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Are You Up to Date on Export Compliance?

August 18, 2008
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Have you encountered customs agents, customers and other third parties inquiring as to whether your company is registered with the State Department? To participate in a global aerospace and defense industry, your company must maintain a compliant export control program. To export defense articles or technical data, companies must remain compliant with regulations enforced by the US State Department (State), US Customs Agency, Department of Commerce (Commerce), the Office of Foreign Asset Control (OFAC), Homeland Security and the Census Bureau among others. This process usually begins with registering with State.1


In October 2005, we presented a guide to help you learn the basics of complying with the United States export laws, including ITAR, the International Trade in Arms Regulations promulgated by State, and enforced by the Directorate of Defense Trade Controls (DDTC). Also presented were the Export Administration Regulations (EAR) promulgated under Commerce and enforced by the Bureau of Industry Security (BIS). With this update, the intent is to provide current web links and more details on dealing with foreign nationals.

Proper export controls demand expert training of your staff from executives to sales to engineering to shipping. If your company sells products internationally or has employees who present to international audiences, it should establish an export compliance program that includes internal and external training of all applicable employees on a regular basis. These mechanisms will serve as the first line of defense against an export audit.

Is an Export License Required?

Companies must determine whether an export license will be required by one of the federal agencies before shipping the products or technical data (see sidebar) to a foreign end-user, or before re-export from one foreign location to another. Note that export licenses control the products or technical services you plan to export, not the purchase orders (so, on a single purchase order some products or service items may require a license while others do not).

Penalties for Exporting without a License

The penalties for exporting without a license may be severe, including both criminal and civil penalties to the corporation and even the individuals involved. Convictions for exporting without a license can bring multi-year prison sentences and fines of $50,000 or more per violation. In this post-9/11 environment individual indictments are a key tool that export officials continue to use to demonstrate the heightened scrutiny the US is placing on export compliance to ensure security.

Several US companies have received penalties for export violations, many of which received multi-million dollar fines. US companies found guilty of violating the various laws will generally be debarred from exporting for three years, and may be debarred for much longer.

US export enforcement agencies do have authority to inspect shipping docks and seize shipments. They do so with “guns and badges” enforcement agents. Such an experience can be very damaging to a company, from the perspective of its employees, its customers and its local community. For public companies this damage can have an order of magnitude greater impact on investors and the Street. How long before stock prices and profits recover following a severe penalty due to export violations? Severity is the key, to be sure. In 2007 one company found out that $100 M was the definition of severe.

The Art of Product Classification

Whether a company sells products or services to a global market, a team of engineers, sales and export professionals should develop an export classification of every product or service it offers from the genesis of development. The State Department uses both the Arms Export Control Act (AECA) and the International Traffic in Arms Regulations (ITAR) to control exports. Services offered overseas in support of foreign military or space activities will be more easily identifiable as defense services governed by the ITAR than will RF and microwave component hardware.

Product classification has become more of a right brain exercise than expression of logic. After first analyzing the prose known as the United States Munitions List (part of the ITAR),2 classification teams must then study the poetry of the ten categories of the EAR-primarily Category 3A for most RF and microwave components, which surely would be more interesting if it were written in iambic pentameter.

Even when this work of art is understood, the “See Thru Rule” starts bleeding through presenting a whole new picture. If you are classifying a microwave assembly, for instance, something as small as a field effect transistor (FET) used in the assembly of your circuits can cause your end product to come under control of the ITAR if the FET itself is classified under the ITAR. If your customer is classifying a jumbo jet, something as small as a microwave chip assembled in the cockpit avionics can render the jet ITAR controlled. Only literature can get away with such non sequiturs, it would seem.

Beware the nature of what defines whether an item is “specifically modified or designed” for one of the major defense articles listed in the USML categories (e.g., aircraft, submersibles, spacecraft, etc.). Each USML category has a catch all definition designed to include in the category and hence make subject to the ITAR any component or subassembly “specifically modified or designed” for the major category item, plane, submarine, satellite, etc. The art lies in interpreting this elusive clause and hence the need to study the genesis of the item subject to classification.

If the product emerged through the result of the creativity of your research and development team, essentially from scratch, and your first sales of the item were for commercial purposes, then it is more likely the item should be classified under the EAR rather than the ITAR. If those first sales were for military uses, however, then the item may well be classified as ITAR controlled. You should pursue “specifically” as though you were defining what is meant by “it”. Perhaps your team designed with dual uses in mind, both military and commercial. Perhaps space applications would be applicable, as well. This “dual use” nature of the product may weigh in your favor when State considers the product classification.

Naturally, the plot thickens when we attempt to deconstruct what is meant by the term, “specifically modified” for military purposes. Again, dual use may trump the notion that an item was modified specifically for a military use. The real debate depends on whether you examine “modified” from the inside, outside or upside down.

