Under the magnifying glass

Customs has stepped up the number of compliance audits and enforcement actions it conducts. Some importers say the agency is being more aggressive than it needs to be.

By Toby B. Gooley -- Logistics Management, 11/1/1999

Sam Banks, deputy commissioner of the U.S. Customs Service, laid it on the line: "You have to get over the idea that our main job is to help facilitate trade," he told attendees at last year's American Association of Exporters and Importers (AAEI) annual conference. "We're cops. We're here to make sure you comply with the law."

Many importers would say that the U.S. Customs Service has made that point all too clearly since passage of the Customs Modernization Act in 1993. That legislation--popularly known as "the Mod Act"--shifted much of the burden of compliance and proof from the Customs Service onto importers, which now are required to exercise "reasonable care" in complying with federal regulations. The act also strengthened the agency's enforcement powers.

The first few years under the Mod Act were a sort of transition period, as importers adjusted to their new responsibilities and the agency reorganized its internal structure. For the last two years, though, the Customs Service has stepped up its audit and enforcement activities, putting many of the country's largest importers under the magnifying glass.

A number of those importers have expressed concern and even anger over the way in which the agency has been conducting what it calls "compliance-assessment audits." Those audits were designed to make a fairly quick evaluation of an importer's level of compliance with customs regulations and procedures. Based on the results of those assessments, the agency was supposed to determine whether or not a full-scale audit would be necessary. That's the theory, but--as many members of the import community report--what's supposed to happen and what actually is happening are quite different. And what's happening, they charge, is unfairly costing importers millions of dollars in operational disruptions, lost business, and lost productivity.

Shared Responsibility

To understand why importers are up in arms about compliance-assessment audits, it's helpful to understand the philosophy behind them and what procedures are involved.

Since 1995, the Customs Service has been "re-engineering" its trade-compliance process to reflect changes under the Mod Act and to respond to the pressures of increasing workload and trade complexity. The most important change was the decision that the agency would be responsible for informing accounts of import rules and regulations, and importers would be responsible for complying with them. Importers also took on a number of responsibilities that previously had been carried out by the Customs Service. This concept of shared responsibility was dubbed "informed compliance."

Customs also shifted from a transaction-based environment to an account-based process--that is, the agency's compliance efforts focused on companies and their performance rather than on individual import transactions. Customs created the position of "account manager," a person who acted as a primary point of contact and improved compliance by identifying problems and helping to resolve issues on behalf of both the account and the Customs Service. Under this account-based approach, an importer's level of compliance is evaluated in the context of its compliance history as well as the "nature, scope, and impact" of any violations.

In order to use its resources most efficiently and to have the greatest impact on overall compliance levels, Customs has focused its compliance-assessment efforts on the 1,000 largest importers and on eight "primary focus industries." They include steel; automobiles and parts; textiles/footwear; advanced displays (cathode ray tubes, flat panels, etc.); critical components (fasteners, bearings, etc.); telecommunications; production equipment; and agriculture.

The tool most often used to measure those companies' level of compliance is the compliance-assessment audit. The purpose of these audits, according to a Customs Service position paper, is "to determine whether or not systems are in place to ensure and sustain a high level of compliance with customs laws and regulations." The audit, the document continues, "is short term [and] of limited scope, and the goal is to ensure maximum compliance."

Compliance-assessment audits are conducted by a "compliance-assessment team," often referred to as a "CAT team." CAT teams include a regulatory auditor, import and international trade specialists, and an account manager, and they consult as necessary with other specialists and agency officials.

Using statistical sampling techniques, the CAT teams look at nine specific areas for accuracy and compliance. They are: record keeping; classification and trade statistics; quantities; antidumping activity and countervailing duties; quotas; value; warehouse and Foreign Trade Zone transactions; transshipments; and special trade programs.

If a compliance assessment finds that the importer has a high level of compliance and has systems in place to ensure continued compliance, that importer may be subject to fewer inspections and investigations in the future. If, on the other hand, the importer is regularly not in compliance or is in compliance but has inadequate internal controls, the Customs Service will require that importer to develop an improvement plan, which the agency must approve before it can be implemented. An importer that fails to take corrective action is subject to enforcement action, including hefty fines and loss of importing privileges.

Policy vs. Practice

All that sounds reasonable and necessary, most would agree. But many importers and customs brokers have complained that policy does not match actual practice. (Logistics repeatedly attempted to obtain comments for this article from the U.S. Customs Service, but the agency declined to respond.)

"The idea behind the CAT teams, as I understood it, was that they were supposed to take a 'snapshot' look at the company procedures, internal controls, and processes in place," says Gerald J. McManus, a former customs district director and now vice president-regulatory affairs for international logistics firm BDP International. The assessment would be quick--perhaps lasting a couple of weeks--then the team would either move on if all was well or follow up with a full audit, he continues. The problem, McManus says, is that the first step is being overlooked. "It seems that they are going straight to a full-blown regulatory-compliance audit."

