The Bureau of Industry and Security (”BIS”) announced late this afternoon that starting April 28, 2008, an Export Control Classification Number (ECCN) would be required by the Automated Export System when exporters sought to export items under license exceptions TSR, RPL, GOV, GFT, TSU, BAG, AVS, APR, KMI, TAPS and ENC. Currently, the ECCN is required by the AES entry form only for exports under exceptions LVS, GBS, CIV, AGR, and APP.

This should not be a burden to exporters. Any reasonably robust export compliance program should assure that before any item is exported, it is classified either under a particular ECCN or as EAR99.

The Validated End User program of the Bureau of Industry and Security (”BIS”) has experienced a fox-in-the-henhouse moment and may come crashing to a screeching halt. Apparently two of the five companies first awarded Validated End User status have ties to the Chinese military, prompting an inquiry by one U.S. lawmaker as to how this might have occurred.

Back in October, BIS announced its first participants in the Validated End User program in China. Chinese companies with a “record of using [dual-use] items responsibly” are eligible for the status of a Validated End User after review by BIS. Under the program, certain dual use items may be exported and re-exported to the Validated End User without a license from BIS.

Unfortunately, according to this AP wire report, two of the five Validated End Users — Shanghai Hua Hong NEC Electronics Co. Ltd. and BHA Aerocomposite Parts Co. Ltd. — have links to the Chinese military. Hua Hong NEC is owned by China Electronics Corp., which provides electronics to China’s People’s Liberation Army. And BHA Aerocomposite is partly owned by China Aviation Industry Corporation I, a state-owned company that makes Chinese military aircraft. Its other owners are two U.S companies: Boeing and Hexcel.

As a result of these revelations, first reported by the Wisconsin Project on Nuclear Arms Control, U.S. Representative Edward Markey sent a letter of inquiry to the Department of Commerce questioning whether BIS’s Validated End User program “has unwisely reduced controls on the sale of dual-use American products with significant links to the the People’s Liberation Army.” The letter requests information relating to the process by which the two companies were designated under the Validated End User program.

Although the designation of Hua Hong NEC clearly seems problematic, I am less convinced that BHA Composites wasn’t properly designated as a Validated End User. After all, BHA is a joint venture that includes two U.S. companies, which should significantly reduce the risk of diversion of dual use products to the Chinese military. The Chinese partner, AVIC I, owns only one-third of the joint venture. The Wisconsin Project argued that Boeing and Hexcel “have a history of violating U.S. export controls that should have barred BHA from consideration.” Admittedly, both companies have entered into settlement agreements relating to export violations, but none of the violations involved illegal exports to the Chinese military or otherwise suggest that the two companies would engage in illegal exports to the Chinese military.

The Bureau of Industry and Security (”BIS”) released, on January 23, a settlement agreement under which freight forwarder Elite International Transportation, Inc. agreed to pay $156,000 in penalties for export violations. According to the Settlement Agreement, Elite made a false statement on a Shipper’s Export Declaration (”SED”) that it prepared when it stated that no license was required for the export of triethanolamine to Mexico. Triethanolamine, which is covered by ECCN 1C350.c.9 is a common ingredient in shampoos, shaving creams and other cosmetics but is also a precursor to nitrogen mustards, which can be used as chemical warfare agents and which cause blistering similar to the sulfur-based mustard gases used in WWI and WWII.

This blog has often criticized certain enforcement actions against freight forwarders that appear to impose upon the freight forwarder an undue burden of due diligence verifying statements made to it by the exporter. This, however, isn’t really such a case. The SED would have described the product as triethanolamine. Even if the exporter indicated to Elite that no license was required, it was a simple matter for Elite to check this statement. After all, triethanolamine is listed in the alphabetical index to the Commerce Control List. Making the classification here wasn’t rocket science.

Freight forwarders are also not doing any favor to their customers by not double checking the classification of exported items. No doubt the exporter here has already received a nastygram from BIS and is negotiating a settlement agreement under which it will pay an ouch-worthy fine to BIS. If the freight forwarder had double checked the classification of triethanolamine and told the exporter of the mistake (rather than ratting it out), both Elite and the exporter wouldn’t be the subject of a post on this blog.

