As most of you are well aware, on December 19, 2011, the US Department of State, Directorate of Defense Trade Controls (DDTC) published the long-awaited proposed rule on defense brokering. (The proposed regulation may be found in the “Downloads” section to the right.) There are those that love to read the brokering regulations, and then there are the rest of us. This summary is intended for the rest of us, too tired so soon after the holidays to attempt an expedition through the relatively short yet expansive and labyrinthine proposed rule.

Fifth: The proposed regulation would add onerous new certification requirements.

In exchange for a one-stop registration benefit that allows Part 122 registrants to add US and foreign affiliates, and joint ventures as brokers, the proposed regulation imposes a certification requirement that must be met not only by the registrant, but also by its foreign parent (if added to the registration), subsidiaries, joint ventures, or “other person{s} required to be listed.”

For foreign brokers, the revised certification requirement includes not only indictments or charges (information) and convictions under the US criminal statutes enumerated in §120.27 of the ITAR, but also:

“foreign criminal statutes dealing with subject matter similar to that in the US criminal statutes enumerated in §120.27.”

How will a foreign company determine what might be the foreign criminal statutes dealing with a similar subject matter to the US criminal statutes enumerated in §120.27? Hire U.S. and local attorneys for an analysis of all applicable statutes? Or ask their officers and directors if they have ever been charged or convicted of any crime, and then analyze any affirmative responses? The former question is likely to be expensive, even for a substantial foreign company. The latter question may well run afoul of non-US privacy laws.

Sixth: The proposed regulation confirms what those of us who tried to get brokering guidance under the prior regulation already knew: you need to provide all the information required in an approval application to get guidance from DDTC, limiting the benefits of the guidance option.

Indeed, in the proposed regulation, to obtain guidance from DDTC, you need to supply one additional item NOT required to get prior approval – a copy of the agreement or documentation between or among the requestor and other persons who will be involved in the activity.

1. Background
   
   When Congress and President Bill Clinton amended the Arms Export Control Act (AECA) in 1996 (Pub L. 104-164) to cover brokering, they did so to close a loophole. The AECA covered exports and reexports of US defense articles and services, but it did not cover U.S. persons who brokered foreign defense articles, unless those foreign defense articles came into the United States. This meant that a US person, sitting in an armchair in any state of the United States, or outside the United States, could engineer arms deals between or within foreign countries without US government approval. Congress and the president thought this sort of activity could undermine U.S. national security and other interests and amended the AECA to ensure that such activities would be subject to US government scrutiny and approval. (Alas, would-be arms dealers instead were relegated to seeking their fortunes in day-trading and brokering subprime mortgage-backed securities.)
   
   In 1997 followed by “clarifying” amendments in 2006, DDTC published brokering regulations that were vague and subject to multiple interpretations. Ever since, DDTC has in unwritten, much less published, guidance taken what many in industry have viewed as an excessively broad interpretation of those regulations.
    
2. What does the proposed rule do?
   
   First: It puts into writing these years of broad but unwritten DDTC interpretations of the brokering regulations.
   • It confirms DDTC’s unwritten guidance that, to be a “broker,” you need not act as an agent for someone else, and you don’t have to get paid for it. Any action that “facilitates” the manufacture, export, reexport, import, transfer, or retransfer of a defense article or defense service is brokering under the proposed rule. Indeed, in its proposal, DDTC eliminated a phrase in its prior draft from fall 2009, which would have required the action be of an “intermediary nature.” While we did not know what that meant at the time, in retrospect, it seems better than no phrase at all.
     
     Note what this broad definition means: distributors of defense articles are likely brokers, even if all they do is purchase and resell defense articles for their own accounts and even if the underlying export/reexport or transfer transactions are approved by DDTC.
      
   • It confirms DDTC’s position that defense articles and defense services subject to part 129 can be of either US or foreign origin – including (of course) foreign defense articles that contain US defense article parts or components (by virtue of DDTC’s again unwritten even unnamed “see-through” rule).
      
