The Library

Are U.S. Companies and Executives Safe When the Public Is Not? A look at FDA Enforcement in the International Arena

Recent events, such as deaths attributable to tainted prescription drugs, massive food recalls, and tainted pet foods, expose the extent to which U.S. consumers are at the mercy of imported products. Those events also reveal the many ways in which antiquated domestic regulatory frameworks strain to keep pace with the globalization of manufacturing. As always, where markets outpace the regulators’ capacities to protect the public, the Federal government looks to the criminal law to establish a last line of defense.

On February 5, 2008 a Federal Grand Jury returned a 27 count indictment against a United States Company, Chemnutra, Inc., its President and majority shareholder, Sally Miller, and its CEO, Stephen Miller. The indictment includes 13 counts of Distribution of Adulterated Food; 13 counts of Distribution of Misbranded Food and one count of Conspiracy to Commit Wire Fraud. If convicted, the officers face a total of 31 years imprisonment and a substantial fine and the corporation faces up to $2,750,000 in fines. In a separate but related indictment, the Grand Jury indicted a Chinese supplier, Xuzhou Anying Biologic Technology Development Co., Ltd., (XAC), its owner and manager, Mao Linzhun; a Chinese export broker, Suzhou Textiles, Silk, Light Industrial Products, Arts and Crafts I/E Co., Ltd. (SSC) and its President, Zhen Hoa Chen. The indictment charged the Chinese companies and officials with 26 counts of Distribution of Adulterated and Misbranded Food with intent to defraud. If convicted the officers face 156 years imprisonment and a substantial fine.

This article will examine the facts giving rise to these indictments and the legal basis for prosecution. The article will also explain the legal framework that regulates food and drug imports. Finally, the article will offer some proactive steps a U.S. company should take to protect the public from harmful products and themselves from criminal prosecution.

Recent Federal Prosecutions

Chemnutra, Inc. is a United States supplier of wheat gluten to pet food manufacturers. Pet manufacturers use wheat gluten as a binding agent in certain pet foods. Pet manufacturers require the wheat gluten to contain a minimum protein content of 75%. Chemnutra bought the wheat gluten from a Chinese export broker, SSC, who bought the product from XAC, the actual producer of the goods. The wheat gluten purchased did not contain the required protein; instead, it contained melamine which is a substance that enhances the appearance of the wheat gluten to contain high levels of protein but which is toxic and used to create plastics, cleaning products, glues and other products. Needless to say, melamine is not approved by the FDA as a food additive.

The indictment alleges that the presence of melamine “contributed to serious illness in, and the deaths of, countless pets” after eating the contaminated pet food.^[1] The indictment also alleges that Chemnutra and its president and CEO conspired with SSA, the Chinese export broker, to falsely describe the exported merchandise on the commercial documents as a chemical, rather than as a food additive, so that it would not be subjected to mandatory inspection by the Chinese government prior to export. The false description of the goods enabled the companies to avoid inspection by the Chinese government of the production facilities of the supplier, XAC. The United States defendants then directed a U.S. customs broker to continue the false description on the U.S. Customs declarations, thus making it appear that the merchandise was not subject to FDA jurisdiction.

A parallel criminal proceeding was initiated in China in May of 2007 when the President of XAC was arrested by the Chinese authorities in connection with the events that lead to the U.S. indictment. The Chinese government also shut down the company. Over the past several years China has been the subject of increasing criticism about lax inspection standards that led to numerous complaints regarding FDA violations. China had refused the FDA’s request for a visa to enter China and conduct inspections. However, in May of last year China finally granted the FDA visas to enter China to inspect the manufacturer’s plant in the pet food case.

The FDA

The Food and Drug Administration (FDA) regulates United States companies that place certain foods, drugs, medical devices or cosmetics in interstate and foreign commerce. The FDA is a branch of the U.S. Department of Health and Human Services. In 1938, Congress enacted the Food Drug and Cosmetic Act (FDCA) which outlines prohibited acts and sanctions including criminal penalties.

