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Trade and Investment
2005 is certain to be another active year in international trade and business. Intellectual property will continue to play an important role both in U.S. policy and in the private sector, as U.S. companies seek intellectual property protections both at home and abroad. Section 337 litigation can be expected to increase, even over record 2004 levels, as more companies recognize its benefits for intellectual property protection. We expect similar high levels of activity in other areas of trade litigation, including antidumping and countervailing duty litigation as well as safeguards measures. Global trade flows will be affected by the emerging emphasis on regional and bilateral free trade agreements. The negotiation and implementation of such agreements will continue to dominate the second Bush administration’s trade agenda, offering new opportunities for U.S. companies and protections for U.S. investors. We expect to see more investor-state dispute resolution mechanisms included in trade agreements and bilateral investment treaties, and major cases that interpret such provisions in existing agreements.
In the legal compliance area, homeland security and enforcement will dominate the agendas of various government agencies charged with regulating imports, exports, and anti-corruption laws. U.S. Customs and Border Protection will continue its emphasis on cargo security, as the agency seeks to increase private sector compliance obligations. Several agencies have experienced turnover of high-level personnel over the past year, but we do not expect enforcement to decrease as a result. On the contrary, enforcement of U.S. export controls will continue to result in enormous monetary penalties and will be marked by higher expectations on U.S. exporters for internal controls and due diligence in corporate mergers and acquisitions. Foreign Corrupt Practices Act enforcement, with its own aggressive pace of cases, will reflect a similar high level of activity and expectations in 2005.
China, Intellectual Property Rights, and Section 337
A trend for 2005 that does not take a crystal ball is continued concern over protecting intellectual property (IP) rights against infringing Chinese products. Late last December, China’s Supreme People’s Court issued new, stricter guidelines for criminal sanctions for violating IP rights, but preliminary reactions from U.S. companies are that China still has a long way to go. Separately, the U.S. Trade Representative (USTR) just requested comments on China’s protection of IP rights as part of a review that could support a World Trade Organization (WTO) challenge to a lack of IP enforcement by China.
An important mechanism for U.S. enforcement of IP rights against infringing imports is an unfair trade investigation before the U.S. International Trade Commission (ITC), under a provision of the U.S. trade laws known as Section 337. Section 337 provides a fast-paced alternative to district court litigation against infringing imports. Cases typically are resolved within 12-15 months, and relief is in the form of an exclusion order barring all infringing importations, which is enforced at the border by Customs.
The past year brought a near-record number of Section 337 cases, with more expected in 2005. With China only behind Canada in the volume of imports into the United States, the number of Section 337 cases filed against Chinese companies has grown dramatically and is likely to continue increasing. Currently, many Chinese companies default. But as more Chinese companies invest in U.S. brands and market presence, and necessarily become more sophisticated about IP rights, the number of Chinese companies that default in Section 337 cases is likely to decline.
Protecting IP Rights Overseas: Fighting in Foreign Courts is Just One Way to Keep IP Safe
Overseas piracy of IP is an increasing problem for U.S. companies. Foreign respect for IP varies greatly, and local remedies may be slim or ineffective. But local courts are not the only tools available to enforce IP rights overseas. Companies are increasingly looking to a number of remedies that can be found within the broader field of U.S. trade and foreign policy. In some instances, these tools may be more effective than traditional legal tactics.
Section 301 Investigations: The USTR can investigate a foreign unfair trade practice, including failure to protect IP, and can negotiate to eliminate the practice, initiate a WTO complaint, or, potentially, retaliate against the foreign government involved.
Special 301 Lists: The USTR also defends IP rights abroad by issuing a Special 301 list, which identifies countries that do not adequately protect IP rights or that limit market access for U.S. companies. The most egregious IP violators are identified as “priority foreign countries,” and are investigated by the USTR. Alternatively, the USTR can include a country on its Special 301 “watch list” or “priority watch list.” As noted above, the USTR just announced an investigation of China’s enforcement of IP rights, and is seeking comments on which countries should be placed on the Special 301 list.
