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BIS Issues New Guidance to Combat Russia Diversion Risks and Highlights Recent Enforcement Actions

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BIS Issues New Guidance to Combat Russia Diversion Risks and Highlights Recent Enforcement Actions

Recently, the U.S. Department of Commerce’s Bureau of Industry and Security (“BIS”) issued new guidance to exporters intended to further assist BIS in its efforts to crack down on third-party diversion to Russia.

Specifically, BIS’s recent guidance outlines the various mechanisms it has employed—outside of its usual public screening lists (i.e., the Unverified List, Entity List, Military End-User List, and Denied Persons List)—to notify companies and universities about parties that present risks of diversion to Russia. According to BIS, it has obtained information supporting the below-described notifications through a variety of sources, including information from the exporting community, government data, news reports, and other open-source resources. The specific mechanisms utilized by BIS to help prevent exporters from unknowingly exporting items to parties of concern include:

1. “Supplier List” Letters identify parties presenting diversion risks that are not on public screening lists but have been identified by BIS as having exported to or facilitated transactions with destinations or end users of concern. BIS may send “Supplier List” letters to companies and institutions that have had no prior dealings with the foreign parties identified therein. Further, BIS encourages recipients of such letters to carefully examine transactions with the named parties for any potential red flags.

2. Project Guardian Requests advise companies and institutions to monitor or “be on the lookout” for transactions with specific parties or for inquiries about specific items. BIS may also advise recipients to deny or suspend any such transactions or inquiries and to contact the local Export Enforcement field office for guidance.

3. “Red Flag” Letters indicate to companies that one of their customers may have engaged in possible violations of the Export Administration Regulations (“EAR”) regarding the same item a company previously exported to that customer. “Red Flag” letters indicate a “high probability” that a future export violation may occur based on the customer’s reexport or transfer history. Recipients of “Red Flag” letters should conduct additional due diligence to be certain they can overcome the red flag identified by BIS before proceeding.

4. “Is Informed” Letters impose licensing requirements on specific items destined to specific entities or destinations, in addition to specific U.S. person activities. Companies and universities must comply with these requirements to avoid violating the EAR, as non-compliance with an “Is Informed” letter is equivalent to non-compliance with any other export licensing requirement for enforcement purposes. While BIS has reemphasized the use of such letters, they are not new.

Importantly, BIS will consider as an aggravating factor in any enforcement action a company or university’s decision to proceed with a transaction (without obtaining an export license) when the company or university knew or had reason to know or believe that a red flag exists which could not be affirmatively addressed or explained.

Screening Against Trade Integrity Project Website

Beyond the above notifications, BIS also increased due diligence expectations for exporters dealing with Common High Priority List (“CHPL”) items, which the U.S. government and its allies have identified as items Russia seeks to procure for its weapons programs. For transactions involving CHPL items, BIS strongly recommends screening against the list provided by the Trade Integrity Project (“TIP”), a non-government U.K. entity that monitors military and dual-use trade with Russia and has identified parties in third countries with a recent history of exporting CHPL items to Russia. For transactions involving CHPL items and parties identified on the TIP list, BIS states that companies should conduct additional due diligence to spot potential red flags before proceeding with any such transactions.

Recent BIS Enforcement Actions

In addition to the new guidance, BIS released an updated version of its Don’t Let This Happen to You! report, which includes case examples of recent BIS criminal and administrative enforcement actions. New actions involve violations of the antiboycott regulations, firearm exports, exports related to China and Iran, non-compliance with a BIS settlement agreement, as well as a voluntary self-disclosure from a university. BIS urges exporters to review this publication to understand the types of activities and missteps that lead to enforcement actions and to avoid violations of the EAR.

