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US Company Settles Whistleblower Lawsuit, Pays for Importer’s Customs Fraud

US companies can be liable for importers' evasions of duties on shipments of export cargo and import cargo in international trade.

US Company Settles Whistleblower Lawsuit, Pays for Importer’s Customs Fraud

Federal prosecutors in New York recently announced the settlement of a remarkable lawsuit relating to a scheme to evade import duties. The case involved an importer’s undervaluation of apparel to pay less duties than were really owed.

The settlement that prosecutors reached, however, was not with the importer, but its customer. Notations, Inc., a Pennsylvania womenswear wholesaler, agreed to pay $1 million and consented to a court order requiring it to implement a broad range of compliance measures designed to prevent it from doing business with customs cheats in the future.

Notably, there was no legal question in the case that the filing of accurate customs entry documents and the payment of appropriate duties were obligations of the importer. So how did Notations wind up being dragged into—and paying a substantial price to settle—the case? This is a key question for companies that source goods from abroad, especially under a president who is generally hostile to foreign imports and keen to enforce US tariffs.

Scope of US False Claims Act

Prosecutors didn’t bring a lawsuit simply to collect unpaid duties. Instead, they brought a case for fraud under the US False Claims Act. The FCA is a multi-purpose anti-fraud statute that imposes substantial potential liability—three times damages, plus penalties—on parties that knowingly overcharge (or underpay) federal agencies. Congress originally enacted the FCA during the Civil War to counter fraud by suppliers of the Union Army. A primary feature of the statute is its qui tam or “whistleblower” provision, under which parties aware of fraudulent conduct can initiate lawsuits on the government’s behalf. The government is entitled to intervene in and assume prosecution of the lawsuit. The whistleblowers—who typically are former or present insiders of the wrongdoing company, but also frequently competitors or industry experts—generally are entitled to receive rewards of 15 percent to 30 percent of any recovery.

As illustrated by the Notations settlement, the scope of the FCA can be quite broad. Parties can be held liable for violations even if they only indirectly participated in, or somehow aided or helped to conceal, a scheme to defraud a federal agency. The statute prohibits not only the making of false claims, but also the making, use, or causing to be made or used of “false records or statements” that are “material to” schemes to defraud an agency. There is no requirement that there be a direct connection between the alleged violator and the agency. Claims under the FCA are therefore unlike and more perilous to a potential defendant than those under, for example, the Tariff Act for unpaid duties.

Liability for turning a blind eye to customs fraud

The Notations case was started by a whistleblower (a relative of a former employee of the importer) who brought FCA claims against the importer and its foreign parent company, which was Notation’s supplier of the goods in question. Federal prosecutors added Notations as a defendant only after investigating the whistleblower’s claims. Prosecutors found that, prior to doing business with the supplier, Notations generally had served as its own importer for garments that it sourced from overseas. It employed staff whose job it was to ensure customs compliance in such Free on Board or FOB type transactions. Yet, when Notations began doing business with the supplier in 2009, it switched to the use of Delivered Duty Paid or DDP type purchase arrangements. This meant that its suppliers had responsibility for taking care of customs entry and duties payment, while Notations simply paid an all-in purchase price.

Prosecutors alleged that, after switching to DDP arrangements, Notations deliberately turned a blind eye to whether its suppliers were cheating on duties obligations. On one occasion, for example, Notations received an invoice that drastically understated the prices of goods it was buying. According to prosecutors, the document easily was recognizable as a fraud directed at Customs and Border Patrol. Notations nevertheless did nothing to stop—or alert CBP to—this illegal conduct. Notations employees testified that they did not believe it was their job to do so.

Prosecutors also alleged that Notations aided the fraud by helping the importer create a phony audit trail. According to the prosecutors, Notations agreed to provide the importer with irregular purchase orders, to accept irregular invoices, and to furnish “assists” (in the form of fabric) knowing that their cost was not being added to the dutiable value as the law required. Notations also agreed to issue its purchase orders directly to the importer—rather than to the importer’s parent company, i.e., the supplier, which is the company to which Notations made its payment for the goods—to support the importer’s false representations to CBP that it was an independent middleman.

