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Tech Companies Brace for Regulatory Impact from US-China Trade War

With impending changes in export controls developing into an expanding area of regulatory enforcement for the US government, corporate executives and in-house counsel need to prepare for increasing amount of lobbying, litigation, and negotiation over loopholes.

An export controls paradigm shift is descending on the technology sector as trade tensions between the United States and China evolve into a new tech cold war. In August 2018, the Export Control Reform Act of 2018 (ECRA) became law, expanding export controls to include “emerging” and “foundational” technologies. The ECRA delegates authority to the president of the United States and the US Department of Commerce (DOC) to determine and define what constitutes these technologies.

In November 2018, the DOC issued a list of representative technology categories for public comment. The DOC indicated that these technologies may be essential to the national security of the United States and thus subject to the new export controls regime. These categories include:

  1. Biotechnology;
  2. Artificial intelligence (AI) and machine learning;
  3. Position, Navigation, and Timing (PNT) technology;
  4. Microprocessor technology;
  5. Advanced computing technology;
  6. Data analytics technology;
  7. Quantum information and sensing technology;
  8. Logistics technology;
  9. Additive manufacturing (e.g., 3D printing);
  10. Robotics;
  11. Brain-computer interfaces;
  12. Hypersonics;
  13. Advanced materials; and
  14. Advanced surveillance technologies.

It’s no coincidence that a significant overlap exists between these technology categories and those listed in China’s “Made in China 2025” development policy. The trade tensions between the United States and China go far beyond tariffs.

The conflict’s roots lie deep in China’s long-term development plans. The United States has alleged China’s plans include forced technology transfer and theft of intellectual property. Geopolitical trends are further complicating matters as China bolsters its military in the region, which the United States perceives as an aggressive stance.

The public comment period ended in January 2019, and it is expected that the DOC will issue the final list in mid-to-late summer 2019.

Obviously, these categories are quite broad in scope, and the tech sector is lobbying to narrow the definitions. Nevertheless, given the dual-use applications of these technologies and the national security implications, export controls are more likely to tighten in the foreseeable future.

For example, the increasing dual-use nature of these technologies’ applications can be seen with advanced materials (item #13) in the form of adaptive textiles that can be used for looking really cool at the gym, but also for enhanced camouflage applications.

Clearly, technological advances over recent years have blurred the lines between benign commercial applications and potential military uses. This lies at the heart of the new export control laws.

In addition to stricter export controls over technologies, the US government is also tightening export controls through targeting individual end-users, the most notable being Huawei. Expect more to come.

The impact

Some businesses specializing in the technologies listed above that are currently not subject to export controls may become illegal for “export” (i.e., international transactions), without a proper license, by the end of this year.

Look for new regulations — and stepped up enforcement activity — to start rolling out around mid-to-late summer.

The stakes are high. In addition to civil and administrative penalties that ominously include “denial of export privileges” (i.e., a moratorium on all international sales), criminal penalties of up to US$1 million and jail time of up to 20 years per violation may also apply.

Furthermore, it is important to note that end-user (or company-specific) sanctions apply across all businesses, not just to those operating in the listed technologies above.

The impact will be felt by stakeholders across the tech sector, including:

  • Tech companies may need to develop and/or enhance their export compliance programs to meet the requirements of this changing regulatory and enforcement environment;
  • Startups and emerging growth companies that previously have not addressed export compliance may need to implement kickstarter compliance programs to avoid serious disruptions to their business and future growth prospects;
  • More mature companies with existing compliance programs could take steps to ensure the integrity of their programs and to assess any new potential gaps;
  • Venture capital/private equity investors with seats on boards of directors face potential liabilities if their companies engage in illegal activities and thus need to address the changing export controls regulations as well. Failure to do so could also likely negatively impact portfolio company exits due to successor liability issues;
  • Companies seeking to take advantage of current loopholes in the regulations (e.g., product origin de minimis amounts) may need to shore up their positions with regulators for heighted scrutiny to come; and
  • Companies active in M&A transactions will need to ensure that export controls are addressed in the due diligence phase to avoid potential successor liability issues.

Actions companies can take now

There are three key actions companies should take to get ahead of the curve and avoid serious disruption to their businesses:

1. Conduct a risk assessment of operations

Companies will need to quickly assess the changing risks their businesses face in terms of revenue exposure, channel exposure, deemed exports, and status of their compliance program. This needs to be done while being mindful of a highly fluid and evolving regulatory environment around the Export Administration Regulations and geopolitical backdrop.

2. Develop or enhance compliance programs

Organizations must assess and catch up in terms of their export compliance programs, both to fill in any current gaps as well as to ensure actual compliance by employees/business units affected by the new export control regulations.

In addition, companies and their boards of directors will need to prepare responsive procedures to address the risk of possible rogue employees who may seek to circumvent controls.

3. Fix deficiencies now and shore up positions on compliance for heightened scrutiny

If any deficiencies are found in existing compliance programs, companies should take steps to remedy them before the regulators and law enforcement (e.g., Bureau of Industry and Security and the FBI) come knocking on the door.

Expect regulatory inquiries, investigations, and litigation around interpretation and application of the ECRA and the Export Administration Regulations to increase. Also make sure any positions taken regarding your compliance program are “litigation ready” to stand up under heightened scrutiny.

For example, representations on product origin and de minimis amounts should align with other contemporaneous records across the company.

Looking ahead

The signals are clear that the issues underlying the trade tensions between the United States and China run deep and that there is a strong momentum behind the changes in export controls. As this area develops into a new area of regulatory enforcement for the US government, there will be an increasing amount of lobbying, litigation, and (back and forth over) loopholes for the foreseeable future.

As the Huawei ban shows, changes are happening quickly, and companies will need to be alert and flexible in their compliance programs to stay on top of this highly fluid and constantly changing environment.

We are only at the beginning of a long road to come.

About the Authors

Patrick TerryPatrick Terry is the senior corporate counsel at F5 Networks. Based in San Francisco, F5 is a leader in providing services and security for enterprise grade applications, whether on-premises or across any multi-cloud environment. Prior to F5, Terry managed in-house legal functions for the F5’s recently acquired Nginx software business unit. His experience ranges from leading legal teams for international Fortune 500 companies to acting as sole corporate attorney for technology startups.
Brent CarlsonBrent Carlson is a director of investigations, disputes, and risk practice at AlixPartners. Carlson has more than 20 years of China business experience that includes senior management positions as chief representative, chief operating officer, deputy general manager, head of marketing and business development, chief financial officer and treasurer, and chief compliance officer. He has a master's degree from Yale University and is fluent in Mandarin Chinese.

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