Minefields in U.S. Export Control System

The First of a Series of Articles on U.S. Export Control System

On 15 April, 2018, the U.S. Department of Commerce's Bureau of Industry and Security (BIS) issued a denial order against a Chinese telecommunications company (hereinafter referred to as "Company Z"), and added the company to the "Denied Persons List." The case of Company Z's violation of U.S. export control, which has lasted for years, again came into the spotlight and raised public concern over the U.S. export control system in China.

The Export Administration Act (hereinafter referred to as "EAA") came into force in 1979. Since then, the U.S. has adopted the most rigorous export control system in the world. Meanwhile, for a long time, many Chinese enterprises lacked awareness of the U.S. export control system, which made them key subjects of U.S. export control investigations. In the United States, China became the second target country of criminal investigation on export control as early as in 2014, just after Iran.[1] In view of this, the Customs and Trade Compliance Team of King & Wood Mallesons (hereinafter referred to as "KWM") will enumerate key issues in the U.S. export control system that concern Chinese enterprises based on the in-effect statutes of U.S. export control and published PRC-related cases. As the first of a series of articles, we will review the "minefields" in U.S. export control frequently encountered by PRC enterprises.

"Minefields" Detection

• Minefield One: Export Control Applies to the Activities Beyond Actual Export

Who Stepped into the Minefield:

Mr Ho

Case Introduction

On April of 2016, U.S. Ministry of Justice accused an American citizen, Mr Ho conspired to engage or participate in the development or production of special nuclear material in China, without specific authorization to do so from the U.S. Secretary of Energy, as required by law. It was claimed that Ho identified, recruited and executed contracts with U.S.-based experts from the civil nuclear industry who provided technical assistance related to the development and production of special nuclear material for a PRC company in China. Ho and the PRC Company also facilitated the travel to China and payments to the U.S.-based experts in exchange for their services. Ho was convicted guilty in violation of the relevant export control acts and statutes and was sentenced 24 months in prison and one year of supervised release eventually.[2]

Comments

Pursuant to the Export Administration Regulation (hereinafter referred to as "EAR"), any U.S. origin items (including goods, software and technology), engaged in the activities of export, re-export (transmit U.S. origin items from one foreign country to another foreign country without U.S.) or transfer (transmit U.S. origin items within the same foreign country), shall subject to EAR. [3] Moreover, in different from the common understanding on the definition of export that an export shall have an actual shipment out of the country, the definition of export is much wider subject to EAR. Other than the actual shipment or transmission of goods or technologies out of U.S., the sending information or even temporary transit will be deemed as export, re-export or transfer of U.S. items and such activities shall be subject to EAR. The following activities will be deemed as export, re-export or transfer under EAR, and was required to apply for a validated license in advance:

1) Actual shipment or transmission of goods or technologies ;

2) Release information of controlled items to abroad through phone call;

3) Release information of controlled items to abroad through email;

4) Release information of controlled items to abroad through providing access authority of Cloud software or FTP;

5) Providing technical drawings of the controlled items to abroad;

6) Sending or taking information of controlled items to abroad

7) Providing encryption source code and objective source code of controlled items to abroad;

8) Providing proprietary courses regarding controlled items to abroad; and

9) Under special circumstances (i.e. special controls of Cuba), temporary sojourn of the vessel and aircraft and in-transit shipments and items to be unladen from vessels or aircraft.

In practice, many Chinese enterprises just consider about the export issues on actual shipment or transmission of goods and technology, while overlook the fact that information release to abroad of controlled items is also deemed as export activities subject to EAR. In consideration of that it is one of the main causes for Chinese enterprise to be punished under EAR; we understand it is a main "Minefield" in U.S. export control.

