US National Security Update: CFIUS Filing Fees, Extension of ITAR Relief, Hong Kong Loses Special Status with Sanctions on the Horizon
The US government recently took several significant steps designed to further protect national security, including: (1) finalizing the filing fee structure of reviews by the Committee on Foreign Investment in the United States (CFIUS or the Committee); (2) extending ITAR regulatory relief related to remote work through at least the end of 2020; and (3) making a number of significant modifications to the revocation of Hong Kong's special trade status and authorizing new sanctions related to Hong Kong's autonomy.
CFIUS Finalizes Fee Structure For Voluntary Notices
On July 28, 2020, the Department of the Treasury, as Chair of CFIUS, published a final rule to impose, for the first time, fees on parties to foreign investment transactions who request that CFIUS review their transaction under Section 721 of the Defense Authorization Act (Section 721).1 Such CFIUS reviews enable the parties to "covered transactions" under Section 721 to obtain CFIUS's assurance that proceeding with the transaction will not be blocked or limited by the President for national security purposes. The final rule sets these fees to range from $750 for lesser value transactions to the statutory maximum of $300,000 for large transactions, adjusted annually for inflation.
The final rule, which will be effective on August 27, 2020, remains consistent with the Treasury Department's proposed rules, which were released in March 2020.
Fees of Filing CFIUS Notices (but not Short Form Declarations)
The new rule establishes filing fees for notices filed with the Committee pursuant to the traditional voluntary notice process—the final rule does not impose any fees on parties who are required to inform CFIUS of their transactions pursuant to the FIRRMA-based mandates for filing short form "declarations" regarding certain particular types of proposed foreign investments. The fees also do not apply to voluntarily filed declarations, which is now an option for investors who believe their transaction can be cleared by CFIUS within 30 days (if CFIUS cannot finish in 30 days, only a notice filing can ensure that CFIUS reaches a final determination).
The fees are based on the expected overall value of the disclosed transaction, with smaller transactions (i.e., those with a value of less than $500,000) not being assessed a filing fee. For transactions with values equal to or greater than $500,000, the filing fee is based on a tiered approach:
- Transactions equal to or greater than $500,000 but less than $5,000,000 require a filing fee of $750.
- Transactions equal to or greater than $5,000,000 but less than $50,000,000 require a filing fee of $7,500.
- Transactions equal to or greater than $50,000,000 but less than $250,000,000 require a filing fee of $75,000.
- Transactions equal to or greater than $250,000,000 but less than $750,000,000 require a filing fee of $150,000.
- Transactions equal to or greater than $750,000,000 require a filing fee of $300,000.
Under the final rule, CFIUS would not begin review of a transaction until after payment of the required fee, which normally occurs at the time parties file their voluntary notice of the transaction.
Although Treasury is not imposing any fee for submitting a mandated short-form "declaration" or for undergoing any review that is self-initiated by CFIUS based on a notice filed by any member of CFIUS, the filing fees are required in cases where CFIUS has completed its review of a declaration and the parties subsequently file a notice, whether CFIUS has requested that the parties file the notice or has informed the parties that it is not able to conclude action and the parties elect to file a written notice. In addition, fees apply in cases where the parties choose to file a notice, rather than a short-form declaration, when a declaration is required.
Calculating Transaction Value
The final rule adopts CFIUS's proposed approach to calculate the overall value of a particular transaction in order to determine the applicable fee. Generally, this process will be straightforward, based on the amount that is being paid by the foreign party to the transaction, including cash, assets, shares or other ownership interests, debt forgiveness, services, or other in-kind consideration. For transactions involving non-cash assets, interests or services, or other similar consideration, the value will generally be calculated using fair market value of the assets or real estate being acquired as of the date the parties file the notice. The proposed rules also provide for the calculation of transaction value under certain more complex transactions, such as when a transaction arises from the conversion of a previously acquired contingent equity interest.
The final rules require that, along with a good faith estimate of the net value of the interest acquired in the US business by the foreign person, parties provide the Committee with the value of the transaction and an explanation of the methodology used to determine such valuation.
Fee Waiver and Refund
Under the final rule, filing fees may be waived in certain, limited circumstances. Specifically, the CFIUS Staff Chair may waive the filing fee, in whole or in part, if the Staff Chair determines that "extraordinary circumstances" related to national security merit waiving the fee. However, the proposed rules make clear that parties should not expect CFIUS to provide waivers on a frequent basis.
Additionally, the final rule allows parties to petition for a refund by demonstrating that a party or parties to a transaction paid a greater fee than the amount required at the time of filing. The final rule also provides that a full refund will be issued if the Committee determines that a transaction is not a covered transaction (i.e., CFIUS lacks jurisdiction to review the transaction under Section 721). Finally, parties will not be required to pay an additional fee where the Committee allows the parties to withdraw and re-file a notice unless the resubmission requires consideration of new information.
