International Law Advisory - BIS Proposes Rule That Would Add Red Flags, Revise Knowledge Definition, and Provide a Safe Harbor From Liability

October 25, 2004

On Wednesday, October 13, 2004, the U.S. Department of Commerce, Bureau of Industry and Security (“BIS”) published a proposed rule in the Federal Register that would enhance its “red flags” guidance, revise the knowledge definition in the Export Administration Regulations (“EAR”) and provide exporters with a safe harbor from liability in some instances. A copy of the proposed rule can be found at 69 Fed. Reg. 60829 (Oct. 13, 2004). The public may submit comments on the proposed rule until November 12, 2004.

Enhanced Red Flags Guidance

BIS has proposed revising supplement No. 3 to part 732 of the EAR to increase the number of red flags to 23, from the current 12. Included among the new red flags proposed by BIS are:

The customer uses an address that is inconsistent with standard business practices in the area (e.g., a P.O. Box address where street addresses are commonly used).
The customer does not have facilities that are appropriate for the items ordered or end-use stated.
The customer’s order is for parts known to be inappropriate or for which the customer appears to have no legitimate need (e.g., there is no indication of prior authorized shipment of the system for which the parts are sought).
The customer is known to have or is suspected of having dealings with embargoed countries.
The transaction involves a party on the Unverified List published by BIS in the Federal Register.
The product into which the exported items is to be incorporated bears unique designs or marks that indicate an embargoed destination or one other than the customer has claimed.
The customer gives different spellings of its name for different shipments, which can suggest that the customer is disguising its identity and/or the nature and extent of its procurement activities.
The requested terms of sale, such as product specification and calibration, suggest a destination or end-use other than what is claimed (e.g., equipment that is calibrated for a specific altitude that differs from the altitude of the claimed destination).
The customer provides information or documentation related to the transaction that you suspect is false, or requests that you provide documentation you suspect is false.

It appears likely that the new red flags would increase due diligence requirements and costs. The red flags would also be incorporated by reference into the safe harbor provision - discussed below - found at Section 764.7 of the EAR. BIS also proposes additional amendments to its “Know Your Customer Guidance,” as described in further detail in the Federal Register notice.

Knowledge Definition

BIS has proposed amending the current definition of “knowledge” in Section 772.1 of the EAR. The excerpt below demonstrates the proposed changes to the definition by indicating words that would be deleted with a strike through mark, and indicating words that would be added in bold. The proposed rule indicates that knowledge will be imputed to a party if that party has:

not only positive knowledge that a fact or circumstance exists or is substantially certain to occur, but also an awareness of a high probability of its that the existence or future occurrence of the fact or circumstance in question is more likely than not. Such awareness is inferred, inter alia, from evidence of the conscious disregard of facts known to a person and is also inferred from a person’s willful avoidance of facts.

The proposed definition would also incorporate a “reasonable person” standard, such that a party would have knowledge of a fact or circumstance if a reasonable person in that party’s situation would conclude that the existence or future occurrence of the fact or circumstance of the fact in question is more likely than not.

Safe Harbor

The proposed rule could create a “safe harbor” from liability arising from knowledge-based provisions of the EAR. Under the safe harbor provision, parties who take the steps in the proposed new section 764.7 will not have knowledge imputed to them. These steps include:

Comply with any item and/or destination-based license requirements and other notification or review requirements;
Determine whether parties in the transaction are subject to a denial order or to certain sanctions, whether they appear on the Entity List or Unverified list, whether the transaction is governed by a general order issued by BIS; and
Follow the procedures for identifying and resolving red flags found in the proposed revisions to Supplement No. 3 to Part 732. If red flags are found and cannot be resolved, the exporter would be required either to refrain from entering into the transaction, or to contact BIS for guidance.

In instances where red flags have been discovered but resolved, the exporter, in order to take advantage of the safe harbor provision, would be required to submit a written report to BIS of all material information regarding the existence, assessment, and satisfactory resolution of the red flag(s) prior to shipment, and must not otherwise have “knowledge” under the proposed new definition. BIS would then inform the exporter whether BIS agrees with its conclusion within 45 days (subject to possible extension) of receipt of the report. A response by BIS stating that it concurs with the exporter’s assessment that the red flags have been resolved or that it will not be responding to the exporter’s report would serve as confirmation that the exporter has adequately resolved the red flag, allowing the export to ship pursuant to the safe harbor provision. However, if the exporter had actual knowledge or awareness that the fact or circumstance in question was more likely than not, or if the submission misstated or withheld relevant material information, BIS would not be precluded from initiating subsequent enforcement actions.

We will continue to keep you apprised of sanctions and export control developments. If you have any questions, please feel free to contact Ed Krauland at 202.429.8083 or Meredith Rathbone at 202-429-6437.