Minefield Two: Export Control  Applies to the Transmission and Release of Controlled Items to Foreign Persons within the United States

Who Stepped into the Minefield:

Company M

Case Introduction: 

On September of 2005, Company M, which is located in California, released controlled technology for the development of electronic components classified as ECCN 3A001, to a Chinese national employee without the required BIS license. This case resulted from an investigation conducted by OEE, and on October 3, 2008, Company M agreed to pay a $192,000 civil penalty. [5]

Comments:

Pursuant to the relevant regulations of EAR, other than the cross-border shipment, transmission and information release, releasing or otherwise transferring the controlled items to a foreign person in U.S. is also deemed to be an export to a foreign country and may subject to the license requirement under EAR. [5] Pursuant to the regulations of EAR, any foreign natural person within U.S. who is not a lawful permanent resident of U.S. or any other protected individual (in general as political asylum) shall be defined as foreign person.[6] In common, the following activities will be defined as deemed export:

1) Releasing information, materials, encryption source code and objective source code of controlled items to foreign employees

2) Providing access or authorization of controlled items to foreign employees;

3) Providing proprietary causes to foreign employees or non-U.S. citizens which may result in the release of information of controlled items;

4) Releasing information  of controlled items to overseas personnel who came to U.S. on business trip;

5) Transferring the registration, control or ownership of certain controlled items to non-U.S. citizens in U.S..

Subject to the statistics of BIS, more than 60% export license application for deemed export occasion are issued to Chinese citizens or Chinese organizations which locate in the U.S. In other word, to Chinese enterprises, their business activities in U.S., such as the interpersonal communication with U.S. affiliates, certain investment and acquisition activities or  employ a non-U.S. citizen technical personnel who used to work in the U.S., etc. , may trap into  the minefield of "deemed export", any carelessness will result a smash crisis. 

Minefield Three: Export Control  Applies to Non-Listed Items

Who Stepped into the Minefield:

A Construction Co., Ltd (Hereinafter referred to as "Company A"), B Paint Trading Co., Ltd (Hereinafter referred to as "Company B")

Case Introduction:

In 2006, Company A was involved in a Nuclear Power Construction Project in Pakistan ("Pakistan Project"). In this regard, Company A entered into a contract with Company B to procure non-special controlled item (EAR 99), epoxy coating from U.S. for use in construction Pakistan Project Construction.  Since Pakistan Project is a project of the Pakistan Atomic Energy Commission ("PAEC"), while PAEC and its subordinate nuclear reactors are on BIS's Entity List. U.S.-origin epoxy coatings are not permitted to be exported, re-exported, or transferred for use in the construction of Pakistan Project without an export license from BIS. However, Company A and Company B colluded to circumvent the license requirement by means of procuring the epoxy coatings through a third party distributor, then transfer to Company A for Pakistan Project use purpose . In December, 2010, Company B in together with its U.S. parent company pleaded guilty and paid 3.75 million USD in criminal and civil fines. Thereafter, on December 3, 2012, Company A entered into a settlement agreement with BIS and a plea agreement with DOJ, which required Company A to pay 3 million USD in criminal and civil fines, implement an export control compliance program, and accept a five-year probationary period. In exchange, BIS would not put Company A into the entity list. The case is believed to be the first time that a Chinese company has pleaded guilty to violating U.S. export control laws. 

Comments:

Pursuant to EAR and its enclosed Commerce Control List (CCL), U.S. have classified all the U.S. items by ECCN code, which consists of 5 characters. The types of control of certain items could be determined by cross-checking on CCL and the Commerce Country Chart (CCC). In general, non-sensitive items (EAR 99) do not require a validated license, i.e., such items could export directly under the general license by declaring the general license information during export declaration. However, subject to EAR, the key concern of U.S. export control is dependent upon the knowledge of the end-use and end-user relating to a transaction of certain U.S. items, which is called Catch-All Rules[7] . Even though there is no special requirement on the items, a special license may still be required for the export, re-export or transfer of the items, provided that a risk of proliferation exists on the end-user or end-use. Recently, BIS releases three lists to identify the end-user reasonable believed to be involved a risk of proliferation and sets up different control requirement separately:

Furthermore, in the event any circumstance of  "red flags"[8]  as listed in EAR occurred in the transactions of non-listed U.S. items with non-listed entities, such as : the client is reluctant to offer information about the end-user, the client has little or no business background, the shipping route is abnormal for the product and destination etc., BIS requires the enterprise to fulfil the responsibilities of end-user and end-use verification, inquire BIS and apply for validated license if it is necessary. 

