Export compliance reforms on the way for aircraft and satellite suppliers

Story

June 13, 2013

Multimillion dollar fines, criminal charges, lost business – all of these are the side effects of noncompliance with the International Traffic in Arms Regulations (ITAR). Ignorance of the law does not guarantee a pass. The ITAR is tough and rigidly enforced as it is designed to protect advanced U.S. defense technology from getting into the wrong hands.

One problem: The rest of the world is catching up to U.S. electronics expertise. U.S. defense and semiconductor suppliers often find themselves shut out on international contracts – with friendly nations, not ITAR proscribed countries like China – because foreign primes and integrators don’t want ITAR headaches and have strong alternative vendors in Europe and Asia. The U.S. government recognizes this and the Departments of State and Commerce are creating new rules and changes to the ITAR and Export Administration Regulations (EAR) to move certain technology not crucial to military programs from State’s U.S. Munitions List (USML) to the Commerce Control List (CCL).

“Since the Obama Administration announced its plans for export reform, it has moved along quite nicely and made significant progress,” says Kay Georgi, an export compliance attorney and partner at Arent Fox LLP in Washington. “Until the proposed satellite regulations came out on May 24, the latest and most significant development happened on April 16 when State and Commerce published their final rules implementing changes to ITAR and EAR. Essentially what this will do is move a very large set of controlled aircraft and aircraft parts common to State’s U.S. Munitions List (USML) Category VIII over to the Commerce Control List (CCL). Those products that move over to Commerce will now be authorized for export to 36 countries – provided that exporters meet all requirements of license exception Strategic Trade Authorization (STA). However, they will not just be able to export to just anyone. Export must be done to the approved countries and must be for the end use of government organizations such as the military, police, search and rescue, etc.

“Parts and components that are staying on the USML are those that are ‘specially designed’ for combat aircraft such as: the B-1B; B-2; F-15SE; F/A-18 G, H, and F; F-22; F-35 Joint Strike Fighter (JSF); and the F-117 Stealth jet – as well as items that are specifically called out on a positive list contained in the revised USML Category VIII,” Georgi continues (see Figure 1 on page 22). “Mission-critical technology that is listed in USML Category VIII on all aircraft – not just military aircraft – will not be allowed to be moved over to Commerce. However, any parts and components not specifically called out in USML Category VIII will move over to Commerce. Because some companies make parts for both the enumerated combat aircraft and other military aircraft, there is a potential for dual licensing and dual burden, outweighed, however, by the unquestioned advantages of exporting 600 series items under license exception STA. The manufacturers will need to figure their licensing obligations on their own. The 600 series refers to a new sequence of Export Control Classification numbers that contain the number 6 in the third position from the left to indicate the military nature of the controlled items.”

 

Figure 1: Items ‘specially designed’ for the F-35 Joint Strike Fighter and other crucial military combat aircraft will not be moving to Commerce, but will remain on the State Department’s USML.

(Click graphic to zoom by 1.9x)

 

Specially designed

“For these rule changes the government has come up with a new definition of ‘specially designed’ to enable the aircraft regulations as well as ITAR and EAR reforms down the road,” Georgi says. “Before ‘specially designed’ was undefined; with the change it becomes a complicated catch and release system. The first part of the test – the catch – defines the universe of items that could be ‘specially designed.’ The second part – the release – provides several criteria that, if met, will release the item from being treated as ‘specially designed.’ The new ‘specially designed’ definition plays a major role in determining which items that are not specifically enumerated in the USML will nevertheless remain there, because they are ‘specially designed’ for an item that is called out in the USML. For example, printed circuit board suppliers will need to evaluate whether their printed circuit boards are ‘specially designed’ for an item remaining in USML Category VIII (or another USML category). But ‘specially designed’ also will play a part in the numerous Commerce Export Control Classification Numbers (including but not limited to the 600 series) that also use the term ‘specially designed.’

“For the most part, however, the new USML will be a positive list, and suppliers will need to spend time with the list and feel comfortable with the new definitions and categories of products,” Georgi continues. “Just like before the rule changes, there is still the Commodity Jurisdiction (CJ) process that can be used to confirm that an item, particularly one designed to work in both commercial and military platforms or being sold for both commercial and military platforms, is not subject to State controls and can be licensed as dual use. Companies need to see what will work best for them – self classification, the CJ process, or a mix of the two. Commerce has announced that it will conduct audits of exporters to make sure they are complying with all the conditions for using license exception STA. Inevitably some items will remain under State, and even if all of what a company produces is transferred, there is still a good chance that some portion of the technical data the company receives from its prime contractors will remain under the USML. Thus, even a company now producing 100% Commerce controlled products might still need to ensure internal ITAR compliance to protect ITAR controlled technical data from unauthorized export, for example, to foreign person employees. Thus, there is still a possibility of dual licensing.

