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More or Less Denied: The OFAC 50% Ownership Rule

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More or Less Denied: The OFAC 50% Ownership Rule

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The OFAC 50% ownership rule is a compliance requirement that, when overlooked, can lead to severe penalties and reputation damage. What exactly is the 50% rule and for which companies is it most relevant?

50% Rule: What is It?

Sorry, German soccer lovers—this 50% rule relates to Denied Party Screening. In 2014,the United States Department of the Treasury’s Office of Foreign Assets Control (OFAC) clarified 2008 guidance in relation to doing business with companies that are not on any OFAC denied parties lists (DPL), but that are in fact owned by people or companies that are on the DPL. The European Union has similar regulations and, as far as OFAC is concerned, the math is simple: if one or more people or entities that are on a DPL own in total 50% or more of an entity that is not listed, that (latter) entity is considered to be under the control of one or more denied parties and cannot be engaged for business.

That seems clear enough, but the bonus question is of course: how do you find out if the company you are planning to do business with is not controlled by actors on the DPL? And how exactly does the math work: is it direct ownership only or do other relations count as well (e.g., what if a denied person’s spouse owns 50.01%)?

Digging Deeper

The only opportunity to flag if an entity is 50% owned by a denied party is to have this information available when denied (or restricted) party screening occurs. Especially for companies with larger transaction volumes and many one-time sales, this implies a gigantic amount of research, which is practically impossible given the usual limited resources compliance departments have available.  Luckily, there are a few companies that have done the research and are also keeping it up to date. Tag their lists on to the regular DPL when screening and all bases are covered.

It’s relevant to note that the amount of research is staggering and performed in old fashion digging style. Typically, entities appearing on the DPL are well aware of that fact and bury their ownership in (at first sight) legit companies three or four layers deep, which is more research than most companies can handle, especially when large parts of it may be in a foreign language.

Obviously, some verticals are subject to both more scrutiny and fraud attempts when it comes to the 50% ownership rule. That soccer jersey sale might not raise too many flags but, for example, in the financial sector, the movement of dual-use goods or complex international agreements (oil, anyone?) calls attention to the necessity to screen all parties involved to the finest detail possible. Or not, in which case preparing for some generous penalties, revoking of business licenses and perhaps jailtime would be time well spent. Recent cases (2018-2020) have seen OFAC dish out penalties in excess of $1.3 billion with a growing part of that related to 50% ownership. In general, most (higher) penalties have been related to the financial sector (the first high profile case was the 50% penalty imposed on Barclays Bank).

As for the relationship part, it is only the actual names on the debarred lists that count towards the 50%. Ownership by their known family and (political) friends does not count toward the 50%, as long as these relations are not on the OFAC lists themselves. Practically, though, a few eyebrows or more should be raised if those relationships do come to light. Either way, if it is under the header of due diligence, reasonable care, or ‘know your customer’ (KYC), the burden is on the exporter/seller to ensure no laws are violated and goods do not end up in debarred hands.

A Closer Look

To illustrate the reach of the 50% rule, consider the following from the aforementioned Barclays case. Barclays US worked with Barclays Bank of Zimbabwe Limited on some of its customers that were not on OFAC’s Specially Designated Nationals and Blocked Persons List (SDN List). Yet, the Industrial Development Corporation of Zimbabwe was on the list (since 2008) and owns 50% or more of these customers. That means Barclays should have effectively blocked these customers and not engaged with them. When business was conducted, Barclays violated the 50% rule and was penalized.

Parting Thoughts

‘What Lies Beneath’ is not only a movie that can keep you up at night. The guidance on OFAC compliance regulations dictates that exporters must be aware of who they are conducting business with, even if that requires a look underneath the surface. That responsibility cannot be ignored.

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Archives, Global Trade Daily, In The News

US Trade Representative Launches Investigations of DSTs of Numerous Trading Partners

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On June 2, 2020, the Office of the United States Trade Representative (USTR) announced that it is beginning investigations under Section 301 of the Trade Act of 1974 (Trade Act) into digital services taxes (DSTs) that have been adopted or are under consideration by ten of the United States’ closest trading partners – Austria, Brazil, the Czech Republic, the European Union, India, Indonesia, Italy, Spain, Turkey, and the United Kingdom (DSTs Investigations).

According to USTR Robert Lighthizer, “President Trump is concerned that many of our trading partners are adopting tax schemes designed to unfairly target our companies,” and that “[the United States] are prepared to take all appropriate action to defend our businesses and workers against any such discrimination.”

The initial focus of USTR’s investigations is to determine whether the existing or proposed DSTs discriminate against U.S. companies, apply retroactively, and/or constitute unreasonable tax policy by diverging from norms reflected in the U.S. tax system and the international tax system. The USTR identified examples of such divergent approaches, including extraterritoriality; taxing revenue not income; and intentionally penalizing particular technology companies for their commercial success.

As a next step, the USTR is seeking public comments on any issue covered by the investigations, in particular, the following:

-Concerns with one or more of the DSTs adopted or under consideration by the jurisdictions covered in the investigation.