Prosecutors additionally found it significant that Notations profited from the fraud and received inducements from the supplier. Notations not only got below-market prices on the garments that it purchased, it also was provided with “an excessive number of chargebacks”, i.e., post-delivery price breaks. Prosecutors also discovered $200,000 in “cash payments for the benefit of Notations or its owner” which, suspiciously, were paid by the supplier to an offshore Notations affiliate.

In the settlement, Notations “accepted responsibility” for failing to “take action in response to multiple warning signs” that the fraud was occurring. The compliance measures to which Notations consented were broad. It agreed to educate its staff on customs compliance and fraud detection, and to require certifications of compliance from all its DDP suppliers. It also agreed to monitor marketplace price levels and demand explanations from suppliers offering prices “substantially below” average. Additionally, it agreed to “cease doing business” with suppliers suspected of fraud or non-compliance or that failed to explain their pricing.

Warning to US demand chain and call to whistleblowers

The settlement serves as a warning for US companies that source goods from abroad and think that they can depend on transactional arrangements in which their suppliers serve as the importer of record to duck responsibility for customs compliance. Such parties expose themselves to potential FCA liability even if they themselves don’t lie to or underpay CBP. This is particularly so if the company receives substantial price discounts or other financial benefits from—or engages in conduct that can be viewed as aiding or helping to conceal—duties evasion. Acting US Attorney for the Southern District of New York Joon H. Kim stated that the Notations case shows that “companies purchasing imported goods cannot turn a blind eye to fraud committed by their business partners. We will be vigilant in holding accountable all parties who engage in or contribute to fraudulent conduct.”

Notably, the targeting of US customers in import-related FCA cases solves a major problem for prosecutors and whistleblowers: the difficulty of collecting judgments against foreign importers that have few if any assets in the US. For this reason, prosecutors and whistleblowers have an incentive to pursue claims against US companies—whose pockets are more accessible—where possible. This puts US counterparties of foreign customs fraudsters such as Notations squarely in the crosshairs for FCA suits.

The settlement also serves as a call to whistleblowers regarding potential FCA claims that they may bring. Whistleblowers should not assume that the importer is the only party that can be sued in an FCA case based on duty evasion. Other parties in the supply or demand chain that contribute to or help cover up an evasion scheme can be named as conspirators and violators under the statute. Furthermore, it is entirely possible for an individual to be an FCA whistleblower in a duties case without being an employee of, or even having first-hand knowledge about, the activities of an importer. Individuals associated with other parties such as a customer like Notations may have information sufficient to support a potentially lucrative whistleblower claim.

There has been a noticeable trend in recent years of federal prosecutors going after duties evasion schemes as FCA violations rather than mere Tariff Act infractions. This trend should accelerate given that a key theme of the Trump administration’s trade agenda has been to prevent foreign manufacturers from gaining an unfair advantage over US producers. Companies that source goods from abroad are thus increasingly vulnerable to FCA trade enforcement, while whistleblowers who uncover duties evasion schemes should benefit from prosecutors increasingly taking their allegations seriously and opting to prosecute their claims.

Mark A. Strauss is a partner in the law firm of Kirby McInerney LLP in New York.  He represents whistleblowers in qui tam lawsuits brought under the False Claims Act. He can be reached at mstrauss@kmllp.com. The opinions expressed are those of the author and do not necessarily reflect the views of his firm or its clients. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

Expect more enforcement actions concening shipments of export cargo and import cargo in international trade.