Generalized System of Preferences (GSP): Under the GSP, the United States provides reduced tariff rates to developing countries, but requires that these countries commit to protecting IP rights. The USTR can investigate developing countries that are accused of failing to protect IP rights. Currently, the USTR is investigating Brazil, Pakistan, and Russia.
Section 332: American companies can encourage the institution of a Section 332 fact-finding investigation by the ITC. Section 332 reports can be valuable references for the administration and Congress in their efforts to address a country’s failure to protect IP rights.
Traditional Diplomacy: U.S. Government officials, including officials from the USTR, the Commerce Department, and the Patent and Trademark Office can forcefully advocate a company’s position, as can members of Congress.
Trade Negotiations: When a foreign country is negotiating for a multilateral or bilateral trade agreement with the United States, American companies have an opportunity to work with the U.S. government to encourage that foreign country to improve its IP protection. In particular, the USTR has a private sector IP committee that often counsels the USTR during its negotiations.
Import Relief Actions: Steadily Increasing or Poised to Decline in 2005?
According to recent statistics of the WTO, the pace of new antidumping, countervailing duty, and safeguard actions launched by WTO member countries against imports is slowing. After climbing steadily since the inception of the WTO in January of 1995, the number of new import relief actions fell by over 12 percent during the first half of 2004.
Some experts believe this decline signals a turning point, on the theory that globalization and its effects are taking hold. In a world where most industries rely on outsourcing and imports to remain competitive, they believe fewer industries are interested in the kind of trade litigation that pits “us against them.”
Certainly, these observers may be right. On the other hand, the WTO’s data may simply be a blip in an otherwise steady increase in such actions. After all, the WTO has accelerated the fall in tariffs, quotas, and non-tariff barriers to trade that often protected domestic industries from import competition. Today, antidumping, countervailing duty, and safeguard actions are the principal means that domestic industries have to combat injurious imports consistent with WTO policies. Lately, developing countries, led by India, China, Turkey, and Mexico, have started to protect their industries from imports through antidumping and other import relief measures.
2005 is shaping up to be an active year for import relief actions in the United States. A new antidumping petition was filed on December 27, 2004 against orange juice from Brazil. And the textile and apparel industries, which have benefited from quotas on imports for over 20 years, recently launched safeguard actions against China based on imports that allegedly disrupt or threaten to disrupt the U.S. market. Some observers expect antidumping and countervailing duty actions against textiles and apparel to follow.
Import relief actions will also continue to be the subject of dispute settlement proceedings before the WTO. Roughly 45 percent of all WTO disputes concern antidumping, a statistic that reflects the important and enduring place import relief actions have come to occupy in the increasingly complex world of international trade.
Crowded Trade Agenda on Capitol Hill in 2005
2005 should be an unusually busy year for trade issues in the United States, especially for the Congress. Some of the key issues likely to arise are the following:
Trade Promotion Authority (TPA): Enacted in 2002, TPA requires Congress to render a swift vote on U.S trade agreements without amendments. TPA is scheduled to expire on June 30, 2005, but can be renewed through 2007 if the President requests an extension by March 1 and neither House or Congress disapproves that extension by June 1. Failure to renew TPA would make approval of U.S. trade agreements more difficult.
Free Trade Agreements (FTAs): Congress will consider a number of FTAs in 2005. The most contentious will be the U.S.-Central America FTA (CAFTA). Congress’s rejection of the CAFTA could slow down pending and future FTAs or, at the very least, result in future FTAs with tougher labor and environmental standards to gain such approval.
U.S. Vote on WTO Membership: The 1994 Uruguay Round Agreements Act allows any Member of Congress to call for the withdrawal of the United States from the WTO. Because of its privileged status, such a motion must be voted on by the full House or Senate, depending on where the issue is raised. The first such vote occurred in 2000 and the motion was easily defeated. We do not expect different results now, but more vigorous debate on this issue could color U.S. trade negotiations during 2005.