“The export reform initiatives are good news, but not completely painless,” Georgi says. “The trick for defense suppliers is they will need to study the new rules and regulations and see whether their products and technology qualify for a move to the CCL. They shouldn’t wait until Oct.15, 2013 either, which is when the new rules go into effect. If they do, they will have waited too long. Commerce is doing a lot of outreach on the new rules and regulations and defense suppliers should seek out these meetings right away to get an understanding of how the USML and CCL are changing. What goes in the aircraft regulations becomes effective on Oct. 15, but you need to prepare for what is coming down the pike in the other USML categories in the export control reforms still to come.”

Commercial satellite technology

It’s likely no group of U.S. companies has been hurt more adversely by U.S. export compliance laws than suppliers of commercial satellite technology. Since 1999 when all satellite technology was moved back to the ITAR as a result of the Strom Thurmond NDAA of 1999, the industry has seen their international business slowly shrink as foreign satellite manufacturers started turning toward non-U.S. suppliers an in effort to have systems be ITAR free.

“The European satellite manufacturers are frustrated with U.S. export restrictions and often choose to go elsewhere for their technology to avoid costly ITAR headaches,” says Chuck Tabbert, Vice President at Ultra Communications in Vista, CA, and a member of the President’s Export Council Subcommittee on Export Administration (PECSEA). “This annoys the European satellite manufacturers but really hurts U.S. satellite technology suppliers since they lose out on contracts. Even after reform it is going to take time to build back that trust. We need to put our money where our mouth is and make changes that consider our allies, and make it easy for them to do business with us. It seems to be the Administration’s intention to get commercial satellite components available for sale to our allies.”

“The toughest challenges to U.S. space companies are the headaches that come from the ITAR,” says Larry Longden, Vice President and General Manager, Microelectronics at Maxwell Technologies in San Diego. “We have major customers in Europe that we’ve been supplying for years, who are now getting reluctant about doing business with U.S. companies because of how volatile U.S. government decision making is when it comes managing ITAR and export compliance. For the European satellite community the ITAR is no longer just an irritant. These companies have direct activities to design U.S. products out even if they replace them with less reliable and lower-performance designs. Even if we change the ITAR restrictions, it will only reduce the paperwork for the U.S. as the Europeans just don’t trust the U.S. government anymore when it comes to export regulations. They always buy European content before they buy U.S. content. In the past five years, the European Space Agency has spent a lot of money developing radiation-hardened technology so they don’t have to buy from us.”

“The large companies with wide portfolios have been better able to weather the storm and are able to sell overseas with the constraints we currently have, but for the smaller suppliers business is down,” Tabbert says. “They have not been able to access the overseas market as much and therefore rely specifically on the U.S. market. These companies need to be able to expand their business internationally or they will not survive. If the change occurs I estimate the semiconductor industry would likely see about a $5 billion increase in revenue over the next 5 years. That would be revenue gained from selling to countries they currently are prevented from selling to by the U.S. export laws.”

Satellite export rules changes

Help looks to be on the way just as it is for aircraft suppliers as Congress passed legislation earlier this year to get it moving and State and Commerce have released the proposed rule changes. “When Congress passed the NDAA for fiscal year 2013 on Jan. 2, 2013, it paved the way for moving satellites and satellite related technology from State to Commerce,” Georgi says. “However, this did not come without strings and it requires action by the Administration to take place. Administration officials will have to ensure the removal of satellites and related technology from the State USML is in the U.S. national security interest; if not, they won’t be removed. Just like the aircraft rule change, the items may only be exported to one of the 36 approved nations. Each export also will require an STA license. Also, no satellite or its related technology may be transferred over to China, North Korea, or any state sponsor of terrorism, nor any entity or person from or acting on behalf of these countries or nationals. It’s not going to be the change that some may have hoped for, but it is a major reform.

“From my perspective it is a big win getting de minimis rules under Commerce as many foreign satellite manufacturers eliminate all parts of U.S. origin to be ITAR free,” Georgi says. “I remember when the Strom Thurmond NDAA of 1999 was passed and had all satellite and related items moved to the ITAR, which has a zero percent de minimis rule. However, you don’t want too many different de minimis rules as that can be risky. For 600 series and satellite-related, we have 25 percent de minimis for most of the world and 10 percent for regular embargoed countries. It is zero percent for ITAR proscribed countries like Iran, Sudan, China, etc.”

Taking commercial satellites from the USML and moving them to the CCL “is not decontrolling – it is just moving jurisdiction,” Tabbert says. “Commerce is more flexible and they have exemptions. You don’t have to ask a question, but just document what you did. We are striving for an easy demarcation point between Commerce and EAR.

“The categories that will enable commercial spacecraft and related technology to move from State to Commerce were published in the federal registry on May 24, 2013,” Tabbert continues. “We have 45 days for industry to comment, followed by comment from the legislative branch. The NDAA had bipartisan support and I don’t think it will run into any roadblocks. The new rules will have a probable implementation by the first quarter of next year. The team that’s been rewriting the rules has had a gargantuan task – taking into account policy, law, and technical content. My hat is off to them. From what I’ve seen so far, there are common definitions that translate across all ITAR and EAR. It will have criteria for how rad-hard components have changed – boards, boxes, the whole food chain.”