US Department of State Extends ITAR Compliance Relief
On July 29, 2020, the US Department of State, Directorate of Defense Trade Controls (DDTC), announced that it was extending certain temporary relief measures with respect to the International Traffic Arms Regulations (ITAR). As noted below, the measures primarily focus on the continued need for remote working environments. According to DDTC, the measures are necessary because it appears that "regulated entities will continue to engage in social distancing measures in the foreseeable future." Under the new extended measures, the following relief will be extended until the end of the calendar year:
- Temporarily, Contract Employees Do Not Need to Work at a Company's Facilities to Qualify as "Regular Employees." Until December 31, 2020, Contract employees are permitted to work remotely and still qualify as regular employees for purposes of ITAR licensing and authorizations, as long as the contract employee is not located in Russia or a country listed in 22 C.F.R. § 126.1.
- Temporarily, Regular Employees Working With Data Transferred Under an ITAR Agreement Can Work Remotely in Most Countries Not Expressly Approved by DDTC on the Face of the Agreement. Until December 31, 2020, Regular employees of entities who are working remotely in a country not currently authorized by a technical assistance agreement (TAA), manufacturing license agreement (MLA), or exemption to send, receive, or access any technical data authorized for export, reexport, or retransfer to their employer via a TAA, MLA, or exemption, are permitted to work remotely as long as the employee is not located in Russia or a country listed in ITAR § 126.1.
It is important to note that the announcement also states that it "will use this period to fully investigate the possibility and ramifications of making this modification [regarding remote work], or a variation thereof, a permanent revision to the ITAR." Therefore, it appears that DDTC, along with much of the modern global workforce, is anticipating a greater need for remote working conditions in the future.
Executive Order Introduces Sanctions, Ends Preferential Treatment for Hong Kong Under US Trade Laws
The US government recently accelerated retaliatory efforts against the People's Republic of China (the PRC or China) for alleged attempts to undermine Hong Kong's autonomy in connection with activities that China deems to be acts of secession, subversion, terrorism, or collusion with a foreign country. Specifically, on July 14, 2020, President Trump issued Executive Order 13936 (the Order), effectively eliminating the decades-long preferential trade relationship between Hong Kong and the United States. For all practical purposes, Hong Kong will be subject to the same economic policy barriers as mainland China. The Order also strengthens and expands sanctions mandated by the Hong Kong Autonomy Act (HKAA), which was simultaneously signed into law on July 14.
The HKAA and the July 14 Order represent the culmination of rapidly increasing strains on US-China relations. Companies and individuals engaging in trade of US goods and technology with Hong Kong should ensure that they revise their trade practices and export compliance procedures to ensure conformance with the enhanced export restrictions on Hong Kong. Additionally, financial institutions and other entities operating within the region should take care to evaluate whether their business dealings involve parties that may be subject to future sanctions under both the HKAA and the Order, as discussed below.
Eliminating Preferential Treatment in Trade
Until recently, the United States-Hong Kong Policy Act of 1992 allowed Hong Kong to receive preferential treatment in recognition of the former British colony's autonomy under Chinese authority. However, the Order suspends the application of Section 201(a) of the United States-Hong Kong Policy Act of 1992, as amended (22 U.S.C. 5721(a)), to numerous trade-based regulatory regimes, including the Arms Export Control Act, the Defense Production Act of 1950, the Export Control Reform Act of 2018, and 19 U.S.C. § 1304 (related to customs marking requirements for imports). This means that the Order effectively eliminates the decades-long preferential trade relationship between Hong Kong and the United States. The Order also directs agency heads to effectuate these regulatory changes within 15 days of the Executive Order date of July 14th, including to:
- Revoke license exceptions for exports, reexports, and transfers (in-country), to or within Hong Kong, of items subject to the Export Administration Regulations (EAR) that provide differential treatment compared to license exceptions applicable to China.2
- Terminate certain export licensing suspensions, to the extent such suspensions apply to exports of defense articles to previously authorized Hong Kong persons who are physically located outside of Hong Kong and China.
- Provide notice of intent to terminate the agreement for the reciprocal exemption with respect to taxes on income from the international operation of ships effected by the Exchange of Notes between the United States and Hong Kong.
The Order's suspension of preferential treatment under export control laws underscores recent trade-related announcements by the US Department of State. On June 29, 2020, the US Secretary of State announced that it will "end exports of U.S.-origin defense equipment and will take steps toward imposing the same restrictions on U.S. defense and dual-use technologies to Hong Kong as it does for China." Similarly, on July 15, 2020, DDTC issued Frequently Asked Questions (FAQs) addressing the Order, noting in particular that Hong Kong is now considered subject to a policy of denial for license authorizations under the ITAR. It is important to note, however, that the FAQs on the Order also assert that "[a]t this time the Department is not taking steps to revoke or rescind previously approved authorizations to export defense articles or services to Hong Kong."