Russia PNTR: As part of its efforts to join the WTO, Russia faces bilateral negotiations with the United States. If Russia and the United States conclude an agreement, the President would ask Congress to grant Russia “permanent normal trade relations,” otherwise known as “most-favored nation” treatment, for tariffs and other trade laws. This would be an important symbolic victory for Russia that would demonstrate a higher level of acceptance by the West.
U.S. FTAs: Opportunities and Risks
With the start of President Bush’s second term and with increased Republican majorities in Congress, FTA negotiations will likely remain at the center of the administration’s trade agenda. By December 2004, the United States had entered into new FTAs with Singapore, Chile, and Australia; had concluded negotiations on four additional FTAs; and had entered into negotiations for four more. Negotiations for a Free Trade Area of the Americas are also ongoing. (See chart below.)
These developments offer both opportunities and risks for those involved in international trade. By educating themselves about the details of relevant FTAs, companies can organize their supply chains to take maximum advantage of the tariff preferences and other provisions that FTAs offer and thereby reduce their duty payments significantly.
But companies must also understand and comply with more regulatory requirements to claim benefits under the FTAs. Non-compliance can result in increased audit scrutiny and assessments of significant back duties and penalties. Each FTA differs in terms of the products eligible for tariff elimination, the speed with which tariffs on each product are to be phased out, and the procedures that govern claims for benefits. Each FTA also has its own rules of origin that determine whether or not goods produced or manipulated in a particular country qualify as originating from the country, which determines eligibility for duty preferences in FTA partner countries.
U.S. Free Trade Agreements (as of January 2005)
U.S. FTAs in Force
Negotiations Underway or Completed
Central American countries (Costa Rica, El Salvador, Nicaragua, Honduras and Guatemala)
South African Customs Union (South Africa, Namibia, Botswana, Lesotho, Swaziland)
Andean countries (Bolivia, Columbia, Ecuador, Peru, Venezuela)
Oman and UAE (recently announced)
Free Trade Area of the Americas
New Foreign FTAs May Shift Asia-Pacific Trade Away from U.S.
New FTAs by the Association of Southeast Asian Nations (ASEAN) (which includes Indonesia, Brunei, the Philippines, Singapore, Malaysia, Thailand, Cambodia, Laos, Vietnam, and Myanmar) could have the effect of undermining U.S. trade interests in the region. On November 29, 2004, ASEAN entered into an FTA with China. The ASEAN-China FTA establishes an enormous free trade area consisting of an economic region with 1.7 billion consumers, a regional gross domestic product of about $2 trillion, and total trade estimated at $1.23 trillion.
ASEAN is also pursuing FTAs with Japan, India, Korea, New Zealand, and Australia. These FTAs would give these U.S. trade competitors a significant advantage in exporting to China and other Pacific Rim countries. A result of these new agreements could be a diversion of investment to ASEAN countries, where it is cheaper to export to China and to other Pacific Rim countries.
Investor-State Dispute Resolution Mechanisms in Recent FTAs
In 2004, the United States negotiated a flurry of new FTAs, almost all of which included mechanisms for resolving investment disputes. These now allow foreign investors who are injured by certain types of actions of the host government to arbitrate their claims.
FTAs with Chile and Singapore, both of which contain investor-state arbitration mechanisms, entered into force in 2004. The FTAs with Morocco and the CAFTA, for which negotiations have been concluded (but which have not yet entered into force), contain similar investor-state arbitration provisions. While the FTA with Bahrain does not contain an arbitration mechanism, such arbitration is allowed by the US-Bahrain bilateral investment treaty. The FTA with Australia does not contain mandatory arbitration of such disputes, but it does encourage both countries to submit investment disputes to arbitration.
Investor-state disputes have been fairly common under the North American Free Trade Agreement and other FTAs that contain investor-state dispute resolution mechanisms. These cases often blend trade and investment elements. A company confronted with arbitrary or discriminatory action in an FTA country may have such investment protections available, if the company qualifies as an “investor” or has an “investment” within the terms of the FTA. In 2005, we expect to see some governments, faced with more investment claims and the creative use of these mechanisms, to try to tighten eligibility standards for recourse to these mechanisms.