-Whether one or more of the covered DSTs is unreasonable or discriminatory.

-The extent to which one or more of the covered DSTs burdens or restricts U.S. commerce.

-Whether one or more of the covered DSTs is inconsistent with obligations under the WTO Agreement or any other international agreement.

-The determinations required under section 304 of the Trade Act, including what action, if any, should be taken.

Written comments should be submitted through the Federal eRulemaking Portal and are due by July 15, 2020. Because of the COVID-19 restrictions, the USTR has not scheduled a public hearing at this time but may indicate in a subsequent notice if a hearing is to be held in the DSTs investigations.

Eversheds Sutherland Observation: The timing of the investigations is noteworthy, as many jurisdictions, including the EU, have been highlighting the need for DSTs to address COVID-19 tax shortfalls. It also comes as the OECD continues efforts to find a consensus solution to taxation of the digital economy. The OECD remains committed to a proposal in 2020, although there is some recognition that this timing may slip due to issues around the pandemic. Nonetheless, the reaction of the U.S. is consistent with the response to the French DST, and is noteworthy in that the administration continues to respond to unilateral digital tax efforts through trade, rather than tax, channels. The U.S. has continued to participate in the OECD’s inclusive framework efforts.

The Previous Section 301 Investigations into the French DST

In July 2019, the USTR had already initiated an investigation under Section 301 of the Trade Act with respect to France’s DST Act (LOI n° 2019-759 du 24 Juliet 2019), which French President Emmanuel Macron had signed into law on July 24, 2019.  After requesting public comments and conducting a public hearing in August 2019 (for a hearing transcript, see here), the USTR in a report published in December 2019 determined that France’s DST is unreasonable or discriminatory and burdens or restricts U.S. commerce. Specifically, the USTR’s investigation concluded that the French DST discriminates against U.S. (digital) companies, is unusually burdensome for affected U.S. companies, and is inconsistent with prevailing principles of international tax policy on account of its retroactivity, its application to revenue rather than income, its extraterritorial application, and its purpose of penalizing particular U.S. technology companies.

At the time, USTR Lighthizer said that the “decision today sends a clear signal that the United States will take action against digital tax regimes that discriminate or otherwise impose undue burdens on U.S. companies” and that the USTR is “exploring whether to open Section 301 investigations into the digital services taxes of Austria, Italy, and Turkey.”

Consequently, the USTR proposed action in the form of additional duties of up to 100 percent on certain products of France and considered imposing fees or restrictions on French services as a further option. The list of French products subject to the potential duties included 63 tariff subheadings with an approximate trade value of $2.4 billion. Another public hearing was conducted on the proposed action in January 2020 (for hearing transcripts, see here and here).

However, as reported in late January 2020, U.S. President Donald Trump and French President Macron agreed to a truce on the dispute over the French DST, under which both countries are extending negotiations, while the U.S. is postponing retaliatory action and France is suspending DST collections until the end of 2020. Furthermore, it was reported that under the deal France will (i) withdraw the DST as soon as the OECD’s Inclusive Framework reaches a multilateral agreement on how to reform the international tax rules in light of the digitalization of the economy, and (ii) repay companies the difference between the DST and whatever tax comes from a planned mechanism being drawn up by the OECD.

Eversheds Sutherland Observation: The reported U.S.-French deal did not address many concerns raised by affected companies at the Section 301 hearing regarding compliance with and the administrability of the DST. Initially, it left many affected companies struggling with obtaining information retroactively and preparing DST returns. At the same time, it has created significant pressure to agree on a multilateral solution as part of the OECD Inclusive Framework. In fact, France may be incentivized not to support a multilateral solution resulting in tax revenues that are less than what France can collect under its DST. Moreover, as subsequently observed, the deal did not appear to discourage other jurisdictions to enact their own digital taxes, subject only to an agreement to adjust to reflect any future multilateral solution agreed by the OECD.

The New Section 301 Investigations

An advance Federal Register Notice (Notice) issued by the Office of the USTR on the same day as the announcement provides additional details on the DSTs Investigations, including summaries of the DSTs that have been adopted or are being considered by the ten trading partners and the schedule for submission of written public comments.

DSTs under Investigation

As stated in the Notice, over the past two years, various jurisdictions—not limited to the ones under investigation—have taken under consideration or adopted taxes on revenues that companies generate from providing certain digital services to, or aimed at, users in those jurisdictions. Moreover, the Notice asserts that available evidence suggests these DST are targeting U.S.-based tech companies.

The DSTs Investigations target the following DST regimes:

Austria: In October 2019, Austria enacted effective January 1, 2020, a DST that applies a 5 percent tax to revenues from online advertising services with two revenue thresholds (at least €750 million in annual global revenues for all services and €25 million in in-country revenues for covered services).

