US Administration Tests the Water on New Unheard-of Government Review of International Technology Transactions

Under this new evaluation process, Commerce can prohibit companies from engaging in a wide variety of transactions and order them to cease using the information technology or telecommunication system in question even if it is already in operation.

What was announced?

Under a proposed rule announced November 26, 2019, certain information and communications technology or service (ICTS) transactions involving a foreign adversary may be blocked if the Department of Commerce finds the transaction presents an undue or unacceptable risk to national security or the safety of US persons.

What kind of transactions can be evaluated and prohibited?

All sorts – provided they are subject to US jurisdiction, involve a foreign entity’s “interest” and were completed after May 15, 2019.

The transactions to be reviewed by Commerce are far broader than the various investments that can be reviewed by the Committee on Foreign Investment in the United States (CFIUS), and the export transactions that may require a license from Commerce. Under Commerce’s proposed rule, the term “transaction” includes “any acquisition, importation, transfer, installation, dealing in, or use of any information and communications technology or service.” Only three things are required for a transaction to be reviewed:

1. a person subject to US jurisdiction or property subject to US jurisdiction;
2. it involves property in which any foreign country or foreign national has an interest; and
3. the transaction was initiated, is pending, or will be completed after May 15, 2019.

This potentially involves all future international trade you say? Yes, in theory, but the only ones that are at risk are ones involving a “foreign adversary.”

How will we know who is a “foreign adversary”?

We won’t.

The President’s May 15, 2019, Executive Order defined a “foreign adversary” as any foreign government or foreign non-government person determined by the Secretary of Commerce to have engaged in a long-term pattern or serious instances of conduct significantly adverse to the national security of the United States or security and safety of United States persons.

The proposed rule says the determination of a “foreign adversary” is a matter of “executive branch discretion” and will be made by the Secretary of Commerce in consultation with other cabinet-level Secretaries. The rule does not state whether Commerce will publish an actual list of these foreign adversaries. The rule also does not indicate that Commerce will provide any notice to foreign companies prior to designating them as foreign adversaries.

How will a review by the Department of Commerce be initiated?

The draft regulations state that the Administration can initiate a review (1) at the Secretary of Commerce’s discretion; (2) by request of other Government Department/agency or the Federal Acquisition Security Council; or (3) based on information submitted by private parties to the Commerce Secretary. The submission by private parties likely would be a submission of information by a competitor unhappy about a transaction where business was awarded to a foreign-controlled company.

Are all information and communications technology or service transactions involving “foreign adversaries” potentially on the chopping block?

Yes, the range of potential transactions subject to Commerce’s forthcoming evaluation process is startling.

Commerce will evaluate – to potentially block or require measures to mitigate – transactions that involve the acquisition, importation, transfer, installation, dealing in, or use of ICTS by any person, where the transaction:

1. Is conducted by any person subject to US jurisdiction or involves property subject to US jurisdiction;
2. Involves any property in which any foreign country or foreign national has an interest; and
3. The transaction was initiated, is pending, or will be completed after May 15, 2019;
4. The transaction involves ICTS that was “designed, developed, manufactured, or supplied,” by persons owned, controlled, or subject to the jurisdiction or direction of a foreign adversary; and
5. The transaction poses an undue or unacceptable risk to the United States.

How would the deal be evaluated?

For transactions that meet the criteria listed above, Commerce would conduct a case- and fact-specific inquiry into whether the transaction poses undue or unacceptable risks to the national security of the United States.

To determine whether a “foreign adversary” was involved in the design, development, manufacture or supply of the ICTS, Commerce would scrutinize the proposed deal, including the division of equity interest, access rights, composition of the board of directors or governing body, contractual arrangements, voting rights, and control over business affairs.

Could parties participate in the evaluation?

Yes, but there may be very little time to defend your transaction.

The rule requires that Commerce inform parties of a preliminary determination that Commerce has found the transaction to be problematic. In other words, although Commerce has the ability to notify parties that an evaluation is ongoing, under the proposed rule, Commerce is not required to do so until it has reached a preliminary decision that the transaction poses undue or unacceptable risks to the national security of the United States.

Once notified of that preliminary determination the parties have only 30 days to submit an opposition with supporting information to the preliminary determination. Commerce would then reach a final determination green-lighting the transaction, prohibiting the transaction, or requiring specific mitigation measures as a condition of approval.

Keep your records related to the deal current and in order! A party will receive notice that its transaction is under evaluation and Commerce will require retention of any and all records relating to the deal. Of course, all public information is fair game. Stay on top of what has been published about your transaction, your company and the foreign entities involved.

What can Commerce do and what are the potential penalties?

Commerce can order the parties to take steps to mitigate the risks posed by the transaction including requiring the parties immediately cease the use of the information technology or telecommunication system in question – even if it has been installed and is in operation.

Failing to abide by Commerce’s final determination prohibiting the transaction or breaching a material provision of any required mitigation measures could cost you dearly – up to $302,584 (adjusted annually for inflation) or twice the amount of the transaction that is the basis of the violation (whichever is greater) – and penalties may be assessed per violation.

When are comments due?

December 27, 2019.

What are the grey areas in the proposed rule where Commerce is inviting comments?

Commerce posed certain questions on which it would particularly welcome comment:

• Should Commerce consider any categorical exclusions to determine if transactions are prohibited, instead of engaging in a case-by-case analysis?
• Are there certain kinds of transactions where the risk could be mitigated and if so what form could such mitigation measures take?
• How should Commerce ensure that the parties comply with the mitigation measures?
• How should the terms “dealing in” and “use of” be interpreted for purposes of the definition of “transaction”?

The proposed rule follows an Executive Order 13873 issued earlier this year that declared a national emergency with regard to (1) foreign adversaries creating and exploiting vulnerabilities in ICTS, and (2) the acquisition or use in the United States of ICTS from foreign adversaries. As noted in our May 22, 2019 Alert, the EO did not target any one country or entity, but increased regulatory scrutiny and escalation of tariffs by the Trump Administration all point to China.

Did Congress legislate this evaluation process?

No. The President relied on his powers under the International Emergency Economic Powers Act (IEEPA) and two other statutes to declare a national emergency in Executive Order 13873. And this evaluation process – which combines elements of an export control review, a CFIUS review and some property and interest concepts contained in OFAC regulations and applies it to a broad range of commercial transactions the US Government has never reviewed before – is brand new.

Of course, many a complex set of OFAC regulations has come out of IEEPA, and IEEPA was also used to authorize the Export Administration Regulations before Congress permanently reauthorized it with the Export Control Reform Act in 2018. But we ask – would such a potentially broad-reaching, yet extremely vague set of rules that allow the US Administration to prohibit and undo a wide variety of transactions have passed Congress had it been legislation? And will it survive a constitutional challenge?