INTRODUCTION

If you ask anyone in your in-house Intellectual Property team what the black market is, they’ll probably come up with a pretty good answer. The black market involves the manufacture and sale of counterfeit products.

Now ask them about the gray market. Chances are they’ll have no idea what you’re talking about or, if they do, they won’t be able to explain it well. That’s because the concept of the gray market, while heavily regulated, is often misunderstood.

At its core, the gray market involves three things: (1) the importation of genuine products from outside the United States; (2) those products bear a legitimate trademark owned by a U.S. citizen or entity; and (3) the trademark owner has not given consent for importation. The permeations of this scenario are vast, as are the federal regulations that dictate how gray market goods are handled by customs officials.

Why the Gray Market Matters

If the imported products bear a genuine trademark, why would brands concern themselves with entry into the U.S. marketplace at all? The answer lies in the potential differences between trademarked goods intended for sale in the United States, and their trademarked counterparts intended for sale elsewhere.

Often, products intended for foreign sale are of an inferior quality. For example, a vitamin product sold in Asia might contain supplements or chemicals that are not allowed by the U.S. Food & Drug Administration. A food product manufactured for sale in South America might have a different recipe from its U.S. counterpart that is intended to appeal to local customs and tastes. It may also be missing nutritional information required by law in the United States.

Durable goods are also an issue. Car parts, for instance, frequently enter the United States via the gray market. Unfortunately, they may not meet U.S. standards for safety. Likewise, electronics that were manufactured for other markets may not meet the UL safety standards required here.

Why, then, would products manufactured for sale in another country ever end up in the United States? One word: profit. Gray market products are imported principally because they are obtained abroad for substantially less than they can be found in the U.S. Typically, they can be bought and sold far below the manufacturer’s minimum advertised price (“MAP”), even after accounting for shipping. Thus, once he is participating in the American marketplace, the gray market seller has a significant price advantage.

This state of affairs can cause wide-spread damage to U.S. brands. First, the competitive pricing referenced above can cause legitimate, state-side sellers to lower their prices in order to compete. The resultant price erosion not only cuts into profits for legitimate sellers and brands, the rock-bottom prices may cause consumers to believe the product itself is of poor quality.

Furthermore, if an American consumer purchases a gray market product without knowing of its origin, that consumer may be greatly disappointed when the product arrives at their doorstep. Even worse, a consumable product intended for sale abroad may actually make the customer sick. Any of these scenarios can be critically detrimental to a brand.

How Amazon Exacerbates the Problem

The recent explosion of E-Commerce only exacerbates the problem, given that the vast majority of gray market products are sold online.[i] Moreover, over half the U.S. population now reports a preference for online shopping over traditional shopping.[ii] E-Commerce sales are expected to eclipse $4.0 trillion in 2020.[iii] This situation creates the perfect storm for gray market proliferation.

Amazon sits front and center in this E-Commerce revolution. From its modest beginnings as an online bookseller in the mid-nineties, the company has grown to become the world’s third-largest retailer. According to the National Retail Federation, it is now the top online retailer in the world.[iv] The latest reports show the company’s annual sales nearing $140 billion.[v]

For consumers and brands, one of the most startling statistics about Amazon relates to its third-party seller program. Amazon was among the first web retailers to allow individuals and entities unrelated to its organization to sell products in its virtual marketplace. In some product categories, third party retailers (“TPRs”) now sell over 75% of the products moved by Amazon.[vi] Unfortunately, many of those TPRs are moving gray market goods.

To make matters worse, Amazon itself does very little policing of the products sold by TPRs on its site. Consequently, if brands aren’t vigilant about watching for gray market goods, counterfeit goods, and other unauthorized sales, they will increase over time. The resultant harm can be devastating for a brand.

Battling the Gray Market

This paper explores the various strategies that brands, working together with E-Enforcement professionals, can employ to prevent gray market versions of their products entering the U.S. marketplace.

In Part 1, we will explore the key role played by the United States Customs & Border Patrol (“CBP”) both in promulgating and enforcing regulations surrounding the gray market. This Part will discuss preventative measures that can be taken to keep gray products from entering the country, as well as reactive measures that can be taken once such products arrive. Finally, we will explore some of the controversial loop-holes that keep gray market products flowing into the country notwithstanding the valiant efforts made by agents and brands.