Brazil: In May 2020, a draft bill was submitted in Brazil’s parliament entitled “contribution for intervention in the economic domain on gross revenue of digital services provided by large technology companies (CIDE-Digital),” which, if adopted, would apply an up to 5 percent tax on revenue from advertising and services in connection with digital platforms located in Brazil.

Czech Republic: The Parliament of the Czech Republic has accepted for consideration a bill that would impose a 7 percent tax on selected digital services provided in the country by companies with global sales exceeding €750 million and a turnover in the Czech Republic in excess of CZK 100 million.

European Union (EU): In its proposal for a COVID-19 recovery plan, the European Commission (EC) said that to raise the necessary funds, it will propose a number of new resources, which “could also include a new digital tax, building on the work done by the Organization for Economic Co-operation and Development (OECD).” The EC proposed a DST (COM(2018) 148 final) that would impose a 3 percent tax on gross revenues from digital online advertisement, digital platform activities, and sales of user data generated via digital platforms from companies with global sales exceeding €750 million and EU taxable revenues exceeding €50 million.

India: In March 2020, India expanded its equalization levy that has been in place since 2016 and will now impose a 2 percent levy on consideration receivable by a non-resident “e-commerce operator” (with annual revenues in excess of approximately ₹20 million) for “e-commerce supply or services” provided or facilitated by it on or after April 1, 2020.

Indonesia: In March 2020, the Indonesian government enacted a government regulation that adopts (but not yet implements) a new tax on Trade Through Electronic Systems (Perdagangan Melalui Sistem Elektronik or “PMSE”), imposing an electronic transaction tax on PMSE activities carried out by foreign tax subjects that meet certain criteria.

Italy: Italy enacted a DST effective January 1, 2020, which imposes a 3 percent tax on revenues from targeted advertising and digital interface services by companies generating at least €750 million in overall worldwide revenues and at least €5.5 million in revenues from qualifying digital services provided to users located in Italy.

Spain: In February 2020, the Spanish government published a draft bill concerning the implementation of a unilateral DST, which would impose a 3 percent tax on revenues from online advertising services targeted at users, online intermediary services, and data transmission services of companies generating at least €750 million in global net turnover and at least €3 million in revenues from taxable provisions of digital services in Spain.

Turkey: Having imposed a 15 percent withholding tax on online advertising since the beginning of 2019, Turkey has now enacted a DST effective March 1, 2020, which currently imposes a 7.5 percent tax (though the Turkish president is authorized to reduce the DST rate to 1 percent or double it) on gross revenues from certain services, including advertisement services provided through digital platforms, sales of auditory, visual or digital contents on digital platforms, and services related to the provision and operation of digital platforms enabling users to interact with each other, provided by companies with worldwide revenue exceeding €750 million and with Turkey-sourced revenue exceeding ₺20 million, in each case from covered digital services.

United Kingdom (UK): The UK government announced the introduction of a DST from April 1, 2020, which would impose a 2 percent tax on the revenues of search engines, social media services and online marketplaces that derive value from UK users of companies when the group’s worldwide revenues from these digital activities are more than £500 million and more than £25 million of these revenues are derived from UK users.

Section 301 Investigations in General

As described in the Notice, the Trade Act of 1974 authorizes the USTR to investigate whether an act, policy, or practice of a foreign country is actionable under Section 301 of the Trade Act. Actionable matters under Section 301 include acts, polices, and practices of a foreign country that are unreasonable or discriminatory and burden or restrict U.S. commerce. An act, policy, or practice is unreasonable if the act, policy, or practice, while not necessarily in violation of, or inconsistent with, the international legal rights of the United States, is otherwise unfair and inequitable.

As a first step in a Section 301 investigation, the USTR consults with appropriate advisory committees, including the Section 301 Committee, and requests consultations with the governments of the affected jurisdiction(s). The Notice confirms with respect to the DSTs Investigations that the USTR has already consulted with the relevant advisory committees in the U.S., as well as reached out to the governments of the ten affected jurisdictions.

After the USTR determines whether an act, policy, or practice under investigation is actionable under Section 301, the USTR must determine what action to take. Notably, Section 301 authorizes the President to take unilateral retaliatory action in order to force the offending country to end the practices that have been found to be unreasonable or discriminatory against the United States. In past Section 301 investigations, such retaliation has typically involved the imposition of significant additional U.S. tariffs on selected products from the targeted country.

Eversheds Sutherland Observation: Initial reactions to the USTR announcement from the targeted jurisdictions suggest that they are unfazed by the threat of a U.S. trade investigation, as they openly reaffirm their commitment to enact and/or enforce these DSTs as planned. This was true of the French response to the Section 301 investigation into its DST. Perhaps the U.S. is anticipating that, as in the case of France, the Section 301 investigations will lead to agreements to refrain from enforcement of unilateral taxes until the OECD Inclusive Framework is able to reach a consensus solution. However, if countries do in fact continue with unilateral DSTs, the situation may well trigger another potential trade war, at a time when the global economy is struggling to respond to the COVID-19 pandemic. It deserves emphasis that Section 301 is the legal basis for the significant tariffs that the U.S. has imposed on Chinese imports, which has in turn triggered tariff retaliation by China against U.S. imports.

