International Client Alert, August 2006

The Chinese "Catch-All" Saga Continues
Article by Clif Burns

On August 9, the Bureau of Industry and Security ("BIS") announced a series of regional meetings on the Chinese "catch-all" rules in an effort to quell the rising tide of exporter dissent over these proposed rules which were announced by BIS in July. A meeting was conducted in Washington on July 17 at which it became clear that the new "catch-all" proposal remains as problematic as earlier proposals. Meetings were also held on August 21 in Houston and August 22 in La Jolla.

Under the Statement of Understanding on Control of Non-Listed Dual-Use Items¹ adopted by the members of the Wassenaar Arrangement in December 2003, the member states, including the United States, agreed that each member state would adopt so-called catch-all provisions. Specifically, the "catch-all" provisions would require export licenses for shipments of "nonlisted" dual-use items to countries that were subject to a U.N. or regional arms embargo when the authorities of that country informed the exporter that the items would be subject to a military end use.

A draft of the "catch-all" rules circulated by BIS for interagency review in late 2005 interpreted non-listed items to include only items listed on the Commodity Control List of dual-use products and indicated that the rules would apply not just to China but to other countries, such as Côte d’Ivoire and Zimbabwe, which are subject to U.N. arms embargos. BIS also indicated that the definition of military use would conform closely to the definition set forth in the Statement of Understanding.

The proposed rules published in the Federal Register on July 6, 2006, depart in some significant ways from public statements that BIS officials had made about the interagency draft. First, although the draft rules were said to be applicable to countries other than China, the proposed rules are limited to China.

Second, the new rules provide that licenses to export to China items which are controlled for national security ("NS") reasons to China and which are destined for a military end use will have a presumption of denial. The presumption of approval will remain in place for NS controlled items destined for civilian use. More significantly, the proposed rules set forth 47 ECCNs which otherwise would not have required a license for export to China, which will now require such a license and which will be subject to a presumption of denial. An example of such an ECCN is 1C996 which controls hydraulic fluids containing synthetic hydrocarbon oils and possessing certain specified characteristics. Such fluids are only subject to the anti-terrorism ("AT") controls and otherwise would not have required a license for export to China.

Industry critics have noted that the commodities covered by these 47 ECCNs are readily available from sources outside the United States, so that the effect of the rule will not be to impede the development of the Chinese military but rather to shift Chinese military business to foreign competitors of American enterprises. The Department of Commerce has indicated that it would be interested in receiving comments indicating the availability of these items from non-U.S. sources.

Third, the proposed rules also provide a definition of military use. Under the Wassenaar Statement of Understanding "military use" is defined as "use in conjunction with an item controlled on the military list of the respective Participating State," which in the case of the United States would be the United States Munitions List ("USML"). The definition of "military use" in the proposed rules covers the incorporation of the item into, or use of the item in connection with the development, installation, maintenance or use of any item on the USML, the Wassenaar Munitions List² or with an ECCN ending in A018.

One difficulty presented by this definition of "military use" is its overlap with the definition of "defense services," which are defined in the International Traffic in Arms Regulations ("ITAR") and which are regulated by the Directorate of Defense Trade Controls ("DDTC") at the Department of State. Under the ITAR a "defense service" is defined as the furnishing of assistance to foreign persons in the design, production, testing, operation or maintenance of defense articles. To the extent that the proposed BIS rules cover the provision of specified dual-use articles for use in connection with the development, installation, maintenance or use of a defense article, it arguably falls within the ITAR’s definition of a "defense service" because it is also clearly the furnishing of assistance in connection with design, production, use or maintenance of a defense article. Officials at the Department of Commerce have tried to dispute the existence of this overlap by noting that DDTC does not in practice interpret the sale of items to a foreign military as a "defense service." This would certainly be the case for sales of pencils or shoes to foreign militaries, but it is not clear that DDTC would not find a sale to a foreign military to be a defense service when it is expressly intended to be incorporated into or used to develop a defense article.

Fourth, the proposed rule prohibits exports where the exporter "has knowledge" that the item is intended for a military use in China. Knowledge is not expressly defined by the new rules but is probably broader than the standard set forth in the Wassenaar Statement of Understanding, which applies "when the authorities of the exporting country inform the exporter that the items in question are or may be intended, entirely or in part, for a military end-use."

