Fashion Police: Types of fraud the US False Claims Act can target in the fashion industry

What does whistleblower law have to do with fashion? Despite the glitz and glamor, the fashion industry ultimately deals in merchandise and must face unsexy topics like supply chain issues, warehousing, shipping, and customs. This article will give a brief overview of the history of US government enforcement against fashion brands for evading their obligations to pay duties imposed on imports into the US.

The modern history starts in 1997, with a False Claims Act case against US clothing brand The Limited. To understand the stakes, however, we’ll need a brief overview of what the False Claims Act is and how it works. The False Claims Act is a powerful anti-fraud tool for the American government. It allows a whistleblower to file a lawsuit on behalf of the US when the government is being defrauded. In this context, the whistleblower is called a relator. The relator’s suit is filed under seal, meaning that it is kept secret from the public. While it is still under seal, the government gets notice of the suit and can investigate and decide if they want to intervene in the lawsuit. Intervening means that the government takes over and moves the lawsuit forward.

Even if the government declines to intervene, the relator can still litigate the case against the fraudster on their own. Whether or not the government intervenes, if the case results in the government getting money back from the perpetrators of the fraud, the relator can share in a portion of that recovery. One way to defraud the government is to avoid paying customs duties that are rightfully owed. It is important to keep in mind that under the False Claims Act, companies found to have committed fraud can owe treble damages to the government – meaning they could end up paying back three times the amount of customs duties they originally dodged.

The case against The Limited started with a lawsuit by the American Textile Manufacturers Institute (ATMI), a trade association, acting as the relator. ATMI alleged that The Limited shipped clothes made in China through Hong Kong or Macau to the US and lied on customs documents and labels by claiming the clothing was made in Hong Kong or Macau. This practice is called transshipment. By allegedly transshipping clothes and lying about it, The Limited avoided quotas limiting textiles imported from China and should have been subject to a 10 percent customs duty for falsely labeled goods. The ATMI eventually lost the case against The Limited for reasons that would only be interesting to law nerds. But the case signaled that the US government was paying attention to customs evasion in the fashion industry, and that competitors and trade associations like ATMI can use whistleblower law to fight back against competitors who use dishonest importing practices to keep their prices low.

Transshipment: Transshipment refers to shipping goods from their country of origin to an intermediary country before shipping them to their final destination. It can be used as a way to fraudulently hide where the goods came from to avoid heavy tariffs the destination country imposes on goods from the true country of origin.

Since 1997, there have been several more customs fraud cases against fashion houses. Although the government declined to intervene in the action against The Limited, more recent cases involve government intervention. In 2014, the government intervened in a False Claims Act case against Dana Kay, Inc. and Siouni & Zar Corporation – related companies – for running a 10-year scheme to undervalue their imported apparel. Dana Kay and Siouni are wholesalers who sold to stores including Ann Taylor, J.C. Penney, Dress Barn, and Sears. The whistleblower in this case was a Dana Kay garment cutter. Dana Kay and Siouni filled out customs forms with artificially low values for the clothing they imported, so that they would pay lower import duties. An investigation revealed that they engaged in the surprisingly common practice of double invoicingto hide the true cost they paid manufacturers for their clothing. They presented one low invoice along with their customs forms and then paid a second invoice to their manufacturers to top up the amount paid to the actual price of the clothes. The case settled with Dana Kay and Siouni & Zar paying a 10 million dollar settlement to the government, and the whistleblower receiving an over two million dollar share of that recovery.

Double invoicing: In this context, double invoicing refers to a common fraud scheme used to understate the value of imported goods.

False Claims Act enforcement is another trend to watch

In 2016, there was a similar case against Motives, Inc., a New York clothing importer, and two of its affiliate companies in China, which settled for 13.375 million dollars. Motives, Inc. also engaged in double invoicing, working with its wholesalers to present documents to US customs that undervalued its imported clothing. Their method was to get one invoice from their importers that they showed to customs. Then, they obtained a second invoice called a debit note or cost sheet that had an additional flat fee charged per garment. Motives quietly paid the additional fee to the importers without ever telling customs authorities. There was a whistleblower in this case, too, but their identity was never made public.

Debit note: This document is sent by a seller to a buyer to note a request for price adjustment. In this context, the buyers sent debit notes to request payment of additional monies on top of the low invoice price.

More recently, in 2022 the New York menswear company Luchiano Visconti, and its manager Sasha Hourizadeh, paid a 3.64 million dollar settlement for evading customs duties. According to the settlement, Luchiano Visconti saved 1.8 million dollars in customs duties by undervaluing its imports, but ended up paying double that back to the government. The defendants used two different modalities to commit the fraud: sometimes they changed the invoices foreign manufacturers gave them and submitted the falsified versions to US customs, and other times they worked with foreign manufacturers to create artificially low invoices from the outset.

It’s notable in this case that the manager who oversaw the fraud schemes was personally made a defendant in the case. It is not just companies, but also individuals who can end up being found liable for fraud under the False Claims Act. The whistleblower in this case was not a US citizen, but rather the general manager of a factory in Turkey that supplied Luchiano Visconti. There is no citizenship or residency requirement for bringing a False Claims Act case and obtaining a whistleblower reward.

Today’s fashion companies should take heed from these cautionary tales. Whistleblowers can come forward from inside a company, as in the Dana Kay case, from competitors and trade associations, as in The Limited case, or from suppliers/partners anywhere in the world, as in the Luchiano Visconti case. As US customs authorities cannot possibly verify the accuracy of every import declaration, the False Claims Act is an especially important weapon for monitoring imports - and it can lead to multimillion dollar fines. Any shady bookkeeping, especially double-invoicing, designed to keep prices declared for imports into the US artificially low could be a target for False Claims Act enforcement. If you’re a fashion insider, don’t forget that False Claims Act enforcement against customs fraud is another trend to watch.