Mind-Realizing Law

Responsible Value Creation

Clarion Call Challenges Supply Chain Champions to Emerging Chinese Companies

Posted by on April 20, 2023

Seagate, major hard disk drives (“HDDs”) producer, becomes the first major Western supplier of Huawei penalized for violation of the so-called FDP (foreign direct product) rule administered by US Department of Commerce (DOC) on April 19, 2023.[1]  This unprecedented enforcement of the controversial FDP rule involves $1,104,732,205 “unlicensed” sales of HDDs produced outside of US, a mass consumer electronics item to Huawei sanctioned under the Entity List.  The $300million penalty and settlement represents the largest standalone administrative penalty in DOC’s enforcement history.

Source: European Central Bank, https://www.ecb.europa.eu/pub/pdf/ecbu/eb202301.en.pdf (PMIs reflect strong economic interdependance by and among China, EU and US. and Japan.)

Regulatory Background

The so-called FDP rule prohibits sanctioned entities from buying semiconductors or components that constitute a direct product of US software or technologies.  Evasive measures are allegedly conceivable, previously, if a sanctioned entity procures from a supplier/item not captured by the previous FDP rule.  In August 2020, US tightened and expanded the jurisdictional reach of “covered transactions” under the FDP rule to capture situation “where U.S. software or technology is the basis for a foreign-produced item” or “when any Huawei entity on the Entity List is a party to such a transaction.  Under the latter situation, it suffices as “covered transaction” under the auspices of US export control regime, so long as Huawei or any of its affiliate is a “purchaser,” “intermediate consignee,” “ultimate consignee,” or “end-user.”[2]  (See our previous briefing)  Such FDP rule has been expanding to cover entities beyond Huawei.

Legal Issues – Scope & Consequence

The Bureau of Industry & Security of DOC determines that Seagate “incorrectly interpreted the FDP rule to require evaluation of only the last stage of its HDD manufacturing process rather than the entire process (to determine the regulatory coverage of its supplies).” 

Instead, BIS stresses that “[A]ny equipment (subject to specified export control items under the FDP rule] that is involved in any of the production stages is considered essential.”  This jurisdictional reach targets assembling plants outside US, e.g., in Asia for finished items in regulated sectors with either:

  • Upstream US technologies or
  • In-plant controlled equipment.

BIS imposes the following penalties:

  • Civil penalty: $300,000,000 by quarterly payment for 5 years till July 31, 2028;
  • Multi-year audit requirement: over export controls compliance program with results including “copies of the export control documents and supporting documentation” for further regulatory scrutiny no later than May 1, 2024
  • Denial order: five-year denial of its export privileges which also applies to its successor-in-interest and third parties (including agents and employees) acting on its behalf.

Notably, the settlement involves no monitorship – a significant recognition of the remediating efforts perhaps by Seagate and its defending trade counsels.

Lesson Learnt on Level & Depth of Legal Oversight

In Seagate-Huawei commercial agreements, Seagate stresses to “engage indepth technical collaboration” and customer support “subject to compliance to US trade entity list rules (if applicable), and any other applicable export related laws and rules, for new product qualification and joint development.”

As such, Seagate’s commercial agreements presumably involve legal & compliance function supports. The “sales list” attachment to the settlement agreement presumably indicates authorized action by financial and risk management functions.

Yet the enforcement indicates that contractual management, albeit critical, is insufficient internal safeguards against trade compliance exposures. It reflects under-appreciated yet highly risky exposure under US export control regime:

  • Maximum civil penalty up to the greater of $353,534 per violation, or twice the transaction value
  • Denial of export privileges
  • Exclusion from practice before BIS; and/or
  • Other civil or even criminal liability, sanction, or penalty enforced by regulators in trade & investment.

Outlook

BIS’s $300 million monetary penalty is more than twice what BIS estimates as “net profits for the alleged illegal exports to or involving Huawei.”