To determine whether a product is specifically designed or modified for a military application, State uses a special standard of review. This standard of review requires an analysis of why a product was originally designed. That is, what is the genesis of the model? Was the model originally created to meet a specific military or space requirement considered a military use?

Take, for instance, hybrids or any chip and wire assembly where an established history shows plenty of commercial sales of a parent product. Derivatives of the parent product become the focal point: How were they modified? Inside, the modifications may simply involve tuning, moving of wire bonds to affect performance, swapping die to increase or decrease performance, or perhaps turning torroids on end to accommodate additional wraps. Outside, modifications may consist of smaller footprints for packaging, painting characteristics, or connector types. Upside down characteristics that might be modified include longer leads, changing to surface-mount packages, or getter material under the package lids.

The more standard options a parent model has from its genesis in design, the less likely a modification will cause EAR products to become subject to the ITAR. Conversely, the more custom options required to bring a parent model into compliance with the military or space application, the more likely it will become ITAR controlled and subject to export licensing requirements. Commonly, the State Department will look to whether a product was designed based on a customer’s specification, including form, fit and function, not just performance.

The phrase “configured” also appears in the components clauses on the USML. For a product to be configured for military or space, State looks to whether the design requires a different arrangement of the product that is specifically for military or space use. That raises a live issue as to whether putting a standard device through various screening levels really rises to the level of “configured,” especially where the device structure is not arranged for this application. Take note that “radiation hardening” is a level of screening that does alter the product enough so that it may be captured by the jurisdiction of either State or Commerce, depending on the level of rads applied.

Commodity Jurisdiction Letter

If you are not sure whether the USML covers your products, you may wish to seek a Commodity Jurisdiction (CJ) letter through State. This process will require submittal of evaluation materials for State to review, and State will use a cross-functional set of agencies (including Commerce) to ensure it determines jurisdiction accurately. Once State determines whether it has jurisdiction over your products, it will issue a CJ letter to your company explaining whether State or Commerce has jurisdiction.

You must hold all purchase orders and technical data from processing until a CJ letter is secured from State, unless otherwise authorized to proceed without the CJ letter concurrently with the CJ letter request (that is, some long lead-time orders may begin concurrently with a CJ letter request). Companies may also seek State export licenses for items submitted for CJ review in order to legally ship the items to meet schedules without creating a precedent that the item is ITAR controlled. Management and legal shall consult with the State Department’s Response Team in further determining whether the products or technical data in question are on the USML.

If you are certain that your products or technical data are not covered by the USML, then the Department of Commerce will most likely have jurisdiction.

Jurisdiction Under Commerce

The regulations promulgated by Commerce are called the Export Administration Regulations, or EAR. The EAR contains a helpful flowchart, shown in Figure 1, by which export managers may determine whether a license is required by Commerce prior to exporting products or technical data. The flowchart contains steps covering commodity classification, “bad guy & country” checklist reviews, and whether an export license is required. The Bureau of Industry & Security (export enforcement division of the Department of Commerce) offers outstanding training seminars and they are presented in major metropolitan areas nationwide.

Primarily, under the EAR, you must classify your products against the Commerce Control List to see if they have an Export Control Classification Number (ECCN) or will be designated as “EAR99”. Most RF and microwave products will fall under Category 3, but you should study all CCL categories to see if your products are listed elsewhere. Where products are not listed as having a designated ECCN, a catch-all phrase at the end of each category will state: “EAR99 Items subject to the EAR that are not elsewhere specified in this CCL Category or in any other category in the CCL are designated by the number EAR99.”

Where doubts persist, seek guidance from management, engineering and legal to properly classify your products. For the latest CCL online visit: www.access.gpo.gov, click on Part 778, and then on your specific product category.

Again, as you can see by the flowchart, just because you have classified products as EAR99 does not necessarily mean that the products may ship as no license required (NLR). You still must consult several prohibitions checklists to determine whether a license is nevertheless required.

Crucial Steps Under the EAR

There are ten General Prohibitions listed in the EAR. The first three apply to all ECCN classified products, and Prohibitions 4 through 10 apply to both ECCN and EAR99 classifications. Consult the latest EAR and
these General Prohibitions at http://www.access.gpo.gov/bis/ear/pdf/736.pdf to ensure compliance with all ten items, when applicable to the classification of the product to be exported.

In some circumstances, a Destination Control Statement is required where product was classified above as having an ECCN (NOT “EAR99”). A Destination Control Statement advises the recipient of US origin products of their legal responsibilities and restrictions under US export and re-export regulations.

When a Destination Control Statement is required, place copies of this Statement on all copies of the invoice, bill of lading, airway bill, or other export control document that accompanies the shipment from its point of origin in the US to the ultimate consignee or end-user abroad.