Foreign Tax Measures Continue to Engender Investment Disputes
The recent US$ 9.4 billion acquisition by Russian government interests of the Yukos oil concern following that government’s cumulative tax claims totaling over US$ 27 billion underscores Supreme Court Justice John Marshall’s 1819 maxim that a “power to tax necessarily involves a power to destroy, because there is a limit beyond which no institution and no property can bear taxation.”
Although Yukos involves a domestic enterprise, the applicability of this maxim is also apparent in a growing number of cases brought by foreign investors against their host governments. These cases involve claims that the host country’s tax measures, or the implementation of those measures, have harmed their investments in that country, or have breached investment protections agreed to by the host government.
These cases reflect the international law principle that tax measures, like other types of regulatory measures, can violate the substantive protections found in bilateral investment treaties (BITs) and FTAs when applied arbitrarily or with discriminatory or expropriatory effect. As the growing body of U.S. BITs and FTAs typically guarantee investors and their investments against expropriation, discrimination, and a lack of “fair and equitable treatment,” investors increasingly turn to these agreements for redress.
The most significant recent investment dispute in this area was Occidental Petroleum Company v. Government of Ecuador, brought under the U.S.-Ecuador BIT. In this case, a panel of arbitrators issued an award in favor of Occidental in the amount of US $75 million for Ecuador’s wrongful withholding of value added tax (VAT) refunds. The tribunal found that, in denying VAT refunds to Occidental, Ecuador breached a BIT obligation to provide Occidental treatment no less favorable than that provided to similarly situated Ecuadorian investors and investments. The tribunal also found that Ecuador violated its obligations under the BIT to accord “fair and equitable treatment” to Occidental, which included the obligation “not to alter the legal and business environment in which the investment [was] made.”
Important pending investment cases with tax issues include a group of cases filed against Mexico under Chapter 11 of the NAFTA involving an excise tax on soft drinks sweetened with high fructose corn syrup rather than sugar. With these cases and others, we expect further developments in the substantive application of BIT and FTA protections to tax measures.
M&A Due Diligence Takes Center Stage in Regulatory Enforcement
The importance of compliance due diligence in the M&A context has been rising steadily in the last two years, and likely will be a keystone issue for Foreign Corrupt Practices Act (FCPA) and export control compliance in 2005.
In recent years, the FCPA arena has generated high profile enforcement actions against the surviving company of a merger or acquisition, including Syncor ($3 million total fines) and ABB ($16.4 million total fines). In addition, the collapse of the proposed Lockheed/Titan merger in June 2004 because of unresolved FCPA issues was widely reported in the press.
Not to be outdone, the Departments of Commerce and State have also imposed successor liability in a number of export control cases including the Sigma-Aldrich decision in late 2002 ($1.76 million total fines), the EDO Corporation settlement in late 2003 ($2.5 million total fines), and the GM/General Dynamics case of late 2004 ($10 million in fines). In addition to hefty monetary penalties, nearly all of these cases have resulted in significant government-dictated compliance obligations, and a requirement to include export compliance reviews in all future M&A due diligence. These cases have signaled that an acquiring company may be held liable for an acquiree’s violations of international regulatory compliance laws, including the FCPA and export control laws, if those violations are not addressed and given a clean bill of health by enforcement officials before the acquisition.
The potential extent of such an undertaking is illustrated by a July 12, 2004 Opinion Procedure Release from the Justice Department related to the ABB case, which described a due diligence effort that included over 44,700 “man-hours” of work by more than 115 attorneys and 100 forensic accountants, review of over 4 million pages of documents and electronic files, over 165 interviews, and “real-time” reporting of results to U.S. enforcement agencies. In our view, such an effort does not represent a plausible minimum standard for avoiding successor liability; instead, the question what level of effort is required to achieve insulation from liability will vary with the circumstances of the particular transactions, the violations discovered, and the remedial actions taken.
