International Law Advisory - BIS Seeks Comment on Two Aspects of the Effects of U.S. Export Controls on Foreign-Produced Products

Export Controls on Foreign-Produced Direct Products of U.S-Origin Encryption Technology and Software

On January 6, 2009, the Bureau of Industry Security (“BIS”) solicited public comments regarding a possible revision to the export licensing requirements applied to foreign-produced direct products of U.S.-origin encryption technology and software products. 74 Fed. Reg. 413 (rel. Jan. 6, 2009)  http://frwebgate3.access.gpo.gov/cgi-bin/TEXTgate.cgi?WAISdocID=36664430559+1+1+0&WAISaction=retrieve.

Currently, General Prohibition Three of the Export Administration Regulations (“EAR”) (15 C.F.R. 736.2(b)(3)) prohibits the re-export or export from abroad of foreign-produced direct products of U.S. technology and software to Cuba and Country Group D:1 countries without a license or license exception.  General Prohibition Three applies if (among other criteria) the foreign-produced product is subject to national security controls under the Country Control List in Part 774 of the EAR.  The rule therefore currently applies to ECCN 5D002 encryption software and 5E002 encryption technology (among other ECCNs), both of which carry National Security controls.

BIS is contemplating a revision of Section 736.2(b)(3) that would, if implemented, extend General Prohibition Three controls to exports or re-exports to all countries, with the exception of Canada (and re-exports from third countries to the United States), of foreign-produced direct products of 5D002 software and 5E002 technology, where the foreign direct product is itself of a functionality that would classify it under ECCNs 5D002 or 5A002 (encryption hardware).  Notably, BIS has indicated that the revised rule would not apply to foreign-produced direct products of encryption technology or software that is exported under License Exception ENC, and given that the foreign-direct product rule applies to only National Security controlled items, it would not apply to encryption items that fall outside of ECCNs 5D002 or 5E002 (such as, for instance, “mass market” software that qualifies for export under ECCN 5D992).

The revision may be intended, in part, to harmonize Parts 736 with the current License Exception ENC in Part 740.17 of the EAR.  Part 740.17(a)(1) and (a)(2), as presently implemented, contain provisions noting that foreign-produced direct products of U.S. technology or software exported under those provisions – which cover certain encryption exports to U.S. subsidiaries and to third parties for product development purposes – are subject to the EAR despite being manufactured abroad.  That provision effectively extends the foreign-produced direct product rule beyond the current Part 736.2(b)(3), in that it covers a wider range of countries (i.e., it is not limited to Cuba and D:1 countries).  The revision described in the January 6 notice would extend Part 736.2(b)(3) controls to be consistent with the scope of the foreign-produced direct product rule in Part 740.17(a)(1) and (a)(2).

The notice requests comments on, among other things, the impact the possible Section 736.2(b)(3)(i) revision will have on U.S. manufacturers of encryption technology and software and foreign manufactures of products that are derived from such U.S.-origin technology and software.  BIS also seeks information from foreign-manufacturers about the factors they might consider in deciding to produce or use U.S.-origin encryption technology or software.  BIS is also seeking specific information about the availability of foreign encryption technology and software that is equivalent to U.S-origin encryption technology and software classified under ECCNs 5E002 and 5D002, and how the U.S. information technology manufacturing base may be affected if such foreign manufactured encryption products continue to be not subject to the EAR when identical products manufactured onshore by U.S. companies are subject to the EAR. 

Comments are due to BIS on March 9, 2009.  The possible revision identified by BIS could, if implemented, have a significant effect on U.S. exporters of encryption software or technology whose business partners overseas utilize U.S.-origin encryption software or technology in the design of foreign encryption products.  Accordingly, companies that currently export or utilize U.S.-origin encryption items in the foreign development of encryption products should review this notice carefully to evaluate how the revision would affect their export controls compliance programs, and consider whether it would be worthwhile for them to offer feedback to BIS.  The notice does not formally set forth a “proposed” regulation, but is at this juncture simply a request for comments regarding a potential revision that BIS is considering. 

Impact of U.S. Export Controls on U.S. Parts/Components in Foreign Manufacturing

BIS also issued a notice requesting comments, due February 19, 2009, on whether export controls imposed by various U.S. agencies affect manufacturers’ decisions to use U.S.-origin parts and components in their commercial products.  74 Fed. Reg. 263 (rel. Jan. 5, 2009)  http://frwebgate3.access.gpo.gov/cgi-bin/TEXTgate.cgi?WAISdocID=36664430559+2+1+0&WAISaction=retrieve.  BIS has requested information on how such decisions affect the effectiveness of export controls, the strength of the defense industrial base, U.S. employment, the financial strength of U.S. industry, and the ability of U.S. industry to compete in the market.  Where manufacturers have decided not to include U.S. parts and components in a foreign-manufactured commercial product because it could subject the product to U.S. export controls, BIS has requested the following additional information:

• Evidence about the existence of marketing efforts that highlight the absence of U.S. origin components or exemption from U.S. export controls as a selling point;
• Information about customer preferences for products free of U.S.-origin components and whether such preference is related to export controls;
• Information describing parts and components that manufacturers may elect not to use because of their U.S.-origin;
• Information about sales lost to non-U.S. competitors;
• Information about specific commercial products that were designed or modified explicitly to exclude U.S. parts and components due to export controls;
• Information about decisions to locate production facilities outside of the U.S.; and
• Information about the possible economic impact to companies, industry segments or communities of any decision not to use U.S.-origin parts and components because of export controls, including any possible impact on the ability to support specific defense industrial base activities.

The extra-territorial scope of U.S. export controls is a feature that generally is not replicated in other countries’ export controls regulations.  This includes, in particular, the U.S. controls on “reexports” from foreign countries of U.S.-origin products, and foreign manufactured products that are based on U.S.-origin technology or software or incorporate U.S. components.  That contrast in comparative international export controls – which is amplified by the fact that the EAR in some respects considers a wider range of products to merit “dual use” controls than do the export laws of other major trading partners – has the potential to put U.S. industries at a competitive disadvantage, in that many foreign producers who have the option of choosing between equivalent U.S. and non-U.S. components could find their regulatory licensing burden reduced if they simply “design out” U.S. products or technology.  This has been identified by several industries in the past, and BIS’s request for comments provides companies with an opportunity to provide detail to the agency regarding how those risks may have been manifested.

If you would like to discuss these notices, please contact Edward Krauland at ekrauland@steptoe.com or (202)429-8083; Julia Court Ryan at jcourtryan@steptoe.com or (202)429-6418; David Lorello at dlorello@steptoe.com or 011-44-207-367-8007; or Petra Vorwig at pvorwig@steptoe.com or (202)429-6417.