DDTC Issues Advisory On Export License Documentary Requirements

U.S. exporters seeking licenses from the Department of State’s Directorate of Defense Trade Controls ("DDTC") to export defense articles are required to submit certain supporting documentation along with the license application. This documentation is set forth in section 123.1(c) of the International Traffic in Arms Regulations (the "ITAR"). The required documentation includes, among other things, a "purchase order, letter of intent or other appropriate documentation" for the defense articles to be exported. DDTC has generally accepted a purchase order alone as satisfying this requirement.

DDTC recently announced on its website new guidelines with respect to purchase documentation submitted with license applications. First, the announcement indicated that DDTC may also require a signed contract in addition to the purchase order. Second, the purchase documentation (whether signed contract, letter of intent or purchase order) must be directed to the U.S. company selling the defense article and filing the export application. Third, DDTC cautioned that the purchase documentation must be from a foreign company and not from its U.S. subsidiary. All applications submitted after September 16 not meeting the last two requirements may be returned without action.

This third requirement is troublesome. The DDTC’s rationale for the third requirement was its cryptic statement that the U.S. subsidiary is a "U.S. person under the ITAR." Since there is no prohibition under the ITAR to contract with another U.S. person for the export of a defense article, this stated rationale of DDTC does not support this new requirement. Furthermore, a variety of legitimate business reasons might make it prudent for the U.S. exporter to deal with the U.S. subsidiary of the ultimate foreign consignee rather than directly with the foreign consignee. One such reason would be the amenability of the U.S. subsidiary to being sued in U.S. courts should problems develop in the transaction. And as long as the foreign consignee is identified as such in the purchase order issued by the U.S. subsidiary, the DDTC is able to fully assess the compliance of the export with the national security interest of the United States.

The DDTC’s statement that it may require a signed contract in addition to a purchase order means that for timesensitive exports, the exporter should submit a signed contract with the initial license application. Otherwise, the license may be delayed if DDTC, upon reviewing the supporting documentation, decides to require additional documentation in the form of a signed contract.

On May 3, 2005, Alltel announced that it advised the U.S. Securities and Exchange Commission (the "SEC") and the Department of Justice (the "DOJ") that it is conducting an independent investigation into alleged improper payments by its former subsidiary, Alltel Information Services ("AIS"), to foreign government officials in violation of the United States Foreign Corrupt Practices Act (the "FCPA"). AIS was sold to Fidelity National Financial in 2003 and was renamed Fidelity Information Services. Both Alltel and Fidelity National Financial confirmed in their quarterly reports in August 2005, that the SEC and DOJ were conducting informal investigations of the allegations. The FCPA prohibits, among other things, U.S. companies from making bribes to foreign government officials in order to obtain or retain business. The FCPA also requires publicly-traded U.S. companies to keep accurate books, records and accounts and to devise and maintain strong internal accounting controls.

The case came to light in an unusual way. The alleged improper payments were disclosed in a lawsuit brought in California by Grace & Digital Information Technology Co., Ltd. ("Grace") in December 2004 against Fidelity Information Services, Fidelity National Financial and other parties. Grace is a Chinese company that served as AIS’ sales representative promoting AIS software products in China. Under its agreement with AIS, Grace was to receive a 33.3% commission on license fees for AIS software products sold to China Construction Bank ("CCB"), a Chinese state-owned bank. The agreement included a provision prohibiting violations of the FCPA by either party. The complaint by the former sales representative alleges that AIS and the former CCB chairman struck a side deal to exclude Grace, thereby causing it to lose a commission of $59 million on AIS sales to CCB that were worth $176 million. Although Alltel was not named a defendant in Grace’s civil lawsuit, the alleged improper conduct occurred when AIS was still owned by Alltel. The law suit is still pending before the U.S. District Court of the Northern District of California.