Expect Increased Use of Whistleblower Law Under Trump

One of the few federal agencies not slated for funding cuts under President Trump’s proposed budget is US Customs and Border Protection.‭ ‬In fact,‭ ‬CBP,‭ ‬which is responsible for enforcing US customs and trade laws,‭ ‬is proposed to receive an additional‭ ‬$300‭ ‬million to recruit,‭ ‬hire,‭ ‬and train thousands of new personnel.‭

On March‭ ‬31,‭ ‬2017,‭ ‬President Trump signed an executive order calling for CBP to ramp up its efforts to combat customs law violations‭ – ‬in particular,‭ ‬breaches of antidumping and countervailing duty orders1‭ – ‬as an element of the administration’s trade policy of preventing foreign competitors from gaining an unfair advantage over US industries.‭

With these developments,‭ ‬we can expect stepped up efforts to counter import duty evasion under President Trump.‭ ‬CBP has authority under the US Tariff Act to assess penalties and seize merchandise for trade violations including duties underpayment.‭ ‬But schemes to evade import duties through fraud‭ – ‬for example,‭ ‬by misrepresenting goods‭’ ‬country of origin in order to avoid antidumping or countervailing duties‭ – ‬increasingly are being prosecuted by the US government,‭ ‬aided by whistleblowers,‭ ‬under the US False Claims Act.‭ ‬We expect this trend to accelerate under the new administration given its trade objectives.‭

Trade enforcement under the False Claims Act
The False Claims Act is the US government’s primary anti-fraud tool.‭ ‬It imposes significant civil liability‭ – ‬three times damages,‭ ‬plus penalties‭ – ‬on parties found to have knowingly overcharged‭ (‬or underpaid‭) ‬federal agencies.‭ ‬The statute dates back to the Civil War,‭ ‬when Congress enacted it to combat fraud by suppliers of materiel to the Union Army.‭

A key feature of the False Claims Act is its qui tam provision,‭ ‬pursuant to which private parties with knowledge of fraudulent conduct‭ – ‬whistleblowers or‭ “‬relators‭” – ‬can file lawsuits on the government’s behalf.‭ ‬The government has the right to intervene in and take over the lawsuit after investigating the allegations.‭ ‬Whistleblowers are incentivized through rewards of‭ ‬15‭ ‬percent to‭ ‬30‭ ‬percent of the recovery obtained from the violator,‭ ‬which can be sizable.

Whistleblowers in False Claims Act lawsuits involving customs violations have generally been former or present employees of the violator‭ – ‬i.e.,‭ ‬parties with inside knowledge of the wrongdoing.‭ ‬Competitors,‭ ‬consultants,‭ ‬and others with expertise in particular markets,‭ ‬however,‭ ‬increasingly are whistleblowers in this area.‭ ‬In some cases,‭ ‬claims have been asserted not just against the importer,‭ ‬but also downstream third-party customers on the theory that those parties participated in and benefitted from the violations.‭

The influential United States Attorney’s Office for the Southern District of New York has been particularly active in prosecuting customs enforcement cases under the False Claims Act.‭ ‬Not surprisingly,‭ ‬most such cases involve imports from the People’s Republic of China,‭ ‬the United States‭’ ‬largest goods trading partner.‭

Three types of violations are prevalent in these lawsuits‭ – ‬transshipment,‭ ‬undervaluation,‭ ‬and tariff misclassification.

Third country transshipment
Transshipment frauds involve disguising imports‭’ ‬country of origin in order to evade antidumping and countervailing duties.‭ ‬The goods are shipped to third countries before being re-shipped to the US with the documentation manipulated to conceal the true source country.‭ ‬Frequently,‭ ‬such schemes involve false product markings or packaging designed to look like goods produced in the third country,‭ ‬making detection difficult.