General Prohibitions number five contains a Red Flags list. Always consult the Red Flags list as defined by BIS at http://www.bis.doc.gov/to ensure all aspects of the End-Use Certification and other leading indicators of suspicious activity are captured before you export or transfer technical data.

Special Considerations

“Technical Data” has been referenced throughout this article along with products because exporting technical data to a foreign national may create a “deemed export” under both State and Commerce. Foreign nationals include your foreign representatives, foreign customers and even your foreign employees who are not permanent residents (e.g., residing and working here in the US on visas).

Consider the difficult circumstance arising when selling to Canadian companies, where Canada allows dual citizenship and human rights laws prevent Canadian companies from exploring the origins of employees. If we are to ensure that we do not export technical data to embargoed countries, foreign nationals, and certainly foreign nationals from embargoed countries, then how are we to reconcile selling to Canadian companies that may be unaware of employee national origin or dual citizenships? Recent cases include the Quebec Human Rights Commission settling with one Canadian company for asking for the birth place of a Haitian-born dual citizen of Canada. Haiti happens be to on the US embargo list, prohibiting any export of technical data to such person, and an export license application to do so would be denied.

Though not an export issue, per se, beware the Foreign Corrupt Practices Act (FCPA), the net of which continues to capture many unsuspecting US companies and individuals for violations of US-owned foreign subsidiaries and sales representatives abroad. The FCPA prohibits payments to foreign state-owned companies, foreign officials and their family members. The state-owned element makes doing business in China especially risky where US companies are not certain of Chinese private ownership. The reason is that “business” under the FCPA constitutes almost any form of value given to obtain or retain business, even administrative or regulatory efforts such as the paying of taxes and customs duties.

In a market shrinking due to mergers and acquisitions, both target and acquiring companies should increase due diligence in the area of export compliance. Proper due diligence contributes to drafting merger and acquisition agreements with sufficient protections against past export violations of either party, including representations, warranties and even indemnifications. Some agreements have been drafted to exclude export violations from deductibles, and companies with tight compliance policies will draft for FCPA and anti-boycott violations, as well. Again, ensuring compliance begins with proper product classification, including the products of acquired companies.

Compliance Programs

To ensure compliance with all US export laws, and to follow Commerce’s flow chart in detail, all companies in the RF and microwave industry should implement an Export Compliance Program. Even where a company has exported only “EAR99” classified products under the EAR, a compliance program can help prevent shipping EAR99 product to embargoed or restricted countries, denied persons and specially designated nationals. Note that even EAR99 classified products may require a license to export.

A solid compliance program should contain procedures on acquiring an end-use certification (EUC) from your customers. The EUC will help you determine whether the customer intends to re-export your products, which could in turn violate US export laws. Periodically, State and Commerce enforcement agents will travel abroad to follow your products to their final destination. If your products require an export license to the end-user or country, you and your company are ultimately responsible and liable for the product arriving there legally (with an export license when required).

The compliance program should also require your employees to run verification checks against the screening lists of “bad guys” and restricted countries. See the sidebar for screening list web sites, and note that several companies offer export control software systems that streamline this screening process through a single interface. Do not assume that because your company does not ship to the “bad guys” that you are clear of liability for an export violation. Many cases exist where products are re-exported from an unrestricted country to a final destination or party without a license where one was required by a US agency.

These lists should be checked at the time an RFQ is received and again when an order is received, or when you suspect a foreign national may acquire technical data or plans to visit your facility, and prior to all international shipments. An authorized, trained export employee should check the name of the end-user, freight forwarder, distributor and end-use country against these lists. If a match exists, this employee should have authority to hold up a shipment, and you must seek an export license immediately. Obviously, the sooner these checks occur prior to product sitting on a dock, the better.

Training

A successful compliance program absolutely must have a periodic training component to ensure that authorized export control personnel have sufficient and on-going training. Training should be provided for your company’s specific export procedures, from product classification to shipments, as well as third party training programs offered by the US agencies, law firms and export consulting firms on the new changes and trends to the export laws.

Audits

Because export laws and the “bad guy lists” are constantly changing, your export compliance program should be reviewed by qualified, trained staff including in-house counsel, or outside legal or consulting firms, or all of the above. When seeking counsel, note well that “international lawyers” may not be well versed in the ITAR and understand product classification, and how to deal with State. Discriminate on choosing counsel to ensure they are experts on the same.

Record Keeping

The final element to implementing a successful export compliance program is to require record retention. All records associated with the review of each export, re-export, deemed export, or exports conducted under a license exception, should be retained by the company and the responsible individuals for five years from the date the item is exported (i.e., the shipment or technical data actually leaves the United States, not just the company’s dock or facility, or is re-exported from a foreign country). These records should include but not be limited to end-use certifications, commercial invoices, copies of Shipper’s Export Declarations, Destination Control Statements, air waybills or bills of lading, and any internal export control forms, logs and checklists the company uses in its compliance program.