Part 2 of this paper will examine other E-Enforcement strategies that can be taken when CBP methods fall short. Again, both preventative and proactive steps will be discussed.

The United States Customs & Border Patrol oversees the gray market. It has an intricate web of regulations and laws to assist this effort, and also publishes a regular bulletin that addresses existing gray market disputes.  These writings can be confusing to the novice gray market observer, however. In this Part, we hope to clarify the varying levels of protection afforded to U.S. trademark owners.

Common Control Gray Market Protection

According to the United States Code of Federal Regulations, gray market goods are “foreign-made articles bearing a genuine trademark or trade name identical with or substantially indistinguishable from one owned and recorded by a citizen of the United States or a corporation, or association created or organized within the United States and imported without the authorization of the U.S. owner.”[vii] As noted at the outset, this definition contains three key components.

First, the product must be “foreign made.” Second, it must bear a genuine trademark owned by a U.S. person or entity. Finally, to be recognized as a gray market product, it must be imported without the authorization of the trademark owner. Note how this distinguishes gray market goods from black market products: black market items are manufactured without consent of the trademark owner; gray market products are manufactured on purpose but imported without consent.

Importantly, just because a product fits the definition of a gray market item does not mean it can be automatically be prohibited from entry into the United States. Indeed, even the CBP describes its ability to exclude gray market products as “limited.”[viii] It might also be described as complicated.

In order to receive gray market protection, a trademark owner must go through a recording process with the CBP. This involves filling out an extensive application and paying a fee.[ix] Once the application is submitted, the CBP will determine if gray market protection is warranted. In a nutshell, the only way to get that protection is to prove: (1) that a valid, registered U.S. trademark exists; (2) that the U.S. trademark and any foreign trademark are not owned by the same person; and (3) that the U.S. and foreign trademark owners are not operated or controlled by related entities (e.g., a parent-subsidiary relationship).[x]

This level of protection (known as “Common Control Protection”) is intended to address a common scenario in today’s global marketplace. Imagine a U.S. company (“Company A”) that develops a popular product. Initially, Company A trademarks and manufactures the product within the United States. Soon, however, the product is in such high demand that Company A needs additional manufacturing options. It finds a manufacturer in China (“Company B”). As part of its deal to manufacture Company A’s product in China, Company B retains the exclusive right to obtain a Chinese trademark for the product, and to distribute a similar product bearing that mark throughout Asia (but not the United States). Company A and Company B are not owned or controlled by related entities.

In this case, Company A could record the product with CBP. If Company B later tried to import the Chinese version of the product into the U.S., the lots would be detained and could be subject to seizure and forfeiture.[xi] It’s a fairly straightforward process. Yet, in order for it to work, very specific variables have to be in place. What would happen, for example, if the two companies merged at some point? Would Company A lose its right to prevent importation against a rogue distributor of the products that were manufactured for sale in China?

The answer to that question is yes and no. Let’s carry the scenario a little further.

Lever Rule Protection

Company A and Company B have now merged within China and are known as “Company AB.” Company AB continues to manufacture two sets of products: (1) those designed for importation and use within the U.S. market; and (2) those designed for distribution and sale in China. To handle sales within China, a large distributor is engaged (“Distributor.”)

Unbeknownst to Company AB, Distributor is part of a global organized crime network. Among other things, it imports gray market goods into the United States for quick sales with high profit margins. Company A (still operating as an independent entity in the U.S.) first learns that these gray market goods have entered the U.S. when it notices its product offered for sale on Amazon.com far below MAP. Upon further inspection, Company A determines the illicit products were manufactured by Company AB, are intended for sale only in China, and – frighteningly – do not contain important safety mechanisms required by the U.S. government.

Under black letter law, Company A would not be entitled Common Interest Protection and the CBP would not make effort to halt importation. Fortunately, however, an exception has emerged known as the “Lever Rule.”