In theory, an imported product falling within the jurisdiction of the FDA must pass inspection by the FDA when it arrives in the United States. However, only 1 percent of all food imports are actually examined by FDA inspectors.^[2] Yet, even within that one percent, the number of imported products the FDA denied entry due to substandard quality or hazardous products has increased considerably over the past several years. If a product violates the Food Drug & Cosmetic Act, the FDA has a right to refuse entry into the United States. China, India and Mexico are the countries with the highest refusal rates.^[3]Not surprisingly, China, India and Mexico are also the countries with the highest numbers of products which the FDA has issued consumer alerts for potential harmful products.^[4]

A United States company and its officers who import products regulated by the FDA for distribution in the United States can be found criminally liable for FDA violations occurring in foreign countries whose quality controls are poor or undefined. United States companies and their officers who accept and introduce imported products into interstate commerce face severe penalties, including imprisonment, for products that are misbranded or adulterated in the foreign country without its knowledge.

Criminal Liability

The FDA oversees $1 trillion worth of products annually^[5]. It holds an arsenal of numerous enforcement weapons including various criminal statutes. According to the FDA, in 1996 the FDA’s Office of Criminal Investigations assisted the Department of Justice in prosecuting 111 individuals and convicting 83 for FDCA violations. In 2006 that number more than tripled to 341 prosecutions and 279 convictions. Most of the criminal statutes require that a corporation or person intend to violate a law. However, there are strict liability statutes that impose criminal liability for acts committed regardless of the actor’s intent. Under a strict liability statute, criminal liability is imposed on corporations as well as individuals, regardless of fault, knowledge, and intent. Strict liability statutes are relegated to criminal acts involving public welfare. Under traditional notions of criminal liability the defendant’s mental state is an essential element of the crime. Under a strict liability statute, no such proof is required. Congress dispensed with the intent element to protect innocent victims from the potential serious harm and to hold accountable corporations and individuals who are in a better position to prevent such harm.

Liability for violations of the FDCA may extend to corporate officers and directors even when they do not have an active role in the offending conduct. Under the doctrine of corporate responsibility, an officer or director is personally liable if that person, by virtue of her managerial position could be deemed responsible for the commission of the prohibited act.^[6] The law holds corporations and individuals responsible because they are in better positions to prevent harm and can exercise the care that society expects in carrying out their responsibilities, even though they lack the intent to harm.

The strict liability provisions of FDCA hold that any person or entity who causes the adulteration or misbranding of food, drug, device or cosmetics or who is in receipt or introduces such products into interstate commerce is guilty of various criminal statutes. For instance, the president of a grocery store chain was held criminally liable for shipping food exposed to rodent contamination even though he delegated the responsibility of keeping the store clean to a trusted employee.^[7] In a separate case, the president and general manager of a pharmaceutical company was convicted of shipping adulterated and misbranded drugs into interstate commerce in violation of the Food Drug and Cosmetic Act.^[8] The defendant had no knowledge of the violation; however, the Court imposed liability and stated that accountability should be placed on the person who is best situated to prevent such harm and not on the innocent public.

Upon notification to the FDA that a certain imported product may be hazardous to public health, the FDA has several options. It can hold the imported product and require corrective measures be taken; it can order the goods exported; it can order the goods destroyed, or it can refer the violation to the Department of Justice for criminal prosecution. If it chooses to pursue criminal prosecution, the FDA may offer the violator an administrative hearing where he can try to convince the agency not to refer the matter for criminal prosecution. An alleged violator must be careful if he chooses to proceed in the administrative hearing. Statements made by him can be used against him in any subsequent judicial proceeding, and statements made in such proceedings, if false, become separately indictable offenses under the perjury or obstruction statutes. The FDA can refer a case to the Department of Justice without offering the alleged violator a hearing. If a referral is made for criminal prosecution, the alleged violators are subject to be served with search warrants, investigated by a federal grand jury, face trial and ultimately face imprisonment, monetary penalties and debarment from the FDA.

