The importance of supply chain due diligence and the risks of modern slavery – OFAC settles North Korean sanctions case with fine

Authors: Kyle Wombolt, Jeremy Birch, Antony Crockett and Emily Purvis.

A recent enforcement action by the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) against US company e.l.f Cosmetics Inc (ELF) highlights the importance of supply chain due diligence in conducting cross border business. The action against ELF reflects a global trend of increased regulatory focus on supply chains in relation to a range of business conduct issues, including corruption, modern slavery, and other human rights violations. To mitigate sanction violation risk, companies should verify the country of origin of goods and services in their supply chains.

Background

On 31 January 2019, OFAC issued an enforcement notice announcing that ELF had agreed to pay US$996,080 to settle its potential civil liability for 156 apparent violations of US sanctions on North Korea. Between April 2012 and January 2017, ELF imported false eyelash kits with a total value of US$4,427,019.26 from two suppliers in China that contained materials sourced from North Korea. ELF’s compliance programme had failed to detect that approximately 80% of the false eyelash kits supplied contained the contraband materials.

The US sanctions

US sanctions on North Korea aim to disrupt revenue to the government it receives from the production of goods and services often through forced labour. According to the 2018 Global Slavery Index, North Korea has the highest prevalence of modern slavery in the world. It is a high risk jurisdiction particularly for companies that produce laptops, computers, mobile phones and clothes.

On 23 July 2018, OFAC and the US Department of Homeland Security issued an Advisory to inform businesses of various sanctions evasion tactics used by North Korea that could result in exposure to sanctions compliance risks. The Advisory encouraged businesses to adopt effective due diligence processes to ensure compliance across their entire supply chains.

ELF was in violation of § 510.201(c) of the North Korea Sanctions Regulations by importing 156 shipments of false eyelashes containing material from North Korea.

Due diligence best practices

The Advisory encourages businesses to closely examine their entire supply chain for North Korean labour, goods, services or technology. Specific due diligence practices will vary depending on the size and nature of the business. However, the Department of Homeland Security recommends that businesses consider:

• Adopting a policy statement demonstrating the company’s commitment to respect human and labour rights;
• Continuously assessing the risk of actual and potential human rights and labour impacts as a result of company activities;
• Integrating commitments and assessments into internal company operation and supply chain controls; and
• Tracking and reporting on areas of risk.

The enforcement notice was critical of ELF’s “non-existent or inadequate” OFAC compliance programme throughout the period April 2012 – January 2017, particularly as the company was sourcing products from a region that poses a high risk to the effectiveness of the North Korea Sanctions Regulations.

Penalties for violations

Although the maximum statutory civil penalty potentially faced was in excess of US$40 million, OFAC settled the case against ELF for US$996,080, reflecting a number of mitigating factors present, including:

• The fact that ELF’s personnel did not appear to have actual knowledge of the conduct that led to the violations;
• ELF had not received a Penalty Notice or Finding of Violation from OFAC for the five years preceding 2012;
• The violations were not a significant part of ELF’s business activities; and
• ELF immediately self-disclosed the apparent violations and cooperated with OFAC.

Comment

OFAC’s action against ELF is a reminder to businesses to implement effective supply chain due diligence and audits to verify the country of origin of goods and services. Companies that do not conduct thorough supply chain due diligence when sourcing products and services, particularly from higher risk regions, are at an increased risk of sanctions violations.

The recommendations in the OFAC/Homeland Security Advisory reflect recommendations contained in the 2011 United Nations Guiding Principles on Business and Human Rights. The enforcement action taken against ELF and the observations regarding the inadequacies of ELF’s due diligence processes show that while these international standards are, in and of themselves, not legally binding, failure to implement them may well be taken into account by prosecutors and other regulators.

If you have any questions, please contact the authors or your usual Herbert Smith Freehills contact.