Export Controls Update: Practical Advice For Updating Your Export Compliance Program

In 2005, there were a number of changes in export control regulations and policies, as well as proposed changes that may affect the export community early in 2006. These include changes to the Export Administration Regulations (EAR), International Traffic in Arms Regulations (ITAR), and Foreign Asset Control Regulations (FACR), as well as policy changes in the way certain rules are interpreted. As detailed in this article, all of the major agencies involved in export control appear to be increasing enforcement efforts with more investigations, higher penalties and more cases being criminalized. In particular, the issue of access by foreign nationals to U.S. technology in the U.S. (i.e., deemed exports), continues to be a focus of the agencies driven in large part by U.S. concerns over perceived attempts by Chinese nationals to gain access to U.S. military and civilian technology.

An effective compliance program continues to gain importance as a means, both to prevent inadvertent violations, and as a significant factor in mitigating penalties (in particular mitigating against criminal prosecution). In fact, as discussed below, it may become a requirement for most Department of Defense (DoD) contractors under a rule change proposed in 2005.

This article is not intended to provide detailed guidance or to focus on any particular industry segment, rather it is intended to alert export managers to changes and pending changes that may affect their export policies and procedures.

Defense Exports Under The ITAR

The State Department Directorate of Defense Trade Controls (DDTC) published a number of changes to the ITAR, as well as issuing policy guidance in a number of areas:

New UK/Australia Expedited Licensing Provision

As a result of U.S. bilateral agreements with the UK and Australia, a new ITAR § 126.15 was added creating an expedited licensing procedure for license applications for defense articles and services to the UK or Australia. It is important to call attention to this provision in any application.¹

Congressional Notification Thresholds²

The threshold level for Congressional notification in ITAR § 123.15 was raised to $25 million for major defense equipment, and $100 million for other defense equipment and services sold to NATO countries, Australia, New Zealand and Japan to reflect legislation already in place. ITAR § 124.11 was modified to provide that any TAA or MLA for the manufacture abroad of Significant Military Equipment (SME) must be notified to Congress regardless of dollar value. Further, a $1 million threshold was established for exports of Category I firearms (e.g., small arms).

Other Changes to the ITAR³

• DDTC amended the Canadian Exemption, ITAR § 126.5, to modify a number of categories excluded from the exemption, and clarified that all military aircraft, not just developmental aircraft, are excluded.⁴
• Registration requirements in ITAR § 122.3 were modified to require registrants to submit renewals at least 30 days prior to expiration.
• Recordkeeping requirements in ITAR § 122.5 were amended to allow electronic recordkeeping. However, records must be reproducible on paper and changes to stored information must be properly annotated with when and by whom they were changed.
• New definitions for "NATO" and for "major non-NATO allies," identifying the countries by name, were added to ITAR Part 120.
• Electronic licensing provisions in ITAR § 123.1 were revised to clarify that if the license is a "fully electronic license application" there is no need for multiple copies of supporting documentation.
• Nondisclosure provisions of ITAR § 126.10 were revised to make clear that registration documents would not generally be disclosable to the public under the Freedom of Information Act (FOIA).
• These rules also made numerous changes to reflect the structural and name changes in DDTC and other government agencies referenced in the ITAR.

Expansion of Who Is Considered a Broker

Based on anecdotal information, it appears that the DDTC has become more stringent in requiring foreign entities indirectly involved in defense transactions to register as brokers under ITAR Part 129. While the brokering regulations were originally designed to shore up jurisdiction to prevent U.S. persons from "brokering" the sale of foreign small arms, the legislation and ITAR section are broadly worded. In particular, ITAR § 129.3(a) requires a foreign person in the U.S. or "otherwise subject to the jurisdiction of the United States" who engages in brokering activities to register with DDTC. Since brokering activities can include brokering foreign defense articles and foreign defense services, the scope and interpretation of this provision remains unclear. A 2004 decision by a federal court in United States v. Yakou appeared to limit the jurisdiction of the ITAR over the activities of foreign persons'' activities outside the U.S. However, in 2005, on motion by the U.S. Government, the court clarified its opinion to make clear that it had not opined on the term "otherwise subject to the jurisdiction of the United States."⁵