Clif adds: Be sure to read the comment below from Jim Dickeson. Jim, who is the import and export compliance manager for a freight forwarder, makes a persuasive case that in this instance the freight forwarder was sandbagged by the exporter. Still, I think there’s plenty of fault to go around in this case because the name of the chemical was listed on the index to the CCL. This wasn’t an instance where you had to know the temperature resistance of a composite material or the size and inclination of a borehole in a turbine. It was one where one only had to look under T in the index and there is was: “triethanolamine.”

Back in November, Pennsylvania-based Colorcon, a manufacturer of specialty chemicals for the food and pharmaceutical industries, agreed to pay $39,000 to the Bureau of Industry and Security, based on alleged violations of BIS’s anti-boycott regulations. According to the charging documents and settlement agreement, Colorcon’s U.K. subsidiary provided assurances in connections with sales to Syrian companies that no Israeli components were used and that Colorcon would otherwise comply with Syria’s boycott of Israel. Additional charges settled by Colorcon included Colorcon’s failure to report the boycott requests at issues.

A recent article in the Jerusalem Post provides some interesting detail on the settlement agreement and the circumstances that led to it. The reporter interviewed Pam Lehrer, general counsel for the Berwind Group, a private investment firm that owns Colorcon. She said that the violations were the result of an “oversight”:

This matter occurred at Colorcon’s UK subsidiary. The requests were typically in the fine print of the terms and conditions, and the UK subsidiary’s employees were not aware of the requirement to look carefully for these matters and report them. We became aware of the issue through an internal audit review. We felt it was important to review our compliance with the antiboycott laws and performed an audit of our subsidiaries. As a result, we found the issue and voluntarily reported it to the US Commerce Department.

That statement differs from what Colorcon admitted in the settlement documents. In those documents, the company conceded that the anti-boycott certifications “with intent to comply with, further or support an unsanctioned foreign boycott.” This specific intent requirement is contained in section 760.1(e) of the Export Administration Regulations. If the information was buried in the fine print and the U.K. employees were not aware of the requirement to find such provisions, it’s hard to say that the U.K. employees signed these contracts with the intent to participate in the boycott against Israel.

Of course, agreeing to pay $39,000 to BIS may make more sense than paying much more to lawyers to litigate with BIS over whether the U.K. subsidiary had the requisite intent to comply with the Syrian boycott of Israel.

Norman Augustine
Chair, Deemed Export
Advisory Committee

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The Deemed Export Advisory Committee released today its report to BIS on BIS’s deemed export rules. The deemed export rules, among other things, require licenses prior to release of technology on a dual-use item to a national of a country if an a license would be required for the export of the particular dual-use item to the country in question.

The report is lengthy and I haven’t had time to review it fully, but an idea of the report’s contents can be gleaned from its epigraph:

If you guard your toothbrushes and diamonds with equal zeal, you’ll probably lose fewer toothbrushes and more diamonds.

— McGeorge Bundy

The diamonds apparently represent dual-use items and the toothbrushes represent the technical data regarding those items. So, not surprisingly, the report recommends loosening the deemed export rules in certain respects. Principally, the report recommends the creation of a “Trusted Entity” category. Trusted Entities would be companies and universities that meet certain criteria and that would therefore not be required to obtain individual export licenses to transfer dual use technologies to foreign nationals. Such foreign nationals would be required, however, to sign non-disclosure agreements.

But in another respect, the report recommends tightening deemed export rules when it wades into the tricky territory of permanent residents, dual nationals and individuals who have resided in multiple countries. Under current rules, the BIS looks at an individual’s current citizenship and/or legal permanent residence. The report recommends expanding the inquiry:

[We recommend] expanding the determination of the national affiliation of potential licensees to include consideration of country of birth, prior countries of residence, and current citizenship, as well as the character of a person’s prior and present activities, to provide a more comprehensive assessment of probable loyalties.

The report’s explication of this recommendation contains this example:

It would seem that inadequate distinction is made between an individual who, say, was born and raised in Iran but only recently became a citizen of the UK and an individual who was born in Iran but moved to the UK and became a citizen of the latter nation shortly after birth. Additionally, it would seem to be important to consider where that individual resided during his or her entire lifetime - not just where he or she was born or where his or her current citizenship has been granted. It is noteworthy that the current BIS interpretation is that the Deemed Export rule does not apply to persons lawfully admitted for permanent residence (i.e., green card holders), wherever their prior residences may have been.