Potentially complicating the U.S. position are digital advertising tax proposals appearing at the U.S. subnational level. The Maryland legislature recently passed a digital advertising tax bill that the state governor vetoed on May 7, and a “copycat bill” was introduced in New York. There are serious questions regarding the constitutionality of the proposals that have been introduced, but their existence may undermine the USTR position that foreign DSTs are unreasonable or discriminatory. Maryland’s proposed digital advertising tax has drawn scrutiny as violating federal law, including the Permanent Internet Tax Freedom Act and the dormant Commerce Clause. For Eversheds Sutherland’s critique of the tax, please see our recent article, If Md.’s Digital Ad Tax Is Passed, Court Challenges Will Follow.”

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Archives, Global Trade Daily, Imports/Exports

The Proposed Expansion of Mandatory Foreign Investment Filings During the Pandemic

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In the midst of the pandemic, the Committee on Foreign Investment in the United States (“CFIUS”) has proposed several revisions to its regulations (“Regulations”) that change when short-form filings (called “declarations”) are required with respect to covered foreign investments of U.S. businesses which work with critical technology [2]. What is most significant for foreign investors is that the proposed rules expand the mandatory declaration and required CFIUS review to include critical technology transactions that range well beyond the 27 industries originally designated by CFIUS – to cover all sectors of the economy [3].

The raison d’etre for this proposed CFIUS rule change is not entirely clear. While the modification largely reads as being technical in nature, CFIUS does, however, observe that other, unspecified “national security considerations” are involved. Thus, a reasonable inference from current circumstances is that CFIUS seeks the ability during the Covid-19 crisis to review acquisitions by China in a broader range of business sectors in order to assess in advance the national security risk, if any, in situations where financially struggling U.S. firms with innovative dual-use technology might be more willing than before to consider such investments as a lifeline.

Interested parties in the business community should note public comments are due by June 22, 2020.

The Proposed Expansion of Mandatory Filings for Critical Technology Transactions

By way of background, under the existing Regulations, a mandatory declaration is required for transactions involving certain U.S. businesses that: 1) produce, design, test, manufacture, fabricate, or develop one or more “critical technologies”; and 2) use the critical technology in specified ways in one or more of 27 specified industries. Significantly, under the revisions, CFIUS eliminated the second prong of the requirement – i.e., the nexus to 27 industries, and refocused the requirement instead on companies that have critical technology that would require certain export licenses or other authorizations to export, re-export, transfer (in-country) or retransfer the critical technology to certain transaction parties and foreign persons in the ownership chain.

CFIUS indicates that the new focus of the mandatory filing requirement on export control requirements for critical technologies “leverages the national security foundations of the established export control regimes, which require licensing or authorization in certain cases based on an analysis of the particular item and end-user, and the particular foreign country for export, re-export transfer (in-country) or retransfer.” 85 Fed. Reg. 30894.

While that is true enough, in fact, the existing standard already is based on the export control standards. The term “critical technology” was and still is, defined as technologies that are subject to export controls (i.e., articles or services on the U.S. Munitions List, items on the Commerce Department’s Control List, and other specialized lists)[4]. Now, in addition to being subject to export controls (e.g., on one of the enumerated lists of controlled items), the technology must specifically be subject to a licensing requirement.

In effect, CFIUS has doubled down on export controls as the criteria for mandatory filing – the item must be on a controlled list and a license must be required for the particular foreign acquirer that is a party to the transaction.

The Significance of the Proposed Change in Mandatory Filing Requirement

Is this licensing requirement a meaningful distinction for foreign investors? While many of the items on these export control lists do require licenses or other authorizations for export, this is not necessarily the case for the export of all items to all countries for all uses. On some lists (e.g., the Munitions Lists), every article and service requires a license for export to all locations. On others (notably the Commerce List, the main list of “dual-use” technologies), items controlled are only licensable for certain countries and certain purposes to certain end-users, as designated on the list.

Overall, however, the universe of items on controlled lists versus those on the lists where licenses are required probably aren’t all that different – i.e., the range of mandatory filings is not very meaningfully limited by this change. Notably, for certain near-peer competitor countries like China and Russia, the distinction is particularly limited. Indeed, for these countries, many items on the Commerce List will require licenses in any event. Moreover, since China is under a U.S. arms embargo in place for many years, any export of an article or service on the Munitions List would certainly require a license (which would not be granted).

In any event, even if the new nexus to export license requirements narrows somewhat the class of critical technology transactions subject to mandatory declarations, this change is undoubtedly more than offset by the elimination of the required nexus to the 27 specified industries. Under the proposal, foreign acquisition of any U.S. business – regardless of what industry it works in – would require a mandatory declaration where the business utilizes critical technology provided that certain export licenses or other authorizations would be required to export such items to the foreign acquiring party.