For example, according to BIS, Cryofab, Inc., a New Jersey-based manufacturer of cryogenic equipment, violated the EAR by exporting gas storage containers and related tools to a nuclear research facility in India without the required export license. BIS stated that Cryofab failed to screen the facility, Bhabha Atomic Research Center (“BARC”), against the BIS Entity List, on which BARC was designated, and did not seek or obtain the required licenses for its transactions. BIS ordered Cryofab, which BIS noted to be an experienced exporter, to pay a civil penalty and to have an independent consultant complete an external audit of its export controls compliance program.

In addition to companies, BIS has increasingly focused its efforts on universities and research institutions, which more often now must ensure they have effective export compliance programs in place, whether due to the involvement or employment of foreign national researchers, global exchange programs, or other international touchpoints that are now common in higher education.

In its report, BIS also highlighted a recent settlement with Indiana University involving the export of genetically modified fruit flies classified under ECCN 1C353 to research institutions and universities around the world without the required export licenses. Notably, Indiana University voluntarily disclosed the violations to BIS, which stated that the university’s disclosure and cooperation resulted in a non-monetary penalty. Instead, BIS imposed a suspended one-year denial order on its export privileges for certain ECCN Category 1C items, required export compliance training to relevant administrators, and required the university to deliver presentations on the circumstances of its violations to relevant forums.

BIS’s cases demonstrate the various ways companies and institutions may run afoul of the EAR, with examples covering China, Russia, Iran, and the rest of the world, as well as licensing requirements imposed by controls related to national security, military end-users, and others. The two aforementioned actions highlight the importance of carefully reviewing all items and parties to a transaction for any licensing requirements or other prohibitions, in addition to the potential benefits of disclosing any actual or apparent violations once they become known.

 

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Biden Administration Issues Executive Order to Restrict U.S. Investment in Chinese Technology Sectors

Last week, President Biden issued an Executive Order outlining the long-anticipated proposed restrictions on outbound U.S. investments in entities located in China or otherwise subject to China’s jurisdiction. The Executive Order would establish a new national security program to be implemented by the U.S. Department of the Treasury, and according to the Biden administration, the program would target “countries of concern” that seek to develop sensitive or advanced technologies and products critical for military, intelligence, surveillance, or cyber-enabled capabilities. The Treasury Department has already established a website for this outbound investment program, which provides copies of a press release and a fact sheet discussing the proposed restrictions in further detail.  

Importantly, the Executive Order does not implement any regulations, nor does it contain any draft regulations. Instead, the Treasury Department has used the authority provided under the Executive Order to issue an Advance Notice of Proposed Rulemaking (ANPRM) which outlines the intended scope of the program and starts a 45-day comment period in which the Treasury Department will seek feedback from the public on the restrictions. The Treasury is expected to issue its proposed draft regulations sometime next year.

The ANPRM generally envisions implementing regulations which will outright prohibit persons subject to U.S. jurisdiction from making certain extremely sensitive investments related to China and then require them to provide prior notification to Treasury before making other less sensitive investments related to China. Key aspects of the ANPRM include (but are not limited to):

  • The proposed restrictions and reporting requirements will cover any “countries of concern” as identified by the president. Thus far, the only designated “country of concern” is China, which also includes the Special Administrative Regions of Hong Kong and Macau.
  • The ANPRM proposes to target U.S. investments in companies subject to China’s jurisdiction which are engaged in activities related to the following advanced technologies and products:

(i) Semiconductors and microelectronics. Proposed prohibited investments would include investments in entities engaged in the development of electronic design automation software or semiconductor manufacturing equipment; the design, fabrication, or packaging of advanced integrated circuits which meet or exceed certain performance capabilities; and the installation or sale of supercomputers. Proposed notification requirements would cover investments in entities engaged in the design, fabrication, and packaging of integrated circuits with performance capabilities below the investment prohibition threshold.

(ii) Quantum information technologies. Proposed prohibited investments would include investments in entities engaged in the production of quantum computers and certain related cooling components; the development of certain quantum sensing platforms to be exclusively used for military end uses, government intelligence, or mass-surveillance; and the development of a quantum network or communication system designed to be exclusively used for secure communications. Treasury stated it is not currently considering a separate notification requirement for this category.

