BIS Warns Industry About Added Compliance Obligations for New 50% Rule

The text of the rule, previously reported by Export Compliance Daily (see 2509280001), was released and effective Sept. 29. A 60-day temporary general license will authorize certain transactions through Nov. 28 involving non-listed, majority-owned affiliates of parties on the Entity List or Military End-User List. BIS is accepting public comments for 30 days, and said it’s specifically seeking feedback about whether the 50% ownership threshold should be lower and whether it should expand the affiliates rule to cover other EAR end-user lists.

“For too long, loopholes have enabled exports that undermine American national security and foreign policy interests,” BIS Undersecretary Jeffrey Kessler said. “Under this administration, BIS is closing the loopholes and ensuring that export controls work as intended.”

Although BIS is expanding its export restrictions to cover only majority-owned affiliates, it also warned that a foreign entity with “significant minority ownership” by a listed entity or that has other “significant ties to” a listed party, such as overlapping board membership, is a red flag that should be resolved. “In this type of situation, additional due diligence is necessary, especially given the opaque ownership structures and limited access to accurate ownership data in certain jurisdictions,” BIS said.

It added that exporters, reexporters and transferors are “responsible for compliance” with the affiliates rule, warning that they “can be held liable” for any illegal transactions “on a strict liability basis, so due diligence must be conducted to determine whether a foreign entity is an entity that is owned by one or more listed entities.” It also said other parties, such as freight forwarders and financial institutions, “may also have compliance obligations.”

The rule requires exporters and other companies to carry out “additional due diligence” to determine whether a company is majority owned, either individually or in aggregate, by one or more parties on the Entity List or MEU List. If the exporter can’t determine the ownership percentage of a foreign entity owned by a party on either list, the exporter must resolve that “red flag” or obtain a BIS license before moving forward with the export, reexport or transfer, unless a license exception is available, the agency said.

If a non-listed foreign entity is owned 50% by more than one party on the Entity List or MEU List, “the most restrictive of those Entity List license requirements apply,” BIS said.

If, after receiving a license application, BIS is able to determine that the foreign entity is not owned 50% or more by a listed party, BIS said it will inform the applicant that a license isn’t required. The agency also said it may issue public guidance, including a frequently asked question on its website, “to advise other exporters of such determination,” the rule says.

BIS said affiliates of listed parties can request of the agency to be exempted from the 50% rule restrictions. In those cases, BIS said it may modify a listing to "exclude" certain affiliates.

The rule also applies to any majority-owned entity blocked under “specific programs” in 744.8(a)(1) of the Export Administration Regulations, which covers certain entities sanctioned by OFAC on its Specially Designated Nationals List. The agency said it’s “warranted to also use the 50 percent ownership standard for the § 744.8 requirements to protect U.S. national security and foreign policy interests and to reflect the close relationship with OFAC for purposes of this section.”

One hypothetical example in the rule illustrates how the new 50% rule will apply in practice. The example says companies A and B are listed on the Entity List, with Company A subject to a more-restrictive license review policy. Company A owns 35% of Company C -- which isn’t on any restricted party list -- and Company B owns 15% of Company C. Because Company C is owned 50% or more in aggregate by the two companies on the Entity List, BIS said it should be treated the “same as if the item was being exported” to an Entity Listed company.

In that scenario, Company C would face the same license review policy that applies to Company A, because that’s the most restrictive. “The Entity List license requirements and license review policy for Company A would be followed for any transaction where Company C is a party to the transaction,” the rule said.

BIS said it’s intentionally mirroring the approach of the 50% rule used by OFAC because it believes “adopting the same standard that exporters, reexporters and transferors have already been using in their OFAC compliance programs will likely ease the burden in adopting the new standard for Entity List compliance as compared with a distinct standard that applies a lower ownership threshold.”

But some industry officials have warned about unintended business consequences of the change, which could effectively expand the Entity List and MEU List to cover thousands of new subsidiaries (see 2505280038 and 2506170016). BIS acknowledged that the new rule may “require additional analysis” and compliance resources by the private sector, and it's expecting to receive about 250 additional license applications annually.

“Applying the Affiliates rule may take more time and compliance resources compared to simply screening a list for identified names," BIS said, "especially in situations where limited information on corporate ownership structures is publicly available, such as where a listed entity is privately held."

The agency said the rule is necessary because it is “concerned” that the previous approach to the Entity List “can enable diversionary schemes, such as the creation of new foreign companies to evade Entity List restrictions. Creations of such companies may allow listed entities to deceive exporters, reexporters, and transferors into the provision of items in violation of the Entity List restrictions that apply to the listed entities.” The agency said it had to “expend substantial efforts to address” Entity List evasion tactics, including by regularly publishing rules to add newly created front companies to the Entity List.

With this rule, BIS is “reducing future piecemeal regulatory activity to expand Entity List restrictions,” the agency said.

The rule also includes guidance about what information exporters should include in license applications when they can’t determine whether a foreign entity is majority owned by a restricted party. Those license applications must specify the names of the listed party or parties that own that entity, BIS said, and also must explain the “due diligence conducted to determine the percentage of ownership, including providing an explanation for why percentage of ownership was not able to be determined.”

The application also must specify the names of the listed party or parties that majority own the affiliate, “including identifying the percentage of ownership by listed parties and identifying the method that the applicant used to make that determination.”

“The inclusion of this information as part of a license application, will assist BIS in identifying why the license application was submitted and in evaluating potential diversion concerns,” the agency said.

BIS also said license exceptions for listed entities can be used for their majority-owned affiliates. BIS gave the example of JSC Integral, an Entity List company that’s eligible for License Exception GOV (Governments, international organizations, international inspections under the Chemical Weapons Convention and the International Space Station). As long as the export isn’t “otherwise restricted,” BIS said exporters can “rely on this license exception authorization for an export to a foreign entity” majority owned by JSC Integral.

BIS added that it’s not adopting the affiliates rule for the Unverified List or for entities majority owned by a party operating at an address listed on the Entity List, as long as the entities operating at that address are not “specifically identified on the Entity List.”

“BIS notes that these addresses pose diversion concerns such as through the operation of corporate secretarial services companies or logistics companies associated with high volumes of diversion,” the rule said, “but that entities located at a different address with a parent company registered at a corporate services address on the Entity List may not present the same diversion risks.”

All exports that now require a license as a result of this rule but were aboard a carrier to a port as of Sept. 29 may proceed to their destinations under the previous eligibility as long as the items are exported before Oct. 29, BIS said.