Historically, international trade regulation has swung between economic protectionism and national security concerns. Between World War II and the 2018 presidential election, the primary international trade regulatory issue from the United States was related to national security and ensuring adversaries did not have an equal or competitive advantage in technical superiority. During this same period, there were significant advances in global supply chains, where nations concentrated on comparative advantages related to natural resources, technological narrowing, or labor.
Since 2018, economic protectionism utilizing international trade regulations has significantly increased. This has led to the increased emphasis on “nearshoring” or “friendshoring.” Nearshoring is the process of moving scattered global supply chains across the world to be centered in North America to avoid international uncertainties and take advantage of the US Mexico and Canada Free Trade Agreement (“USMCA”). Friendshoring expands this concept to concentrating supply chains in countries that have deep alliances with the United States. The “list” for this is primarily identified by the Committee on Foreign Investment in the United States (“CFIUS”) because, if the country is exempt from CFIUS, then it is considered to be the closest of allies that have trade controls (and policies) that mirror the United States. Currently, this is Canada, the United Kingdom, Australia, and New Zealand. The next groupings would be any country in NATO and Japan.
The key, though, is an integrated supply chain that is primarily domesticated in the United States, hence the increase in incentives to build research and manufacturing facilities in the United States and only rely on friendly countries. In essence, the increase costs related to labor and parts from not having a global system is offset by the government incentives.
In addition to significant economic incentives, this policy is primarily carried out via the United States export and sanction compliance agencies, who have significantly increased more stringent requirements and enhanced related enforcement. Companies will need to understand the policy decisions between such increased regulation and enforcement, especially as it is related to China, in navigating competitive advantages that depend less on global supply chains and more on domestication.
I. The Regulation of International Trade Impacts Every Industry
As exemplified by the COVID-19 Pandemic, there is no industry that is not impacted by the global supply chain and the related international trade regulations. For example, United States hospital systems, government agencies, and businesses were impacted by the shortage of personal protective equipment, such as masks, gowns, gloves, or hand sanitizer. In addition, the concentration of the international semi-conductor industry in China and Taiwan raised significant concerns among all industries because the shortage of semi-conductors impacts the production of technical equipment, vehicles, and modern machinery.
So, even though a service company, such as a law firm, may purchase equipment and goods domestically, the reality is that those items usually have a long global supply chain tail that may see an item, such as a vehicle, cross borders multiple times during the manufacturing process before it is ever delivered to the eventual end-user. As such, when international trade regulation is changed – such as with tariff duties or value added taxes – the quality and costs of items and goods is impacted, sometimes immediately and other times incrementally. When such regulation is modified to impact international and domestic policy – such as with the United States’ decoupling from China policy – the changes can be drastic for those companies not prepared to assimilate.
II. The Committee on Foreign Investment in the United States
CFIUS continues to be the most favored vehicle in limiting foreign investment related to critical technologies – especially in relation to China. Generally, CFIUS is a government body that has authority to review transactions that could result in foreign control of a U.S. business. CFIUS’ review authority has expanded to include certain noncontrolling transactions that impact such critical technologies. Any company considering a merger, sale of assets, or joint venture that entails the transfer of technology will need to understand the impact of CFIUS oversight and the need to allocate appropriate risk.
The main legal issue is the scope of “mandatory” declarations for certain transactions related to critical technologies. The mandatory disclosure depends on whether certain U.S. government authorizations would be required to export, re-export, transfer (in country), or retransfer the critical technology or technologies produced, designed, tested, manufactured, fabricated, or developed by the U.S. business to certain transaction parties and foreign persons in the ownership chain. Under this criterion, a company would likely be required to submit a declaration, even if an International Traffic in Arms Regulations (“ITAR”) or Export Administration Regulation (“EAR”) exception or exemption applied.
In addition, the scope of control based around “substantial interest” for a foreign entity is a required element in determining indirect ownership interests that trigger a CFIUS disclosure. The reality is that even if “negative control” exists and there is access to critical technologies, CFIUS will have an interest in ensuring adequate safeguards and protection from technical exports to foreign entities.
Although, there is a focus on critical technologies, CFIUS is also concerned about the make-up of the parties to a transaction. So, even though the technology may be “old,” the fact that certain companies from specific countries are involved may raise significant concerns that put any deal at risk. In addition to the involved parties, CFIUS is also concerned with domestic real property transactions, especially those near government facilities and military installations, and utility companies. Also, even if there is no technology that is a part of the transaction, CFIUS is wary of the transfer of personal identifying information, such as patient records or financial data. For example, a bioscience firm that does not directly treat patients, but only collects patient data as a part of clinical trials, may be subject to CFIUS.
As such, companies should consider evaluating their export policies and, if appropriate, implement CFIUS and other export control specific policies. In any transaction involving foreign ownership, technology license, or joint venture arrangement, companies should consider the impact of such policies. But, by the time companies begin negotiating such deals, it may be too late because the company may have engaged in transactions that may raise suspicion during any review period. This is especially the case in M&A or asset purchase deals, where the seller may not have had any compliance program and yet wants to shift the risk to the buyer for past transaction.