On balance, this change is significant. It broadens the scope of the mandatory filing requirement to a wide variety of acquisitions involving critical technology applications from medical devices to commercial vehicles to a wide range of high tech sectors. Foreign investors thus would need to be considerably more diligent in considering the CFIUS risk with respect to structuring a broader range of these acquisitions.

Why the Expansion of the Mandatory Filing Requirement?

Why the expansion of mandatory declarations and does it relate to the pandemic?  CFIUS offers only vague explanations – noting its further consideration of public comments made in prior rulemakings, the Committee’s additional experience assessing mandatory declarations, and “other,” unnamed, national security considerations” [5].

One very possible set of such “national security considerations” is to afford CFIUS the ability to investigate a considerably broader range of transactions involving China where any critical technology requiring a license is involved. Since many dual-use items on the Commerce Control List and everything on the Munitions List do require licenses for China, the expansion of jurisdiction would be significant – as it applies without regard to the industry where the critical technology is used.

The logic of this expanded approach would be that, under Chinese laws and policies on civil-military fusion, any Chinese company, regardless of industry, could be required to divert the critical technology it is acquiring to the state sector for military use. Thus, it arguably makes sense for CFIUS to seek to examine these technology deals across the board.

This action also would be consistent with a range of other recent Administration actions during the Covid-19 crisis – from restrictions on participation in the U.S. bulk-power infrastructure to additional export control restrictions on Huawei – all of which appear to be focused on limiting U.S. high tech engagement with China.

Why now? The pandemic has raised the specter of foreign firms from potential adversaries buying sensitive assets at steep discounts. Numerous European governments are very focused on protecting sensitive assets against distress buying.  In this context, recent comments by Ms. Ellen Lord, the Under Secretary of Defense for Acquisition and Sustainment, suggest concern that during the pandemic smaller U.S. companies that support the aerospace and defense sector could experience “significant financial fragility” and therefore be more vulnerable to acquisition by potential adversaries [6]. She also noted the prospect of “nefarious” acquisitions involving the use of shell companies during the pandemic and indicated a desire for CFIUS to have more authority to address these situations. Thus, it just may be that the proposed revision to the Regulations is an effort to address this felt DoD need.

______________________________________________________________

A partner in Eversheds-Sutherland, a global law firm, Mr. Bialos [1] previously served as Deputy Under Secretary of Defense for Industrial Affairs and co-chairs the firm’s Aerospace and Defense practice.

_______________________________________________________________

References

[1] A partner in Eversheds-Sutherland, a global law firm, Mr. Bialos previously served as Deputy Under Secretary of Defense for Industrial Affairs and co-chairs the firm’s Aerospace and Defense practice.

[2] 85 Fed. Reg. 30893 (setting forth amendments to 31 C.F.R. §800). The mandatory filing requirements were established pursuant to the Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”).  The proposed amendments also make clarifying changes with respect to mandatory declarations in transactions involving foreign States. Specifically,  section 800.244 of the Regulations (see 85 Fed. Reg 30898) would, among other things, change the definition of “substantial interest” with respect to transactions where a general partner, managing member or the equivalent is involved, to clarify that the foreign state’s interest is only relevant it applies only where a general partner, managing member, or equivalent “primarily directs, controls or coordinates the activities” of the entity that is the acquiring party.  In effect, this change narrows to a limited extent the range of transactions with foreign government involvement where a mandatory declaration is required.

[3] CFIUS accomplishes this expansion through a series of technical amendments to the Regulations: Section 800.254 (defining U.S. “regulatory authorization” to refer to the types of export licenses that require mandatory declarations); section 800.256 (introducing the concept of “voting interest” to include foreign persons in the ownership chain that would need to be analyzed from an export control standpoint to determine if a license would be required to transfer the technology in question to that party); and 800.401 (which re-scopes the mandatory declaration requirement for critical technology transactions).  See 85 C.F.R. 30895-8.

[4] 31 c.f.r. § 800.215.

[5] 85 Fed. Reg. 3894.

[6] See Transcript, Press Briefing of Ellen Lord, Undersecretary of Defense (A&S) Ellen Lord on COVID-19 Response Efforts (April 30, 2020).   Available at: https://www.defense.gov/Newsroom/Transcripts/Transcript/Article/2172171/undersecretary-of-defense-as-ellen-lord-holds-a-press-briefing-on-covid-19-resp/

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BIS Introduces Significant Restrictions on U.S. Exports to China, Russia, and Venezuela

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On April 28, 2020, the U.S. Department of Commerce, Bureau of Industry and Security (“BIS”) published three amendments to the Export Administration Regulations (“EAR”) that are expected to have a significant impact on businesses – both within the U.S. and beyond – with regard to the export, re-export, or transfer of goods, software, and technology subject to U.S. jurisdiction to Chinese, Russian, and Venezuelan entities, including both commercial and military end-users.