(iii) Artificial intelligence systems. Proposed prohibited investments would include investments in entities engaged in the development of software that incorporates an AI system and is designed to be either “exclusively used” (the Treasury Department indicated that the term “primarily used” is also under consideration) for military, government intelligence, or mass-surveillance end uses. Proposed notification requirements would cover investments in entities engaged in the development of software that incorporates an AI system and is designed to be either “exclusively used” (or possibly “primarily used”) for certain uses related to cybersecurity, robotic controls, surreptitious listening, non-cooperative location tracking, or facial recognition.

  • The ANPRM anticipates the prohibitions and/or notification requirements will apply to U.S. investments in companies that are engaged in the above activities and that are legally organized and/or headquartered in China or owned by Chinese citizens or the Chinese government, in addition to companies located outside of China that are at least 50% owned, individually or in the aggregate, directly or indirectly, by Chinese citizens, Chinese parent companies, or the Chinese government.
  • The ANPRM also proposes prohibiting or requiring notice for certain transactions, including greenfield investments in certain industries in China. From a practical standpoint, this could restrict certain companies from forming subsidiaries in China if they do business in any of the industries subject to the ANPRM’s prohibitions or notice requirements.
  • The ANPRM technically only applies to U.S. persons, which it defines as any U.S. citizen, lawful permanent resident, entity organized under U.S. law (including foreign branches), and any person in the U.S. However, Treasury is considering imposing requirements which could effectively extend the ANPRM’s restrictions to subsidiaries legally organized outside the U.S. by prohibiting U.S. persons from “directing” any action by a non-U.S. person that would violate the ANPRM’s restrictions if performed by a U.S. person. The ANPRM also contemplates requiring U.S. persons to take appropriate action to cause foreign-organized subsidiaries under their control to comply with its restrictions.
  • When the Treasury Department does eventually enact implementing regulations under the Executive Order and the ANPRM, it does not appear that the Treasury Department will seek to retroactively impose those regulations’ prohibitions and notification requirements on transactions conducted before the forthcoming regulations’ eventual effective date. However, once the Treasury Department does implement these regulations, the ANPRM explicitly states that Treasury is “not considering granting retroactive waivers or exemptions (i.e., waivers or exemptions after a prohibited transaction has been completed).” Therefore, once the new rules take effect, companies will need to avoid prohibited transactions and proactively disclose reportable transactions to avoid violating the new rules.
  • Comments to the ANPRM must be submitted within 45 days after the ANPRM is published in the Federal Register. The ANPRM was published on August 14, 2023, and therefore comments must be received by September 28, 2023, to be considered. If you are interested in submitting a comment, please reach out to HB’s export controls and economic sanctions team or your HB contact for additional guidance.

The ANPRM’s prohibitions appear to apply to a very narrow segment of industries and therefore may only impact a very small number of U.S. investors (if any). However, even if their transactions will not implicate any of the ANPRM’s prohibitions or notice requirements, persons subject to U.S. jurisdiction and seeking to invest in China should be aware that various other existing U.S. laws and regulations could still severely restrict their ability to invest in China. For example, export controls imposed under the U.S. International Traffic in Arms Regulations (ITAR) and U.S. Export Administration Regulations (EAR) will potentially restrict any exports of U.S. origin “technical data” or “technology” to China made in connection with otherwise permissible foreign investments. If Chinese companies do receive U.S. origin software or technology in connection with any U.S. investment, then products manufactured in China through the use of such software or technology could become subject to the EAR’s export controls pursuant to the EAR’s existing foreign-produced direct product rules. Additionally, sanctions imposed by the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) will prohibit U.S. persons from purchasing any publicly traded securities issued by certain companies listed on the Non-SDN Chinese Military Industrial Complex List.