The Lever Rule stems from a 1989 case in which Lever Brothers, makers of “Shield” soap, sought to halt importation of a U.K. version of the product because it didn’t perform in a manner that would be appealing to American consumers. There were also slight differences in packaging between the two products. Although Lever Brothers could not meet the standards for Common Control Protection, the court nonetheless put a stop to importation of the U.K. soap because it was “physically and materially different” from its U.S. counterpart, which, the court reasoned, might lead to consumer confusion.[xii]

Following the Lever case, CBP amended its regulations to provide that certain gray market goods could be seized even if: (1) the trademark at issue was not a genuine, registered mark; and (2) the U.S. and foreign companies shared some formal affiliation. Lever Rule protection, however, is not automatic. The holder of a U.S. trademark must apply to CBP for consideration. The agency’s decision hinges on a finding of “physical and material” differences between the U.S. product and its foreign counterpart.

Physical and Material Differences

According to current regulations[xiii] the material differences analysis may incorporate the following factors: (1) composition of the U.S. and gray market products (including chemical composition); (2) formulation, construction, or structure of the two products; (3) performance or operational characteristics; (4) differences stemming from legal or regulatory requirements; and (5) other distinguishing and defined factors “that would likely result in consumer deception or confusion.”[xiv]

Interestingly, the CBP publishes the “Customs Bulletin & Decisions,” in which it announces its initial findings on applications for Lever Rule protection. While the bulletin does not publish in-depth factual details concerning each application, regular review of its decisions can be a good tool for understanding the types of product differences the agency finds to be material.

For example, the following cases were reported in the bulletin concerning popular brands within the United States:

Duracell: Batteries manufactured for sale outside the United States were deemed to be physically and materially different because of differing “label warnings, consumer assistance information, product guarantees, and warranty coverage.”[xv]

La Costeña: pickled jalapeño peppers were found to be physically and materially different from the U.S. brand because of the following label variations: “language, labeling, nutritional information, ingredients, bar codes, and contact information.”[xvi]

Tide: The CBP determine that several package types of Tide laundry detergent manufactured in Vietnam were physically and materially different from the detergent intended for the U.S. market due to differing “product formulas, operation and performance, language, warnings, consumer hotlines, product codes, distributors, measurement units, and absence of relevant product information.”

As discussed below, these examples are illustrative of what the CBP really cares about when making Lever Rule decisions. Hence, it is a good idea to appoint someone on your in-house IP team to review them regularly.

  The Controversial Sticker Exemption

While the above tests and standards might normally warrant more extensive treatment, an exemption to gray market protection exists that many experts find frustratingly difficult to overcome. Known as the “sticker exemption,” federal regulations provide that gray market goods are “still permitted entry if bearing a conspicuous and legible label designed to remain on the product until the first point of sale to a retail consumer stating ‘This product is not a product authorized by the United States trademark owner for importation and is physically and materially different from the authorized product.’”[xvii]

Under the sticker exemption, gray market goods can earn a ticket into the U.S. marketplace without regard to trademarks, authorization, or affiliations. Of course, the American consumer may not find out about the sticker until the product is delivered by a TPR via a site like Amazon.com. Worse yet, some experts think that applications for Lever Rule protection end up simply informing gray market importers of loopholes they might not have discovered otherwise.[xviii]

This state of affairs has led the International Trademark Association (“INTA”) to strongly advocate for removal of the sticker exemption from American lawbooks. In fact, INTA aptly describes the exemption as “widely criticized.”[xix] It’s easy to see why.

In the final analysis, the gray market is a heavily regulated industry with strong enforcement agencies acting as watchdogs. Nonetheless, it remains relatively simple for importers to skirt the rules. Given these circumstances, how does a brand combat an influx of gray market goods and the concomitant negative impacts they have on the U.S. market? The answer lies in two distinct strategies: prevention and enforcement.

Prevention Strategies:

Obtain Registered U.S. Trademarks

It is hard to overstate the significance of registered trademarks in the battle against gray market imports. While the federal Lanham Act does provide some level of protection to owners of common law marks (those denoted with the “™” symbol as opposed to the “®” symbol)[xx] , the CBP affords the greatest level of protection to trademark owners who have registered their marks with the United States Patent and Trademark Office. Regardless, companies without any recognizable marks will have no recourse against gray market imports.