   • It asserts jurisdiction quite broadly and extraterritorially. It covers US persons, wherever they might be located, who facilitate sales of U.S. or foreign-origin defense articles or defense services. The proposed regulation also applies to foreign persons in three circumstances:
     1. When they are “located in the United States”;
         
     2. When a US-origin defense article or defense service is involved; OR
         
     3. When they are “located outside the United States” but are “acting on behalf of a U.S. person.”
         
     DDTC makes no attempt to define what constitutes “located in the United States.” With respect to natural persons, one can conclude that the acts of a natural person when he or she is physically located in the United States would be captured. A far more difficult question is when a foreign legal entity might be “located in the United States” for purposes of the ITAR. Part 129 would likely apply if the foreign person opened a branch in the United States, and the branch engaged in “brokering activities.” But would part 129 apply to a foreign legal entity when one of its employees undertook an action facilitating the sale of a foreign defense article while that employee is on a business trip to the United States? What if he makes a phone call or two while visiting Disneyworld? Would part 129 apply to a foreign legal entity when it sends communications through the United States that relate to the sale of a foreign defense article?
     
     DDTC also does not indicate under what circumstances a foreign person might be found to be “acting on behalf of a US person.” Since the proposed regulation eliminates the concept of agency from Part 129, it is possible that DDTC could take the position that an actual agency or other contractual relationship might not be required to act “on behalf of” a U.S. person. Would a foreign subsidiary of a US company be acting on behalf of a US person when it sells foreign defense articles and the profits from those transactions are repatriated in the form of corporate dividends? It certainly should not, but absent a regulatory definition of “acting on behalf of.” DDTC has substantial discretion to interpret this phrase.
      
   • Under the proposed regulation, DDTC potentially could assert jurisdiction over additional brokering activities conducted by foreign persons largely outside the United States. The section provides that the brokering activities subject to part 129 only “include” the enumerated four circumstances, thereby allowing DDTC at least in theory to assert jurisdiction under other circumstances.

   Second: It creates three narrow carve outs to the definition of “brokering activities.”
   
   Persons meeting these three narrow carve outs need not register, get prior approvals, or even file annual reports or keep records because these carve outs are not considered brokering activities. In addition, it is not prohibited for these persons to conduct those activities in transactions involving countries proscribed under section 126.1 of the ITAR, such as Iran, China, and Afghanistan. These exceptions are:

   • Activities of a US person in the United States limited exclusively to US domestic sales and transfers. Note that this exception is limited to US persons, so in theory foreign persons located in the United States or acting on behalf of a US person would still be brokering and required to register, even if the transactions were wholly US domestic. Note also that transfers to foreign persons in the United States are apparently not considered to be US domestic sales and transfers due to a small parenthetical phrase. This parenthetical could mean any sale of a defense article to a foreign person in the United States could be considered brokering, even when it is not an export as defined by the ITAR. In other words, companies not obtaining export licenses because they are selling defense articles exclusively within the United States could be required to register as brokers and obtain DDTC prior approvals when they sell to foreign persons in the United States. We doubt this was DDTC’s intention, so hopefully this parenthetical will be changed in the final regulation.
      
   • Activities by employees of the U.S. government acting in an official capacity. This essentially means that a US government employee of, for example, the Central Intelligence Agency, could broker an arms deal in a proscribed country such as Iraq or Afghanistan, as long as he or she were acting in “an official capacity.”
      
   • Activities that do not extend beyond administrative services, such as providing or arranging office space and equipment, hospitality, advertising, or clerical, visa, or translation services, or activities by an attorney “that do not extend beyond providing legal advice to a broker.”

   Third: It creates exemptions from brokering registration and in some cases brokering approvals and reporting. But watch out! These exemptions are complicated and narrower than they first appear, and they never apply to activities involving the proscribed countries.
   
   Who is exempt from registration, approvals and reporting? The following categories of individuals and entities are exempt:

   • 129.3(b)(1) – Employees of foreign governments or international organizations acting in their official capacities.
      
   • 129.3(b)(2) – Persons exclusively engaged in the business of financing, insuring, transporting, or freight forwarding, such as air carriers and freight forwarders. Watch out here, because any activity beyond these in a particular transaction pushes those persons outside the exemption. Thus, activities such as arranging the transaction, making introductions, or taking title to the goods – even when there is no physical possession – can disqualify use of the exemption.
      
