Export Control News & Alerts

The Export Control Update Newsletter
OCTOBER 2007

CONTENTS

1. Reports Question Pratt Canada Sales to China
2. Bush Signs Law Raising Fines for Violating the EAR from $50,000 to $250,000
3. BIS Publishes List of First Validated End Users in China
4. 5 New VEUs in China = A Reason to Review the New China Rules One Last Time
5. OFAC Blocks More Burmese Officials
6. BIS Proposes to Make Electronic License Filing Mandatory
7. E-Business Bad Idea: Selling F-4 and F-14 Parts on a Website
8. Qing Li Indicted for Conspiracy to Violate ITAR
9. New Defense Trade Treaties Will Streamline ITAR Licensing Special Guest Article

1. Reports Question Pratt Canada Sales to China

Well, even though accusations are flying all around, it is not yet clear as to whether Pratt & Whitney Canada have violated U.S. restrictions by exporting military items to China. The company sold their PT6C-67C engines to China for the use in civilian helicopters; however a new brochure for the Chinese Z-10 Zhisheng, an attack helicopter, has the same engine listed. If these engines contain parts or technology controlled by the ITAR, the company could face an enormous fine and negative implications for future ITAR-controlled exports.

The Z-10 helicopter is an anti-armor and battlefield interdiction, with the capability of air-to-air combat. The air craft holds air-to-air missiles and unguided rocket launcher pods. Observers expect that the helicopter will be mass produced, and will acquire numerous sales. Richard Fisher, the vice president of International Assessment and Strategy Center, warns that, “The chances are very good that the Z-10’s will be hurting Americans, either killing them on some future battlefield or attacking their jobs”. (Obviously, the former is a bit more painful than the latter-jb.)

According to published reports, Pratt & Whitney claims it had no idea that the engine was used for anything besides the civilian aircraft it was intended for. Some however, believe that the company knew, “Claims that P&WC had no idea they were supporting a military program truly beg credulity, China’s efforts to support the Z-10 through massive foreign technology acquisitions have been an open secret for over a decade,” Fisher alleges.

At this time, the company has not violated any Canadian export regulations and the U.S. Government is currently taking steps to gather more information to ensure that the company is not violating any U.S. exporting restrictions pertaining to the engine.

We all know that accusations flow eagerly from the mouth of headline seeking fear mongers like the proclamations of a carnival barker. Accusations make news, but it normally will be the facts that will determine whether the US Government will take or threaten enforcement actions against Pratt Canada.

Information available at:

SinoDefense.com

DefenseNews.com

— Danielle McClellan

2. Bush Signs Law Raising Fines for Violating the EAR from $50,000 to $250,000

On October 16, 2007, President Bush signed legislation increasing by a factor of five the civil and criminal penalties under International Emergency Economic Powers Act and penalties for violations of the Export Administration Regulations. Previously, civil penalties had been $50,000 per violation; the amended statute now calls for the greater of $250,000 or twice “the amount of the transaction that is the basis of the violation”. The news is worse than appears because a single export transactions can result in multiple violations, because of this: many times the BIS can double or triple count violations for one shipment. For example, Violation 1) would be the illegal export, Violation 2) would be acting with knowledge of an illegal export, Violation 3) would be making false statements on AES/SED records that no license is required). With this is mind, the practice of multi-counting counting, combined with the new fines could send the monetary amounts of the penalties into the stratosphere if companies are not careful.

The legislation also adds new activities that represent violations; in the past civil violations consisted of violating or attempting to violate the law. Now it is a violation to “conspire” or “cause a violation” of the law. The criminal side merely adds that it is a violations to “willfully conspire to commit” or “aid or abet” a violation.

— Danielle McClellan

3. BIS Publishes List of First Validated End Users in China

In the October 19, 2007 Federal Register the Bureau of Industry and Security published the names of the five entities in China who are the first BIS has designated to be Validated End-Users (VEU) eligible to receive certain items without export/reexport licenses. The five VEUs are:

• Applied Material China: supplier
• Boeing Hexcel AVIC I Joint Venture National Semiconductor Corporation
• Semiconductor Manufacturing International Corporation
• Shanghai Hua Hong NEC Corporation
• National Semiconductor Corporation

Each VEU has a list of specific Export Control Classification Numbers (ECCNs) that they may receive license-free under the VEU program. The eligible ECCNs vary from one VEU to the next. The new rule also identifies which facilities for each VEU are eligible to receive license-free exports/reexports.