The first rule expands existing export restrictions on military end-users in China, Russia, and Venezuela. The second rule eliminates License Exception Civil End Users (“CIV”), which previously authorized the export of certain items restricted for national security reasons to countries in Country Group D:1, including China, Russia, and Venezuela. These two rules are being issued as final rules (i.e., without an opportunity for public comment), and will become effective on June 29, 2020. The third rule is a proposal to modify license exception Additional Permissive Reexports (“APR”), which currently authorizes the re-export of certain U.S.-origin items from third countries to China and other Country Group D:1 destinations that cannot be exported directly from the United States without a license. Under the proposed revisions, a license from BIS would be required for such re-exports. Comments on this proposal must be received by BIS no later than June 29, 2020.

The three rules may have been the product of a White House Cabinet meeting that apparently took place on March 25, 2020.  That meeting reportedly considered U.S. policies with respect to transfers of U.S. technology to China, particularly those involving Huawei. Prior to the meeting, BIS prepared two draft rules that would (1) reduce the de minimis U.S. controlled content threshold applicable to Huawei and its affiliated companies from 25% to 10%, which would dramatically increase the number of foreign-made products that would be considered subject to U.S. jurisdiction and therefore require a license, and (2) amend the EAR’s “foreign direct product rule” to limit Huawei’s ability to obtain chips that are the product of U.S.-origin semiconductor manufacturing equipment (for example, chips produced by Taiwan Semiconductor Manufacturing Company).

According to reports, the Cabinet meeting resulted in an agreement to tighten these limitations through an amendment to the foreign direct product rule. While that rule has not yet been released by BIS (and may yet be forthcoming), the three rules published on April 28, 2020, constitute an even broader effort to tighten technology controls on China.

Expansion of Export, Re-export, and In-Country Transfer Controls for Military End-Use or Military End Users

The first rule will significantly expand export restrictions on military end-users by broadening the list of items requiring a license when exported, re-exported, or transferred to a “military end-user” or for a “military end-use” in China, Russia, and Venezuela pursuant to § 744.21 of the EAR.  For example, under the new rule, mass-market encryption items classified under Export Control Classification Number (“ECCN”) 5A992.c would trigger the license requirement.  Popular consumer devices – including mobile phones, laptops, and “smart” devices – may potentially be restricted under the new rule if intended to any “military end-user” or a “military end-use” in any of the three destinations.

In connection with this new rule, it is important to note that the existing definition of “military end-users” is already very broad. In addition to the army, navy, air force, marines, and coast guard, it also includes “national guard/police, government intelligence and reconnaissance organization[s],” as well as “any person or entity whose actions or functions are intended to support ‘military end-uses.’” Additionally, the rule further expands the definition of “military end-use” to include any item that supports or contributes to the operation, installation, maintenance, repair, overhaul, refurbishing, “development,” or “production,” of certain military items.

Businesses involved with the export, re-export, or in-country transfer of items or technology subject to U.S. jurisdiction to China, Russia, and Venezuela will, therefore, need to conduct increased diligence and carefully assess whether the end-users or end-uses of those items or technology fall within these broad definitions, in particular government-adjacent end-users, such as state-owned enterprises or government contractors. BIS has indicated that it intends to issue guidance regarding the level of due diligence it expects from industry to comply with the expanded licensing requirements.

Additionally, this rule broadens the list of items requiring a license when exported to a military end-user or for a military end-use to cover items and technology subject to relatively low levels of control that relate to materials processing, electronics, telecommunications, information security, sensors and lasers, and propulsion. The new ECCNs covered under the scope of new regulation include, by way of example, mass-market encryption items and software (e.g., smartphones), certain microchips and integrated circuits, certain electronic testing and processing equipment, telecommunications test equipment, and certain materials processing equipment, such as mining and drilling equipment and industrial pumps.

Further, while exports that previously required a license under § 744.21 were reviewed on a case-by-case basis by BIS, the new rule states that license requests will be reviewed under a presumption of denial.  This means that such applications will be rejected in principle unless the presumption can be overcome. Overcoming the presumption is fact-specific and rare, but will likely depend upon the policy goals of BIS at the time the license application is made (for example, BIS could conclude that an export that would meet a humanitarian need could outweigh the presumption of denial).

Finally, the rule separately expands Electronic Export Information (“EEI”) filing requirements in the Automated Export System (“AES”) for all exports to China, Russia, or Venezuela. Previously, exporters were not required to file an EEI for many shipments valued under $2500 (unless an export license is required), nor was it necessary to enter the ECCN in the EEI when the item is classified EAR99 (i.e., the item is not identified on the Commerce Control List (“CCL”)), nor if the sole reason for control is for anti-terrorism (“AT”) reasons. The new rule will now require filing an EEI for all items destined to China, Russia, or Venezuela regardless of the value of the shipment unless the shipment is eligible for License Exception GOV. This is significant because the failure to file EEI, even if a license from BIS is not required, may constitute a separate violation of the EAR and of the Foreign Trade Regulations administered by the U.S. Census Bureau.

