Smaller Firms Still ‘Surprisingly Naive’ About Export Compliance Obligations, Panel Says

Wolf-Christian Paes, senior fellow with the International Institute for Strategic Studies, said many small and medium-sized companies are still “surprisingly naive about the nature of their customers” and don’t always carry out as much due diligence as they should. Maria Shagina, also a senior fellow at the London-headquartered think tank, noted that even larger and more sophisticated firms may not be doing enough.

“The problem is, as we've seen with the testimony in the U.S. Congress of key semiconductor companies, they didn't really do this due diligence," Shagina said during a May 5 event hosted by the International Institute for Strategic Studies. "They outsourced it to distributors."

U.S. lawmakers pressed American chip manufacturers last year to better scrutinize products that have ended up in Russian weapons, with one lawmaker calling their efforts "willful ignorance or perhaps something more" (see 2412190033, 2409100069 and 2409110064).

Companies are in the “driving seat” of making sure export controls are effective, Shagina said, and they need to have a solid grasp of the end-users of their products. But she said there are still open questions about “how seriously” they treat compliance “and how comprehensive of an approach they take to due diligence.”

She also acknowledged that exercise has become “much more complicated” by some countries and sanctioned suppliers using front companies or multiple intermediaries to illegally buy export-controlled goods.

Paes said many manufacturers of microelectronics and other parts sought by Russia are smaller companies that may not have many customers. Those firms may be less able to spot red flags or less willing to investigate them, he said, especially if a possible sale is lucrative and doesn't appear to violate any laws.

He pointed to a hypothetical situation in which a small jet engine manufacturer that makes a few hundred engines per year suddenly gets an order for 100 engines from a “previously unknown” customer. Although the order would trigger know-your-customer procedures for most businesses, the engine maker might be “so excited about the sudden order volume that all caution goes out of the window and they say, 'OK yes, of course, dear new customer, here are my 200 engines. Please transfer the money to my bank account."

They might be especially willing to process the order if they can’t spot any obvious “evil intent” and if no export license is required, he said.

“So if you get, suddenly, a very large order from an unknown customer, be cautious,” Paes said. “Even though the export might be legal, there might well be reputational damage in your future if you don't pay more attention. That seems to be an issue particularly with smaller enterprises.”

Shagina said Russian export enforcement in particular has been “lagging” partly because of the “deep involvement of small and middle-sized enterprises” in that trade, saying those firms are “much more ill-equipped to understand due diligence.” She said government agencies, particularly the Bureau of Industry and Security and authorities in the U.K., “have invested a lot in business outreach” to create compliance guidance for smaller businesses, and other governments should follow suit.

Shagina also pointed out that BIS and the Office of Foreign Assets Control have imposed or promised to impose large penalties on companies violating their rules (see 2503180041 and 2503280039), which helps encourage American firms to invest in compliance. It also encourages them to self-disclose possible violations to avoid a large fine, she said.

“In the U.S. context, that has been really the key,” she said. “Companies are seeking contact with OFAC, for example, and BIS -- not vice versa. Because they know that steep penalties are coming.”

Shagina and Paes also said governments need to manage their own export control lists, and modernize multilateral regimes, in order to keep the restrictions effective. Paes specifically said multilateral regimes haven’t kept up with the pace of technology.

“It's not so much that the control regimes themselves are poor,” he said. “The problem is that the control lists are really not up to date.”

Paes said he worked on research in 2021 that showed many of the parts discovered in the Yemen-based Houthis' missile systems weren’t controlled by Wassenaar. “I have not checked today,” he said, “but I dare say that probably hasn't changed massively.”

That’s a “problem” because most countries’ export control lists “are basically copies of the Wassenaar Arrangement list, even countries who are not part of Wassenaar,” Paes said. That makes “investigations -- but also stopping [trade] flows -- really, really challenging.”

Shagina also called multilateral lists “outdated,” partly because Russia remains a Wassenaar member with veto power, but also because the regimes haven’t kept up with emerging technologies.

“It's just old lists that are not keeping up fast enough with the development of technological progress,” she said.

She also noted that Russia has been able to adapt to export controls, including by finding substitutions or by rerouting shipments to avoid detection. Countries imposing restrictions against Moscow "need to constantly update export controls,” Shagina said. “It’s something that the U.S. has done much more quickly vis-a-vis-China than vis-a-vis Russia.”