The sanctions attendant to an FDCA violation can be severe. For instance, a person introducing adulterated products into interstate commerce faces a misdemeanor charge which carries a penalty of imprisonment of not more than one year and/or a fine of not more than $1000. If, however, the person has been previously warned or has been found to have committed the prohibited act with intent to defraud or mislead, the charge becomes a felony carrying a possible imprisonment of three years and/or a fine of not more than $10,000.^[9] If sued in civil court, a company may be liable for up to $1 million and an individual may be liable for up to $250,000.^[10] In addition to the above sanctions, a company and/or individual may be temporarily or permanently barred from providing services or products regulated by the FDA.^[11]

The FDA is using the criminal justice system in the United States and internationally as a vehicle to further curtail the importation of hazardous consumer products and to enforce its standards. The United States has reciprocal extradition treaties with over 100 countries such as India. It has also signed Multilateral Conventions (including Customs Cooperation Agreements) with several countries including Mexico.

There is no extradition treaty or formal agreement with China but because business executives move so freely throughout the world, extradition treaties are less serious hurdles for the prosecution. A recent case arising from indictments in the Northern District of Florida demonstrates the point. The Government indicted a Vietnamese exporter of fish and its CEO, not for violating the FDA rules, but for falsely describing the fish to avoid an extremely high U.S. anti-dumping duty that was assessed on this particular species. The Vietnamese government refused to extradite, and in simpler times the case may have died. But in this case, the U.S. Attorney in Florida lodged the indictment with Interpol, and when the Vietnamese executive went to Belgium for business, he was arrested by Belgian authorities as he deplaned. The Vietnam executive now faces U.S. charges.

Criminal Customs Liability

What is significant about the two animal feed indictments we have discussed is that neither of these frauds could have been perpetrated without a falsification of customs documents. The fact is not lost on the federal prosecutors. In these cases no criminal customs violations were alleged, only because the FDA violations were so egregious. However, in other cases where federal prosecutors allege fraudulent conduct related to imported merchandise or where the case is marginal, they will add one of two charges. Either importers will be charged with entering goods by means of false statements, which carries a two year prison term^[12], or they will be charged with the far more serious crime of smuggling, which carries a five year prison term.^[13] Most executives associate the charge of smuggling with the clandestine entry of goods. The statute, however, is far broader. It also defines smuggling as knowingly importing goods in violation of law. Thus, an allegation, as in these food cases, that the goods would not have been allowed to enter the U.S. but for the violations of the FDCA will expose the company and its executives to a charge of smuggling. To compound matters, these statutes authorize penalties equal to the value of the merchandise illegally entered. The clear goal of the enforcers is to ensure that those who commit these offenses never profit from them.

China

In recent months, China has increased its efforts to bring consumer products into conformity with U.S. safety standards. In September of 2007, the Chinese government signed an agreement with the United States to place better controls on consumer exports and crack down on counterfeit pharmaceuticals and unsafe food.^[14] China agreed to increase inspections of U.S. bound products and to cooperate with the United States in tracing the path of hazardous products. Under this agreement, both governments have committed to sharing more information about the manufacturing and inspection processes. The Chinese government has also proposed to require Chinese exporters to provide documentation evidencing their adherence to U.S. safety standards.

The Chinese are not taking their responsibilities lightly. In July of 2007, the former Director of the Chinese equivalent of the FDA (SFDA) was executed for approving untested and substandard pharmaceuticals in exchange for cash.^[15] This execution and the arrest of XAC’s president in the pet food case above seems to be an effort by the Chinese government to show the world its willingness to cooperate with foreign governments, including the United States, in preventing the export of unsafe products. However, on February 28, 2008, the Chinese SFDA stated that although it will continue to cooperate with the importing countries in making food and drugs safer, it is the importing countries’ responsibility to ensure that the products are safe. Thus, the FDA will have to use all of its weapons to safeguard the American people, even if it means putting more pressure on U.S. companies to take responsibility for unsafe products.

Proactive Measures

It is critical that United States companies and their officers pay careful attention to the food and drugs they import. They need to make sure that the product is what it is purported to be, that the goods are properly described on the commercial documents, that the labels are accurate, that the quality complies with U.S. standards and that the product’s country of origin and its logistics path are documented properly. Many companies, recognizing that the agencies of the foreign governments are as overwhelmed as the USFDA, now require independent, third party, inspections of regulated products and require that the foreign inspection certificate be included as a required document before bank payment will be made. It may be of great benefit for a U.S. company to also visit the plants and manufacturers of products they are importing to ascertain whether more monitoring is necessary. In fact, one U.S. Court held that a U.S. importing company, which conducted no foreign inspection of its supplier acted in negligent violation of the law, although not criminally negligent. The Court found that had the company conducted such an inspection, it would have known that goods could not have been produced in the facility identified on the documents. The country of origin provided by the supplier turned out to be false.^[16]