It is clear that in 2005 any company active in the M&A field target, acquirer, lender, underwriter, or other should be considering appropriate due diligence measures, as traditional indemnities may no longer be adequate.
Supply Chain Security: Will C-TPAT Become Mandatory?
From its inception, the Customs-Trade Partnership Against Terrorism (C-TPAT) has been promoted by U.S. Customs and Border Protection (CBP) as a government-industry partnership -- that is, a voluntary, cooperative endeavor to secure an importer’s supply chain against infiltration and misuse by terrorists. However, the value of the program is now being questioned. The main purported benefit of participation expedited customs clearance is seen by some importers as illusory. Even after nearly three years, CBP’s provision of supply chain security expertise and guidance is criticized as lacking, with the costs of the program perceived as falling primarily on importers who choose to participate. Security experts believe that most companies’ supply chains remain vulnerable.
One of the reasons for this vulnerability is that only a small fraction of U.S. importers approximately 4,700 have signed up for the program. But even if every U.S. importer were to join, C-TPAT participation is not available to the thousands of foreign suppliers who export to the United States, leaving an obvious, gaping hole in the program.
A General Accounting Office (GAO) study of C-TPAT will be released in late January, and is expected to be critical of the program’s lack of uniform, clear standards, and of the missing link in the supply chain. Recent CBP activity suggests it is attempting to address these criticisms before the report is issued. In late 2004, CBP floated proposals that would have included, albeit indirectly, many foreign suppliers and established some uniform standards for supply chain security. The catch was that C-TPAT participants would have been responsible for evaluating and approving the supply chains of every one of their unrelated suppliers and service providers. Not surprisingly, the response to this proposal was generally negative. Importers are concerned that CBP is transforming a “voluntary” program into mandatory requirements. While CBP cannot require an importer to participate in C-TPAT, it links participation in C-TPAT to other programs that importers find desirable.
C-TPAT remains a mandatory prerequisite for companies seeking to participate in the Importer Self-Assessment (ISA) program or in the Free and Secure Trade (FAST) program along the northern and southern borders. And even though C-TPAT is a flawed program, there are obviously very good reasons to enhance a company’s supply chain security and to leverage that investment by participating in the program. For those companies still deciding whether to participate in C-TPAT, CBP’s latest proposals should not affect that decision. Dramatic revisions to the program are unlikely unless Congress gives CBP additional authority, which will not happen soon.
Export Controls: U.S. Continues Vigorous Approach Towards Enforcement
2004 continued the recent upsurge in enforcement of U.S. export control laws, a trend we expect to continue in 2005. In the past year, the State Department extracted eye-popping, multimillion-dollar settlements from U.S. companies charged with violating the State Department’s International Traffic in Arms Regulations (ITAR). At the same time, the Commerce Department’s Bureau of Industry and Security (BIS) imposed a large number of significant civil penalties for violations of the Export Administration Regulations (EAR).
These trends, particularly within BIS, suggest that the benefits of voluntarily disclosing export control violations have diminished. Generally, the rule-of-thumb 50 percent penalty mitigation for voluntary disclosures still applies, but BIS increasingly appears to treat voluntary disclosures as a springboard to enforcement actions as opposed to warning letters.
BIS has also recently proposed changes to expand the regulatory bases for liability. In October 2004, BIS proposed a rule that would nearly double the number of “red flags” that increase due diligence obligations, and that would redefine “knowledge” to establish certain violations of the EAR. If finalized, the new rule would impose a “reasonable person” standard and lower the threshold of knowledge from a “high probability” to “more likely than not,” making EAR violations easier to establish.
