different departments within your company from business development to shipping. Having a well-established export compliance program that includes specific departmental export compliance training and specific procedures that include "red flag" alerts and reviews will allow your personnel to identify potentially suspect export transactions and further research them to ensure the transaction is valid before proceeding.
We have utilized the "red flags" published on the Department of Commerce, Bureau of Industry and Security's ("BIS") webpage as a guide for this article.