Elimination of License Exception Civil End Users (CIV)

Pursuant to the second new rule, License Exception CIV is eliminated in whole. In the explanatory portion of the final rule, BIS stated, “the primary goal of this effort is to advance U.S. national security, foreign policy, and economic objectives by ensuring an effective export control and treaty compliance system and promoting continued U.S. strategic technology leadership.” While the final rule did not make mention of China, China most assuredly is the primary target of this effort, as the country has long been criticized by Trump Administration officials for exploiting perceived gaps in U.S. export controls via retransfers of U.S. technology. Previously, the License Exception authorized the export, re-export, or transfer (in-country) of certain items subject to control only for low-level national security (“NS”) reasons, and identified as eligible for the license exception most commercial end-users in destinations identified in Country Group D:1 (including China, Russia, and Venezuela, among other countries), without the need for prior review by BIS. This rule modification removes the previously applicable license exception for such low-level items.

Modification of License Exception Additional Permissive Reexports (APR)

Finally, citing the need “[t]o get better visibility into transactions of national security or foreign policy interest to the United States,” BIS proposes to modify License Exception APR for certain controlled items.  Previously, paragraph (a) of License Exception APR authorized the re-export of certain US.-origin items from a country in Country Group A:1 (i.e., countries, like the United States, participating in the Wassenaar Arrangement for multilateral export controls) or Hong Kong to certain more controlled destinations, provided that the re-export is consistent with an export authorization from the country of re-export.

In particular, License Exception APR currently authorizes re-exports to Country Group D:1 (which, as noted above, includes China, Russia, and Venezuela) so long as the items are only subject to national security controls.  BIS is proposing to remove countries in Country Group D:1 as a category of eligible destinations, as “even Wassenaar participating states in Country Group A:1 may have export authorization policies that do not align with the national security or foreign policy interests of the U.S. government.” If License Exception APR is modified as proposed, re-exports of certain national security-controlled items must be reviewed by the U.S. government before proceeding. Given the increasing consensus within the U.S. government that additional U.S. export restrictions will be needed to counter China’s “civil-military fusion,” it is reasonable to conclude that the new rule also is intended to target China in particular.

Unlike the other two rules released contemporaneously by BIS, this third rule is only a proposal. BIS is currently accepting comments on the rule through June 29, 2020, and so it is possible that revisions may be made to the final version of the rule. Companies that would be affected by the proposed rule and other interested parties should consider drafting comments on the rule to make their voices heard prior to the deadline.

Conclusion

The three rules published by BIS on April 28, 2020, reflect the Trump Administration’s latest effort to pursue stricter controls on U.S. goods and technology, even as the full economic effect of the COVID-19 pandemic has yet to be realized. While the April 28, 2020 rules impact exports, re-exports, and in-country transfers to a variety of destinations, based on reports of the March 25, 2020, Cabinet meeting, and other high-profile actions targeting Huawei, China appears to be the principal motivation behind the new rules.

Although the two final rules will not become effective for 60 days, all companies conducting cross-border transactions involving goods, software, or technology subject to U.S. jurisdiction should carefully conduct due diligence on the end-users of their items and ensure that their compliance procedures are fully implemented to avoid even inadvertent violations of these tightened trade restrictions.

FCPA
Archives, Commentary, Global Trade Daily

How You can Certify 100% FCPA Compliance Based on New SEC/DOJ Requirements

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Now that the SEC has gotten involved with FCPA along with the DOJ they have interpreted the FPCA statute to mean that a company must maintain a system of internal accounting controls that monitors FCPA Compliance not only internally within the organization, but for all its third parties including customers and  suppliers

With the average Fortune 50 company having over 75,000 suppliers and 300,000 large customers the enforcement is nearly impossible and deemed as “sneaky.”

Even former DOJ Leadership acknowledges the incredible challenge around FCPA Compliance, especially now that the SEC is stepped up its enforcement (See video like below at around the 14:40 mark).

https://youtu.be/xpo9d4CbHG0

However, there is a solution to avoid or mitigate FCPA  fines/actions as well as damaging public press-releases by the DOJ/SEC due to third party violations.  A robust but straightforward certification program can significantly mitigate this risk.

A Certification Program is primarily an attestation or assertion document that is acknowledged or signed by an employee/and all third parties delivered by email, a simple workflow software or even post mail. It is generally language-specific but is translators are not available English only works. The attestation or assertion document is asking an individual/entity/official to certify that they are Understand FCPA, Are FCPA Compliant, and Unaware of any violations.

You might be asking yourself that there is no way that all of my hundreds of thousands of suppliers/customers/colleagues will comply, and we will have with exposure? 

In the case of colleagues, its a more straightforward answer as the certification process should be mandatory using internal email or workflow tools driven from the top of the organization. In the case of third parties where there is less control, the recommendation is to send the certification communication (via email/post) up to three times in  90 days.  If there is no response, this is OK!

The key to this entire process is a robust documentation and controls process over the certifications – this includes the third parties that have not responded despite three attempts.