A Changing of the Guard in Sanctions and Export Controls
The last year has witnessed departures of several key officials in the U.S. government agencies charged with the administration and enforcement of U.S. sanctions laws and export controls. Although we expect the trend of heightened enforcement to continue, the coming year should show the impact of the new appointments on the policies and practices of those agencies. Here is a quick glance at some of the important changes:
Office of Foreign Assets Control (OFAC): Robert Werner has replaced Richard Newcomb as director of OFAC, the agency responsible for the administration of the U.S. government’s economic sanctions programs. In his more than 15 years as OFAC director, Mr. Newcomb had come to embody virtually all of the attributes of this small but very powerful office. Mr. Werner, who previously served as the Treasury Department’s Assistant General Counsel for enforcement and intelligence, has already taken steps to review OFAC’s internal structure as well as its enforcement policies and procedures. He has also pledged his commitment to rulemaking and due process, a commitment that has not always been evident at OFAC.
Bureau of Industry and Security (BIS): Windy L. Wysong, a former federal prosecutor, is the new Deputy Assistant Secretary of Commerce for Export Enforcement at BIS. That office is responsible for enforcing “dual-use” export controls. Ms. Wysong has a reputation as an able and tough prosecutor. While Assistant U.S. Attorney for the District of Columbia, she oversaw numerous criminal export enforcement actions.
Meanwhile, BIS has seen many recent departures, including Kenneth I. Juster, Undersecretary of Commerce and the head of BIS; Julie Myers, Assistant Secretary for Export Enforcement; and Mark Menefee and Dexter Price, long time Directors of the Export Enforcement Office and the Antiboycott Compliance Office, respectively. These important posts still remain to be filled.
Directorate of Defense Trade Controls (DDTC): DDTC is the State Department office charged with controlling the export of defense articles and defense services covered by the United States Munitions List. Robert Maggi left the position of DDTC’s Managing Director, and Michael T. Dixon currently holds this post on an acting basis. Patricia Slygh replaced Deborah Carroll as the Compliance and Enforcement Branch Chief. Carroll, a long-time head of compliance at DDTC, now serves as the Compliance and Registration Branch Chief. In general, more staff and more resources have been added throughout the last year to strengthen DDTC’s compliance and enforcement capabilities.
Senior FCPA Enforcement Official Departs, Having Set Multiple Recent High Water Marks
The departure of Peter Clark after more than 25 years as the Justice Department’s chief FCPA enforcement official marks the end of an era in which he became the personification of aggressive FCPA enforcement. In his last year, both Justice and the SEC established precedents that have ratcheted up the stakes and the penalties in FCPA cases:
More “Voluntary” Disclosures and “Cooperation”: The government’s insistence on prompt voluntary disclosure was dramatically boosted by the confluence of Sarbanes-Oxley and modified Sentencing Guidelines, both of which have diminished companies’ discretion for self-reporting. This has increased voluntary disclosures and enforcement actions (as well as a growing divergence of views over how much credit is, in fact, given for voluntary disclosure). For failing to cooperate with the SEC, Lucent paid a $25 million fine.
Aggressive Enforcement: The Justice Department pursued foreign persons in the ABB and Bodmer decisions. The past year also saw use of a non-prosecution agreement and a criminal internal controls violation (InVision), an enforcement action based on charitable contributions (Schering-Plough), and new hospitality violations (ABB).
The Business Purpose Element: The Fifth Circuit reversed a District Court decision substantially vindicating Justice’s broad reading of the “business purpose” element of the statute, allowing for the subsequent conviction of two executives of American Rice.
Increasingly Harsh Penalties: In ABB, the SEC and Justice complimented the companies involved for their full disclosure and cooperation, and then imposed the second largest fines ever exacted for FCPA violations more than $10 million in fines and nearly $6 million in disgorged profits. The two convicted executives of American Rice could face multi-year prison sentences. Several settlements also required companies to hire independent compliance monitors.
Big Cases and Investigations in 2005: The upcoming trial of James Giffen arising out of his work for the government of Kazakhstan could become the largest FCPA case to date. The reported Halliburton investigations in Europe and the United States have similar potential. IBM and Lucent are reportedly among companies facing FCPA inquiries, and the publicized investigation of Riggs Bank has led to an SEC investigation into U.S. company activities in Equatorial Guinea.