License Documentation

DDTC announced that after September 15, 2005, it will generally require that under ITAR § 123.1(c)(4) a license for export of defense articles (i.e., DSP-5) be accompanied by a purchase contract or purchase order signed by the foreign purchaser, and not from the exporter or another U.S. person such as a subsidiary or intermediate company.⁶ Further, this notice reminded exporters of the requirement to identify the roles of each party to the transaction (e.g., supplier, manufacturer, freight forwarder, etc.).

Restrictions on Freight Forwarders

DDTC has informally made a policy decision that the license applicant for the export of defense articles must generally be the seller/manufacturer and cannot be the freight forwarder. DDTC has apparently Returned Without Action (RWO) a number of applications submitted by freight forwarders.

Indonesia

In November 2005, DDTC lifted the policy of denial for exports of lethal defense articles/services for end-use by the Indonesia Armed Forces. Applications will now be considered on a case-by-case basis.

Enforcement and Compliance

DDTC officials indicated that they had obtained 60 criminal convictions for ITAR violations in fiscal year 2005, in addition to civil penalties against four companies totaling $35 million. DDTC indicated it received 396 voluntary disclosures during this period, increased the number of U.S. companies contacted under the Compliance Visit Program, and conducted more than 500 pre- or post-license checks of foreign entities under its "Blue Lantern" program.⁷

Commercial Exports Under The EAR

Definition of "Specially Designed" Components

The BIS practice of giving broad meaning to the term "specially designed," when determining whether a component is a "specially designed" component of equipment falling under a particular Export Control Classification Number (ECCN), appears to have withstood judicial challenge. In 2005, U.S. v. Lachman, a case lasting over a decade, was finally resolved with the sentencing of the defendants. ⁸ The crux of this case was the meaning of the term "specially designed" component as used in the EAR. Defendants argued this term meant that the component was solely or exclusively designed for use in the particular controlled item, pointing to the definition in the EAR for "specially designed" under the Missile Technology Control Regime and other government statements. The government on the other hand, argued that this term was much broader and applied to any component capable of being used in such controlled items. The court formulated its own definition as follows:

A device is "specially designed" for use with a [controlled] commodity if it is intentionally created for use, and in fact capable of being used with the [controlled] commodity ... this definition does not extend the [controls] to devices simply because they could in theory be used with [controlled] commodities, thus ensuring legitimate exports are not prohibited.⁹

However, BIS has not formally or informally adopted this Court definition, leading to continued uncertainty as to how certain components with multiple applications are classified.

Substantial Changes to the Commerce Control List (CCL)

In July 2005, BIS adopted a number of technical changes to items on the CCL to conform to revisions to the Wassenaar List agreed to by Wassenaar member countries in late 2004. These include changes in virtually every category of the CCL. Of particular note are substantial changes to the criteria for microprocessors under Export Control Classification Number 3A001, and raising of the performance threshold on certain controls for computers from 33,000 Million of Theoretical Operations Per Second (MTOPS) to 190,000 MTOPS. In addition, BIS used this rule to make some unilateral changes to other sections of the Export Administration Regulation.¹⁰

WMD End-Use Catch Alls

BIS amended its rules to require a license for export or reexport of any item subject to the EAR (i.e., virtually any product of U.S. origin) to any destination, if at the time of the export or reexport the exporter knows that the items are intended for use in chemical or biological weapons activities.¹¹

Libya

Although the Libyan embargo was lifted in September 2004, because Libya is still considered a state sponsor of terrorism, most items controlled under the CCL require a license for export to Libya. During 2005, BIS published several rule changes to ease these restrictions primarily for U.S. persons doing business in Libya, including the following:

