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Unparalleled $300 Million Civil Penalty for Export Control Violations Underscores the Imperative of Strong Compliance for Companies Operating InternationallyApril 25, 2023
The Biden Administration has sent its strongest signal yet that it intends to vigorously enforce U.S. export control laws as a means to counter perceived national security threats posed by China. Last Friday, the Commerce Department announced the largest-ever standalone civil settlement of violations of the Export Administration Regulations (“EAR”). The settlement stems from a Commerce Department investigation of unlawful exports to a Chinese entity.
The U.S. Commerce Department’s Bureau of Industry and Security (“BIS”) has reached a $300 million settlement with Seagate Technology LLC (“Seagate”) to resolve violations of U.S. export control restrictions on shipments to Huawei Technologies Co. Ltd. (“Huawei”). BIS alleged, and Seagate admitted, that after BIS imposed export controls specifically targeting Huawei in 2020, Seagate continued to sell more than 7.4 million hard disk drives (“HDDs”) to Huawei valued at over $1.1 billion without BIS authorization. Seagate engaged in this prohibited conduct despite having notice that its HDDs destined for Huawei were subject to U.S. export controls and knowing that its competitors stopped their sales to Huawei because of those new rules. BIS’s enforcement action against Seagate is the largest standalone administrative penalty in the agency’s history. In announcing the resolution, Assistant Secretary for Export Enforcement Matthew Axelrod described the settlement as “a clarion call about the need for companies to comply rigorously with BIS export rules, as our enforcement team works to ensure both our national security and a level playing field.”
This landmark Seagate settlement is most fully understood within the context of developments in the national security regulatory arena, both in the significant expansion in restrictions, as well the government’s strategy for enforcing those restrictions.
The Broader Context
U.S. Government national security concerns about China increased significantly beginning in the Obama Administration, and since that time, successive administrations have focused sharply on expanding existing measures to address those concerns, as well as developing new tools. Huawei and other high-tech Chinese companies have been a significant target of such new and expanded measures.
The Huawei Rule
Beginning in 2019 during the Trump Administration, BIS initiated a series of measures designed to restrict Huawei, including more than 100 of its global subsidiaries, from accessing goods, software, and technology subject to U.S. jurisdiction. See OMM Alerts - United States Expands Export Controls Targeting Huawei’s Access to US Technology; Trump Administration Continues to Target TikTok and Huawei. In May 2019, BIS designated Huawei and 68 of its affiliates on the Entity List, which imposed a license requirement on the export, reexport, or transfer (in-country) of all items subject to the EAR to those Huawei entities. 84 additional Huawei entities were designated on the Entity List in 2019 and 2020.
In August 2020, BIS imposed further restrictions on Huawei by expanding the EAR’s so-called “foreign-direct product rule” (“FDPR”) specifically with regard to Huawei. The FDPR provides that items produced outside of the United States can be subject to the EAR if they are a direct product of specified U.S.-origin software or technology, or are produced by a plant, or major component of a plant, that itself is a direct product of specified U.S.-origin software or technology. The Huawei-specific FDPR expanded the scope of U.S.-origin software and technology (and overseas plants and major components that are direct products thereof) to include software and technology used in semiconductors and telecom and imposed a license requirement where there is knowledge that Huawei is a party to the transaction as a purchaser or end-user.
The Biden Administration’s Export Control and Economic Sanctions Enforcement Strategy
The Biden Administration has continued to expand restrictions related to China, most notably with broader restrictions on the export of semiconductor technology. See OMM Alerts — United States Imposes New Restrictions on Exports of Advanced Computing Chips and Semiconductor Manufacturing Items to China. These measures have been imposed in parallel to significant restrictions on Russia following its invasion of Ukraine. See OMM Alerts — Biden Administration Issues Initial Set of Sanctions in Response to Russian Invasion of Eastern Ukraine; Biden Administration Issues Second Set of Sanctions on Russia Broadly Targeting the Financial and High-Tech Sectors; Biden Administration Continues to Broaden Economic Sanctions on Russia in Response to Ongoing Aggression in Ukraine; Biden Administration Further Expands Sanctions on Russia as War in Ukraine Continues.
Through its actions targeting China and Russia, several themes have emerged that define the Biden Administration’s strategic approach to enforcement of export controls and the related area of economic sanctions:
Senior Enforcement Official Attention
Export control and economic sanctions enforcement have been a clearly stated priority since the early months of the Biden Administration. In October 2021, Deputy Attorney General Lisa Monaco issued a new memorandum on corporate criminal enforcement, specifically mentioning the growing national security dimension of corporate crime, including export controls and economic sanctions. In June 2022 remarks, DAG Monaco announced that economic sanctions is one of DOJ’s highest enforcement priorities, noting that the private sector is on the “front lines” of emerging geopolitical realities, such as corruption and sanctions evasion. She further stated that DOJ’s criminal enforcement strategy “includes enlisting the private sector to help watch out for misconduct within companies.” Emphasizing the importance of compliance, she further added that DOJ stands ready to work with companies that are “truly committed to promoting a corporate culture that values and invests in compliance – rather than begrudges or under-resources it.”