As a result, the CAT teams often are spending months rather than weeks conducting their investigations. Those that metamorphose into full audits, moreover, can take years. Speakers at the AAEI conference, for example, reported that the time from their initial notice of a compliance-assessment audit to the final auditor's report ranged from 10 months to two years.

Such long investigations are extremely disruptive to a company's operations. Import managers who have experienced these audits report that they were obligated to reassign personnel from their regular duties, hire additional staff, and allocate additional resources and funding for the entire audit period. BDP's McManus tells of one client who estimated that a year-long customs audit that turned up violations that were "very, very small" cost his company about $1 million.

Why are the compliance assessments and full audits taking so long? According to Rodney C. Schonland, a Boston-based customs attorney and Logistics columnist, it's because auditors are not just looking at the import transactions themselves; they also are examining the audited company's general ledger. They want that information because it allows them to find discrepancies between import entries and the corporate books.

One such discrepancy might be a cost overrun at the foreign manufacturing plant. The purchasing department may not have told the import department that there's a supplemental invoice, Schonland explains. "There are going to be price adjustments that won't be on the customs invoice, but the import person who presented [the original documents] to customs is never going to know that," he says. To avoid situations like this, customs auditors want to see that an importer has a procedures manual as well as safeguards in place to ensure that the information that is filed with customs matches the payables to vendors.

Another source of concern for importers is the very strict limit on allowable errors. Until recently, CAT teams sampled 220 import entries for mistakes and allowed five errors. Now, the audit teams sample 100 entries but allow only one error. That seemed draconian to some, so to address that issue, the agency introduced the concept of "materiality," or seriousness, of an error. Materiality separates the occasional simple clerical error from repeated or deliberate errors. That's small comfort, though, since what the Customs Service considers to be "serious" can be as small as a 0.5-percent error in declared value.

Some industry insiders charge that the CAT teams are too aggressive. Speaking at the AAEI conference, Melvin Minsky, a customs attorney with the New York City-based firm of Serko and Simon, blasted the CAT teams for overstepping their bounds and taking actions he believed should be limited to formal, long-term audits. "The CAT teams," he said, "do not have the authority to impose penalties in some circumstances that I believe are questions of law, not fact."

Here to Stay

The CAT teams and compliance-assessment audits will not go away anytime soon. In fact, it is clear from statements made by Customs Commissioner Raymond Kelly in congressional testimony that enforcement will continue to be a major focus of the agency.

Importers say they accept that fact and are only asking that the agency meet its own standards. They also would like customs authorities to be less aggressive, especially in cases where there is no prior evidence of wrongdoing and errors turn out to be insignificant. Furthermore, they say, the agency needs to work with importers to find a way to obtain the information it needs without seriously disrupting their day-to-day business. If the Customs Service can do that, they say, they'll be much more willing to take a turn under the magnifying glass.

How to Prepare for a Customs Audit

The U.S. Customs Service generally gives 30 days' written notice prior to conducting a compliance-assessment audit. What's the best way to prepare for the inspectors' arrival? Here is advice from customs compliance managers at such companies as Robert Bosch, Polaroid, Cincinnati Milacron, and Philips Electronics, as well as from customs brokers BDP International, Tower Group International, and Barthco International.

- Appoint an audit coordinator and a cross-functional audit team. It's strongly recommended that importers appoint a single, knowledgeable person to act as their liaison with customs authorities. This "point" person should manage the collection, review, and distribution of information to the Customs Service, thus ensuring adequate control, record-keeping, and consistency of the data provided to auditors. Don't leave this responsibility up to regional branch offices or local manufacturing plants, either--the stakes are so high that it should be centrally managed by corporate headquarters.

- Use every available source of information. Customs makes a surprising amount of information about its audit strategy and process available to importers. Most of this information can be found on the agency's Web site (www.customs.treas.gov). The agency's position papers on "informed compliance" and its trade compliance and enforcement plan are on the Web site, as are a "reasonable care" compliance checklist and a copy of the agency's "CAT Kit." This kit includes documents the Compliance Assessment Teams use to conduct audits, including questionnaires and sampling guidelines.

- Conduct your own internal audit. The best way to prepare for what's coming is to do a preliminary internal audit. Do a "dry run" to test the procedures, responses, and lines of authority you will use during the actual customs audit. Try to find and correct weaknesses and deficiencies before the auditors do.

- Make use of "prior disclosure." An importer that finds errors while preparing for an audit or during the course of daily business can elect to disclose those errors to customs officials in advance. This procedure is known as "prior disclosure" and, if correctly done, allows the importer to avoid penalties and instead pay only the duties owed as a result of those errors. The procedure also requires the importer to correct internal processes to prevent those errors from being repeated. Prior disclosure can be tricky, particularly while an audit is in progress, so be sure to get expert advice from a trained customs professional before filing.

- Get everything in writing. Insist that the auditors put every request for information in writing, no matter how small. Importers can be held accountable for even the tiniest error, so putting every transaction between your company and the auditors in writing is an important safeguard. Be sure to document your responses and their replies as well.