Essential elements to an FCPA  Certification process are:

-How the Certification is written ensuring that there is an emphasis on full disclosure and awareness and understanding of the FCPA Statute and any potential violations

-Process for Disseminating to third parties and internal employees

-Tracking and reporting

-Frequency

It is proven that a robust Certification Program implemented in advance of a certification program has lead to reduced penalties and even eliminated penalties as well as damaging Public Relations from the announcement of an SEC/DOJ Investigation.

A robust FCPA certification program may be the most significant cost avoidance and reputation damaging you can implement within your organization.

____________________________________________________

For more information and learning more please contact Ation Advisory Group  (www.ationadvisory.com) or at (917) 821-2147.

International Trade
Archives, Global Trade Daily, News

Hughes Hubbard & Reed Add Partner for International Trade Practices

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Boasting international recognition in areas including U.S. investment and international trade regulatory issues related to China, Roy (Ruoweng) Liu is the newest partner of New York-based international law firm. Liu will serve as chair of the Greater China practice for the firm’s Sanctions, Export Controls & Anti-Money Laundering practice.

“As one of the few U.S. trade attorneys based in Washington, D.C., who can advise clients in Mandarin Chinese, Roy Liu brings substantial strengths and unique perspective to Hughes Hubbard,” said Ted Mayer, chair of Hughes Hubbard.

“We are thrilled to have him join our talented team, and we believe his experience, particularly with export controls, economic sanctions, CFIUS, and China-related trade issues, will be extremely valuable to our clients, especially amidst a potentially long-term trade war.”

Liu brings with him a Bachelor of Arts from Williams College and a Juris Doctorate from Stanford University Law School. His professional background includes addressing challenges related to the Entity List, U.S. export controls and economic sanctions, reviews and investigations by the Committee on Foreign Investment in the United States (CFIUS), Foreign Corrupt Practices Act (FCPA), and anti-money laundering (AML). Liu also brings substantial experience in client advising pertaining to a variety of regulatory environments.

“I am excited to join the nimble and effective team at Hughes Hubbard,” said Liu. “I look forward to partnering with their world-renowned International Trade, investigations, and white collar practices.”

Archives, Global Trade Daily, Software

Shipment Identification Simplified with Amber Road’s Cargo Screening Solution

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Global logistics providers seeking a unique solution to overcome challenges related to trade regulations – such as Know Your Customer, and trying to avoid fines and penalties should look no further than Amber Road’s recently launched Carrier Cargo Screening Solution.

The new cargo screening solution – which is equipped with advanced computational linguistics algorithms and translated technical phraseology, was built to assist carriers in quickly navigating through high-volume, multiple provider shipment challenges and accurately identify prohibited, hazardous, or dual-use goods.

“Global trade requires that companies keep up with ever-changing regulations and standards of reasonable care to maintain their trade privileges,” Nathan Pieri, Chief Product Officer at Amber Road said. “However, the market has been devoid of tools to meet these more stringent examinations. With our new Carrier Cargo Screening Solution, we have developed new content libraries and advanced algorithms to offer a robust supply chain risk platform ideally suited for global logistics providers.”

Amber Road’s Carrier Cargo Screening Solution offers advanced risk scoring capabilities that provide carriers alerts to potential issues within shipments. The solution’s unique use of technology further simplifies processes when problems arise, as it is equipped to resolve issues within the platform.

“We are very excited about the impact our new solution will have in the carrier industry,” said Jim Preuninger, CEO, Amber Road.  “We have solved a critical problem by combining our advanced technologies with our vast experience in linking software with content.  We expect our new offering to generate significant interest and meaningful new subscriptions starting this year.” 

Archives, Global Trade Daily, News

WTO Slams China for Lack of Trade Transparency

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Los Angeles, CA – China is coming under harsh criticism from the World Trade Organization with members of the 160-nation body asserting that Beijing has failed to live up to key transparency commitments it made when it joined the organization in 2001.

The WTO Secretariat recently released the results of a critical 200-page report on China’s trade policy which concluded that, over the past two years, the country continues to exhibit a lack of clarity, organization and centralization of its trade rules and regulations.

EU ambassador Angelos Pangratis described the lack of clarity on trade issues as “striking,” while Canada’s representative also criticized the “often vague and insufficent information available” from Beijing.

Release of the report came during the WTO’s recent, bi-annual policy review held at the group’s headquarters in Geneva, Switzerland.

Many of the 50 WTO members who took part in the review also criticized Beijing’s use of export restraints and taxes, restrictions on foreign investments and said it must improve protection for intellectual property rights (IPR).

The US Representative to the WTO, Christopher Wilson, said that China’s “apparently retaliatory conduct” in its use of duties, and said the country appeared to ignore a number of WTO findings against it.”

Wilson added, “An enormous amount of work remains if China is to close significant loopholes in its legal framework and reduce the unacceptably high IPR infringement levels.”

Responding to the WTO report, China’s Assistant Minister of Commerce, Wang Shouwen said its findings were “baseless” and that China “has one of the best track records of implementing WTO rulings.”

But, he added, though China “has made great strides to address these issues…it has pledged to do more to improve transparency.”

07/30/2014