Moreover, it shall be noted that U.S. items defined by EAR is not just the items located within U.S., such as:

1) U.S. origin items located out of U.S.;

2) Foreign-made commodities that incorporate controlled U.S. origin commodities in quantities exceeding the de minims levels (based on the characteristics and categories of the commodities , there are three de minims Rules,  0%, 10% and 25%);

3) Foreign-made direct products of U.S. origin technology or software;

4) Certain activities of U.S. persons related to the proliferation of nuclear explosive devices, no matter such items are origin from U.S.;

For Chinese enterprises, misjudgement on whether the business activities shall apply for an export license becomes the main cause for being punished by U.S. export control regulations, especially in the following circumstances:

1) Negligence on the confirmation of end-user and end-use of non-listed items for re-export or transfer in-country;

2) Erroneous understanding on the definition of U.S. items, misjudging some PRC origin commodities don't need to subject to the U.S. export controlsystem; 

Such erroneous judgement could be entitled as the biggest minefield for Chinese enterprise. 

Minefield Four: Assistance from Non-U.S. Entity on Transaction Shall Applies to U.S. Export Control and Sanction Management

Who Stepped into the Minefield:

Bank K

Case Introduction:

On 31th of July, 2012, the Office of Foreign Assets Control ("OFAC") announced the imposition of sanctions against Bank K under the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010 (CISADA), claiming that Bank K provided hundreds of millions of dollars' worth of financial services to Iran banks, including holding accounts, making transfers, and paying their letters of credit. OFAC bared Bank K from directly accessing the U.S. financial system, and financial institutions may not open correspondent or payable-through accounts for Bank K in the United States. The other Chinese bank had to cease their business operation with Bank K to avoid being sanctioned by U.S .[9]

Comments:

In general, the main enforcement organizations of U.S. export control are BIS, which is responsible of controlling the export of dual-item and civil items, and Directorate of Defence Trade Controls ("DTC"), which is responsible of controlling military items, on the export activities by U.S. persons and non-U.S. persons.  The definition of U.S. persons generally includes the following:

1) Any individual in the U.S.;

2) Any individual who is a citizen of U.S., no matter where he is located;

3) Any permanent resident alien of U.S., or a protected individual of U.S.;

4) Any U.S. enterprises and their foreign branches

5) Any foreign enterprises which are controlled de facto by U.S. citizens or U.S. enterprises.

Pursuant to the relevant regulations of BIS and DTC, U.S. persons are not allowed to engage in any activities may violating the export control regulations, while the non-U.S. persons are not allowed to provide facilitation or take advantage of U.S. persons to engage in any activities may violating the export control regulations directly. Otherwise, apart from being punished by BIS and DTC accordingly, the violators will be subject to OFAC's sanctions in further. However, since the adoption of CISADA in 2010, OFAC is eligible to implement a long-arm jurisdiction to the activities of violation of U.S. controls and sanction measures on Iran conducted by non-U.S. persons and without the jurisdiction of U.S., which is known as secondary sanction. OFAC could implement the sanctions as follow once the violation of U.S. sanction and export control by non-U.S. persons is detected:

1) Freezing or confiscation property in U.S.;

2) Prohibited from entering of U.S.;

3) Access denied of U.S. financial service system;

4) Deprivation of the qualification of signing contract with U.S. government;

5) Criminal Charges.

In the most recent sanction cases on North Korea Sanctions[10] , the secondary sanction methods have been expanded to the sanction against North Korea in further.

For Chinese enterprises, especially for the I/E agencies and financial institutions, it is not a good sign that OFAC is tending to expand the application scope of secondary sanction. A newly "Minefield" is laid in the middle of the trade route between Chinese enterprises and regions which are sanctioned by U.S..

How to Cross the "Minefield"

In front of the rigorous export control system of U.S. and the multitudinous risks from it, we suggest that Chinese enterprises could take the following three solutions to cross the minefields: 

Plan A: Clearing the Minefield in Advance--- Establishing a Comprehensive Export Control Compliance System

Subject to the strict U.S. export control system, the tricks for circumvention always invite humiliation to itself. In order to mitigate the risks, the best approach is to improve the internal export control regulatory system and operate it effectively. In general, a comprehensive export control regulatory system shall cover the following aspects:

In the event the enterprise is not able to make such judgement or the circumstance is in emergency, pursuant to the relevant regulation of EAR[11] , the enterprise may communicate with BIS to seek for supports and guidance from U.S. authorities.