More recently, on July 31, 2020, the US Department of Commerce, Bureau of Industry and Security (BIS), which oversees trade controls involving "dual use" commercial items under the Export Administration Regulations (EAR), published a final rule suspending the availability of all EAR license exceptions for Hong Kong that provide differential treatment as compared to those available to China. It is important to note that, under the EAR, Hong Kong is treated separately from China and is included in Country Groups A:6 and B, while China is included in Country Groups D:1, D:2-5. BIS' rule falls short of changing the applicable country groups and thus does not have the immediate impact of normalizing all of Hong Kong's preferential treatment under the EAR. However, the issuance of the Order in conjunction with BIS' rule should serve as a strong signal that BIS will amend the EAR to remove Hong Kong from Country Groups A:6 and B and to treat Hong Kong in the same manner as China. This will have a significant impact on businesses in Asia (in particular, China) that maintain assets in Hong Kong in order to benefit from its A:6 and B group status.
Sanctions of Foreign Persons Involved in the China's New National Security Law
The July 14 Order also strengthens and expands sanctions mandated under the HKAA. Under the HKAA, sanctions may be imposed on foreign persons and entities whom the US Department of State identifies as materially contributing, have materially contributed, or are attempting to materially contribute, to the failure of China to meet its obligations to ensure Hong Kong retains a high degree of autonomy.3 A person or entity "materially" contributes to such failure if the person:
- Took action that resulted in the inability of the People of Hong Kong:
- To enjoy freedom of assembly, speech, press, or independent rule of law; or
- To participate in democratic outcomes; or
- Otherwise took action that reduces the high degree of autonomy of Hong Kong.
Financial institutions identified by the US Department of the Treasury to have knowingly conducted a significant transaction with such foreign persons also are subject to sanctions under the HKAA, including losing broad access to the US financial system.4
Section 4 of the Order builds on the sanctions authorized under the HKAA by directing the Secretary of State and Secretary of Treasury to impose blocking sanctions on foreign persons determined "to be or have been involved, directly or indirectly, in the coercing, arresting, detaining, or imprisoning of individuals under the authority of, or to be or have been responsible for or involved in developing, adopting, or implementing, the Law of the People's Republic of China on Safeguarding National Security in the Hong Kong Administrative Region" (the National Security Law). The Order also blocks any transactions or transfers involving the property and interests of foreign persons that are determined:
- To be responsible for or complicit in, or to have engaged in, directly or indirectly, any of the following:
- Actions or policies that undermine democratic processes or institutions in Hong Kong;
- Actions or policies that threaten the peace, security, stability, or autonomy of Hong Kong;
- Censorship or other activities with respect to Hong Kong that prohibit, limit, or penalize the exercise of freedom of expression or assembly by citizens of Hong Kong, or that limit access to free and independent print, online or broadcast media; or
- The extrajudicial rendition, arbitrary detention, or torture of any person in Hong Kong or other gross violations of internationally recognized human rights or serious human rights abuse in Hong Kong;
- To be or have been a leader or official of:
- An entity, including any government entity, that has engaged in, or whose members have engaged in, any of the activities described above; or
- An entity whose property and interests in property are blocked under the Order;
- To have materially assisted, sponsored, or provided financial, material, or technological support for, or goods or services to or in support of, any person whose property and interests in property are blocked under the Order;
- To be owned or controlled by, or to have acted or purported to act for or on behalf of, directly or indirectly, any person whose property and interests in property are blocked under the Order; or
- To be a member of the board of directors or a senior executive officer of any entity whose property and interests in property are blocked under the Order.
The Order also prohibits any transactions that evade, avoid, violate or attempt to violate the Order, as well as conspiracies to violate the Order. Additionally, persons determined to be blocked under this Order and their family members will also be denied entry into the United States.
Additional Administrative Changes Under the Order
The Order implements additional modification of previously enacted policies, including but not limited to: the elimination of preferences for Hong Kong passport holders compared with those of China; the incorporation of Hong Kong persons to certain US immigration and visa policies for China; the termination of the Fulbright exchange program with respect to future exchanges for participants traveling both from and to China or Hong Kong; and the reallocation of admissions within the refugee ceiling set by the annual Presidential Determination to residents of Hong Kong based on humanitarian concerns. The Order also directs heads of agencies to give notice of intent to suspend various US-Hong Kong agreements related to the surrender of fugitive offenders and the transfer of sentenced persons.
Impact of Executive Order
Given the extensive effort to eliminate preferential trade treatment and to punish actions that allegedly undermine Hong Kong's autonomy, the Order serves as a stark signal that the US no longer views Hong Kong separately from China. As a result, any trade-based, financial, or other business engaged in the region should carefully review its operations in light of the restrictions and possible sanctions under these new policies. Moreover, interested parties should stay vigilant. The US government is likely to implement additional requirements, the severity of which is likely dependent on how China implements the National Security Law.
© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.
The US Secretary of Commerce previously announced that "Commerce Department regulations affording preferential treatment to Hong Kong over China, including the availability of export license exceptions, are suspended", effective June 29, 2020. The Commerce Department also published a notice of its Suspension of License Exceptions for Hong Kong.
The HKAA is also somewhat overlapping with the Hong Kong Human Rights and Democracy Act of 2019, which provides authority to sanction persons involved in "gross violations of internationally recognized human rights in Hong Kong."
The HKAA does not define "significant transaction", but the parameters of what the US government typically considers to be a "significant transaction" are available at the US Department of the Treasury's FAQ 542.