According to the complaint, AIS allegedly paid $1 million in bribes to the former chairman of CCB. In addition, AIS officers invited the CCB chairman and his friends to the exclusive Pebble Beach golf resort in California to the cost of $10,000. AIS is also alleged to have paid the travel expenses for a trip to London by the wife of CCB’s chairman, as well as for his son’s education in the United Kingdom. Moreover, AIS reportedly made monthly payments of $3,500 to a close friend of CCB’s chairman. In return, the CCB chairman allegedly helped AIS to secure several CCB contracts.

This case reveals yet another category of risk for U.S. companies doing business overseas that have traditionally faced enforcement of anti-bribery laws by the U.S. agencies, shareholder derivative lawsuits and prosecution in foreign countries. Now it appears that improper conduct may also cause U.S. companies to face legal claims from third parties that were originally retained to promote company products overseas. In addition, this case underscores the importance of doing FPCA due diligence in the merger and acquisition context to avoid unknown legal liabilities that may ensue down the line.

Willbros Group, Inc., a Panamanian corporation that provides construction and engineering services in the oil, gas and power sectors throughout the world, has announced that it is under investigation by the DOJ and the SEC for alleged FCPA violations. Specifically, Willbros has announced in its corporate filings that its international unit paid bribes directly or indirectly to government officials in Bolivia, Nigeria, Mexico and Ecuador for a number of reasons, including: (i) to obtain new business; (ii) to reduce taxes; (iii) to dispose of local legal proceedings; and (iv) to resolve customs issues. The international business unit mischaracterized the nature of the payments on its financial records to hide the widespread corruption. Although Willbros is a Panamanian company, its shares are traded on the New York Stock Exchange, and it is managed from offices in the United States. It is therefore directly subject to the FCPA.

Willbros has terminated a number of its overseas commercial and consulting arrangements with entities and individuals that acted as conduits of improper payments to foreign government officials. In at least two instances, the terminated intermediaries have threatened legal action against Willbros for breaching their contracts.

The investigation into the alleged misconduct started in December 2004, when Bolivian tax authorities charged Willbros’ local subsidiary with tax fraud and assessed $2.5 million in penalties and back taxes. The internal investigation that lasted six months and cost at least $4 million revealed that the head of Willbros’ overseas operations orchestrated widespread fraud and violations of antitrust, tax, securities, export control and other laws and trade sanctions in multiple countries over a number of years.

Since Willbros announced the alleged misconduct in its securities filings, the company has faced multiple shareholder lawsuits, in addition to the investigations launched by the SEC and DOJ. Moreover, the company is separately under investigation by the Treasury Department’s Office of Foreign Assets Control for potential violations of U.S. trade sanctions and export control laws arising from Willbros’ activities in Sudan.

The Willbros case illustrates the importance of robust internal controls that are designed to detect misconduct at all levels of management. Given the number of violations in various countries over a long period of time, potential penalties could be significant. We will keep a close eye on the developments in this case and report them to our readers.

The SEC issued a formal order on August 26, 2005, in its investigation of Immucor, a U.S. based manufacturer of products used to detect and identify certain properties in human blood before a patient transfusion. The order cited a potential violation of the books and records provision of the Foreign Corrupt Practices Act ("FCPA"). The books and records provision of the FCPA requires publicly-traded companies to maintain accurate records that reasonably reflect the company’s activities and assets. The provision also requires publicly-traded companies to maintain robust internal controls. Immucor voluntarily disclosed a potential violation of the books and records provision by its Italian subsidiary in 2004. During an internal investigation, Immucor reportedly found that payments were made to an Italian doctor and administrator of a state-owned hospital who rendered services as the organizer and chairman of a convention sponsored by Immucor’s Italian subsidiary in October 2003. He received 13,500 Euros for these services. However, the invoices, in violation of the books and records provisions of the FCPA, did not identify the physician or the nature of his services. The formal order allows the SEC to compel testimony and document production.