Choose Foreign Markets & Foreign Business Partners Carefully

Before diving into foreign manufacturing, conduct extensive research into the pros and cons of various markets. While things like corporate tax rates and labor costs will influence the analysis[xxi], so too should factors such as organized crime, reputation for honesty, and governmental hostilities toward (or alliances with) the United States. This is a good time to retain an attorney specializing in international relations and who can advise your brand on the intellectual property protections afforded in different regions.

Once the nation of manufacture has been determined, do a similar level of research concerning manufacturing partners. Again, local or specialized attorneys can help avoid partnerships with shady manufacturers, distributors, and exporters. Additionally, they can help negotiate contracts and explain localized customs that may impact available remedies in the event the relationship is later tarnished.

Consider Foreign Trademarks

When determining whether to obtain trademarks from the country of manufacture, it is important to weigh the risks and rewards of that decision. Recall that Common Control Protection from the CBP is not available if the owner of the U.S. mark and the foreign trademark are the same. This means products cannot be recorded with the CBP and gray market enforcement may be more difficult.

On the other hand, having a foreign trademark provides greater protections in the event you’re trying to prevent the export of counterfeit goods from the country of manufacture.[xxii] Of course, there are dozens of considerations like this – which again warrants the advice of attorneys or other intellectual property consultants who specialize in foreign registrations.

Recordation with U.S. Customs & Border Patrol

In the event your products are subject to valid, registered trademarks and there is no common ownership or control between your company and the foreign manufacturer, it is hard to find a reason not to record your foreign-manufactured products with the CBP. As discussed above, recordation gives the CBP authority to prevent importation and cause the forfeiture and seizure of gray market goods. This is a significant layer of protection when working with new or less-than-trustworthy foreign business partners.

Physical & Material Differences

This is one of the most important steps a company can take to prevent importation of gray market products. Companies regularly produce similar products for foreign and domestic distribution. If the product intended for foreign distribution is significantly cheaper than its U.S. counterpart, that product is at great risk of being imported through the gray market. In order to increase the likelihood of receiving Lever Rule protection from the CBP, it is wise to make sure the differences between the two products are “physical and material.”

Packaging should be different. If the ingredients or components of the products are different, list them. Make sure that the product intended for foreign sale has instructions or other writing that appears in the native language of that country. Set up different customer service numbers for the two products. State differing warranties right on the package. These are relatively simple steps that can make the difference between receiving Lever Rule protection and not.

Tell the Public

Finally, it is good practice to inform the public of the dangers of the gray market. We can’t blame consumers for seeking the best deal in online marketplaces like Amazon. We can, however, educate them on the indicia of gray market goods, as well as the risks of purchasing such products.

For example, the product website can warn buyers that prices that seem too good to be true, probably are. Likewise, inform them that standard U.S. warranties and money-back guarantees will not be honored if a foreign product is purchased for use in the States. If there are risks involved in using the foreign product, warn them. Not only will this practice lessen the risk of harm to customers, it can have the simultaneous effects of reducing liabilities and preserving brand reputation.

Enforcement Measures

Given the shortcomings of gray market regulations and enforcement (not to mention loopholes such as the sticker exception), many brands will fall subject to illicit importers despite their best efforts. When that happens, immediate E-Enforcement is the best form of damage control.

Gray Market Intelligence & Monitoring

E-Enforcement strategy begins with identifying gray market imports through marketplace intelligence. Investigators create automated processes that scan the internet (including TPR-rich environments like Amazon) searching for evidence of gray market sales. To accomplish this, E-Enforcers use proprietary software and algorithms that find indicia of gray market goods. Red flags include

products sold far below MAP, UPC and ASIN numbers that don’t match products intended for the U.S. market, missing serial numbers, and other proprietary factors.

One of the main advantages of working with experienced E-Enforcement teams is that they can often identify gray market importers from their modus operandi. If a targeted suspect emerges, E-Enforcement teams can then monitor the universe of that seller’s online activity and provide real-time snapshots of how the foreign products are being sold in the U.S. Sometimes, these initial reports reveal gray market sales the domestic trademark owner wasn’t even aware of yet.

Importantly, monitoring is a continual process. Gray market importers and sellers employ sophisticated strategies to obfuscate their identity. By monitoring non-stop for gray market warning signs, investigators are alerted around the clock each time a concerning product offering is identified.