• BIS created a new license exception USPL (U.S. persons in Libya), to allow U.S. persons to bring certain non-EAR99 items to Libya for use by U.S. persons. These items include portable generators, certain telecommunications equipment, computers and encryption hardware.¹²
• This rule clarified restrictions regarding U.S. persons using items (installed base) that may have been illegally exported to Libya in the past.
• BIS will now allow vessels departing U.S. waters to make temporary sojourns to Libya under license exemption AVS.¹³

India

In July 2005, the U.S. and India reached agreement on Next Steps in Strategic Partnership (NSSP). As a result, BIS has lifted restrictions on exports to India for Nuclear Non-Proliferation reasons (NP Column 2), and removed certain Indian entities from the "Entity List."¹⁴

Former Eastern Bloc Countries

Due to the expansion of NATO to include Bulgaria, Estonia, Latvia, Lithuania, Romania, Slovakia and Slovenia, BIS in November 2005 amended its regulations to treat these countries as well as Hungary, Iceland and Poland consistent with treatment of other NATO members. In effect, many items controlled for export for National Security reasons under NS Column 2 can now generally be exported to any NATO country without a license. Further, because these former eastern block countries were added to Country Group B, certain exemptions may now be available for the export and temporary exports, which were previously unavailable, e.g., exports of technology under restriction (TSR).¹⁵

Import Certificates

BIS has removed the requirement for import certificates in most circumstances for the former Eastern Bloc countries that recently joined NATO or other multi-lateral export control regimes. The latter category includes India.¹⁶

Intra-Country Transfers

In September 2005, BIS amended its instructions in 15 C.F.R. § 748.8 to clarify procedures for applying for intra-country transfers of controlled products using form 748P or SNAP, and eliminating the letter procedure previously in place.¹⁷

Enforcement

Anecdotally, it appears that the number of enforcement cases and severity of penalties imposed continued to rise in 2005. BIS''s Office of Export Enforcement (OEE) published statistics indicating that over the last two years OEE has conducted 1,500 enforcement investigations resulting in 61 criminal convictions, criminal fines totaling $17.4 million, $11 million in civil penalties, and 36 denial orders. Violations involving exports to China and Iran were significant.¹⁸

Embargo Regulations

Burma

In response to legislation passed in 2003, OFAC has further tightened U.S. sanctions on Burma to ban virtually all imports from Burma.¹⁹ Exports of goods are still generally allowable, but exports of services or new investment in Burma are significantly curtailed, except for the humanitarian efforts of NGOs licensed by OFAC.

Cuba

OFAC amended the Cuban Sanction Regulations to clarify that the term "payment of cash in advance" for agricultural commodities sold to Cuba means payment before shipment of the goods. Prior to this rule change, many U.S. exporters were paid upon delivery.²⁰

Iran

OFAC modified the embargo regulations to clarify when and how U.S. brokers or dealers in securities can use general licenses to administer Iranian accounts.²¹

Syria

In April 2005, OFAC published rules further implementing portions of Executive Order 13338 regarding blocking of property.²² This rule requires U.S. companies and overseas branches to block and report any property owned by certain Syrian entities and individuals designated by the U.S. Government to be contributing to the Government of Syria's support of terrorism, support of Syria's military security presence, or Syria's efforts to develop weapons of mass destruction or missile technology. As a practical matter, this means entities and individuals identified by OFAC on the Specially Designated Nationals List (SDNL), or any entity owned or controlled by an entity on the list.

Note: While the OFAC rules on Syria do not generally prohibit transactions with Syria, the BIS'' 2004 general order on Syria essentially prohibits virtually all export-related transactions with Syria.