   • 129.3(b)(3) – This is the exemption the US defense industry has been pushing for, and it helps but likely comes up short in many circumstances. Under this exemption, a US defense manufacturer/exporter already registered under part 122 of the ITAR as a manufacturer or exporter can simply add US person subsidiaries, joint ventures, and other affiliates and foreign person brokers listed and identified as their exclusive brokers in their part 122 Statement of Registration. This sounds like it might help reduce the duplication caused by two registrations and two approvals for a single transaction, but there are some catches:
     1. First, the use of the word “exclusive” would seem to indicate that foreign brokers who represent more than one U.S. defense contractor will need to register on their own.
         
     2. Second, the foreign person broker must EITHER:
        • Engage only in brokering activities that involve the US registrant’s defense articles and services and are (or will be) subject to a DDTC approval obtained by the U.S. registrant; OR
        • Engage only in brokering activities that are “on behalf of” the part 122 registrant AND involve only defense articles and services that are “located in and obtained from” a US manufacturer or a source in the United States pursuant to an export approval.

     In other words, if the broker is (1) working for a company other than the US registrant on a particular transaction, (2) assisting to sell foreign defense articles, or (3) assisting to sell US defense articles procured outside the United States (even if properly licensed), this exemption might not apply. Another exemption (129.3(d)) might apply – but it is not nearly as useful.

   • 129.3(d) – This exempts some companies that would not meet the 129.3(b)(3) exclusivity requirements, BUT it exempts only US and foreign subsidiaries, joint ventures, and affiliates listed on the part 122 registration. Unrelated foreign brokers do not qualify. Even worse, the only exemption granted by 129.3(d) is from registration. The prior approval, reporting, and recordkeeping provisions all still apply.
     
     The combined effect of 129.3(b)(3) and 129.3(d), if implemented as written in the proposed rule, likely would be to limit substantially the benefits of what could otherwise be a major improvement and streamlining in the brokering regulations. If DDTC were to take full advantage of this exemption, US registered manufacturers and exporters who were already registered under part 122 could simply add their US and foreign affiliates, and unrelated foreign brokers to their registration. Then, provided those entities only participated in transactions already licensed under the ITAR, no additional registration, approval, reporting, or recordkeeping would be required. This would eliminate the double licensing requirements that result from the extremely broad interpretation of what constitutes a “brokering activity” subject to part 129. But with their built-in limitations, the proposed 129.3(b)(3) and 129.3(d) would likely be of most benefit to the larger defense contractors, who are able to retain exclusive brokers, leaving smaller US defense exporters to beseech their foreign brokers to register and apply for the necessary approvals under Part 129.
      
   • 129.3(b)(4) – This “end-user” focused provision exempts persons, including bona fide employees, “whose activities do not extend beyond acting as an end-user of a defense article or service” when those articles or services are exported pursuant to a license or other approval. It also exempts those end-users when they are “subsequently acting as a reexporter or retransferor” of such defense articles or services under a license or approval, or a subsequent 123.9 retransfer approval. Based on one example in the proposed regulation, this exemption is intended to cover not only traditional end-users, who may ultimately decide to resell a defense article they purchase, but also foreign defense manufacturers that incorporate US defense articles into their foreign products and then resell those foreign products pursuant to a DDTC license. This is certainly a positive development, but under the prior Part 129, those companies were not brokers in the first place, although DDTC apparently took a different view.
     
     Proposed 129.3(b)(4) does NOT, however, cover the foreign distributor of US defense articles. Under the expanded proposed definition of “brokering activities”, the foreign distributor now likely would be considered a broker, even if all it does is buy and resell properly licensed US defense articles on its own account. This means that, with the exception of those exclusive distributors that meet the proposed 129.3(b)(3) requirements, foreign distributors of US-origin defense articles will need to register and obtain brokering approvals – even when DDTC has already licensed their transactions. In other words, two registrations and two licenses could potentially be needed for every transaction. It is unclear why, in the midst of the Export Control Reform Initiative and a weak economy, such a major duplication of US government (not to mention industry) resources is necessary.