This enforcement action indicates the aggressive approach with respect to how BIS interprets and enforces US presidential power “under emergency.”  Its profound ramifications would be beyond cutting off the entire ecosystem from any emerging Chinese companies beyond Huawei, if and when sanctioned for alleged “circumventing U.S. law.”

Referring this case as “a clarion call about the need for companies to comply rigorously with BIS export rules,” BIS further announced that

“Any company exporting to an entity subject to the additional FDP rule restrictions needs to evaluate its entire manufacturing process to determine if specified U.S. technologies or software were used in building the essential tools used in production. Companies that discover violations should submit voluntary self-disclosures….”

China has strongly opposed to such extra-territorial jurisdiction and enforcement as unjustified violation of the most favored nation (MFN) treatment among other WTO principles.  China has appealed to the WTO with respect to US-imposed de facto embargo[3] against semiconductor above certain technology nodes[4] as well as “any ongoing conduct resulting from the continued application of these measures.”

The Government of China takes the position at the WTO:

“An export control regime should serve to promote global security and facilitate responsible export with respect to the international commitments of non-proliferation. However, the United States abuses its export control regime as a tool to achieve its objectives of maintaining “its leadership in science, technology, engineering and manufacturing sectors”. As a blatant example, the United States implements export control on items for civilian use or on activities of commercial entities, with a view to weaken the scientific and technological development of other WTO Members and to preserve its technology edge.”

Domestically, China had initiated on March 31 a “cybersecurity and national security” review against Micron, a major global DRAM and NAND flash maker, with respect to “Micron’s products sold in China.”[5]

Also, the “countermeasures” by China against foreign measures detrimental to its essential security interests will be in the form beyond Chinese sanction / export control regime. 

Compliance with and respecting both US and Chinese law must be critical component to ensure informed business decision-making and execution.

[1] U.S. Dep’t of Commerce, Bureau of Industry Security, “Order Relating To Seagate Technology Llc And Seagate Singapore International Headquarters Pte. Ltd” (Apr. 19, 2023), https://efoia.bis.doc.gov/index.php/documents/export-violations/export-violations-2023/1497-e2836/file.

[2] U.S. Dep’t of Commerce, Bureau of Industry Security, “Addition of Huawei Non-U.S. Affiliates to the Entity List, the Removal of Temporary General License, and Amendments to General Prohibition Three (Foreign-Produced Direct Product Rule)” 85 Fed. Reg. 51596 (Aug. 20, 2020) (imposing licensing requirements on the foreign-produced direct product of certain U.S.-origin technologies and software, effective August 17, 2020), https://www.federalregister.gov/documents/2020/08/20/2020-18213/addition-of-huawei-non-us-affiliates-to-the-entity-list-the-removal-of-temporary-general-license-and.

[3] U.S. Dep’t of Commerce, Bureau of Industry Security, “Implementation of Additional Export Controls: Certain Advanced Computing and Semiconductor Manufacturing Items; Supercomputer and Semiconductor End Use; Entity List Modification” and “Revisions to the Unverified List; Clarifications to Activities and Criteria That May Lead to Additions to the Entity List” (Oct. 13, 2022), https://www.govinfo.gov/content/pkg/FR-2022-10-13/pdf/2022-21658.pdf.

[4] Government of China, Request for Consultation by China, United States – Measures on Certain Semiconductor and Other Products, and Related Services and Technologies (Feb. 10, 2023), WT/DS615/1/Rev.1, https://docs.wto.org/dol2fe/Pages/SS/directdoc.aspx?filename=q%3A%2FWT%2FDS%2F615-1R1.pdf.

[5] Office of Central Cyberspace Affairs Commission of the People’s Republic of China (PRC or China), Announcement to Initiate Cybersecurity Review Regarding Products Sold in China by Micron Corporation (Mar 31, 2023), http://www.cac.gov.cn/2023-03/31/c_1681904291361295.htm.