Immediate Response

In addition to monitoring ongoing activities, E-Enforcement professionals will initiate immediate procedures aimed at shutting down TPRs who are peddling gray market goods. Typically, the first step is to send an electronic cease and desist notice (“EC&D Notice”) directly to the seller via the online seller portal offered by the marketplace. Amazon, for example, offers a communication portal designed for consumers to communicate directly with sellers. For the first few weeks of the investigation, this may be the sole manner of communication with sellers.

With gray market goods, there is always a chance that the seller is a small-time operator who bought a small lot of goods during a trip abroad. They may not even realize there is a problem with selling products intended for foreign markets. These types of sellers tend to rapidly disappear upon receiving an EC&D notice.

If the seller is part of a larger operation, however, E-Enforcement teams will contact Amazon (and other marketplaces) to notify the company of the unauthorized sales. This step is particularly important if products intended for the foreign marketplace pose health or safety hazards for U.S. consumers. While Amazon’s internal investigations and response time is not ideal, the company will frequently shut down seller sites while investigations are underway.

Product Buys

Simultaneously with cease and desist efforts, E-Enforcers coordinate undercover product purchases from the rogue seller. This step is critical for two reasons.

First, purchases made by a brand’s in-house personnel are too easy to trace. Big-time gray market sellers may be part of intricate crime organizations and tend to be very careful about who they’ll send product to. E-Enforcers, however, will use covert names, addresses, and payment methods that are virtually impossible to trace.

Perhaps more importantly, an experienced E-Enforcement team will very carefully execute the product purchase so that the chain of custody is preserved. In other words, they will follow precise steps to ensure that the phony product is admissible as evidence in court should it ever come to that.

Upon receiving the gray market goods, investigators will conduct side-by-side examinations of the foreign products against like products intended for the U.S. market. Results will be documented and preserved for evidentiary purposes. Additionally, positive identification of a gray market product can signal the initiation of formal law enforcement strategies.

Lever Rule Application.

At this point, the U.S. trademark owner can apply for Lever Rule protection with CBP. This is another reason the covert product purchase is so important – a gray market product sample is absolutely necessary for proving to CBP that “physical and material” differences exist between foreign and domestic products.

Investigation of Upstream Sources

Many times, an online seller who is peddling gray market products is not the ultimate source of those products. They may, however, know who is. Not wanting to give up that information, illicit importers and other unauthorized sellers frequently use multiple seller names, disappear and re-appear in multiple online venues, and use other tactics to hide their identities.

Given the sophistication of proprietary monitoring software, these tactics are usually ineffective. After all, monitoring software doesn’t have an “off” button. Investigators are alerted the moment sellers reappear and take same-day steps to renew cease and desist demands.

If those demands go unanswered, E-Enforcement investigators will turn to Open Source Intelligence (“OSINT”), combined with proprietary database intelligence to discover more detailed identifying information about the seller. Within a relatively short period of time, investigators can determine a seller’s name, physical address, telephone number, and relevant background information.

Armed with this information, physical notices are sent directly to the individuals selling the gray market products. Certified cease and desist demands are delivered right to their home and/or business addresses. Within these demands, sellers are notified that they have a very short window to stop selling gray market items before more extreme measures are taken.

In gray market cases, of course, the seller is often located in a foreign jurisdiction. If that is the case, then an E-Enforcment team can assist with coordinating attorney’s in both the U.S. and the country in question. In the U.S. a “John Doe” suit can be filed to identify the foreign sellers, and in the offending country an IP attorney can be contacted to file the necessary law suit. In addition an E-Enforcement team can coordinate contact with the appropriate law enforcement agencies, and on the ground assets to locate the offending party and to initiate, if warranted products seizures.

Escalated Enforcement

The final step in the E-Enforcement process is a measure of last resort. Working in conjunction with in-house legal teams or outside law firms, E-Enforcement teams will prepare a draft trademark infringement/counterfeiting complaint against the sellers of gray market goods and any formal entities they operate. Of course, if the seller is located outside the United States, foreign counsel must be consulted as U.S. courts will lack enforcement power.

This initial complaint is, in many cases, a bluff. Not many gray marketeers or other unauthorized sellers have the resources or desire to battle a popular brand in court. While sophisticated foreign sellers may take solace in their remote location, communications from a law firm and a knock at their door within their home country will often signal an end to their operations.