Big fines still happening

While export reform is happening and likely to create more opportunities for aircraft and commercial satellite technology suppliers, export compliance enforcement continues to hammer out big fines. Two of the most recent were United Technologies Corp. (UTC) and Raytheon, which got hit with $55 million and $8 million penalties respectively. UTC was charged with violating the Arms Export Control Act (AECA) and the ITAR “in connection with the unauthorized export and transfer of defense articles, to include technical data, and the unauthorized provision of defense services to various countries, including proscribed destinations,” according to the proposed charging letter from the State Department to UTC. UTC was ordered to pay $35 million of its $55 million penalty to State in four installments with the remaining $20 million to be directed for remedial compliance measures. However, the $20 million may be suspended if the company makes certain certifications in their consent agreement.

Raytheon’s violations were for “failure to properly manage department-authorized agreements; and … failure to properly manage temporary export and import authorizations,” according to the charging letter from the State Department to Raytheon. The $8 million civil penalty leveled against Raytheon is being split two ways: $4 million was paid to State with the other $4 million ordered to be used for improving Raytheon’s internal export compliance program. For more on ITAR fines, visit the State Department website at www.pmddtc.state.gov/compliance/consent_agreements.html.

“I see the State Directorate of Defense Trade Controls (DDTC) and the Department of Justice (DOJ) continuing to level ITAR fines and big ones,” Georgi says. “Defense suppliers need to spend money for compliance now or spend more money in fines and penalties later. The fines have functioned as a deterrent as the multimillion dollar penalties have forced companies to get their act together so they don’t get hit with a fine or even worse – criminal charges. The large companies have made strong efforts to put in place best practices on export compliance and then follow them.”

Sidebar 1: Export compliance in 15 steps

(Click graphic to zoom)

Compliance and standards

Officials at VITA see companies being more diligent with ITAR compliance as a result of the fines. “In the beginning when large ITAR fines started getting published, the industry was in a tizzy,” says Ray Alderman, Executive Director of VITA. “Three or four high-profile cases taught us a lot and companies have gotten better with export compliance, developing internal ITAR procedures and policies. People are no longer sitting around in open meetings talking about weapon systems and mission computers. Nobody wants to get one of those high-profile violations.

“There were two ways to enable compliance from a VITA perspective,” he continues. “We could create a separate segment of VITA where only those with a cleared U.S. passport could get in a room to work on a standard. This was frustrating for some companies that have personnel in Canada and the U.S – one could attend and one could not. After meeting with our attorneys we decided we wanted VITA standards to be viewable by anybody in world” – in other words be ITAR free. Therefore, VITA put the responsibility for removing ITAR content from standards specifications on the people working on those particular standards where ITAR is an issue – the individual working groups within VITA, Alderman explains. “This is the cleanest way of doing it because the working groups work independently and have prime contractor and military representatives that have a much better perspective on what is ITAR sensitive and what is not,” he continues. “For public consumption we boil down the standards to basic engineering specs for the device and how it is hooked together; nobody knows what data is on the pins, what application the board will be used for, etc. We don’t define what it does, what mission it will be used for, or on which platform.”

Compliance pitfalls

Export compliance, while not rocket science, does require vigilance and a rigorous attention to detail if companies and individuals want to avoid big fines and in some cases criminal charges. Errors are bound to happen, but Georgi says there are three points that defense suppliers need to stay on top of in today’s environment. “The first one is to make sure to disclose any unlicensed export or transfer of ITAR items immediately,” she says. “Do not pass go, do not collect a hundred dollars. State Department agents might have a problem later, especially if the items went to China or other arms-embargoed countries. The State Department is very clear that they want to know now.

“The second one is not new, but still important,” Georgi continues. “You must make sure you have your facts correct in any disclosure – the first time it happens. Minor voluntary disclosures are not what I’m referring to, but if it involves security or any intentional misdoing you really need to go on the deep dive and get outside legal counsel. This is not the case to skimp on but potentially abet the company case. Make sure you your get facts right because you are potentially at risk for criminal violations.

“The third one is make sure you don’t skimp on compliance after you get your license,” she warns. “State Department licenses such as Manufacturing License Agreements (MLAs) and Technical Assistance Agreements (TAAs) can last as long as 10 years. That is a long time and creates a huge potential for you and your company to make mistakes. Suppliers must be vigilant and do periodic checks on their compliance practices such as making sure no foreign nationals have been hired [who are] now working on ITAR technology. In that way, it is like raising children. Many first-time parents think it’s all about the pregnancy, but that’s nothing compared with raising the child. Once State approves the export license, the job isn’t over – it’s just beginning.”