Expectation of Greater Cooperation from Private Sector
DAG Monaco’s stated expectations of the private sector are mirrored in last week’s release of an amended BIS voluntary disclosure policy, which has been revised to state that a failure to disclose significant export violations would be considered an aggravating circumstance in penalty negotiations. (Voluntary disclosures always — and continue to be — rewarded with mitigated penalties, but the failure to disclose has not, to date, been considered an aggravating circumstance.)
Allocation of Greater Resources
The Biden Administration’s prioritization of export controls and economic sanctions enforcement has led to significantly increased resource allocation. Last month, DAG Monaco announced the addition of 25 prosecutors to the National Security Division’s Counterintelligence and Export Control Section, and BIS and OFAC have also received substantial budget increases for enforcement.
Greater Interagency Coordination on Enforcement
The prioritization of export controls and economic sanctions enforcement has also resulted in the establishment of new inter-agency teams to pro-actively combat evasion of economic sanctions and export control rules. In March 2022, the DOJ announced the creation of the Task Force KleptoCapture, an interagency team dedicated to enforcing economic sanctions and export control laws by pursuing blocked assets of Russian oligarchs and sanctions evaders. This task force recently obtained the forfeiture of $826,000 in funds that was intended for the illegal purchase of U.S. defense goods. On February 16, 2023, DOJ and Commerce announced the creation of the Disruptive Technology Strike Force, an interagency team focused on disrupting efforts by “nation-state adversaries” from illegally obtaining advanced U.S. technology.
Government Guidance to Private Sector
As new restrictions are imposed or new intelligence emerges, key stakeholder agencies have issued parallel guidance to the private sector in efforts to disrupt evasion and support compliance. On March 3, 2023, Commerce, Treasury, and the DOJ released a Tri-Seal Compliance Note that details ways in which intermediary companies are instrumental in evading export controls by obfuscating the ultimate Russian destination for goods. Other examples of such detailed guidance include BIS’s March 30, 2022 release of information on which aircraft were exported to Russia in violation of the EAR (alerting the aviation sector which aircraft were illegal to service). Efforts to guide the private sector on how to avoid non compliance are perhaps best exemplified in the increasingly detailed OFAC Enforcement Releases. A recent notable example is the April 6, 2023 Enforcement Release announcing a nearly $2 million OFAC settlement with Microsoft Corporation for apparent violations of multiple sanctions programs. That release contains instructional guidance on areas of risk related to software exports, exposure arising from actions of foreign subsidiaries, and evasion tactics of Russian companies.
Increased Cooperation with Allies
New restrictions on Russia (and to a lesser extent China) have been developed in close coordination with allies, most notably the European Union and the United Kingdom. This cooperation has extended to the enforcement arena.
Implications of the Seagate Settlement
The Seagate settlement is one of the first penalties to emerge from the new Huawei restrictions and signals that BIS will not be hesitant to enforce these technically challenging rules.
The fact that Seagate not only did not stop selling to Huawei, but in fact substantially increased its sales contributed to the largeness of the penalty. The BIS Order describes how Seagate’s overseas plants used third-party equipment subject to the EAR’s Huawei-specific FDPR to manufacture HDDs for Huawei. As a result, beginning in August 2020, Seagate’s HDDs required a license from BIS in order to ship the products to Huawei. Instead, after the implementation of the Huawei-specific FDPR, Seagate expanded its business with Huawei by entering into a Strategic Cooperation Agreement and Long Term Agreement with Huawei, becoming a “key strategic supplier” of Huawei, and extending Huawei multiple lines of credit totaling more than $1 billion. Ultimately, Seagate ceased its sales to Huawei in September 2021, after committing 429 violations of the EAR.
Seagate’s ignoring of red flags also likely contributed to the size of the penalty. One notable red flag is that one of Seagate’s third-party equipment suppliers provided notice to Seagate that its equipment was subject to the Huawei-specific FDPR, but Seagate continued to sell to Huawei without obtaining the necessary authorization from BIS.
Perhaps the most stark lesson learned from the Seagate settlement is that a company ignores the publicly announced actions of its competitors at its peril. The Order states that Seagate continued and then increased its sales to Huawei even after hearing its competitors announce their intent to cease shipments in light of the new restrictions.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Greta Lichtenbaum, an O'Melveny partner licensed to practice law in the District of Columbia, Sid Mody, an O'Melveny partner licensed to practice law in Texas, and David J. Ribner, an O'Melveny counsel licensed to practice law in the District of Columbia and New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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