Indeed, officials of BIS, in a meeting held on the proposed rules in Washington, D.C. on July 17, 2006, suggested that "knowledge" in the proposed rules not only means information supplied to the exporter by the foreign government but also covers imputed knowledge that the exporter would have upon conducting due diligence as to the ultimate end use of the exported product. Exporters should rightly fear a high risk of liability under such a broad definition of knowledge since it is frequently difficult for exporters to determine the ultimate use of products shipped to China.

The proposed rules attempt to respond to the difficulty of determining end use in China by establishing a system of Validated End Users, i.e., customers in China that would be deemed to be civilian and not using purchased items for a military use. Unfortunately, this mechanism relies on an interagency review mechanism that does not exist yet and imposes burdensome audit requirements on the VEU which the proposed VEU’s are likely to reject.

Comments are due on or before November 3, 2006. Please contact Clif Burns for more information on the proposed rules or if you are interested in filing comments on the proposed rules.

As enforcement of the Foreign Corrupt Practices Act (the "FCPA") reaches an all-time high, a new trend has emerged – the prosecution of individuals involved in overseas bribery schemes. The FCPA prohibits U.S. companies and individuals from making payments to foreign government officials in order to obtain or retain business (among other things). In 2006, not less than twelve individuals have faced some form of individual liability for their role in alleged bribes of foreign government officials.

On August 15, 2006, the Securities and Exchange Commission ("SEC") announced a settlement of civil charges brought by the SEC against David M. Pillor, the former Senior Vice President for Sales and Marketing for InVision Technologies, Inc. The SEC alleged that Mr. Pillor had failed to establish adequate internal controls to prevent the company from violating the FCPA and that he indirectly caused the falsification of the company's books and records. In the settlement agreement, Pillor agreed to pay a $65,000 civil penalty without admitting or denying the allegations.

As we reported earlier, InVision previously settled the cases brought by the SEC and the Department of Justice ("DOJ") for violations of the FCPA. The SEC’s complaint against Pillor indicated that he had authority to ensure that InVision’s sales staff complied with the FCPA; however, he "failed to devise and maintain a system of internal controls adequate to detect and prevent InVision’s violations of the FCPA."

The fine imposed on Mr. Pillor is particularly significant for corporate employees and officers with responsibility for managing overseas business opportunities or supervising the activities of foreign intermediaries. Mr. Pillor was not fined for creating or structuring a bribery scheme. Rather, he was punished for allegedly failing to implement adequate internal procedures to avoid FCPA violations. In other words, he was fined $65,000 for allegedly failing to do his job with diligence and vigor. The message for those with authority over international transactions is clear – their personal savings are on the line if they do not adequately police the people who report to them. The case further underscores the need for robust internal controls governing international business transactions and interactions with third party intermediaries.

On July 5, 2006, the SEC announced the settlement of charges against four individuals for violating the antibribery provisions of the FCPA. The individuals, John Samson, John Munro, Ian Campbell, and John Whelan, are former executives of Vetco Gray Ltd., a former UK subsidiary of ABB Ltd. Three of the individuals are citizens and residents of the United Kingdom. The SEC alleged that the individuals bribed or approved of bribes to Nigerian officials to obtain oil engineering contracts worth $180 million. The bribes allegedly took the form of cash payments and lavish gifts to Nigerian government officials in charge of awarding the contracts. The illicit payments, made between 1999 and 2001, totaled around $1.1 million.

The former executives agreed to settle the charges without admitting or denying the allegations. As part of their settlement, Samson agreed to pay $114,675 in disgorgement and penalties, and the other three each consented to a fine of $40,000. ABB Ltd. and the Vetco Gray companies separately settled criminal and civil charges arising from the same conduct in 2004.

In June 2006, Steven Lynwood Head, former president of an African subsidiary of Titan Corporation, pled guilty to a single count of falsifying a financial document – an invoice from a Titan agent for nearly $2 million which was allegedly used to support the 2001 re-election campaign of the then-president of Benin. As part of the plea agreement, the DOJ recommended a lenient sentence for Mr. Head to recognize his "substantial cooperation" with the five-year old investigation. Media reports indicate that the investigation is still on-going and more prosecutions may follow. Mr. Head’s sentencing is scheduled for September.