   Fourth: It creates exemptions from brokering approval for certain activities. But only one exemption is new, and modifications to previously existing exemptions actually reduce their scope.
   
   Assuming you could not find a way out of registering, you are now a registered broker. What activities do NOT require a prior approval? DDTC has created one new exemption from brokering approvals for defense articles that are not Significant Military Equipment (SME) for foreign governments and international organizations but has added more restrictions to the preexisting exemptions that limit their availability. We address each exemption below:

   • The US Government exemption: The current regulations contain an exemption for brokering activities undertaken by or for an agency of the United States Government—
     1. For use by an agency of the United States Government; or
         
     2. For carrying out any foreign assistance or sales program authorized by law and subject to the control of the President by other means.

     The proposed regulation adds a requirement that the activities must be:

     1. EITHER “solely for the use of the US Government agency” – meaning no other beneficiaries;
         
     2. OR if they are for foreign assistance or sales programs, the contract must contain an explicit provision stating so and declaring that the control of the activity is “established by other means equivalent” to those of the ITAR, or DDTC must provide written concurrence that the conditions are met.

     Translated into English this means your US government contract must be solely for US Government end-use – i.e., not for contractors or subcontractors of the US Government, or for foreign beneficiaries that the U.S. Government wants to help. If the US Government contract requires you to provide defense articles or services to, or for the benefit of, anyone other than the US Government agency, you need an express clause in your U.S. Government contract (good luck with that), or a “written concurrence” from DDTC. In other words, you need a license. Why not just say, get a license? What is the rationale for so limiting an otherwise perfectly usable exception?

   • The NATO plus exemption: The current regulations contain an exemption for brokering activities that are “arranged wholly within and destined exclusively” for the North Atlantic Treaty Organization, any member country of that Organization, Australia, Japan, New Zealand, or South Korea. The proposed regulation requires that brokering activities be “undertaken wholly within and involve defense articles or defense services located within and destined exclusively for the NATO plus countries.”
     
     Although this change merely confirms in writing DDTC’s prior interpretation of the NATO plus exemption, the question remains, why restrict the exemption to activities conducted entirely within the NATO plus countries? Wouldn’t this exemption be useful to our allies when they operate outside their borders, often in concert with the United States? The NATO plus exemption continues to exclude defense articles and associated defense services listed in 129.7(e), an exclusionary section listing automatic firearms, night vision equipment, chemical agents and precursors, and other items.
      
   • The New Foreign Government and International Organization Exemption: This new exemption does not require prior approval for transactions, provided the items are:
     1. US origin;
         
     2. Not SME;
         
     3. Not listed in 129.7(e);
         
     4. Not equal or greater than $25 million; AND
         
     5. For end-use by an international organization or foreign government.

     This is a potentially useful exemption from the prior approval requirement.

3. Conclusion
   
   The proposed regulation appears to be a sincere attempt to provide clarity to a murky topic and reduce to some extent the duplication of registration and prior approvals created by having two different licensing regimes for exports/reexports/transfers and the brokering of such activities. Unfortunately, the added clarity of the proposed rule in most cases confirms the previously unwritten but widely known expansive interpretation by DDTC of what constitutes brokering, both in terms of activities and in terms of jurisdictional reach. Likewise, the attempt to avoid duplicate registration and approvals has been narrowed to such a degree that it is likely to help only large defense contractors with exclusive foreign brokers or affiliates. Even those companies who can take advantage of this might be loath to sign onto the certification requirements.
   
   On the positive side, DDTC has reduced its practice to writing and invited notice and comment, thereby beginning a dialogue with industry and the ITAR practitioners’ bar. One can only hope that DDTC takes into account what are likely to be numerous comments on its proposed rule in formulating a final brokering regulation. Comments are due to DDTC by February 17, 2012, so there is still plenty of time to express your thoughts.
   
   Should you have any questions regarding this Alert, please contact Kay Georgi, Michael Burton, or Regan Alberda, members of Arent Fox’s International Trade Group, or the Arent Fox attorney who handles your matters.