More information and the complete final rule are available at:

Federal Register Notice

BIS Announcement

— Danielle McClellan

4. 5 New VEUs in China = A Reason to Review the New China Rules One Last Time

It has been a few months since the US slapped new export/reexport controls on China to attempt to slow the growth of the Chinese defense industry, and thus hamper the growth of Chinese military capability. On October 17, 2007, BIS announced the the names of the five new Validated End Users (VEUs) in China. (OK, I admit my prediction that the VEUs would be a long time coming was wrong.)

So, it after hearing a wide range of people talk about the new China military end use license requirement and the VEU program, maybe now is time for me to issue the last word analysis of the new China rules.

For the most part, what does exist today, and what companies must comply with today, is a new approach to restricting certain export/reexport to China that are imposed by the new set of export/reexport restrictions on China.

So, let's look at the details of the new requirements.

The new rule requires an export/reexport license for exports/reexports of certain formerly no license required (NLR) items to “military end use” in China. The new provisions in the Export Administration Regulations (EAR) are intended to have a direct impact on manufacturers of military items in the PRC; and, by impacting the manufacture of military equipment in the PRC, the new rule will impact the Chinese military. The new rule does not impact as many items as the Commerce Department original proposal. For example, the original proposed rule applied to exports/reexports of commercial aircraft parts classified as ECCN 9A991 to “military end use” in China, while the new rule does not restrict exports/reexports of commercial aircraft parts. The new rule, however, does require an export/reexport license for commercial aircraft, commercial aircraft engines, and 9E991 technical data related to commercial aircraft, engines and parts.

OK, let's get more specific and look at the details of the new restrictions.

Main Impact - License Requirement for Certain Transfers to “Military End Uses”:

The EAR now requires an export/reexport license for items listed in the new Supplement 2 to Part 744 when the items are intended for a “military end use” in the PRC. So, it is a two part control-for the control to apply the items must be listed in the new Supp. 2 and they must be destined to a “military end use.” If either of those facts is not present, the new rule does not apply.

So, review the new Supp. 2 to see if it includes any items you export/reexport. If it doesn't, the new rule doesn't impact your exports/reexports. If you do have stuff in the new Supp 2, then take the next step.

The key issue is that “military end use” activities are what cause there to be an export/reexport license requirement for Supp 2 items. If you “know” (think of it as you know or suspect) your Supp 2 item is destined for a “military end use” you now need an export/reexport license. “Military end use” means:

• Incorporation into a military item;
• For the “use”, “development”, or “production” of military items;
• Deployment of 9A991 items

The rule is not an across the board ban on exports/reexports to military end users. If the Chinese military is flying an unmodified Cessna, you can send 9E991 technical data to it without an export/reexport license because the use of an unmodified commercial aircraft by the military is not a “military end use” under the new China requirements. And, be careful because things can get tricky-for example, the new rule does not prohibit you from shipping 9A991 parts to “military end use” but it does prohibit the export/reexport of 9E991 data to “military end use.”

You need to realize that you should not base your new compliance procedures on simply determining who your customer or end user is-the new rule is not a prohibition against exports/reexports to military end users, it is a prohibition against exports/reexports to “military end uses.” In many cases the new rule will apply when you export/reexport to a manufacturer or somebody doing service, for example, if they are making or servicing a military item. So, you need to know what your customer will do with your stuff to know whether there is a “military end use.”

Secondary Impact - Reduction of License Requirements for VEUs

The EAR authorizes the Commerce Department to grant a special Validated End User (VEU) status to certain entities in China and not require export/reexport licenses for those entities. The items that will not require an export/reexport license may vary from one approved VEU to another and will be whatever items the US Government decides should be license free to a specific entity. If a Chinese entity agrees to be audited by the US Government whenever the US Government requests to do so, and the US Government decides it can trust the Chinese entity, the entity might get the VEU status. So far, all of the VEUs are actually Chinese entities that are owned/controlled/affiliated by/with companies from other countries.

