Caught in the crosshairs: Mitigating supply chain risks from Cartel FTO designations

This realignment began with the January 20 Executive Order 14157, which directed the U.S. government to designate cartels and other organizations as FTOs.¹

On February 5, the Bondi Memo directed the Department of Justice (DOJ) “to pursue total elimination of Cartels and Transnational Criminal Organizations” (emphasis in original), including by directing prosecutors to enforce against cartels the U.S. Foreign Corrupt Practices Act (FCPA) and Foreign Extortion Prevention Act (FEPA), counter-terrorism offenses, and trade-related offenses under the International Emergency Economic Powers Act (IEEPA).

On February 10, Executive Order 14209 instructed DOJ to pause enforcement of the FCPA and issue new enforcement guidelines that take into consideration U.S. national security, which may include the cartel/FTO connection, as we previously discussed.

Reassignment of talent and material resources is already underway with prosecutors from Main Justice and U.S. Attorney Offices now positioned well to bring enforcement actions, per the Bondi Memo.

The newly designated FTOs are said to operate primarily in Mexico, Colombia, Ecuador, Chile, El Salvador, Honduras, and Guatemala. Beyond the FTO-designated cartels, Brazil also hosts a number of large cartels that DOJ could target next based on the Bondi Memo, or State could consider for FTO designation. The U.S. Treasury’s Office of Foreign Assets Control (OFAC) has already included in its sanctions lists criminal organizations in Brazil. Other large countries in Latin America, including Argentina, Colombia, and Peru, also host similar cartel organizations and could become a target.

Companies that operate in these countries may attract investigative interest if their operations are vulnerable to FTO activity. Depending on DOJ’s investigative findings, DOJ may bring charges under a combination of FCPA, FEPA, counter-terrorism statutes, or IEEPA, as well as money laundering and racketeering statutes.

Although the Trump administration presently appears to focus on criminal organizations operating in Latin America, other regions beset by organized crime may be affected by these developments, including Eastern Europe and the Balkans, Southeast Asia, and Central and Western Africa.

Extortion and other forms of support to FTOs

Complex and multi-tiered corporate structures, shady intermediaries, personal connections, and threats, extortion, or duress may result in companies making payments to cartels, FTOs, and FTO-affiliated organizations or individuals. For example, in our experience:

• Companies establish legitimate relationships with foreign third parties that have been infiltrated are or effectively controlled by a cartel or FTO.
• Companies may be confronted with demands for “extortion payments,” “right of way,” “donations to communities,” or other similar payments, to receive protection from locals, access to roads or facilities, or to enhance community services. The recipients may be directly or indirectly associated with a cartel or FTO, even if they are nominally a local government official.
• Companies are forced to do business with specific individuals or companies associated with cartels or FTOs, including purchasing supplies, raw materials, or equipment from individuals.
• Companies make protection payments or ransom payments where employees or infrastructure are threatened or kidnaped.
• Companies´ logistics departments are often infiltrated by FTO operatives, who surreptitiously ship goods pertaining to FTO’s operations through the companies’ legitimate operations.

Payments to FTOs have previously led to enforcement actions for providing broadly-defined “material support” to FTOs.² “Material support” includes (i) tangible or intangible property, including cash or cash-equivalents, (ii) services, including financial services, lodging, training, expert advice or assistance, safehouses, false documentation or identification, communications equipment, (iii) facilities, (iv) weapons, lethal substances, and explosives, (v) personnel, and (vi) transportation.

A company must knowingly provide material support to the FTO; however, willful blindness can establish the knowledge element. DOJ would need to demonstrate only that the defendant consciously avoided knowledge of the FTO’s activities or the nature of the support being provided. In enacting these laws, the U.S. Congress expressly found that “foreign organizations that engage in terrorist activity are so tainted by their criminal conduct that any contribution to such an organization facilitates that conduct.”³ Willful blindness can also satisfy knowledge elements of other relevant statutes, such as inappropriate payments through intermediaries and violations or sanctions, money laundering, and racketeering laws.

Local experience suggests willful blindness has been a common approach for companies operating in Mexico and Central America given the difficulty to operate in the absence of collaboration with local criminal organizations. Many companies rely on the idea that “extortion” payments will not satisfy the corrupt intent required for an FCPA violation.

Although the elements of the FCPA may not be satisfied in cases of extortion or duress, the argument is quite narrow and requires real threats of imminent violence or harm to personal safety. DOJ is likely to consider recurring payments as a form of economic coercion, which would be considered an FCPA violation, material support to FTOs, and/or sanctions violations, depending on the circumstances.⁴ True payments under duress must also be accurately reflected in an issuer’s books and records, otherwise criminal or civil books and records violations under the FCPA may be levied.

Further, in addition to potential consequences on the U.S. law, supporting FTOs may have criminal consequence under local laws. Domestic criminal enforcement agencies often take action in their home jurisdictions during international corruption investigations. Likewise, “extortion” payments may face tax implications, more often when these payments are recategorized, for instance, from deductible business expenses to nondeductible payments by U.S. subsidiaries in Mexico.