One example is the Univar case.‭ ‬There,‭ ‬the violator allegedly evaded antidumping duties on imports of the artificial sweetener saccharin from the PRC by transshipping the product through Taiwan,‭ “‬re-bagging‭” ‬it,‭ ‬and falsely identifying Taiwan as the country of origin.‭ ‬The whistleblower‭ – ‬a US saccharin distributor that competed with the violator‭ – ‬uncovered the scheme by analyzing trade data and investigating Taiwanese manufacturing capabilities.‭ ‬It traced Taiwanese saccharin imports from the PRC to matching saccharin exports to the US,‭ ‬and found that no factories in Taiwan even possessed the chemical-use permits required to make saccharin.‭ ‬The government sued Univar to recover unpaid antidumping duties and penalties in a lawsuit now pending in the US Court of International Trade in New York.

Another transshipment case was Tai Shan Golden Gain Aluminum Products.‭ ‬There,‭ ‬four US manufacturers allegedly colluded to evade antidumping and countervailing duties on aluminum extrusions that they imported from the same suppliers in the PRC.‭ ‬The manufacturers arranged to transship the goods through Malaysia‭ – ‬falsely relabeling them as Malaysian in origin‭ – ‬using a dummy,‭ ‬front corporation that they set up to be the importer of record.‭ ‬The government intervened,‭ ‬and,‭ ‬in‭ ‬2015,‭ ‬reached settlements with the defendants totaling‭ ‬$4.5‭ ‬million.‭ ‬The whistleblower,‭ ‬a Florida-based Asia-Pacific trade consultant,‭ ‬received‭ ‬18‭ ‬percent as a reward.‭

Undervaluation frauds‭
When goods are entered,‭ ‬the importer is required to declare their value and submit verifying commercial invoices.‭ ‬Undervaluation frauds generally involve false declarations accompanied by fake invoices containing understated prices.‭ ‬Sometimes this occurs as part of a double-invoice scheme in which the importer issues corresponding true invoices,‭ ‬reflecting accurate prices,‭ ‬to its US customers.‭ ‬In other instances,‭ ‬the fraud involves the submission of invoices from a purportedly unrelated third-party manufacturer,‭ ‬when,‭ ‬in fact,‭ ‬the manufacturer is an affiliate of the importer and the invoices therefore fail to satisfy the requirement that they be‭ “‬arm’s length.‭” ‬Still other undervaluation frauds involve the failure to include the cost of‭ “‬assists‭” – ‬items or services supplied by the importer to the manufacturer‭ – ‬in the values declared to CBP as required.

In the Motives case,‭ ‬for example,‭ ‬the whistleblower alleged that the violator provided CBP with fake invoices undervaluing certain apparel imports while secretly issuing a second set of true invoices‭ – ‬characterized as‭ “‬debit notes‭” – ‬to its customers reflecting the actual amounts charged.‭ ‬The government intervened,‭ ‬and,‭ ‬in July‭ ‬2016,‭ ‬the defendants paid‭ ‬$13.4‭ ‬million to settle the claims.

Similarly,‭ ‬in Yinghsun Garments,‭ ‬a case currently being litigated in federal court in New York,‭ ‬the whistleblower alleges that an apparel manufacturer evaded millions of dollars in import duties through a double-invoice scheme that resulted in undervaluing its imports by‭ ‬75‭ ‬percent.‭ ‬The government intervened,‭ ‬bringing claims against one of the manufacturer’s US customers as well.‭ ‬The government alleges that the customer violated the False Claims Act by failing to monitor the manufacturer’s customs entry practices,‭ ‬accepting‭ “‬irregular‭” ‬documentation from the manufacturer,‭ ‬and providing it with‭ “‬assists‭” ‬in the form of fabric without taking appropriate steps to ensure that their cost was included in the declared entry value.‭ ‬The government has also claimed that the customer profited from the scheme by receiving‭ “‬below-market‭” ‬prices on the garments that it purchased from the manufacturer.‭

And in Otter Products,‭ ‬a Colorado case,‭ ‬a producer of protective cases for mobile devices allegedly underpaid millions of dollars in import duties by failing to include the value of engineering,‭ ‬design,‭ ‬and product-mold‭ “‬assists‭” ‬that it provided to its overseas manufacturers in its entry declarations.‭ ‬The whistleblower‭ – ‬a former logistics coordinator for the company who was fired after trying to bring it into compliance‭ – ‬received a reward of‭ ‬20‭ ‬percent of the‭ ‬$4.3‭ ‬million that the company paid to settle the case in April‭ ‬2014.‭

