Where Export Controls and Chinese Military Meet

In China, it’s not always easy to tell where private enterprise ends and the public sector begins. That can create problems for Western businesses operating under U.S. law.

First, corporations might do business with Chinese companies that have Communist Party or government officials sitting on their boards or acting in an executive capacity; that raises the specter of violating the Foreign Corrupt Practices Act, if U.S. prosecutors interpret some business payment as a bribe to Chinese officials. Then there’s the risk that a U.S. company accidentally ends up doing business with the Chinese military, which would mean non-compliance with the U.S. arms embargo against China.

Such encounters with the Chinese military can happen more often than one would think. The military is enmeshed in China’s commercial sector, with wholly owned subsidiaries, manufacturing plants, and equity stakes in corporations. It is also a customer for many products, from boots to semiconductors. U.S. companies—and all companies with some nexus to U.S. legal jurisdiction—must tread carefully. Something as harmless as hydraulic oil for elevator maintenance could end up resold to a Chinese business that makes tanks, and then the compliance questions can come fast and furious.

Epstein

“My view of China is that the government and military are pervasive,” says Jonathan Epstein, a partner at the law firm Holland and Knight who practices international trade law. “It’s hard to find a company that doesn’t have a connection to the military.”

Still, U.S. companies have a strong interest in selling goods and services to China. It is a market far larger than Cuba, North Korea, and other nations under a U.S. arms embargo and can have huge consequences for a company’s bottom line. What’s more, most technologies considered sensitive by the U.S. government are readily available to China from European countries—so it’s not as if the arms embargo does much to help U.S. national security.

“We have a dyslexic policy,” Epstein says. “China is a huge trading partner on one hand. On the other hand, there is a serious military concern about China.”

U.S. regulators have recently tried to simplify the delicate balance companies face, with mixed results. The Commerce Department’s Bureau of International Security launched a new program last year to pre-screen Chinese companies. If they passed muster, they would be designated as Validated End-Users (VEUs), and U.S. companies would be permitted to export certain dual-use products to them.

“You have to know your customer and not sell blind. If the seller has any doubt, it has the obligation to go one step further.”

— Jo-Anne Daniels,

President,

Trade Resources & Associates

In October, five Chinese companies were designated as the first wave of VEUs: Applied Materials China (a subsidiary of Applied Materials Corp. in California), National Semiconductor, Semiconductor Manufacturing International, Shanghai Hua Hong NEC Electronics, and BHA Aerocomposite Parts.

Then the trouble started.

Just as BIS introduced the Validated User program, the Bush Administration added more items to the list of products that require export license to send to China. That has made selling dual-use items to Chinese companies more difficult, unless the U.S. company is dealing with a VEU.

Another headache cropped up in January: The Wisconsin Project, a nuclear disarmament group, issued a report saying that two of the five VEUs—BHA Aerocomposite and Hua Hong—actually do have strong ties to the Chinese military. U.S. Rep. Ed Markey, D-Mass., then circulated a letter raising concerns about the VEU program and calling on the Commerce Department to provide more information about it. Those efforts did soon lose steam (no other congressmen have signed onto Markey’s letter; the Wisconsin Project did not respond to a request for an interview for this article). Trade compliance experts say the VEU program is moving forward in fits and starts.

Daniels

“There was certainly a lot of vetting and a lot of questions” about the first five VEUs, says Jo-Anne Daniels, president of Trade Resources & Associates, a consulting company that specializes in customs issues. “They had to explain exactly how they are going to put controls in place and detail their recordkeeping and compliance programs.”

Others working in export control compliance also say that the VEU program is not easily subject to abuse. The five companies that have received the coveted designation endured strong scrutiny from a wide range of U.S. departments and regulatory agencies. More broadly, the program compels VEUs to adopt U.S.-style compliance policies and practices, such as documentation and records retention. They will also have to accept inspections by U.S. government officials.

“In some ways I like the VEU program,” Epstein says. “The government wants the Chinese companies to have a compliance program.”

U.S. companies still have their own formidable compliance obligations when selling to China. They must confirm that their products do not need an export license (or get one if they do) and also must check whether the purchaser is on a “restricted” or “denied-parties” list, which the State, Treasury, and Commerce departments all play a role in creating. And finally, an exporter must “know the buyer” and understand his or her intentions for the product—including an assessment of whether the buyer might then resell the goods to the Chinese military.

“You have to put together an entire program,” Daniels says. “You have to know your customer and not sell blind. If the seller has any doubt, it has the obligation to go one step further.”