CFIUS compliance should be one of the first discussion points between would be dealmakers. There are strategies that could mitigate risk, such as an independent board of directors, technology control plans, firewalls, or the selling of concerned technology or business units to a company solely owned by U.S. persons.
III. The Realities of Exports Controls Impacting Supply Chains and Professional Migration
In addition to CFIUS, there are several agencies involved in the enforcement of export controls. These agencies have taken a primary role in national security and economic protectionism, especially in relation to the China decoupling policy and ever-changing international trade regulations related to the Russian invasion of Ukraine.
A. Bureau of Industry and Security
The Bureau of Industry and Security (“BIS”), an agency of the U.S. Department of Commerce, focuses on protecting U.S. security by preventing the spread of U.S. technology and military weapons to terrorists and certain foreign regimes. BIS regulates the export of sensitive goods and dual-use technology; enforces export control, anti-boycott, and public safety laws; and promotes policies to stop the proliferations of weapons of mass destruction. In addition, BIS assists U.S. industry in following international arms control agreements, encourages the development of a strong defense industrial base to create new technologies, and promotes public private partnerships to protect the U.S.’ infrastructure. BIS continues to play a large role in international trade compliance as more countries and foreign regimes are regulated under the EAR.
Amongst multiple published policy guidelines, BIS has issued a memorandum that announced a stricter Administrative Enforcement Program. This is particularly relevant as the war in Ukraine continues, as the ensuing sanctions packages are only enhanced – especially when combined with export sanctions by other countries. Notably, the enhanced penalties and related policy changes announced by the BIS memorandum apply not only to Russia and Belarus, but to the entire U.S. export controls regime. Companies should be aware of the BIS guidance and the heightened enforcement environment due to ongoing national security threats precipitated by illicit acquisition of U.S. technology.
One of the most noteworthy recent BIS policy changes is the publication of administrative charging letters. Previously, these letters were issued privately to the violator and were only shared on a need-to-know basis. For example, the letters were historically shared with counsel to obtain legal advice. Administrative charging letters usually did become public, but not until the violation was completely resolved. As the memorandum references, this process often lasted years. Under the updated policy, administrative charging letters will be made public when filed. Moreover, they will be easily accessible via the BIS website. The stated purpose of this change is to “spark urgency” to upgrade compliance programs or to submit voluntary self-disclosures (“VSD”). Consequently, company compliance officers may want to consider monitoring the published administrative charging letters, potentially adjust policies and procedures accordingly, or consider submitting a VSD if prior actions would be implicated by the published charging letter.
Among the most striking policy changes announced by BIS is the elimination of the “No Admit, No Deny” settlement agreements. These types of settlements, which are readily used by various government agencies interested in expediting resolution of a matter, traditionally permitted entities, and individuals to resolve export violations without admitting to the underlying conduct. It is the equivalent of a “no contest” plea in a criminal action. An enticing benefit of entering into a settlement agreement is the resulting penalty reduction. Under the updated policy however, an exporter cannot enjoy the benefits of resolving a violation via a settlement agreement without admitting to some wrongdoing. According to the memorandum, the timely publishing of details of specific conduct leading to a violation encourages others to “modify their behavior to prevent similar outcomes.” This may have a chilling effect on the ability to settle such matters in the future due to other factors, including breach of supply chain contracts, loss of other business, and potentially even loss of goodwill in any potential sale of the company.
Finally, in an attempt to resolve the backlog of pending administrative matters, BIS will offer non-monetary settlement agreements in limited instances. Only violations where the conduct was not deemed “egregious” or did not result in serious national security harm are subject to this updated policy. As detailed above, an admission of wrongdoing is required. Among the non-monetary remedies set forth by the memorandum is the imposition of a suspended denial order. As is routine, suspended denial orders include terms that if violated, trigger the full effects of the denial order. For instance, the settlement agreement may require implementing or upgrading compliance programs and trainings. Generally, the aim of these terms is to mitigate past violations and prevent future ones.
Companies engaged in international trade may want to review the guidance and consider taking action to review policies, procedures, auditing, and training. Combined with the ever-changing sanctions – especially related to the Russian invasion of Ukraine, compliance with export controls and sanctions is growing more complicated and leading to significant risk for those interested in international trade or global supply chain opportunities.
B. The Office of Foreign Assets Control
The Office of Foreign Assets Control (“OFAC”) is an agency within the U.S. Department of the Treasury. OFAC administers economic and trade sanctions against foreign states, organizations, and individuals in support of U.S. foreign policy and national security goals. OFAC operates under the president’s emergency powers to impose controls on foreign transactions and freeze assets under U.S. jurisdiction, such as the now famous Russian sanctions that have caused significant ripples through the international energy trading circles. OFAC also develops regulations to direct financial institutions on correctly adhering to the sanctioned regimes.