The SEC investigation is another example of the heightened scrutiny directed at U.S. pharmaceutical and medical device companies and their relationships with foreign doctors. Earlier this year Diagnostic Products, Inc. ("DPC") and Micrus Corporation both paid fines related to payments made to doctors of state-owned hospitals abroad. DPC settled a probe with the SEC for regular payments made to doctors and laboratory staff in state-owned hospitals in China in order to induce them to buy DPC products, in violation of the FCPA. DPC paid disgorgement of $2,038,727 and prejudgment interest in the amount of $749,895. DPC’s whollyowned Chinese subsidiary pled guilty to charges brought by the U.S. Department of Justice ("DOJ") and paid an additional criminal penalty of $2,000,000. Micrus entered into a non-prosecution agreement with the DOJ for payments made to doctors at state-owned hospitals in Turkey, France, Spain and Germany to induce them to purchase medical devices. Micrus agreed to pay $405,000 in penalties.

The Bureau of Industry and Security ("BIS") will probably not implement a recommendation from the Commerce Department’s Office of Inspector General that would change deemed export rules to require BIS to base export licensing decisions on the birthplace of foreign nationals rather than their country of citizenship or permanent residence. The proposed rule received "emotionally charged" comments, according to Hillary Hess, director of the Regulatory Policy Division for BIS. In addition, Hess noted that the proposed change would be difficult to implement because it is illegal in some countries to ask foreign nationals where they were born.

Deemed export licenses allow foreign nationals working in the United States to gain access to sensitive technology. Currently, BIS bases licenses on a foreign national’s country of citizenship and not their country of birth. Under the original proposal, a U.K. citizen (or permanent resident) born in China and working in the United States would be treated as a Chinese citizen for purposes of deemed export licensing decisions.

The December 2003, Statement of Understanding on Control of Non-listed Dual-Use Items (the "Statement of Understanding") adopted at the last plenary session of Wassenaar Arrangement called upon member states to "take appropriate measures to ensure that their regulations require authorisation for the transfer of non-listed dual-use items to destinations subject to a binding United Nations Security Council arms embargo . . . when . . . the items in question are or may be intended . . . for a military end-use." The Statement of Understanding also applied to countries subject to regional arms embargos in which Wassenaar member states are participants.

Pursuant to this obligation, the Bureau of Industry and Security is preparing draft rules to be circulated for interagency comment prior to the next plenary session of Wassenaar in December 2005. During a recent meeting of certain industry participants with officials of BIS, agency officials provided some advance indication of what the draft rules would look like.

Most significantly, agency officials suggested that "non-listed dual-use" would be interpreted by BIS to mean items listed on the Commodity Control List ("CCL") but not on the Wassenaar list. According to the officials, this approach is justified because the CCL is broader than Wassenaar and includes items not listed on Wassenaar.

Agency officials also suggested that the new rules would define "military end-use" in a manner that would adhere closely to the Statement’s definition of military end-use, i.e. "use in conjunction with an item controlled on the military list of the respective Participating State." Accordingly, the proposed definition would cover incorporation into or use in the development, production or deployment of items on the United States Munitions List.

Finally, agency officials noted that although these rules are often referred to as the "China catch-all" rules, they were in fact intended to cover other countries as well. The proposed scope would include countries subject to unilateral U.S. arms embargoes as well as those subject to U.N. and regional embargoes. Accordingly, the rules would cover exports to China as well as 19 other countries, including, among others, Burma, Belarus, Cote d’Ivoire, Indonesia, Liberia, Syria, Yemen and Zimbabwe.

On August 16, 2005, the Office of Foreign Assets Control ("OFAC") issued regulations implementing Executive Order 13310 signed by President Bush on July 28, 2003, and effective the following day. Prior to Executive Order 13310, the sanctions in place against Burma prevented new investments by U.S. persons in Burma. The new sanctions imposed by Executive 13310 prohibited imports from Burma, outlawed provision of certain financial services to Burma, and blocked all assets of members of the Burmese government and certain para-governmental organizations of Burma listed on the Specially Designated Nationals list maintained and published by OFAC.

Because Executive Order 13310 was self-implementing, the new regulations in large part codify sanctions that have been in effect since July 29, 2003. The new regulations also incorporate the thirteen general licenses that OFAC had issued since July 29, 2003, permitting certain imports and financial transactions that would otherwise be prohibited by Executive Order 13310, such as General License No. 9 which permitted the importation of informational materials from Burma and General License No. 10 which permitted the importation of certain household and personal effects of persons moving from Burma to the United States.