Sudan

Although there were widespread rumors that the U.S. embargo on Sudan would be lifted following the election of a new government in Sudan and visits to Sudan by high-ranking U.S. officials, this has not yet occurred due to continued concerns over Darfur. However, the flow of humanitarian aid to Sudan continues under USAID funded programs, as well as the use of the special registration provisions for non-governmental organizations (NGOs). In June 2005, OFAC amended the Sudanese Sanction Regulations to allow U.S. financial institutions to make transfers of funds to and from Iraq for individuals ordinarily resident in Sudan. This rule clarified the rules regarding the reexport of U.S. origin goods to Sudan by foreign persons.²³ In addition, BIS modified its rules to allow use of a temporary license exception for carrying basic communications equipment to Sudan (e.g., cell phones, laptops, etc.) by staff of organizations performing relief work in Sudan.²⁴

Financial Institution Internal Controls

In June 2005, the Federal Financial Institutions Examination Council published a 300+ page Bank Secrecy Act/Anti-Money Laundering Examination Manual that includes a special chapter on prohibited transactions with embargoed countries and with persons and entities on the SDN List.²⁵ This chapter, which was developed in conjunction with OFAC, gives guidance on the type of risk factors that banks should take into account in setting up internal controls procedures including procedures for screening suspect transactions, updating the SDN list, etc. Following the "best practices" laid out in this document is critical because, in January 2006, OFAC published new interim enforcement procedures for banking institutions that appears to weigh internal controls heavily in making enforcement decisions.²⁶

OFAC Civil Penalty of $40 Million

In a consent agreement, ABN AMRO Bank, N.V., an international bank headquartered in the Netherlands with offices in the U.S., agreed to pay $40 million to OFAC in civil penalties for its participation in a series of banking transactions with Iran and Libya. In addition, AMRO agreed to pay $30 million for anti-money laundering violations.²⁷ This appears to be the largest OFAC penalty to date.

Future Changes For 2006

Defense Contractor Technology Controls

In July 2005, the Department of Defense proposed a change to DoD acquisition rules that would require virtually all DoD contractors to put in place export control programs.²⁸ In particular, the proposed rule focused on "deemed exports" (i.e., access by foreign companies or individuals). The proposal would require a formal program that includes:

• controls on physical, visual and electronic access to export controlled information
• access controls including unique badging for foreign nationals and segregated work areas for export-controlled information/technology
• initial and periodic training
• period self-assessments/audits

While major defense contractors likely have these plans in place, smaller contractors, particularly those handling dual-use technology, may need to ramp up for this. This requirement is much less invasive than the exclusion and specific contract waiver provisions found in certain Department of Homeland Security contracts involving "sensitive information," or access to government facilities.

BIS Proposal Regarding Dual-Nationals

One of the most controversial proposals in recent years was a BIS proposal that would have required companies to consider a foreign national's country of birth – in addition to his or her citizenship – in determining whether a deemed export license is required for access to technology.²⁹ BIS also proposed to modify its rules regarding access and use of controlled equipment in the U.S. by foreign nationals. This proposal received an outpouring of negative comments from universities and industry, and based on informal comments from senior government officials in December 2005, the country of birth requirement will likely be removed from the final rule.³⁰

China Military Catch-All

Look for changes in 2006 that would require U.S. exporters to obtain a license for a broad range of products not otherwise controlled for export to China if the exporter knows, or has reason to know, that the products will be used by the Chinese military.

This publication is intended to summarize points of interest in the material discussed herein. It is not intended to be exhaustive or to be legal advice with respect to the matters discussed.

¹ Final Rule, Amendments to the International Traffic in Arms Regulations: Part 126, 70 Fed. Reg. 39919 (July 12, 2005).

² Final Rule, Amendments to the International Traffic in Arms Regulations, 70 Fed. Reg. 35652 (June 15, 2005)

³ Final Rule, Amendments to the International Traffic in Arms Regulations, 70 Fed. Reg. 50958 (Aug. 29, 2005)

⁴ Final Rule, Amendments to the International Traffic in Arms Regulations, 70 Fed. Reg. 35652 (June 15, 2005)

⁵ Order in Case No. 04-3037 dated May 9, 2005, clarifying opinion in U.S. v. Yakou, 393 F.3d 231 (D.C. Cir. 2005).

⁶ Notice on License Support Documentation available at: www.pmdtc.org/

⁷ John Hilden, Assistant Secretary for Political-Military Affairs, Address to the 18^th Annual Global Trade Controls Conference, Nov. 3, 2005.