Tariff misclassification‭
Tariff misclassification frauds involve attempts to misrepresent the type of goods being imported in order to declare them under incorrect duty classifications.‭ ‬The violator’s goal may be to evade antidumping or countervailing duties,‭ ‬get a lower duty rate,‭ ‬or avoid duties altogether.‭

A prime example is the AmeriSource case.‭ ‬There,‭ ‬an importer allegedly evaded antidumping duties on small diameter graphite electrodes‭ (‬a product used in steel manufacturing‭) ‬from the PRC by misclassifying the goods as larger diameter electrodes not subject to such duties.‭ ‬It paid‭ ‬$3‭ ‬million to settle the claims in February‭ ‬2016.‭ ‬The whistleblower‭ – ‬a competitor of the violator that lost business due to the violator’s underselling‭ – ‬uncovered the fraud through its own market checks and analysis of public trade data.‭ ‬It received a‭ ‬16‭ ‬percent reward.

Another example is the FSM Group case.‭ ‬There,‭ ‬an importer of military grade ultra-fine magnesium powder from the PRC falsely identified the goods on its entry documents as magnesium desulphurization reagent‭ – ‬a distinct product made up‭ ‬90‭ ‬percent of magnesium powder.‭ ‬It thereby avoided antidumping duties of over‭ ‬300‭ ‬percent.‭

The False Claims Act whistleblower,‭ ‬a competitor of the violator,‭ ‬discovered the fraud through its own investigation.‭ ‬It found evidence that the violator was importing the ultra-fine magnesium powder under the guise of magnesium desulphurization reagent by shipping it with aluminum rods‭ – ‬easily removed after delivery‭ – ‬comprising‭ ‬10‭ ‬percent by weight of each package.‭ ‬The government intervened,‭ ‬and the violator settled the claims in March‭ ‬2016‭ ‬for‭ ‬$8‭ ‬million.‭

Notably,‭ ‬the misclassification of the goods in FSM Group was part of a larger scheme in violation of the False Claims Act.‭ ‬After importing the ultra-fine magnesium powder,‭ ‬the violator supplied it to a US military contractor,‭ ‬falsely passing it off as manufactured in the US or Canada‭ – ‬not overseas‭ – ‬in order to meet governmental contracting requirements.‭ ‬Five former employees and agents of the violator pled guilty to criminal offenses in connection with the scheme and were ordered to pay‭ ‬$14‭ ‬million in restitution.

Another,‭ ‬rarer type of duty evasion scheme is‭ “‬failure to manifest‭” – ‬otherwise known as smuggling.‭ ‬This is when an importer circumvents duties by failing to declare the goods at all on its entry documents.‭ ‬These types of schemes generally are prosecuted under criminal laws,‭ ‬but may also form the basis for whistleblower lawsuits under the False Claims Act.‭

The US government recovered‭ ‬$4.7‭ ‬billion from False Claims Act litigation last year,‭ ‬of which‭ ‬$2.9‭ ‬billion came from cases initiated by qui tam whistleblowers who received a total of‭ ‬$519‭ ‬million in rewards.‭ ‬Although duty evasion cases accounted for a small fraction of this haul‭ – ‬the bulk came from cases relating to health care and defense spending‭ – ‬we anticipate more activity in this area under the new administration.‭ ‬The result should be a higher rate of government intervention in whistleblower actions,‭ ‬larger recoveries,‭ ‬and more substantial whistleblower rewards.‭

Mark A.‭ ‬Strauss is a partner in the law firm of Kirby McInerney LLP in New York.‭ ‬He represents whistleblowers in qui tam cases. The opinions expressed are those of the author and do not necessarily reflect the views of his firm or its clients.