Identity Theft and the Perils of Prior Disclosure

Looking to read a judicial opinion that is not a leaked draft? U.S. v. Katana Racing is a fascinating look into how Customs and Border Protection tried to hold a company responsible for entries someone else made fraudulently and the risk of making a prior disclosure while also maintaining that no violation has occurred. 

The facts are that Katana had been importing passenger and light truck tires from China. After the U.S. began assessing safeguard duties on these tires, Katana sought to find new suppliers. Rather than lose the business, one of its existing suppliers proposed that it would assume the responsibilities of importing the goods and the parties negotiated a new price for the tires. This is a Delivered Duty Paid arrangement and makes the seller responsible for customs clearance and the payment of duties, taxes, and fees. Shortly thereafter, the supplier asked Katana to execute a Power of Attorney with the stated reason that it was necessary to allow the supplier to move the goods to Katana's warehouse. That was not true but gave the supplier and possibly unknown parties access to Katana's business information. 

At some later point in time, Customs came to Katana to conduct an audit of 61 entries of tires from China. After looking at its records, Katana determined that it had not made those entries. Katana concluded that someone had stolen its importer identity and made those entries fraudulently. In an apparent effort to do the right thing and to protect itself, Katana notified CBP and chose to do so in the form of a prior disclosure. After further review, Katana found hundreds of similar fraudulent entries had been made in its name.

A prior disclosure is a very important and useful tool for importers. The law (19 USC 1592) allows Customs and Border Protection to penalize any person who enters (or attempts to enter) merchandise into the United States by means of a material false statement or omission that results from fraud, gross negligence or negligence. The penalties can be as great as four times any unpaid duties, taxes, and fees if the violation results from gross negligence and two time that amount for simple negligence. Ironically, where there is no loss of revenue, the penalties can be 40% of the value of the merchandise where gross negligence occurred and 20% for simple negligence. The penalties for fraud can be up to the domestic value of the merchandise. "Domestic value" is not entered value; it is an approximation of the total landed cost plus a profit.

The important thing to understand about a § 1592 penalty is that the whole thing is predicated on there being an underlying violation caused by negligence, gross negligence, or fraud. Not every error is the result of negligence (or worse) and, therefore, not every error is a violation. We know this because it says so right there in § 1592. On top of that, the entry requirement in § 1484 sets the standard of care for importers of record as "reasonable care," which is similar to but not quite the same as negligence. For anyone other than the importer of record, the standard is "don't be negligent." Assuming no violation, after Customs liquidates the entry, that entry is "final and conclusive," meaning there can be no additional liability to the importer.

When an importer discovers something that appears to be an error, it can mitigate its risk of penalties by submitting a voluntary prior disclosure under § 1592(c)(4). The regulations (19 CFR 162.74) specify how an importer can make a disclosure. If the disclosure is done properly, the potential for penalties is limited to the interest on the unpaid duties, taxes, and fees. The importer must also pay the loss of revenue. Importantly, as part of the disclosure, the party seeking the benefit must specify the material false statement or omission and how the occurred. All of this sounds like the disclosing party is making an admission that is has done something that constitutes a violation.

That takes us back to Katana. After a review of import data tied to Katana's importer ID, CBP determined there was a loss of revenue of $10.45 million and requested that Katana pay that amount to complete the disclosure process. Remember, these are fraudulent entries made by parties unknown for which Katana is the victim of corporate identity theft. After some discussion, CBP reduced the demand to $5.74 million. CBP did not add a penalty to that amount and did not immediately issue a formal Pre-Penalty Notice. When it did send a Pre-Penalty Notice, Customs referred to the disclosure and stated that Katana "Katana admitted to $5,393,570.88 in duties and fees owed to CBP . . . ." 

At that point, there was much discussion between Katana and CBP and long periods of inactivity. CBP seems to have wanted to negotiate a settlement with Katana, which provided three waivers of the statute of limitations. More on that later. Eventually, discussions broke down and the government sued Katana to recover the duties someone else failed to pay while pretending to be Katana.

The Court notes that in the demand letter and in the Complaint the Department of Justice filed with the Court, there is no allegation indicating what Katana did that constitutes the alleged violation. As the Court put it in reference to the demand, "any such notice must explain not only what the violation of subsection (a) actually is but also the accused's relationship to it." Further, the Court noted that "What is missing from the written demand, however, is a clear statement of how that subsection (a) violation is attributable to the defendant."

The government's position was simple; it relied on the attempted prior disclosure as an admission of a violation and, therefore, of liability. The Court says this was a mistake and that, in hindsight, it would have been better for Katana to simply alert CBP to the fraud and not present it as a disclosure. Moreover, the Court was not happy with the exercise of governmental power in this way:

All things considered, the plaintiff does not deserve judgment on this complaint. The papers and extrinsic evidence indicate that the plaintiff chose to exert the entirety of its federal power to “go after” the named defendant -- not only as to certain “admitted” (and for purposes of this motion irrelevant) “irregularities” but to demand as well all the “unpaid duties” from the defendant alone, rather than exert any effort (none is apparent among the papers) to detect and pursue the person(s) actually responsible for those unpaid duties. 

Moreover, the Court explicitly held that the disclosure does not constitute an admission or a finding of a violation by the United States. That is a big deal right there. It means that the practice of using a disclosure to alert CBP to a potential violation may be less risky than was previously thought. If the disclosure is not a violation and triggers the obligation of CBP to investigate, as the opinion implies, it may be easier to back out of a disclosure if the facts ultimately show no violation by the disclosing party.

That brings us to the statute of limitations waiver. Customs routinely requests waivers when it receives a disclosure. The waiver allows Customs to process the disclosure, which may take a very long time, without risking an inability to collect on the earliest entries covered by the disclosure. In this case, Katana give three statute of limitations waivers. The last waiver was predicated on Katana's understanding that it would be receiving a formal Penalty Notice in the ordinary administrative process. From there, Katana could go through the process of responding to the notice with a petition to mitigate. Katana never received that notice and CBP did not go through the administrative process.

The United States, according to the decision, commenced the action in the Court of International Trade without undertaking the promised administrative action. The duty demand, on its own, was not sufficient on the facts of this case. The complaint is also lacking in enough detail to constitute sufficient further proceedings. 

Based on the facts and CBP's failure to provide explicit reasons for holding Katana responsible for the unpaid duties beyond the use of its IOR number, the Court found the process insufficient. Consequently, the Court concluded that Katana could revoke its statute of limitations waiver. Another way to put this might be that the point of the SOL waiver was to permit for the orderly completion of the administrative penalty process. CBP never finished that process. As a result, the premise on which Katana agreed to the waiver was untrue and the waiver can be revoked. That is also an important holding.

The upshot from all that is that the Court agreed that the last SOL waiver had been revoked. As a result, the case is time barred and the Court ordered it dismissed. It seems, however, that even if the case had not been time barred, it might have been dismissed for failing to state a cause of action against the defendant.

One side note, this is not the first time that importer identity theft has made it to Court. Take a look at this post and the string of comments from the victim/defendant.