(emphasis in original)

This analysis is sensible, but it also carefully finesses a significant problem. It is not clear whether the report is recommending that a foreign national admitted to lawful permanent residence in the U.S. should continue to be treated as a U.S. citizen for purposes of deemed exports or whether the rules should be revised to treat a U.S. permanent resident like any other foreign national and potentially subject to disqualification from deemed exports based on country of birth or country of former residence.

There has been some discussion here at Export Law Blog about the proper role of freight forwarding companies in export enforcement. If a customer of a freight forwarder proffers a package addressed to Iran without an OFAC license, should the freight forwarder decline the package and tell the customer that shipments to Iran must be licensed? Or should the freight forwarder accept the package and call the authorities? The recent settlement agreement entered into between Kuwaiti-owned Proclad International Pipelines and the Bureau of Industry and Security shows, I think, a freight forwarder that struck exactly the right balance.

At issue were attempted exports by Proclad of nickel alloy pipes classified as EAR99 to Iran without a license. The company attempted to export the pipes to Iran by transshipping them through the UAE. In the recitation of the various counts with which Proclad was charged is this interesting language:

Proclad altered markings for use on the crates of nickel alloy pipes that it was attempting to export to Iran. The altered markings were provided to the U.s. manufacturers in lieu of markings previously provided indicating that pipes were being exported to Iran. Proclad altered the markings to conceal the true ultimate destination of the items after it had been informed by a freight forwarder of the applicable licensing requirements during a previous attempt to export the pipes to Iran.

What apparently happened was that once the freight forwarder said the pipes couldn’t be shipped to Iran, Proclad simply slapped on new labels saying that the pipes were going to the UAE. I suspect the freight forwarder then called the authorities.

The freight forwarder did the right thing by initially telling the exporter that exports to Iran required licenses. Clearly any exporter that hands documents to the freight forwarder showing Iran as the ultimate destination is clueless about U.S. law. Proclad Pipelines is located in Scotland, so it’s a reasonable assumption that they may not have been familiar with U.S. export restrictions.

But what initially might be seen as an innocent mistake quickly became an illegal undertaking when Proclad decided that the appropriate response wasn’t to decline to export items to Iran but to pretend to export the Iranian-bound goods elsewhere. And a freight forwarder who saw that a package previously bound for Iran now had on shipping labels for the UAE would have to be well-aware that the exporter was attempting some shenanigans. And that, in my view, fully-justified the freight forwarder ratting out Proclad.

The Bureau of Industry and Security (”BIS”) recently set aside a default judgment denying export privileges to S.P. Equipamentos de Protecao ao Trabalho Ltda (”SPE”), a Brazilian firm charged with violating U.S. export laws by re-exporting night vision equipment to Brazil’s State Secretariat of Civil Defense. The reasons given by Undersecretary Mancuso for setting aside the judgment suggest, at best, a simple mistake by BIS’s Office of Chief Counsel (”OCC”) and, at worst, a violation of BIS’s rules by the OCC. Somewhere in between is the possibility of some legal but unfair shenanigans by BIS’s lawyers.

According to Undersecretary Mancuso’s decision, a charging letter was sent to SPE on September 13, 2004, and received by SPE eleven days later. On February 7, 2005, counsel for SPE filed an appearance with BIS. On November 11, 2006, BIS filed a motion for default based on the failure of SPE to file an answer to the charging letter within 30 days as required by the Export Administration Regulations (”EAR”). On January 31, 2007, the BIS Administrative Law Judge entered a default judgment which was approved by BIS on February 26, 2007.

On September 7, 2007, Counsel for SPE filed motion to set aside the default judgment for good cause, arguing that it did not receive a copy from BIS’s counsel of the motion for default. The certificate of service for the default judgment, which is addressed only to BIS’s counsel, supports this claim of failure of service. Undersecretary Mancuso’s decision further states that there is evidence that for about a year prior to BIS’s filing of the motion for default, counsel for SPE and counsel for BIS “engaged in settlement negotiations” regarding these charges. BIS filed a response which did not oppose SPE’s claim that good cause existed to set aside the default.