Maybe only second to CFIUS, OFAC has been the preferred agency to address national security issues and address foreign policy concerns. As discussed above, international trade control is usually concentrated on national security, with economic policy making gains since 2018. However, international trade regulations are also utilized to influence foreign policy. For example, OFAC regulates the international finance system and prohibits certain transactions between U.S. banks and foreign banks, most notably with Iran and Russia. Although national security may play a part in the sanctions, OFAC is primarily used to influence foreign policy and work toward changing a foreign government’s behavior.
OFAC enforces its powers through various country-specific trade sanctions and restrictions on various companies or individuals. Although other agencies have prohibition lists, OFAC’s sanction list is the most comprehensive. As such, companies should have a screening process in place to ensure that its supply chain does not include countries, entities, or individuals that are prohibited. Even if a transaction is innocuous (e.g., the transfer of monies), the penalties for violating the OFAC regulations are significant and, in many cases, will lead to coattail actions by other countries that have similar international trade regulations in place.
C. The Directorate of Defense Trade Controls
Similar to BIS, the Directorate of Defense Trade Controls (“DDTC”) controls the export/import of defense articles and services under the U.S. Munitions List, in accordance with the Arms Export Control Act and the ITAR. DDTC works to help the U.S. defense trade support both national security and foreign policy interests, and to prevent America’s enemies from accessing our defense technology. In order to manufacture and export certain technology, U.S. defense firms must register and, in most cases, receive a license from the DDTC.
DDTC has been increasingly active in enforcement of technology export controls as it is related to China and Russia. Specifically, combined with economic incentives from the Inflation Reduction Act and the CHIPs Act, DDTC’s efforts have been significant in encouraging supply chains that support national security efforts to domesticate in the United States or, at the minimum, allied countries such as Canada, the United Kingdom, or Australia. In essence, the economic incentives to domesticate are the carrot and DDTC enforcement of technology controls is the stick related to the United States’ decoupling policy related to China.
In addition to having policies and controls related to technical transfers, it is important that companies have correct item classifications. With export control reform in 2014, many items and services were transferred from DDTC jurisdiction to BIS’ purview. However, markings associated with such changes have not necessarily caught up with the reforms, leading to confusion and potentially unnecessary disclosures. The main takeaway is that if a company is involved in military or aerospace industries (directly or indirectly), understanding the company’s items and services from the government’s perspective is vital.
IV. Trends in International Trade Compliance in Relation to Repositioning Global Supply Chain
As relations with China continue to sour and the Russia-Ukraine conflict continues, the United States and allied countries in Europe and Asia will continue to enhance enforcement of ever-changing international trade regulations. The various government agencies have put out significant guidance that reiterates the importance of voluntary disclosure reports when a mishap occurs. The enhanced enforcement will occur internationally, with different governments working collaboratively to enforce each other’s regulations.
Nevertheless, the enforcement domestically will continue to increase. This enforcement will take place on multiple fronts from directed disclosures, subpoenas, or “friendly” site visits where agents appear at facilities or contact employees directly about specific transactions. Company monetary penalties will increase, but the government has also reinforced that companies cannot settle while there may be individual (usually senior management) liability.
In regard to the on-going tariff increases, primarily with China, or in dealing with the Buy American Act, which is a major requirement for the CHIPs Act and the Inflation Reduction Act, there are strategies to minimize risks and costs. For example, when goods are assembled primarily in the United States, they still may qualify for the Buy American Act. To avoid the duties associated with the imported parts, the assembly could take place in a Foreign Trade Zone (“FTZ”). In fact, operating in a FTZ may also enhance other economic incentives, at the State and local levels, which will in turn entice federal incentives. It is these incentives that will entire the nearshoring of the supply chains and decoupling from China.
V. Now What?
In any investigation (not just dealing with international trade compliance), the first questions do not necessarily revolve around the narrow facts presented. Instead, the initial inquiry is about the compliance program, whether training occurred, whether audits are conducted, whether a hotline is in-place, and whether the appropriate standards of conduct clauses are in the pertinent agreements with either a vendor (consultant or supplier) or a customer (or third-party distributors or resellers).
In proactively creating and supporting an international trade compliance program, a company will need to appreciate which government agencies have jurisdiction over its products and services (and what classifications are applicable). For the companies that are primarily domestic, understanding the impact of the international trade regulations on the global supply chain is important from an operational (and cost) perspective. In evaluation expansion of facilities or moving into new markets to handle research and manufacturing, international trade controls will be significant issues to address and ensure that agreements have the necessary terms to mitigate risk. Further, “know your customer” that financial institutions have dealt with for years will significantly trickle down to all entities, which will require companies to understand the full extent of their supply chains. Finally, in the event a potential mishap occurs, determining what the plan would be to review the issue and possibly report to the applicable agencies proactively is a standard planning discussion for any crisis management strategy.