Although companies need to investigate and halt these forms of support given the FTO designation, the sudden halt of these payments may well bring security issues at the company’s facilities operating on the ground or retaliation by FTOs. Thus, the analysis of these payments needs to be reviewed from a legal and a practical crisis management perspective.

In several well-publicized cases, DOJ brought criminal enforcement actions involving fines and forfeitures of hundreds of millions of dollars against companies that made payments to FTOs to ensure the safety of their personnel and operations in conflict zones. DOJ has a long record of enforcement actions against financial institutions for providing services to FTOs also leveraging IEEPA charges. In certain instances, DOJ has brought enforcement actions against U.S.-based charities that funneled resources to FTOs.

Spotlight on nearshoring in Mexico

Nearshoring in Mexico has become a critical strategy for U.S. supply chains, encouraged by NAFTA and the USMCA. Through manufacturing and sourcing in Mexico, companies have sought to mitigate risks associated with global disruptions and logistical inefficiencies, while benefiting from a skilled workforce. Nearshoring is not exclusive to the U.S. companies, but companies from other countries seeking to supply the U.S. market from Mexico have taken similar steps. However, cartel and FTO activity in the country are now leading to increased DOJ enforcement risk.

Examples of high-risk industries in Mexico include automotive, energy, minerals extraction, technology, manufacturing, agribusiness, and logistics. Logistics companies have been for long asked to pay “right of way” to allow free passage in certain parts of Mexico. Manufacturing facilities sometimes face collaboration arrangements with local communities, which are often linked to FTOs. The mining industry also regularly faces security issues by community leaders. Obtaining permits and licenses from municipal authorities in remote rural areas may also be challenging when local governments may have a direct or indirect link with FTOs.

Regional analysis is relevant to understand the presence and practices of different cartels. For example, the Sinaloa Cartel operates in the Northwest of Mexico, while the Familia Santa Rosa de Lima Cartel, which has not been designated an FTO, operates in Central Mexico. Additionally, each cartel seeks “extortion payments” under different pretenses, for example as payments for “right of way,” “donations to communities,” “union payments,” “ransom,” or forced purchases of supplies or raw materials from the cartels.

Risk mitigation

Companies should reassess the compliance risk that operations in known cartel/FTO territories now pose and factor in the new enforcement priorities.

• Recalibrate compliance risk assessment and investigations. Consider looking at industry and geographic risks at the sub-regional level and overlay maps featuring cartel activity and activity by the specific cartels that have been designated as FTOs.
• Broaden the scope of enhanced due diligence. Consider subjecting additional types of third parties to enhanced due diligence and implement more rigorous methods.
• Increase compliance resources and oversight in implicated jurisdictions and industries. Consider staffing with professionals with local knowledge of the reality on the ground and deep understanding of international compliance expectations.
• Regularize third-party monitoring: Consider if the existing cadence of due diligence refreshers remains adequate. Invest in third-party monitoring tools that allow real-time notifications. Ensure that compliance and business teams frequently review the compliance posture of third parties.
• Create an inventory of permits and licenses at facilities in implicated areas, and link and monitor associated payments.
• Review and amplify policies and procedures pertaining to handling extortive requests, requests for charitable donations, and local community offsets.
• Train employees on identifying FTO red flags, escalating them internally, and refusing them when safe.
• When investigating an allegation or conducting a compliance audit, consider implementing forensic accounting procedures when financial discrepancies or FTO red flags present themselves.
• Dedicate more physical security resources available to field operations, logistics, inventory, waste management, and other functions that are susceptible to cartel and FTO infiltration.
• Develop a cross-function and multidisciplinary crisis management playbook that outlines the company’s response in the critical hours and days after a significant incident occurs, and run a tabletop exercise to identify weaknesses, improve coordination, and test decision-making under pressure.
• Conduct due diligence and background checks on employees of sensitive functions to assess links with cartel and FTOs.
• Consider consulting with legal counsel when contemplating strategic expansion in implicated areas and when investigating issues on the ground.
• Consider contacting State and the local U.S. Embassy for assistance when coordinating with local government.
• Consider, if time permits, seeking a formal opinion under DOJ’s FCPA opinion process for contemplated actions that may otherwise attract DOJ scrutiny.

Conclusion

As the Trump administration continues to change and reprioritize the enforcement landscape in the U.S., companies may face difficult compliance and business challenges. Proactive strategies are necessary to adhere to anti-corruption and anti-terrorism laws. And if the realities on the ground conflict with those requirements, companies need to be able to implement swift remediation and mitigation strategies.

Hogan Lovells has deep experience advising companies on mitigating foreign corruption and FTO risks, as well as defending companies when lawsuits or investigations arise. We regularly advise clients on how to pursue their objectives without running afoul of the law or risking the personal security of their employees. Our team in the U.S., Mexico, and Brazil stands ready to help navigate these difficult issues at a time of uncertainty across the Americas.

Authored by Peter Spivack, Guillermo Larrea, Isabel Costa Carvalho, Lillian S. Hardy, Juan Carlos Quinzaños, and Nikolaos Doukellis.