A U.S. company should also have an effective compliance program which should be reviewed annually. A compliance program provides a checklist for the company to ensure that all safety precautions are being taken. The U.S. Sentencing Guidelines draw a stark contrast between a defendant corporation with a robust compliance program that in an individual instance failed, and a defendant corporation with an ineffective program or no such program at all.^[17] The Guidelines provide a substantial reduction in sentencing for companies that enforce an effective compliance program.

In addition, the contract between the U.S. company and any foreign company should be tailored according to the specific needs of the importing company. It should specify the steps the foreign company must take to ensure that the product they are exporting to the U.S. meets the FDA standards.

The United States government realizes that the financial gains associated with importing food and pharmaceuticals from developing countries are substantial. However, the government is also realizing that the lack of overseas safety precautions has severe consequences for consumers in the United States.^[18] Simply denying entry to such products and imposing civil penalties is not likely to deter U.S. companies from purchasing substandard products abroad. Thus, we expect that the United States will be stepping up its efforts to make corporate America more accountable by using its most onerous tool, the criminal justice system.

For assistance with respect to this subject, contact Lourdes Sanchez Ridge at 412-394-2462, John Donohue at 215-829-9900 or Robert Ridge at 412 394 2440.

This Thorp Reed & Armstrong, LLP Communiqué is prepared in summary form and is not to be construed as legal advice or opinion on any specific fact or circumstance. We do not assume any responsibility to revise the Communiqué if there are subsequent changes in the law.

April 2008

[1]U.S. v. Miller, et al., - In the Middle States District Court for the Western District of Missouri.

[2] Snow: Product unsafe? Recall it! www.wnd.com/news/article.asp?Article_ID=56416 (6/28/07)

[3]www.fda.gov/ora/oasis/4/ora_oasis_cntry_1st

[4]http://www.fda.gov/ora/fiars/ora_import_
country.html

[5]www.fda.gov

[8] U.S. v. Dotterweich, 320 U.S. 277 (1943)

[9]21 U.S.C. § 333

[10]21 U.S.C. § 335(b)

[11]21 U.S.C. § 335(a)

[12]18 U.S.C. § 542

[13]18 U.S.C. § 545

[14]“U.S. and Chinese Product Safety Agencies Announce Agreement to improve The Safety of Imported Toys and Other Consumer Products”9/11/07 www.cpsc.gov/cpscpub/prerel/prhtml07.07305.html and “China Pours Money Into Drug, Food Safety”, http://abcnews.go.com/print?id=3458082

[15] “China Executes Ex-Food and Drug Chief”, www.npr.org/templates/story/story.php?storyId=11846089

[16]U.S. v. Golden Ship Trading, et al, 22 C.I.T. 950, 20 Int’l. Rep. Dec. (BNA) 2050 (Ct. Int’l. Trade 1998)

[17]United States Sentencing Guidelines, § 8C2.5(f)

[18] Over the past several years, the FDA has had to recall and destroy a myriad of imported products due to safety concerns.Most of the unsafe condition stems from lack of quality control of foreign companies and lack of inspection of foreign governments. The State Food and Drug Administration(SFDA) in China, which is the equivalent to the FDA, requires that Chinese companies register and be certified by SFDA to export food and drugs. Companies that are certified are supposed to be inspected by the SFDA. Earlier this month the FDA initiated an investigation into the cause of death and allergic reaction of several people who used Heparin, a blood thinner. A manufacturer in China supplied the active ingredient of Heparin to Baxter International Inc, a domestic company. However, the Chinese supplier, which is certified by US officials to export drugs to the United States, is 55% owned by Baxter International. It has never been inspected by the SFDA. The supplier obtains its raw materials from tiny villages across China. These suppliers are family owned Chinese companies that are not required to be inspected by the SFDA. It has not yet been proven that the cause of the deaths and allergic reactions is the Heparin ingredients that came from China. The FDA investigation is currently ongoing in the United States and in China.