In August 2006, a translator working for a U.S. government contractor in Iraq pled guilty to offering a bribe to an Iraqi police officer. Faheem Mousa Salam, a naturalized United States citizen, acknowledged that he offered an Iraqi officer $60,000 to assist in facilitating the purchase by an Iraqi police training organization of 1,000 armored vests and a sophisticated map printer for $1 million. Salam faces up to five years in prison and a $100,000 fine for violating the FCPA. Salam was arrested at Dulles International Airport on March 24, 2006 after he attempted to make arrangements for the bribe with an undercover U.S. law enforcement agent posing as an Iraqi procurement officer.

Earlier this year, Richard John Novak and Blake Alan Carlson pled guilty for their role in a scheme to pay more than $43,000 to Liberian officials to provide fake accreditation to an online diploma mill. Due to the false accreditation, the online outfit was able to collect $4.7 million for over 6,000 degrees. Many of the degrees went to foreign nationals seeking entry into the United States. The trial of the conspirators is pending.

As we reported in our November 2005 client alert, the DOJ indicted three individuals, Viktor Kozeny, Frederic Bourke, Jr, and David Pinkerton, for allegedly lavishing millions of dollars worth of bribes on senior government officials in Azerbaijan. The bribes were paid to secure the privatization of the State Oil Company of Azerbaijan Republic ("SOCAR") and to permit entities owned or managed by the individuals to gain control of SOCAR. The case is pending.

For additional information on this issue, please contact Bill Steinman.

The fortunes of the controversial agreement aimed at ending the longrunning dispute between the United States and Canada continue to change. On April 27, 2006, both the U.S. and Canadian governments touted the outline of an agreement aimed at ending the long-running dispute between the two countries over trade in softwood lumber. On July 1, 2006, the governments claimed victory when they initialed a "final" agreement. Companies, however, immediately began to question the agreement. In mid-August the agreement seemed unlikely to succeed. Now, however, the Canadian government, has once again indicated it will stake its political future on the agreement by making this September’s parliamentary vote to implement the agreement a vote of confidence. The underlying dispute has resulted in the collection by the United States of approximately $5 billion in antidumping and countervailing duty deposits to date.

Most of the agreement is focused on government actions. Under the terms of the agreement, the United States will terminate the U.S. antidumping and countervailing duty orders in exchange for Canada’s assessment of an export tax when the price for lumber falls below $355. The agreement will remain in place for seven years with a two-year renewal option. In addition, it calls for the return of $4 billion of the $5 billion duty deposits paid. Of the remainder, $500 million will go to the U.S. petitioners, $450 million will go to emergency relief efforts and $50 million will go to joint marketing efforts.

However, two of the agreement’s provisions require the Canadian producers to take certain actions before the agreement can be implemented, giving the producers an effective veto. First, 95% of the importers (largely controlled by the Canadian industry) must agree to the United States retaining $1 billion of the duty deposits before the agreement will enter into force. Canadian authorities have indicated that this percentage may be lowered as long as most large companies agree. The Agreement provides that the Canadian government can make up the difference to reach $1 billion. Second, the agreement requires the cessation of all litigation. Because much of that litigation was brought by private parties, those private parties will have to accept the agreement or the agreement will fail.

Major Canadian lumber companies and several industry associations have expressed opposition to the agreement as signed; opposition that has strengthened as the result of recent Canadian legal victories in the U.S. Court of International Trade ("CIT"). A prime source of discontent with the agreement is an opt-out clause that permits the United States to terminate the agreement after one year and to initiate new antidumping and countervailing duty actions one year thereafter. Many companies consider the export tax and the U.S. retention of $1 billion too high a price to pay for a two-year guarantee. The Canadian government has stated that such provisions are normal in these types of agreements and do not eliminate the seven-year peace the agreement provides. Some companies are concerned about how the lumber content of remanufactured products crossing the border will be treated. Nevertheless, most major companies and industry associations are now on record as supporting the agreement, albeit with significant reservations.

