By Doug Jacobson, Jacobson Burton Kelley PLLC, Washington, DC
The Commerce Department's Bureau of Industry and Security today published a notice in the Federal Register (reprinted below) announcing that China's ZTE Corporation (ZTE or ZTEC), and three of its affiliates, have been added to the Entity List.
Founded in 1985 and headquartered in Shenzhen China, ZTE, whose shares are traded on the Shenzhen, China and Hong Kong stock exchanges, is China's second largest telecommunications company. ZTE is also the world's seventh largest producer of smartphones and has operations in the US and more than 160 other countries. ZTE has annual revenues of approximately $15 billion per year.
ZTE is being added to the BIS Entity List for allegedly reexporting US origin products to sanctioned countries, including Iran, and for planning "a scheme to establish, control, and use a series of “detached” (i.e., shell) companies to evade US export controls.
This action, which comes after a four-year investigation of ZTE by BIS's Office of Export Enforcement and the Federal Bureau of Investigation will have a major impact on ZTE and US and non-US companies.
BIS Entity List
The BIS Entity List, found at Part 744 of the US Export Administration Regulations (EAR), includes non-US businesses, research institutions, government and private organizations, individuals, and other types of legal persons, that are subject to specific license requirements for the export, reexport and/or transfer (in-country) of specified items. Parties are added to the Entity List by BIS when there is an increased risk of diversion of US-origin items or where the parties engaged in activities contrary to U.S. national security and/or foreign policy interests. BIS has been using the BIS more frequently in the past few years.
Specific entries on the Entity List identify the items that are subject to a license requirement and BIS's licensing policy regarding any license applications that are submitted.
Parties Added to Entity List and Licensing Requirements
As a result of today's BIS action, which takes effect immediately, BIS will impose a license requirement for all persons and companies, wherever located, to export, reexport or transfer to "all items subject to the EAR" to the following four companies:
1. Zhongxing Telecommunications Equipment (ZTE) Corporation (also referred to as ZTEC)
Address: ZTE Plaza, Keji Road South, Hi-Tech Industrial Park, Nanshan District, Shenzhen, China;
2. Beijing 8 Star International Co.
Address: Unit 601, 6thFloor, Tower 1, Prosper Center, No. 5, Guanghua Road, Chaoyang District, Beijing, China;
2. ZTE Kangxun Telecommunications Ltd.
Address: 2/3 Floor, Suite A, Zte Communication Mansion Keji (S) Road, Hi-New Shenzhen, 518057 China
4. ZTE Parsian.
Address No. 100, Africa Ave., Mirdamad Entersection [sic], Tehran, Iran.
The license review policy for all four entities is "presumption of denial", meaning that is not likely that BIS will approve any license applications to these four parties.
Because the license requirement for all four companies applies to all "items subject to the EAR", as defined in section 734.3 of the EAR, a license will be required to export, reexport or transfer all US-origin goods, software or technology, wherever located, whether classified as EAR99 or listed on the Commerce Control list (i.e., identified with an ECCN number, such as ECCN 3A001).
This will also have an impact on non-US companies because the license requirement will also apply to any item produced outside the US and sold to the four ZTE entities that incorporates US-origin parts, components, software if the total value of the controlled US content exceeds the de minimis level in section 734.4 of the EAR (e.g., 25% for reexports to China).
Impact on ZTE and US and non-US companies
This action will have a major impact on ZTE and many US companies as it has been estimated that ZTE sources more than 40% of its parts and components from US suppliers. As a result of ZTE's size and international footprint, US and non-US companies should immediately screen their customer databases to make sure that ZTE is flagged as a party subject to Entity List restrictions and that any shipments be stopped. While the BIS notice contains a "savings clause" for certain items that were already en route aboard a carrier to ZTE, there is no "grandfathering" of items that had been ordered but have not been shipped.