In the October 19, 2007 Federal Register the Commerce Department granted VEU status to these five entities in China:

• Applied Materials China, Ltd.
• BHA Aerocomposite Parts Co., Ltd.
• National Semiconductor Corporation
• Semiconductor Manufacturing International Corporation
• Shanghai Hua Hong NEC Electronics Company, Ltd.

These VEUs are listed in the new Supplement No. 7 to Part 748 of the EAR. Supplement 7 identifies the eligible locations for each of the VEUs and specifies which ECCNs are eligible for shipment to each of the VEUs. In other words, you may use the VEU authorization only to export/reexport specifically listed ECCNs to specifically listed locations for each VEU.

Tertiary Impact - New Written License Approval Policies for China

The new rule also adds a lot of information related to US export license approval policy for exports/reexports that may directly or indirectly involve military-type activities in China. The bottom line is if the US Government wants to deny your license for whatever reason, the licensing policy gives it plenty of explicit policies upon which it may base its denial. In the past the US Government normally was able to find a legal basis for denying any license it wanted to deny for China, so I wouldn't have even brought up this aspect of the new rule if it weren't for the fact that it gives me a chance to use the word “tertiary.”

— John Black

5. OFAC Blocks More Burmese Officials

More Burmese officials have been added to the Specially Designated Nationals list, 23 to be exact, blocking them from any U.S. contact. The list consists of Burmese persons that the US Government has determined have participated in “human rights abuses,” have been engaged in “activities that facilitate public corruption,” have “materially” supported the Government of Burma. The list also includes persons that are “owned or controlled by any blocked person. In fact, even the “spouse or child of” any person who is blocked can be listed too.

President Bush is not backing down either (hmm, that's a surprise, President Bush isn't backing down). “So, along the lines in Burma, we have sanctioned individuals within Burma and are considering additional sanctions,” President Bush explained in an interview on the subject. He also made a point of explaining, “[but] sanctions don't mean anything if we're the only sanctioner.” Bush made sure as to not give any clues about what is in store for the Burmese Sanctions, possibly there will be even more additions to the Specially Designated Nationals list, or even more bans on exports to Burma; it is hard to tell at this point.

More information available at:

Recent OFAC Actions

Recent OFAC Actions (2)

Executive Order from White House

— Danielle McClellan

6. BIS Proposes to Make Electronic License Filing Mandatory

The Bureau of Industry and Security has proposed a rule that would require that export and re-export license applications, classification requests, encryption review requests, License Exception AGR notifications and related documents be submitted to the BIS (Bureau of Industry and Security) via its Simplified Network Application Process (SNAP-R) system.

The SNAP-R is an improvement of the BIS’s latter system, SNAP. The new system includes the ability to include documents related to a submission in the form of PDF files as “attachments” to the submission. The system also includes a feature that allows BIS personnel to request additional information from the submitting party and for the party to submit that information in a manner that ties the chain of communication to the submission.

SNAP-R is intended to reduce processing times and simplify compliance with the administration of export controls. The system should provide improved efficiency in submission and processing and will hopefully improve end-user security through rights management and an updated application and security infrastructure.

Under the proposal, paper submissions will only be accepted if:

1. The party has had only had one submission in the twelve months immediately preceding the current submission
2. The party does not have access to the internet
3. BIS has rejected the party's electronic filing registration or revoked its eligibility to file electronically
4. BIS has determined that the party submit on paper for a particular transaction
5. BIS has determined that certain conditions justify allowing paper submissions on a particular instance.

More information:

Federal Register Notice (PDF)

— Danielle McClellan

7. E-Business Bad Idea: Selling F-4 and F-14 Parts on a Website

Immigration and Customs Enforcement (ICE) agents revealed a website run by Abraham Trujillo and David Waye which listed both F-14 and F-4 parts for sale. The website company, NSN Specialists, attempted to export the parts without a license. The ICE agents tracked the company over the next several months and eventually set up a sting operation to arrest the men.

Trujillo and Waye would repackage the parts and assign them commercial part numbers and even invoiced them as “gear sprockets” to guarantee that the parts would not be conspicuous. They intended on exporting the parts to Canada where they would then go to Iran where the only F-14 are flown.

The men are charged by the U.S. Attorney for Utah with 3 felony counts. The felony information includes attempted export of the F-14 and F-4 fighter aircraft parts without a license, attempted export of F-14 wiring harnesses and impeller assemblies and the repackaging to the goods.

