Legal Affairs: TRADE
EXPORTS THAT AREN'T GOING ANYWHERE
It seemed like the perfect opportunity to break into an important emerging market. At least that's what LifeScan Inc., a Johnson & Johnson subsidiary, thought when it agreed in 1993 to sell $400,000 worth of glucose test strips at half the U.S. wholesale price. The buyer, Swiss-based Anglo-American Foundation, promised to distribute the Milpitas (Calif.) company's devices to needy diabetics in the former Soviet Union. But the deal was costly--particularly when LifeScan discovered that its strips never even left U.S. shores. Instead, they allegedly were diverted by Anglo-American to a New Jersey warehouse and then resold to local distributors for a tidy profit.
LifeScan is just one of a growing number of U.S. companies claiming to be victimized by a little-known crime called export diversion. At first blush, the fraud might seem like just another petty rip-off. In reality, export diversion presents an enormous danger to business and the public. "This is a sinister and evil form of fraud that threatens the health and safety of consumers and costs taxpayers millions of dollars," says Noel L. Hillman, an assistant U.S. attorney in Newark who is at the forefront of a nationwide crackdown on export diversion.
Consumer-product giants, including Borden, Nestle USA, and Procter & Gamble, have been hit hard by such schemes recently. Diverters buy premium-brand goods, such as Alpo dog food and Trek bicycles, at the deeply discounted prices typical of orders bound for untapped markets. During shipment, the goods are turned around at foreign ports and illegally resold to dealers and retailers in the U.S. for a sizable profit--stealing domestic customers from the original manufacturer as well, say the feds. "Diversion has become increasingly expensive for legitimate American exporters," says Donald E. deKieffer, a Washington attorney who has investigated dozens of such cases.
No one knows for sure how widespread the problem has become. Says one U.S. Customs official: "It's like asking how much narcotics are coming into the U.S." But another Customs Service agent estimates that nearly $100 million worth of imported goods that entered the Port of Newark, N.J., alone in the 12 months through September were false exports. Attorney deKieffer thinks at least half of the $15 billion in goods returned to the U.S. in 1994, or 3% of all exports, could be fraudulent.
BILK MAN. Harm to big business is bad enough. But discrepancies in the data may mean that government economists are overstating figures used to tally closely watched trade-balance statistics. Taxpayers, too, get the shaft when export-incentive payments are made to victimized companies. The government provides a variety of financial inducements to manufacturers to spur them to export. First Brands Corp. in Danbury, Conn., the maker of Glad plastic bags, got a $238,316 rebate on duty paid for imported petroleum resin used to make the bags the company thought it was exporting to Nigeria. But it turned out a New Jersey food broker, Steve Lasala, had sold the bags back into the U.S.
First Brands wasn't the only company bilked by Lasala. The food broker was charged with cheating 39 corporations out of $20 million. The victims included Quaker Oats, P&G, Duracell, and Hormel Foods. Lasala pleaded guilty in 1994 to a number of charges, including wire and customs fraud. His punishment: $1.9 million in fines and restitution and four months in jail.
The diversion game also puts consumers at risk because companies don't always know where their products end up. "A company distributing food in the U.S. is supposed to be able to tell the government where it goes in case of a recall," explains Nancy G. Brown, vice-president and general counsel for Borden Foods Corp. "If the stuff is being diverted, you lose that control." In August, Borden Inc. filed civil charges against two companies for allegedly selling Realemon juice in the U.S. after agreeing to export it to the Czech Republic. The defendants could not be reached for comment.
RX RISK. The Food & Drug Administration needs to keep track, too. The agency is focusing on the way in which export-diversion scams skew statistics medical experts rely on to determine a drug's safety. The FDA regularly monitors the adverse side effects caused by drugs, in case it needs to pull dangerous medication from the market. "Those statistics could be off if there's actually more of the drug being consumed in the U.S. than we know about," says James Dahl, assistant director of the FDA's Office of Criminal Investigations.
With so much at stake, law enforcers who once cast aside export-diversion cases are clamping down. In recent months, trade sleuths from Customs and the FDA have joined forces in dozens of ongoing investigations in Miami, San Diego, and Newark to nab diverters.
In one of the biggest busts to date, three people were indicted in July for their alleged roles in a slew of export scams, including the one that allegedly ripped off LifeScan. The 122-count indictment, which includes wire fraud and money-laundering charges, accuses the three of defrauding Nestle, J&J, Bayer, and ICN Pharmaceuticals out of $19 million. Two defendants deny the charges, while a third, awaiting extradition in France, declines comment through his lawyer. The three are scheduled to go to trial on Jan. 16 in Newark.
Until recently, most trade-diversion cases have been handled by companies internally or in civil court. Johnson & Johnson's international sales staff, for example, refer about a dozen suspicious foreign orders every month to the company's executive director for security, Wayne Gilbert, who says at least a couple turn out to be bogus. But the Lasala case has emboldened angry executives to get the government more involved. "Now, companies are coming out of the woodwork, saying, `Can you help us?"' says a Customs agent who tracks export diversion. "I could easily spend the next 20 years doing this."
J&J collaborated with U.S. authorities in a sting in 1994 that nailed Anglo-American and helped crack other allegedly fraudulent operations, the Justice Dept. says. Customs strongly suspected Anglo-American was selling the glucose test strips it purchased from LifeScan in the U.S.--not in the former Soviet Union. So the next time the group offered to buy more, Customs investigators secretly tracked the shipment from the New Jersey warehouse to a storage site in New York and finally to U.S. distributors. How did they do it? At the feds' suggestion, LifeScan stuffed coupons for a free box of strips intm the shipment. When users around the country started phoning in for their freebie, Customs traced the purchases back to specific pharmacies and from there to distributors and to the phony foundation.
SKIN DEEP. In the LifeScan case, the elaborate plan did the trick. But given the far-flung nature of many of these operations, most export diversion goes undetected. That's because once a sale is made, diverters often mask their fraud by using "U-boat" schemes. These involve shipping the goods abroad to an intermediate port, such as Rotterdam, where they are rerouted back to the U.S. duty-free as "American goods returned." In other scams, the goods never leave the U.S. The diverter tells the manufacturer to deliver the products to a warehouse near a port for consolidation with other shipments. From there, they are trucked to another location and parceled out to the diverter's customers.
Regulators suspect that export diversion also provides organized crime with a new technique for laundering money. The appeal of the scheme has grown as reporting requirements for bank-wire transfers have stiffened. Under a typical scenario, a drug kingpin wires $10 million to a Swiss bank account and directs a front company to buy $10 million worth of shampoo purportedly for Tajikistan at 50% below U.S. wholesale prices. He then has the money sent to the shampoo manufacturer's bank account. Now, the druglord has a paper pedigree for his cash. But instead of sending the goods to Tajikistan, he resells the shampoo to U.S. distributors and pockets a substantial profit. "Product diversion is the perfect device to launder money," says prosecutor Hillman. "A diverter sitting offshore may launder millions of dollars a day and earn a substantial profit through two telephone calls and two wire transfers."
Being duped into serving as laundromats for dirty money only adds insult to the multitude of injuries U.S. exporters suffer at the hands of diverters. And as these schemes proliferate, companies are starting to wonder whether some of the risks of exporting to developing economies are just too great. For the moment, benefits still outweigh potential harm. But should that change, U.S. exporters may not feel so adventurous.By Amy Borrus in Washington