Unlike parties included on OFAC's SDN List, the addition of ZTE to the Entity List does not prohibit US or non-US persons from engaging in financial transactions with ZTE or require that any of the listed companies' assets be frozen. Rather, BIS is restricting the export, reexport or transfer of any goods, technology, or software to these ZTE companies. Also, unlike OFAC, BIS does not control the export of services to a listed party. However, the term “technology” is broadly defined in the EAR to include certain types of information, including specific information necessary for operation, maintenance, repair, overhaul and refurbishing of items subject to the EAR.
In addition, BIS does not have a 50% rule that applies to companies owned by the four ZTE companies listed. BIS has stated that the licensing requirements imposed on a listed entity by virtue of its being listed do not per se apply to its subsidiaries, sister companies, or other legally distinct affiliates that are not listed on the Entity List. However, BIS has also stated that if affiliates of the listed company act as an agent, a front, or a shell company for the listed entity in order to facilitate transactions that would not otherwise be permissible with the listed entity, then the company is likely violating General Prohibition 10 and other provisions of the EAR. Therefore, exporters are encouraged to take extra steps in an effort to make sure that items are not ultimately destined for the listed entities.
Reasons for Adding ZTE to Entity List
The Federal Register notice specifies that ZTE was added to the BIS Entity List because it reexported controlled US origin items to Iran in violation of US law. In addition, BIS noted that the company created an internal document entitled: “Proposal for Import and Export Control Risk Avoidance” describing how ZTE planned and organized a scheme to use a series of shell companies to reexport controlled items to Iran in violation of US export control laws.
In an unusual move, BIS published on its website documents obtained during its investigation of ZTE to support its findings. These documents, which are published below, are very thorough and read like a playbook on how to circumvent US export controls.
These documents, which were posted by BIS in their original Mandarin and translated English versions, provide detailed information on ZTE's understanding of how US export control laws applied to them and the repercussions if they were unable to continue with their work in the US sanctions countries, including Iran, Sudan, North Korea, Cuba and Syria. The documents even included a summary of the enforcement actions that could be taken against the company, including listing the US supply chain, and provided examples of prior export control issues the company had faced, and recent enforcement cases brought against other Chines companies. The documents show that ZTE tried to attract members to its export control team by paying a bonus.
For example, the "Proposal for Import and Export Control Risk Avoidance" describes how ZTE planned to establish and use "detached" (i.e., shell) companies and other measures to avoid "risks of import and export control". The document suggests that the company use the Jebel Ali Free Zone in Dubai as the "primary choice" to locate one of the companies. The document also describes ways to properly handle and pack the goods to minimize the risks to ZTE.
Because ZTE is a major telecommunications company the addition of ZTE to the Entity List has already had ripple effects. ZTE's stock has been suspended from trading on the Hong Kong and Shenzhen Stock Exchanges and China's Ministry of Foreign Affairs denounced the BIS actions in the following statement:
"The Chinese side is firmly opposed to the US using domestic laws to place sanctions on Chinese companies. The Chinese side urges the US side to call off the wrong action lest it should jeopardize economic cooperation and relationship between China and the US."
Representative Eliot L. Engel (D-NY), Ranking Member of the House Committee on Foreign Affairs, called for further restrictions on ZTE in the following statement:
"Today's action to impose a virtual embargo on exports to China's number-two telecom company, ZTE, reveals publicly for the first time that this company has systematically violated U.S. sanctions on Iran, North Korea, and other proscribed countries. ZTE bought U.S. telecom equipment and illegally incorporated it into communications systems for the Iranian and North Korean security, military, and intelligence agencies. I commend the federal agents at the Commerce Department, FBI, and Homeland Security Department for carrying out this four-year investigation. Additional criminal charges are likely to be brought. I believe that the U.S. sanctions should be extended to cut off all ZTE commercial activity and investment in the United States.”
It has been widely reported that BIS and the FBI commenced an investigation on ZTE's compliance with US export control laws in 2012. It has also been reported that senior ZTE executives have not traveled to the US over the past few years for fear of being arrested.
Given the activities described in the ZTE documents and in the BIS Entity List notice, it appears likely that ZTE will remain in the crosshairs of the US Government for some time to come.