In the meantime, E-Enforcers will continue to work with appropriate law enforcement agencies both domestically and abroad. E-Enforcement teams can “talk the talk” in order to stop international shipping, initiate investigations, and get product seizure efforts underway.

As enforcement operations escalate, the subject of investigation often cracks under the pressure. This is the ideal time to leverage that person’s upstream connections to determine the ultimate source of gray market products entering the U.S. Those at the top sometimes prove to be manufacturing partners, distributors, or other trusted entities. Regardless of the culprit, their identification is the lynchpin of any gray market E-Enforcement operation.

E-Enforce is a division of an internationally recognized Cyber investigation firm, Cyber Investigation Services LLC.  We have been providing litigation support and investigations for high profile cases and top law firms since 2010.

In 2012, we began combatting unauthorized sellers at the request of our client, Zo Skin Health. When we began that process, the company was overwhelmed with unauthorized retailers in online marketplaces. Today, they have virtually zero. They have also enjoyed exponential growth in that time.

In February 2017, we made our proprietary E-Enforcement system available commercially. We currently work with a top 200 AM Law Law firm in addition to our own clients. Collectively we have or currently managed numerous brands, including global companies, mid-sized operations, and small-but-growing manufacturers across several verticles. Our clients represent the following industries:

  • Cosmetics
  • Direct sales
  • Paper products
  • Home repair
  • Clothing
  • Women’s accessories
  • Food supplements
  • Pet products
  • Sunglasses & accessories
  • Consumer electronics
  • Vacuum cleaners
  • Purses and bags
  • Radar detectors
  • Cutlery
  • Skin care
  • Health products
  • Vitamins
  • Hair products

If you have questions about combatting the gray market, or would like additional information, contact the E-Enforce™ team at sales@e-enforce.com, or call us at (800) 892-0450. You can also follow us at e-enforceCIS@twitter.com, via the ECommerce Enforcement Group on LinkedIn, or visit E-Enforcement.com/services.

ENDNOTES

[i] https://apps.americanbar.org/buslaw/blt/2009-11-12/mendelsohn-stanton.shtml

Business Law Today

[ii] https://www.bigcommerce.com/blog/ecommerce-trends/

[iii] https://www.census.gov/retail/mrts/www/data/pdf/ec_current.pdf

[iv] http://www.businessinsider.com/third-party-merchants-drive-amazon-grow-2015-10

[v] https://www.statista.com/statistics/266282/annual-net-revenue-of-amazoncom/

[vi] http://www.webretailer.com/lean-commerce/multichannel-selling-online-marketplaces/

[vii] 19 C.F.R. § 133.23(a)

[viii] https://www.cbp.gov/sites/default/files/assets/documents/2017-Feb/enforce_ipr_3_0.pdf

[ix] https://apps.cbp.gov/e-recordations/docs/trademark_Application.pdf

[x] https://www.cbp.gov/sites/default/files/assets/documents/2017-Feb/enforce_ipr_3_0.pdf

[xi] See 19 C.F.R. § 133.23, 19 C.F.R. §133.25, 1986 U.S.C. §1526(b).

[xii] See Lever Bros. v. United States, 877 F.2d 101 (D.C. Cir. 1989).

[xiii] See generally 19 C.F.R. § 133.2 through 133.27.

[xiv] 19 C.F.R. §133.2(e).

[xv] https://www.cbp.gov/sites/default/files/assets/documents/2017-Mar/Vol_51_No_12_Title.pdf

[xvi] https://www.cbp.gov/sites/default/files/documents/Vol_48_No_13_Title.pdf

[xvii] 19 C.F.R. §133.2(e).

[xviii] http://customslaw.blogspot.com/2017/08/the-xyz-affiar-and-quasi-war-over-gray.html

[xix] http://customslaw.blogspot.com/2017/08/the-xyz-affiar-and-quasi-war-over-gray.html

[xx] https://www.lawtrades.com/blog/answers/intellectual-property-differences/

[xxi] https://www2.deloitte.com/in/en/pages/manufacturing/articles/global-manufacturing-competitiveness-index.html#

[xxii] https://www.chinalawblog.com/2013/04/stopping_china_counterfeiting.html

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