— Danielle McClellan

8. Qing Li Indicted for Conspiracy to Violate ITAR

On October 18, 2007, Qing Li was indicted on charges of conspiracy to procure the illegal export of military-grade accelerometers from the United States to the Republic of China. The accelerometer measures massive shocks up to and beyond 200,000g and has numerous military applications. The accelerometer is a designated defense article of the United States Munitions List and requires written permission from the United States Department of State to be exported.

Li lived in Connecticut and was conspiring with an individual in China to locate and procure accelerometers for scientific agencies in China. Li and her co-conspirator used email messages and telephone calls to make negotiations referring to the accelerometers. Both also had contact with an undercover ICE agent in San Diego, who posed as a seller of accelerometers. He was promised that if the accelerometers he sold tested properly, large orders would follow.

Li faces a potential of 5 years in prison and a $250,000 fine, the indictment itself is not evidence that Li committed the crimes she is charged with, she is innocent until proven guilty beyond a reasonable doubt.

More information:

DOJ Announcement

— Danielle McClellan

9. New Defense Trade Treaties Will Streamline ITAR Licensing

Special Guest Article from Pillsbury Winthrop Shaw Pittman LLP

The U.S. Government recently completed the negotiation of two defense trade cooperation treaties, one with the United Kingdom and the other with Australia. These treaties establish a bilateral framework with each country to enhance defense cooperation and reduce barriers to the exchange of defense goods, services and information. If ratified, the treaties will allow the U.S. to streamline licensing for items subject to the International Traffic in Arms Regulations (ITAR) when exported to members of an “Approved Community” in each country for specified programs.

U.S. - UK Treaty

On September 20, 2007, the President transmitted to the Senate for advice and consent to ratification the Treaty Between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland Concerning Defense Trade Cooperation, which was signed in London on June 21, 2007 and in Washington on June 26, 2007.

Focus on Defense Cooperation Between Governments

The report issued by the State Department and included with the President's transmittal letter to the Senate identifies the purpose of the treaty, which is “to improve the interoperability” of the armed forces of the U.S. and UK “by facilitating the movement of Defense Articles in support of certain mutually agreed activities, while maintaining and ensuring proper safeguards against unauthorized release of the defense technology involved.” The treaty applies to defense articles required for combined military or counter-terrorism operations; cooperative security and defense research, development, production and support programs; specific security and defense projects where the UK Government is the end-user; and U.S. Government end-use.

No Licenses Required

The treaty establishes a framework for exports of defense articles and defense services without a license or other authorization from the U.S. State Department's Directorate of Defense Trade Controls (DDTC) to entities within an “Approved Community.” Transfers outside the Approved Community would remain subject to DDTC licensing and unauthorized transfers would constitute violations of the Arms Export Control Act.

The treaty defines “Defense Articles” as “articles, services and related technical data, including software, in tangible or intangible form, listed on the United States Munitions List of the International Traffic in Arms Regulations, as modified or amended.” This definition applies to both U.S.- and UK-origin items, thus obliging the UK to observe the U.S. Munitions List as DDTC may interpret and apply it.

The “Approved Community” of entities eligible for license-free exports will consist primarily of agencies or facilities of the two governments. Identified nongovernmental UK entities (i.e., companies) may be eligible if they meet agreed eligibility requirements, are accredited by the UK Government according to treaty implementation arrangements, and the parties mutually agree to include them on an approved list. UK Government employees and employees of eligible UK entities may have access to defense articles (which would include, for example, exports or deemed exports of controlled technical data) if they meet certain criteria including UK security accreditation and need-to-know.

The U.S. Community includes companies that are eligible to export under U.S. laws and regulations, including registration with DDTC. The UK Government will not require licenses to export defense articles to members of the U.S. Community, and may permit such exports under blanket or open authorizations.

Retransfers and Reexports Still Require Authorization

Under the treaty, U.S. Government authorization would not be required for “transfers” that take place within the U.S. or UK Approved Communities. However, “retransfers” to an entity in the UK that is outside the UK Approved Community or “reexports” to a location outside the UK will require UK Government authorization. Before approving such a retransfer or reexport, the exporter will be required to provide the UK Government with supporting documentation including U.S. Government approval of the retransfer or reexport. Exports from the U.S. to an entity or facility outside the UK Approved Community would continue to require licenses as before. Unauthorized retransfers and reexports from the UK Approved Community could violate both U.S. and UK law.