Under the new Federal Rules of Civil Procedure, companies are now under fire to ensure they retain e-mail in accordance with retention schedules. Ensure that your compliance program includes electronically stored information as part of its record keeping—an e-mail may be your best or only defense.

Voluntary Disclosures

Each of the enforcement divisions for the agencies discussed in this article offer voluntary disclosure programs where companies discover exports occurred without a license though one was required. Voluntary disclosures are often treated by the agencies as mitigating factors in the penalty phase of enforcement. While penalties may be reduced, they are nevertheless levied in many cases due to the seriousness of export control violations and in the interest of national security.

Other Agencies Controlling Exports

Generally, OFAC controls transactions with respect to finances, but OFAC also controls any shipments through or to embargoed countries or shipments using embargoed country vessels. Therefore, certain payments made to your company under international purchase orders may come under the jurisdiction of OFAC as may shipments of your company’s product that may be transported on embargoed country carriers or vessels. Note well the danger of using a Cuban-owned vessel to transport goods even to a NLR country or party.

The Office of Antiboycott Compliance enforces US law prohibiting US firms from recognizing a foreign boycott not sanctioned by the United States. The Arab League boycott of Israel is the principal foreign economic boycott that US companies must be concerned with today. The antiboycott laws, however, apply to all boycotts imposed by foreign countries that are unsanctioned by the United States. The antiboycott rules prohibit companies from entering into:

    • Agreements to refuse or actual refusal to do business with or in Israel or with blacklisted companies

    • Agreements to discriminate or actual discrimination against other persons based on race, religion, sex, national origin or nationality

    • Agreements to furnish or actual furnishing of information about business relationships with or in Israel or with blacklisted companies

    • Agreements to furnish or actual furnishing of information about the race, religion, sex, or national origin of another person.

There are some key reporting requirements for your company under the antiboycott laws. Management must submit quarterly reports showing requests employees received in the previous quarterly period to take certain actions to comply with, further, or support an unsanctioned foreign boycott. Under the Tax Reform Act, Management must also report “operations” in, with, or related to a boycotting country or its nationals and requests received to participate in or cooperate with an international boycott. The Treasury Department publishes a quarterly list of “boycotting countries.”3

The US Census Bureau, through its Foreign Trade Division and the US International Trade Commission, controls exports to the extent that it requires a commodity number classification for virtually every commodity or material exported. The Census Bureau uses these classifications to simply count total commodities exported. This classification system is known as the Harmonized Tariff Schedule (HTS). Consult the latest HTS to classify your company’s
products to be exported and assign each product a corresponding HTS
number: www.usitc.gov.

The Office of Management and Budget (OMB), meanwhile, governs the North American Industry Classification System (NAICS, pronounced, “Nakes”),4 which also requires counting those commodities made in Canada and Mexico. However, the intent of NAICS is to capture data on the manufacturers and producers of commodities more so than the commodities themselves. Consult the latest version of NAICS to classify your company’s products: www.census.gov. When shipping documentation and catalogs or other items that are not manufactured goods, review NAICS for their separate classification numbers.

Seek Legal Advice

This article is intended to provide the reader with accurate and authoritative information regarding export compliance. This article was not published as legal advice. If you require legal or other expert advice, you should seek the services of a competent attorney in your jurisdiction or another export professional. Many communities will have attorneys who practice in the area of international law, which often covers US export laws and foreign treaties. In addition, several reputable consulting firms serve companies in all areas of export compliance.

References

1. Register here: www.pmddtc.state.gov.

2. Click on the USML link on DDTC’s web site: www.pmddtc.state.gov.

3. Consult this web page to learn how to report: http://www.bis.doc.gov.

4. In 1997, the OMB revised the old Standard Industrial Classification (SIC) numbering system into the current NAICS numbering system, and then modified the 1997 version of NAICS in 2002. The 2002 NAICS is the current version to use as of the date of this publication; the next published version of NAICS was scheduled for 2007.

Shawn Cheadle is Associate General Counsel to Lockheed Martin Space Systems Company, and General Counsel to the company’s Surveillance & Navigation Systems line of business. Cheadle is a member of the Colorado Bar Association. He serves on the Board of Directors for the Association of Corporate Counsel, Colorado chapter, where he was President and Chair of the Board in 2007. He is a member of the ABA, Public Contract section and ARMA International. He also is a key member to the Dean’s Diversity Council in Colorado, where he serves on the Pipeline Working Group. He received his Juris Doctor degree from the University of Denver, College of Law, and his BA in English from San Jose State University.

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