Although a large part of the new regulations simply codify the existing prohibitions of Executive Order 13310 and the pre-existing General Licenses for Burma, the regulations also clarify certain issues as to the application of the Burma sanctions. The old version of the rules did not contain certain provisions routinely found in sanctions regulations, but it was widely assumed that these provisions would more or less apply to Burma. It was not uncommon for the staff of OFAC, in response to telephone inquiries, to say that exceptions found in the sanctions regulations for one country were applicable "by implication" to sanctions regulations for other countries even if not explicitly set forth in the regulations for that country.

The newly issued rules, therefore, include a number of exceptions that were commonly found in regulations for other countries but not previously contained in the Burma regulations. For example, the new regulations include a specific provision setting forth the conditions under which legal services could be provided to Burmese companies and residents. These conditions are similar to those found with respect to other sanctioned countries and which were assumed to be applicable to Burma. Similarly, as permitted by sanctions rules for other countries, the new regulations now specifically permit the provision of non-scheduled emergency medical services to persons whose assets are blocked under the Burma sanctions (although no payments can be received for such services until a license is obtained). The rules also clarify that U.S. citizens living in Burma can pay incidental living expenses, that airlines may make overflight payments to Burma and that payments can be made in Burma to protect U.S. intellectual property.

Of course the new regulations do not import all of the exceptions that might have been "implied." For example, the Cuba sanctions regulations permit the import of "research samples." The reasons permitting such imports from Cuba could justify imports of research samples from Burma, but no equivalent provision is contained in the new Burma regulations. Whether this omission was intentional or whether OFAC staff might later say that such an exception is also "implied" in the Burma sanctions remains to be seen.

One final point of interest in the new Burma regulations relates to their limitation on situations in which OFAC can grant licenses for imports from, or new investments in, Burma. Under the Burmese Freedom and Democracy Act of 2003, pursuant to which the President promulgated Executive Order 13310, imports and new investments were permitted only if the President determined that it was in the national interest to permit them and provided notice of such determination to specified Congressional committees. Because of this waiver procedure, a note to the rules on importation and new investments indicates that no licenses will be granted for imports or new investments absent such a waiver determination by the President. Executive Order 13310 delegated that waiver function to the Secretary of State. Accordingly, persons seeking to import goods from Burma, or to make new investments in Burma, will be required to first obtain a waiver from the Department of State and thereafter to obtain a license from OFAC.

As noted in our August 18, 2005 Client Alert, Customs and Border Protection ("CBP") announced that as of September 16, 2005, it would begin to enforce new rules requiring that wood packaging materials ("WPM") imported into the United States be treated to prevent the accidental introduction of certain pests into the United States. On September 14, 2005, CBP announced that this would be done in three phases.

Phase I, beginning September 16, 2005, will be an informed compliance period, with no stoppage of shipments for non-compliant WPM. During this phase, all visual exams of cargo performed by CBP will include a WPM component.

Phase II, beginning February 1, 2006, will continue informed compliance measures on all regulated WPM except pallets and crates. CBP will begin full enforcement of the ban on noncompliant pallets and crates. Beginning with Phase II, immediate export of all shipments containing non-compliant pallets or crates will be ordered if the Port Director determines that it is not feasible to separate merchandise from the non-compliant WPM.

Phase III, beginning July 5, 2006, will represent full enforcement of the WPM rules. CBP will no longer conduct informed compliance at the shipment level. In Phase III, immediate export of all shipments containing non-compliant WPM will be ordered if the Port Director determines that it is not feasible to separate merchandise from the non-compliant WPM.

All expenses incurred for the services of CBP Officers and Agriculture Specialists involved in the separation of cargo will be billed to the importer or other party of interest. WPM and associated merchandise will be exported at the expense of the importer or other party of interest.

The U.S. regulation for WPM does not allow for treatment at the ports. Nor does it allow for any alternative disposal methods. It only allows for the immediate export of the non-compliant WPM. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.