Implementation of the Treaty

Although the treaty is self-executing upon ratification, it will be necessary for DDTC to adopt implementing regulations to identify which defense articles are eligible. Potential exporters will also need to know whether the proposed recipient is eligible and the proposed project is within the scope of the treaty. Exporters who ship under the treaty will be required to maintain records, and each government may establish procedures for notification to legislative bodies, including advance notification of certain exports. Each government will maintain enforcement authority for exports, transfers, retransfers or reexports outside the scope of the treaty.

Implementation of the treaty in the UK will likely be swifter than in the U.S. The treaty has been presented to the Parliament, which will have 21 sitting days to approve or deny the treaty. The U.S. Administration has requested the Senate to ratify the treaty promptly with the aim of finalizing implementation arrangements by the end of 2007. The Senate, however, has not yet scheduled legislative action.

U.S. - Australia Treaty

On September 5, 2007, President Bush and Australian Prime Minister John Howard signed the U.S.-Australia Treaty on Defense Trade Cooperation. The text of the treaty has not been published, but documents released by Howard's office describe the treaty in terms that are similar (if not identical) in concept and content to the U.S.-UK Treaty. The U.S.-Australia Treaty is intended to provide a “comprehensive framework for two way trade between Australia and the United States in defense articles, including equipment, spare parts, services and related technical data, within an ‘approved community’ of government facilities and private companies in the United States and Australia without the need for licenses.”

Like the UK treaty, the Australia treaty will apply to articles, services and related technical data required for combined U.S. and Australian military or counter-terrorism operations and cooperative security and defense research. The approved community will include the U.S. and Australian governments and companies in both countries that have been qualified to receive license-free exports under the treaty. Implementing arrangements will specify what articles will be covered and details including qualification criteria.

Neither the U.S. nor the Australian government has provided a time line for implementation of the treaty, other than a statement of general intent to present it to their respective legislatures and to develop implementing arrangements promptly thereafter.

Potential Benefits to Industry

The documents released by Prime Minister Howard's office highlight the benefits of the treaty to Australian industry by opening new avenues for industrial cooperation and allowing for effective partnering and technology sharing. For example, although the treaty will not address procedures for exports under the Foreign Military Sales (FMS) program, it will permit the transfer of equipment to members of the approved community facilitating the involvement of Australian companies in support work. A particular benefit will be timely access to U.S. technology and the ability to share technical data without the need for an export license, which will reduce lead times in discussing potential business opportunities and improve the prospects for Australian companies seeking to participate in U.S. defense programs.

Prospects for Implementation and Ratification

Although the text of the UK treaty focuses on defense cooperation between the two governments, the UK treaty will facilitate broader cooperation between the U.S. and UK defense industries, just as the explanatory materials from Prime Minister Howard's office emphasize the benefits to Australian industry. For defense manufacturers in both the UK and Australia, bypassing cumbersome ITAR licensing requirements will offer significant benefits. The extent of these benefits will depend on how the treaties are implemented. Access to technical data by third-country nationals or dual nationals, even if eligible under UK or Australian security requirements, will need to be clarified. Narrow lists of defense articles or specifically identified programs or restrictions on companies in the UK and Australian Approved Communities will limit the utility of the treaties and turn them into elaborate variations on previous unsuccessful efforts to facilitate defense trade through the little-used bulk licensing arrangements for major projects, major programs or global authorizations in ITAR § 126.14. If implemented broadly, however, the treaties could establish a model, offering the prospect of a license-free zone for countries whose security policies are fully aligned with those of the United States.

Senate ratification of the treaties is not a certainty and the Administration may not have sufficient political capital to overcome objections at this late stage in its second term. The Administration's failed effort in 2004 to amend the Arms Export Control Act to exempt exports to the UK and Australia from ITAR license requirements does not give cause for hope. UK and Australian companies with a stake in the ratification of these treaties should engage resources quickly to press for early Senate action.

— by Christopher R. Wall, Thomas M. deButts, and Ada L. Loo, Pillsbury Winthrop Shaw Pittman LLP

To contact the authors, visit pillsburylaw.com

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