Let’s suppose you are a manufacturer of EAR99 items. You have a number of foreign subsidiaries to assist foreign sales in their countries, including one in Lower Slobodovia. The employees of that sub would like to sell your products to Kenneth Widmerpool, an SDN in Lower Slobodovia. Knowing that you would not sell to an SDN, they tell you falsely that the end-user is Nick Jenkins, who is not an SDN.
When you ship the product, you note on the EEI that the end-user is Nick Jenkins, sincerely believing that to be the case and with no idea this Widmerpool fellow is the actual end user. Next thing you know, the DOJ is breathing down your throat, accusing you of a criminal violation of section 30.71(a)(1) of the Foreign Trade Regulations which makes it a crime to “knowingly [submit], directly or indirectly, to the U.S. Government, false or misleading export information through the AES.” The prosecutors claim the EEI you submitted was “knowingly” submitted by you because the employees of your sub RUSCo knew the information you would put on the EEI and file through AES was false. Respondeat superior, you know.
Deciding that an orange jumpsuit is not a good look, you sign a Non-Prosecution Agreement. Under that NPA, you agree, among other things, that you will pay the DoJ a significant chunk of change.
Could this actually happen? Yep, it could and did. Remember the OFAC settlement agreement discussed in my last post? Well, the DoJ piled on top of the OFAC tackle, and accused the company, among other things, of criminal violations of section 30.71(a) for “knowingly” filing an EEI that provided a false identification of the true ultimate consignee. The statement of facts in the NPA does not allege that the parent knew the ultimate consignee named in the EEI was false; rather, it asserted repeatedly, and presented the factual basis that demonstrated, that the employees of the Russian subsidiary knew that the ultimate consignee information they gave to the parent was false.
The big problem here is that attributing the knowledge of the Russian subsidiary’s employees to the parent U.S. company in this case is more than a little questionable, particularly where the Russian employees were actively concealing that knowledge from the U.S. parent. To begin with the relevant regulation says this
All EEI[s] submitted to the AES shall be complete, accurate, and timely. The filer is responsible for ensuring that the EEI is complete, accurate, and timely, except insofar as that party can demonstrate that it reasonably relied on information based on personal knowledge of the facts and information furnished by other responsible persons participating in the transaction.
Here the parent company was relying on the representations of the Russian employees actually handling the transaction and who presumably could be trusted in their representations of the actual ultimate consignee.
Let’s also look at some case law on this.
“[T]he mere existence of a parent-subsidiary or affiliate relationship is not on its own sufficient to impute the scienter of the subsidiary to the parent or affiliate.” Valentini v. Citigroup, Inc., 837 F. Supp. 2d 304, 317 (S.D.N.Y. 2011) (citing Chill v. Gen. Elec. Co., 101 F.3d 263, 270–71 (2d Cir. 1996)); see also In re Comshare Inc. Sec. Litig., 183 F.3d 542, 553–54 (6th Cir. 1999); Defer LP v. Raymond James Fin., Inc., 654 F. Supp. 2d 204, 218–19 (S.D.N.Y. 2009); In re Marsh, 501 F. Supp. 2d at 482–83. In order to impute the scienter of an officer of a subsidiary to the subsidiary’s parent corporation, the plaintiff must allege either that the officer is sufficiently senior in the parent’s management that he serves as a “prox[y]” for the parent, Thomas, 2017 WL 2937620, at *3, or that the parent otherwise “possessed some degree of control over, or awareness about, the fraud,” Valentini, 837 F. Supp. 2d at 317.
Schiro v. Cemex, S.A.B. de C.V., 396 F. Supp. 3d 283 (S.D.N.Y. 2019).
Here the two Russian employees appear to have had no seniority in the parent company, and the company had no knowledge of or control over the false statement because the two employees actively concealed the truth from the parent. In fact the DoJ concedes as much in its cover letter for the NPA where it cites the concealment as a mitigating factor:
the misconduct was committed by a small group of employees in the Company’s Russia-based subsidiary (which was subsequently shut down) who actively concealed the activity from the Company’s U.S.-based compliance personnel
There is related applicable case law that the knowledge of a rogue employee can’t be attributed to his or her employers. The keystone case here is Standard Oil Co. of Texas v. United States, 307 F.2d 120, 127–29 (5th Cir. 1962). In that case, a subsidiary of Standard Oil obtained and transported oil to Standard Oil which it then sold on the open market. The Connally Hot Oil Act forbade sales from certain wells based on their daily production levels. The subsidiary employees falsified certificates of origin so that the operator of the wells not meeting those levels could sell the oil to Standard. Based on those false certifications, Standard bought the “hot” oil, sold it and then was convicted of violations of the Connally Hot Oil Act for “knowingly” selling hot oil.
The Fifth Circuit reversed those convictions saying:
For [Standard Oil] to be found guilty of violating the Connally Hot Oil Act we may assume that it is not necessary to prove that through imputation each corporation consciously knew that the acts being done were in violation of the law. But to subject [Standard Oil] to criminal accountability it was necessary on accepted principles of imputation [it] to know that these acts of [the subsidiary’s employees] were being done. Under a statute requiring that there be “a specific wrongful intent,” and the “presence of culpable intent as a necessary element of the offense * * *,” the corporation does not acquire that knowledge or possess the requisite “state of mind essential for responsibility,” through the activities of unfaithful servants whose conduct was undertaken to advance the interests of parties other than their corporate employer.
See also Wight v. BankAmerica Corp., 219 F.3d 79, 87 (2d Cir. 2000)(where an agent, though ostensibly acting in the business of the principal, is really committing a fraud for his own benefit, he is acting outside of the scope of his agency, and it would therefore be most unjust to charge the principal with knowledge of it.).
The parallel is hard to miss. In Standard Oil and the case under discussion, employees of a subsidiary deliberately supplied false information that caused an unsuspecting corporation to engage in a transaction that was unlawful precisely because the information supplied by those employees was false.
The transaction brought about here by the Russian subsidiary employees’ lies to the parent was not in the parent’s interest at all but rather was wholly against it because it was an illegal business transaction with an SDN. Such a transaction could lead to civil fines in excess of any revenue received from the transaction. This is to be distinguished from, for example, an illegal activity such as bribery which leads to a legal business transaction that benefits the company. Instead, the principal benefit here was for the SDN. It also benefited the rogue Russian employees themselves. They certainly thought it would benefit them in some way whether it was through commissions or anticipated salary increases or otherwise.
Nor is it necessary to speculate whether the Russian employees were acting contrary to the parent company’s compliance requirements. The NPA itself states that “multiple documents generated and handled by EN-Russia employees reinforced the requirement that their sales must abide by U.S. export laws.” The Russian employees therefore were not merely pursuing a sale through unlawful means; they were deliberately concealing information necessary to determine whether the transaction itself complied with an express requirement governing their sales.
Of course, here the parent company did in fact take the NPA deal. Even if the prosecution’s theory on the EEI violations was deficient, there were other crimes alleged and admitted to in the NPA