Two recent court decisions also reduced industry support for the agreement. In the first decision, the CIT issued a permanent injunction barring the U.S. government from distributing any additional antidumping or countervailing duties collected in the softwood lumber cases to the U.S. industry supporting the orders pursuant to the Byrd Amendment. See Canadian Lumber Trade Alliance et al. v. United States, Slip Op. 06-104 (July 14, 2006). This decision establishes the remedy for a previous decision that found that the Byrd Amendment (which provides that antidumping and countervailing duties assessed will be distributed to qualified members of the U.S. industry, rather than being retained by the government) did not apply to cases against Canada. In the second decision, the CIT found that the International Trade Commission’s decision pursuant to NAFTA dispute proceedings that the U.S. industry was not injured by reason of dumped or subsidized imports (a necessary prerequisite to the imposition of antidumping or countervailing duties) was not overturned by a later decision and that, therefore, the May 2002 orders were not supported by an injury finding. See Tembec Inc, et al. v. United States, Slip Op. 109 (July 21, 2006). The second decision, if upheld, would mean that the orders must be revoked and that the United States must refund some or all of the duty deposits paid. The first decision, if upheld, prevents the U.S. petitioners from gaining a direct financial benefit in the form of government payouts from the continuing existence of the orders (they would still receive an indirect benefit arising from the existence of the orders).

If an agreement is not reached that terminates the litigation, both decisions are likely to be appealed. The Canadian Lumber Alliance litigation may continue even if the agreement is implemented because other industries also subject to antidumping duty orders are also parties to this litigation and would not be bound by the agreement. The U.S. government may well decide not to take action to implement either agreement until all appeals have been exhausted, therefore, these decisions likely will not result in an immediate cessation of the cases. Therefore, there may still be several more years of litigation, during which time duties may still be collected, and at the end of which these decisions could be reversed. Moreover, even if the orders were to be terminated as the result of this litigation, Canada faces the near certainty that the U.S. industry would immediately submit new petitions to begin the dispute all over again. As a result, the industries and governments in both countries have reasons to continue to seek a negotiated settlement.

It remains to be seen whether the July 1 Agreement will be implemented, but as of today it appears both sides will deal.

For additional information on this issue, please contact Peggy Clarke.

On August 17, 2006, the Directorate of Defense Trade Controls ("DDTC") issued on August 17, 2006, a notice announcing that there was a policy of denial for all licenses to export defense articles or defense services to Venezuela. All existing licenses are revoked. The revocation includes deletion of Venezuela from all technical assistance agreements and manufacturing license agreements involving Venezuela, including any agreement that has Venezuela as a territory. Additionally, no exemptions may be applied for exports of defense articles and services to Venezuela other than the exemption permitting temporary export of firearms for personal use (and ultimate return to the United States). This announcement more or less formalizes what was believed to have been the practice of the DDTC with respect to license applications involving Venezuela since the inauguration of Hugo Chavez as President of the country.

For additional information on this issue, please contact Clif Burns.

The Office of the United States Trade Representative ("USTR") is preparing its annual report of China’s compliance with its commitments made pursuant to its accession to the WTO. The Interagency Trade Policy Staff Committee will hold a public hearing on September 28, 2006 and is seeking public comments from interested persons. USTR is specifically seeking comments or testimony on China’s compliance in the following areas: (1) trading rights; (2) import regulation; (3) export regulation; (4) internal policies affecting trade (e.g., subsidies, standards and technical regulations, sanitary and phytosanitary standards, government procurement, trade-related investment measures, taxes and charges levied on imports and exports); (5) intellectual property rights; (6) services; (7) rule of law issues (e.g., transparency, judicial review); and (8) any other WTO commitments. USTR is specifically asking that interested persons identify unresolved compliance issues that warrant review and evaluation by USTR’s China Enforcement Task Force. Comments are due no later than noon, September 18, 2006. Persons wishing to testify at the hearing must provide both a written notification of their intent and a copy of their testimony by noon, September 14, 2006. Submissions may be made electronically (the preferred form) by e-mailing to: fr0622@ustr.eop.gov or by fax to Gloria Blue, Executive Secretary, Trade Policy Staff Committee, Office of the United States Trade Representative, (202) 395-6143. Comments are due on September 18, 2006.

For further information on this issue, please contact Clif Burns, or Peggy Clarke.

Footnotes

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