Plan B: Self-rescue after stepping into the minefield--- voluntary disclosure

Once the enterprise realizes the risk of violation of U.S. export control occurs, don't be flustered. Pursuant to the relevant regulation of EAR, BIS encourages voluntary disclosure of violations.  [12]

Typically, the exporters shall submit an initial notification to OEE prior to OEE discovers such violation facts. Within 180 days of the initial notification date, the export shall submit a narrative account to OEE. After received the narrative account, OEE will exercise its discretion based on the disclosed facts on the following issues:

1) Whether the disclosed the activities violate the EAR;

2) Whether the disclosed parties have adopted corrective measures.

In most cases, OEE will only issue a warning letter, especially for negligence violations and mild compliance defects without of aggravating circumstance, such as intentionally violation. According to the statistics of BIS, in fiscal year 2015, BIS accepted 382 voluntary disclosure reports, while only less than 1% of them were settled by administrative punishment. [13]  Even if the administrative punishment is inflicted, the voluntary disclosed exporter still could enjoy a 50% reduction of punishment on fines granted by OEE in general. Under some circumstances, fines and other administrative punishments during the probationary period will be further reduced or suspended in consideration of the voluntary disclosure.

Plan C: A Shortcut for Escaping the Minefields--- VEU Program

In 2007, BIS established the "Authorization Validated End-User" (VEU) program for China and India companies in particular. The authorized VEU in China are permitted to accept certain controlled items from U.S. by means of export, re-export and transfer without a license. Pursuant to the relevant regulations of EAR, [14] any entity in China or India may apply for VEU status, but the applicant shall satisfy the following criteria:

1) Having a comprehensive internal export control system;

2) Having a strict management of the operation place of controlled items;

3) Complying with the record-keeping requirement set forth in EAR;

4) The controlled items shall only for self-use purpose;

5) The re-export or transfer of controlled items shall be approved by BIS.

As of now, there are 11 authorized VEU enterprises in China.[15] 

Although authorized VEU enterprises may face some restriction in daily operation, such as items controlled by MT and CC reason are not allowed to export under VEU, the import controlled item shall be used in certain eligible place, etc., it is still a fast pass for Chinese enterprises to cross the minefield of U.S. export control system comparing with the heavy work on application, verification and assessment for export control license application to other enterprises.

Conclusion

Indeed, the export control system is an important tool for the United States to implement its global strategy and it bothers a large number of Chinese enterprises participating in International trade and foreign investment. But on the other hand, it is also a touchstone for Chinese enterprises to enhance their awareness of trade compliance. In June, 2017, MOFCOM issued an exposure draft of the Export Control Law of PRC, wherein many principles that have been implemented in the U.S. for years were introduced into China for the first timesuch as catch-all rules, country assessment chart, control list management and end-user verification, etc.  A perfect statutory system of export control will undoubtedly be a major driving force for China to initiative the Belt and Road strategy, and enterprises with a competitive trade compliance system have a head start in this new era.

[1]https://www.bis.doc.gov/index.php/about-bis/newsroom/speeches/148-about-bis/newsroom/speeches/speeches-2014/719-keynote-speech-of-david-w-mills-assistant-secretary-for-export-enforcement-update-conference-july-30-2014

[2]https://www.justice.gov/opa/pr/us-nuclear-engineer-sentenced-24-months-prison-violating-atomic-energy-act

[3]https://efoia.bis.doc.gov/index.php/documents/export-violations/470-e2078/file

[4]https://efoia.bis.doc.gov/index.php/documents/export-violations/470-e2078/file

[5]15 C.F.R. &734

[6]15 C.F.R. &734.2

[7]15 C.F.R. &732, supplement No.3

[8]15 C.F.R .&732, supplement No.3

[9]https://www.treasury.gov/press-center/press-releases/Pages/tg1661.aspx

[10]https://www.treasury.gov/press-center/press-releases/Pages/jl5059.aspx

[11]15 C.F.R .&748.3

[12]15 C.F.R .&764.5（a）

[13]"An introduction to the Consequences of Violating US Export Control Law"

[14]15 C.F.R .&748.15

[15]https://www.bis.doc.gov/index.php/documents/Compliance-&-Training/Export-Administration-Regulations-Training/1204-supplement-no-7-to-part-748-veu-list-1/file