⁸ See U.S. Department of Justice Press Release, High-Tech Firms/Executive Sentence in Export Case, (Nov. 21, 2005).

⁹ United States v. Lachman, 387 F.3d 42, 52-53(1^st Cir. 2004)

¹⁰ Final Rule, 15 CFR Parts 740, 742, 743, 772, and 774 Export Administration Regulations: December 2004 Wassenaar Arrangement Plenary Agreement Implementation, 70 Fed. Reg. 41993 (July 15, 2005).

¹¹ Final Rule, Amendments Affecting the Country Scope of the Chemical/Biological End-User/End-Use Controls, 70 Fed. Reg. 16110 (Mar. 30, 2005).

¹² Final Rule, Establishment of New License Exception for the Export or Reexport to U.S. Persons in Libya of Certain Items Controlled for Anti-Terrorism Reasons Only on the Commerce Control List, 70 Fed. Reg. 69432 (Nov. 16, 2005).

¹³ Final Rule, Revision to Export and Reexport Restrictions on Libya, 70 Fed. Reg. 14387 (Mar. 22, 2005).

¹⁴ Final Rule, Removal of License Requirements for Exports and Reexports to India of Items Controlled Unilaterally for Nuclear Nonproliferation Reasons and Removal of Certain Indian Entities from the Entity List, 70 Fed. Reg. 51251 (Aug. 30, 2005).

¹⁵ Final Rule, Revision of License Requirements and Licensing Policy , and Increased Availability of License Exceptions for Certain North Atlantic Treaty Organization (NATO) Member States, 70 Fed. Reg. 67346.

¹⁶ Final Rule, Revision to the Import Certificate Requirements in the Export Administration Regulations, 70 Fed. Reg. 72072 (Dec. 1, 2005).

¹⁷ Final Rule, Revisions and Clarifications to the Export Administration Regulations, 70 Fed. Reg. 54626 (Sep. 16, 2005).

¹⁸ BIS Major Case List, published August 2005.

¹⁹ Interim Final Rule, Burmese Sanctions Regulations, 70 Fed. Reg. 48240 (Aug. 16, 2005).

²⁰ Final Rule, Cuban Asset Control Regulations, 70 Fed. Reg., 9225 (Feb. 25, 2005).

²¹ Final Rule, Iranian Transaction Regulations, 70 Fed. Reg. 15583 (Mar. 28, 2005).

²² Final Rule, Syria Sanctions Regulations, 64 Fed. Reg. 17201 (Apr. 5, 2005).

²³ Final Rule, Reporting, Procedures, and Penalty Regulations and Sudanese Sanction Regulations, 70 Fed. Reg. 34060 (June 13, 2005).

²⁴ Final Rule, Revision of License Exception TMP for Activities by Organizations Working to Relieve Human Suffering in Sudan, 70 Fed. Reg. 8251 (Feb. 18, 2005).

²⁵ http://www.ffiec.gov/bsa_aml_infobase/documents/BSA_AML_Man.pdf.

²⁶ Interim Final Rule with Request for Comments, Economic Sanctions Enforcement Procedures for Banking Institutions, 71 Fed. Reg. 1971 (Jan. 12, 2006).

²⁷ Order of Assessment of a Civil Money Penalty, Monetary Payment and Order to File Reports Issued Upon Consent, In re: ABN AMRO Bank N.Y., FRB Dkt. No. 05-035 CMP-FB (Dec. 19, 2005).

²⁸ Proposed Rule, Defense Federal Acquisition Regulations Supplement; Export-Controlled Information and Technology, 70 Fed. Reg. 39976 (July 12, 2005).

²⁹ Advance Notice of Proposed Rulemaking, Revision and Clarification of Deemed Export Related Regulatory Requirements, 70 Fed. Reg. 15607 (Mar. 28, 2005).

³⁰ Op Ed by David McCormick, BIS Undersecretary in the Financial Times, Dec. 13, 2005.