The question here, of course, is why on earth did counsel for BIS fail to file the motion for default on SPE’s counsel with whom it had been negotiating the matter for a considerable period of time? Section 766.5 of the EAR governs service of papers other than the charging letter. It explicitly states that service must be made on “each party in the proceeding.” If a party is represented by counsel, service on such counsel constitutes service on the party.

Section 766.7 of the EAR governs default motions and states:

Failure of the respondent to file an answer within the time provided constitutes a waiver of the respondent’s right to appear and contest the allegations in the charging letter. In such event, the administrative law judge, on BIS’s motion and without further notice to the respondent, shall find the facts to be as alleged in the charging letter.

That rule says that the default judgment can be entered “without further notice,” but it doesn’t say, in my view, that the motion for default isn’t subject to the service rules provided in Section 766.5. Even supposing that it does, isn’t it a violation of Simple Decency and Fairness 101 not to mail a copy of such a motion to opposing counsel?

Perhaps it was a simple oversight by BIS’s lawyer, but it’s hard to imagine how that happened. In all events, however, BIS did what appears to be the right thing by setting aside a default judgment that was obtained through a motion that wasn’t served on the respondent’s counsel.

If any company considering its first export transaction actually read and tried to understand the recordkeeping requirements of Part 762 of the Export Administration Regulations (”EAR”), it is unlikely that anything would ever be exported from the United States. And although enforcement actions by the Bureau of Industry and Security (”BIS”) which promulgated and enforces these regulations are rare, they are not non-existent as Hardinge, Inc., the New York-based manufacturer of milling, grinding, turning and workholding machinery learned the hard way. Well, not that hard. The company signed at the beginning of the month a Settlement Agreement pursuant to which it agreed to pay BIS $3,000 for failure to keep records relating to its export of “metalworking and/or machine tools” to Israel. There was no allegation by BIS that the exported equipment was subject to any licensing requirements.

The recordkeeping requirements of Part 762 are, to say the least, extensive. Section 762.2 states:

The records required to be retained under this part 762 include the following:
(1) Export control documents, as defined in part 772 of the EAR;
(2) Memoranda;
(3) Notes;
(4) Correspondence;
(5) Contracts;
(6) Invitations to bid;
(7) Books of account;
(8) Financial records;

Just let that sink in for a moment. Let’s say one of your company’s salespersons receives a call from an overseas customer and he jots down on a piece of paper “Company X wants us to quote prices to export three cases of peanut butter to the U.K.” If you ship the peanut butter, but don’t retain the original of that note, you’ve broken the rule.

The rule does permit copies to be retained under section 762.5 but only if you comply with an onerous set of restrictions relating to the copies, including making a copy of the “obverse and reverse”* sides of paper documents. You also have to keep a record of “where, when, by whom, and on what equipment” the document was copied. You don’t have to be a management consultant to figure out that this is simply not going to happen.

Section 762.4 describes a number of documents exempted from the broad recordkeeping requirements of section 762.2. But these exemptions don’t include the note I described or other “notes” or “memoranda” regarding the transaction.

Of course, the charging documents and the Settlement Agreement don’t tell the whole story. It’s doubtful that it was just a salesman’s note that was involved. Still, the BIS requirements are extremely broad and quite easy for even a legitimately concerned and compliant exporter to trip over.

*”Obverse” and “reverse” are terms that are normally applied to coins and paper currency. The corresponding words for book pages, prints and drawings are “recto” and “verso.” And the words used by ordinary people who haven’t spent three years in law school or too much time in government agencies are, of course, simply “front” and “back.”

