Expect BIS to Prioritize Egregious Violators of New 50% Rule, Lawyers and Advisers Say

Matthew Axelrod, the former head of BIS export enforcement during the Biden administration, said the BIS "enforcement team is going to be happy with this change" because they felt it was too easy for Entity List companies to set up subsidiaries and evade the restrictions. "Whether that leads to additional enforcement cases against companies that have shipped to unlisted subsidiaries remains an open question," he said.

Although BIS could have begun enforcing the rules as soon as they were released and made effective on Sept. 29, Axelrod said, during his time in government, the agency prioritized what it believed were the most egregious violators after new, complex regulations were released, partly because BIS didn’t have enough agents to look into every breach.

“A foot fault by a company that is trying to get into compliance with a brand-new rule wasn't at the top of our priority list. I assume that will be the same this time,” he said. He added that some commercial vendors that provide restricted party list screening are still adjusting their services to meet the new regulations.

“If it's a couple days, a week or two after the new rule comes in,” it’s “still a violation,” said Axelrod, now a lawyer with Gibson Dunn. “I just don't think that it's going to be at the top of the BIS to-do list.”

A BIS spokesperson didn't respond to a request for comment.

The rule expanded the universe of companies subject to stringent BIS license requirements by making any majority-owned affiliate subject to the same export restrictions as their owner on either the Entity List, Military End-User List or under certain financial sanctions (see 2509290017).

Consultants and lawyers interviewed by Export Compliance Daily described a panic last week among many exporters -- particularly smaller firms with fewer resources devoted to compliance -- that may have been aware the rule was being drafted but didn’t know exactly how it would apply and when it would become effective.

Compliance for some firms is expected to be challenging, especially around portions of the BIS rule that don’t necessarily impose new export controls but do require exporters to carry out extra due diligence. BIS has said exporters may have a responsibility to apply for a license in cases where the exporter can’t calculate the entire ownership breakdown of a foreign customer, but they know the customer is at least minority-owned by a restricted party (see 2510020012).

Some U.S. companies may have been doing business under those conditions for years, lawyers and industry officials said, and the restrictions may have caught them off-guard on Sept. 29.

“There's always an adjustment period when BIS does what it did here, which is change a rule and make that rule change effective immediately,” Axelrod said. “That makes it hard for industry, because there is necessarily a bit of a scramble to get into compliance.”

Mike Huneke, a trade lawyer with Morgan Lewis, said he wouldn’t assume BIS is observing an enforcement grace period. But he said companies will have a better chance of avoiding BIS scrutiny -- or dodging a harsh penalty -- if they show they took steps to comply.

“I think if you could show a good faith effort to get your arms around this and respond, in some reasonable amount of time, or at least explain why it took the amount of time it did for you to respond, I think that's something they would take into consideration,” he said. “Again, it wouldn't excuse a violation. It wouldn't be a total defense. But it would, I think, be mitigating if you could show the efforts you've made to try to get your arms around this.”

In those cases, BIS could offer mitigation credit, for example, if it decides to impose a penalty, Huneke said. BIS also may take into account the size of the exporter and the types of challenges it faced getting quickly into compliance, he said.

“If you're a huge company, and you have a Rolls Royce compliance program and screening tools, you can move reasonably quickly on this. But what if you’re not? What if you're far from that?” Huneke said, adding that this topic could be featured in future BIS guidance. “I think that’s where risk-based compliance, as it's been practiced in the [Foreign Corrupt Practices Act] world, could be helpful to people.”

Breck Heidlberg, managing director with FTI Consulting and a former State Department official, said the “immediate concern” of most companies has been the increased restricted-party screening workload they now have to undertake. He also noted, as BIS has, that the Consolidated Screening List, the government-run list of parties subject to export controls, no longer captures the range of companies subject to strict U.S. export licensing rules.

“For any size of your compliance maturity, it's going to create a lot of work,” Heidlberg said. He added that compliance concerns among exporters and other companies were likely exacerbated because the 50% rule became effective immediately.

“I think that probably is the cause of some of the underlying panic,” he said. While companies may be hopeful that BIS will give them time to bring their programs into compliance with the new restrictions, he said they shouldn't count on it, especially because rumors of the new rule have been circulating since spring.