Almost a year after the last plenary of the Wassenaar Arrangement approved and adopted changes to the Wassenaar List of Dual-Use Goods and Technologies, the Bureau of Industry and Security (”BIS”) yesterday released a final rule implementing those changes on the Commerce Control List (”CCL”). A number of changes have been made, including the addition of some items that were not previously on that list. The list of changes is too long (and in some case too tedious) to fully detail in a blog post, but I did want to discuss briefly the addition of microwave power modules to the CCL which appears to be yet another item which could pose overlapping export control jurisdiction between BIS and the Department of State’s Directorate of Defense Trade Controls (”DDTC”)

Microwave power modules are a recent technology that combines solid-state and vacuum electronics to provide highly efficient and powerful amplifiers with very low signal-to-noise ratio and extremely compact size. MPMs are also known for their rapid turn-on times. These properties have made them attractive for use in military applications such as radar, communications, and unmanned aerial vehicles (”UAVs”). In particular, MPMs have been used in the Predator and Global Hawk UAVs for both satellite and line-of-sight communications to and from the remote pilot. Commercial uses for MPMs include civilian satellite communications, wireless communications, and high power RF sources for laboratory use

The new ECCN for MPMs is 3A001.b.9. The controls on the new ECCN are NS2 and AT controls. The NS2 controls mean that licenses will be required for all countries other than those classified on those in Country Group A:1 on the Country List. License requests to any country other than one in Country Group D:1 will be subject to a general policy of approval unless there is evidence of a possibility of diversion to a country in Country Group D:1. License requests for a country in Country Group D:1 are subject to a case-by-case examination and will be approved if BIS determines that the item will not be used for military purposes. AT controls mean that license requests for exports or re-exports to Cuba, North Korea, Iran, Sudan and Syria are subject to a general policy of denial.

ECCN 3A001.b.9 sets forth certain performance requirements for an MPM to be covered. These include the unit’s turn-on time, the size of the unit as a function of its output power, and a measure relating to the unit’s instantaneous bandwidth.

A large number of MPMs are explicitly identified by their manufacturers as designed for military use, in which case they are covered under Category XI (Military Electronics) of the United States Munitions List (”USML”) or possibly Category XV (Spacecraft Systems and Associated Equipment). Interestingly, the related controls section of ECCN 3A001 only references, and excludes, MPMs covered under Category XV. This leads, of course, to an interesting question of overlapping or conflicting jurisdiction.

Consider, for example, an MPM designed for a military terrestrial communication system which therefore is covered by USML Category XI(a)(4)(iii). If that MPM meets or exceeds the performance characteristics of ECCN 3A001.b.9, then it would also be covered by that ECCN because only items covered by USML Category XV are excluded from the ECCN. Do you file a commodity jurisdiction request for that MPM? Or should you simply file for export licenses from both BIS and DDTC? Given the length of time it takes for a commodity jurisdiction request to be decided, the answer, of course, is to file for licenses from both agencies. To avoid this result, BIS should add to the “related controls” section of ECCN 3A001 an exclusion for MPMs covered by USML Category XI.

The Bureau of Industry and Security (”BIS”) recently designated five Chinese companies under BIS’s Validated End User Program. Because of that designation, certain dual-use items can be exported to those companies in China without an export license.

The first reviews from China are now in. And they aren’t good:

The government yesterday criticized the United States over a new system that’s likely to reduce China’s imports of hi-tech products. Wang Xinpei, spokesman for the Ministry of Commerce, expressed “strong dissatisfaction” over the US move, as the “US side did not have enough consultation with China to reach a consensus on implementing the new VEU system”. The United States should not visit any companies registered in China for VEU screening without permission from the Ministry of Commerce, Wang said.

We have previously criticized the VEU program because it was unlikely that China would permit on-site inspections as part of that process. The statement by the Chinese spokesman confirms that, although it is not entirely clear that BIS actually visited the Chinese sites of the companies granted VEU status. It does seem likely, however, that the companies at least agreed to future on-site visits — one of the factors set forth as a consideration for granting VEU status under section 748.15 of the Export Administration Regulations

More significantly, one has to wonder if there is a veiled threat behind the puzzling statement that the VEU program “will reduce China’s imports of high-tech products.” If the VEU program operates as anticipated by BIS, it would increase such imports. Perhaps this statement is a harbinger that China may take internal measure to block the program. After all, from the Chinese perspective at least, the VEU program would give advantages to the VEU companies but not to their Chinese competitors. That might serve as a motive for China to block imports to the VEU companies unless they withdrew from the program.

Of course, this is just speculation based on a somewhat puzzling statement in a Chinese state-owned news outlet. But it will be interesting to see if China does adopt countermeasures.