“Given that this has been kind of out there for a while,” Heidlberg said, “I just don't know if it’s realistic to expect there not to be immediate enforcement.”

Still, the exact details of the rule weren’t yet known until it was released last week, and many companies were likely “waiting to see the final form,” said Lindsay Wardlaw, a lawyer with Gibson Dunn. While some companies expected the 50% ownership threshold to at least apply to the Entity List, Wardlaw said it may have surprised some that it also applied to the MEU List and to certain parties restricted under the Export Administration Regulations because of their placement on the Treasury Department’s Specially Designated Nationals List.

“And now there's a mad scramble because you have to stop shipping the very same day, unless your goods are already on route,” Wardlaw said, referencing the rule’s savings clause that allowed certain goods to be shipped if they were aboard a carrier to a port as of Sept. 29.

“But if you have a purchase order in your hand that you haven't shipped yet, you may have contractual liability under the purchase order without actually being covered by the savings clause,” she said, “which could put you in a very nasty place contractually.”

Wardlaw also said she believes BIS could begin enforcing the rule immediately.

“I think the very fact that they” issued the rule effective immediately, “even as [public] comments are pending because it's an interim final rule, tells us there's no grace period,” she said. “I think it's possible enforcement will not be harsh for violations in the week or two after the rule was released, because it does take industry time to adjust to new rules. But I don't think we can assume there's a so-called grace period.”

Geoffrey Gertz, a senior fellow with the Center for a New American Security and the former director for international economics in the Biden White House, said it’s unclear how many companies may have been in violation of the rule as soon as it was released.

“That's the million-dollar question,” he said. “We have no idea.”

He also said carrying out due diligence under this rule and other similar, complex trade regulations is a “genuinely hard problem,” especially for smaller companies that may now have to scrutinize the ownership structure of all their customers.

“The challenge here is going to be that, for a rule that has such sweeping implications, if you're the little mom-and-pop shop who's selling things only to a handful of small countries, not dealing with sort of advanced Chinese tech or anything like that, are you really going to do a bunch of due diligence to ensure whoever your counterparty [is] for every export is not owned by somebody on the Entity List?” Gertz said. “That seems kind of unrealistic.”

He said that could lead BIS to receive a “bunch” of export license applications, especially in cases where companies can’t determine the entire ownership breakdown of a foreign customer that they know is less than 50%-owned by an Entity Listed party.

“The onus will then be on BIS to get those properly evaluated and assessed,” Gertz said.

It’s unclear whether BIS will be able to handle a potential surge in applications, partly because the agency is still dealing with a backlog of applications after it paused and resumed processing licenses multiple times earlier this year (see 2506110008, 2504020051 and 2504140055).

“I think there are real concerns about BIS’ current bureaucratic capability in issuing licenses,” Gertz said.

Lawyers and industry officials still say license reviews are slow, and the agency suspended processing all non-emergency license applications last week because of the government shutdown (see 2510010019).

Axelrod said companies could choose instead to informally ask BIS about whether a potential customer is captured by the rule, but that presents its own risks.

“That's a risky thing to come in and ask that question, because then you’ve got to live with the answer,” said Axelrod, who signed off on multiple BIS penalties against companies for illegally exporting items to parties on the Entity List. He said exporters are more likely to “do their own internal risk assessments” before deciding whether to apply for a license or potentially submit a voluntary disclosure.

“The rule changed overnight. I'm sure there are some companies that are out of compliance,” Axelrod said. “It's going to require companies to start -- the ones that aren't already -- to start using commercially available services in order to make sure they're screening against all the parties that are caught by the new Affiliates Rule. And until those commercial services adjust, and then companies onboard those services, or something like it, they certainly risk being out of compliance.”

Heidlberg, who was a senior manager for risk and compliance at Microsoft before joining FTI Consulting, said he believes more companies, especially those that kept their sanctions and export compliance teams separate, may need to merge those processes to best comply with the rule. He noted that new sanctions designations by the Office of Foreign Assets Control have always taken effect immediately, but companies have traditionally had longer to comply with new export control rules and restrictions.

“The export control side is now going through a lot of the same things that the sanctions space has done for a long time,” he said. “The sanctions staff always has this compliance readiness mindset of, ‘OK, pull the teams together, how do we react?’

“You're starting to see more companies do this on the export control side to adopt that mentality of crisis management.”