For small exporters, security-related regulations can be a thicket
By Jason Harrison,
Frasier, Mich. — Richard Kincaid’s family business is printed circuit boards, the nerve centers that power not just consumer electronics and household appliances but also tools of war such as improvised-explosive-device jammers and avionics systems.
K&F Electronics, based in a perfectly square industrial suburb northeast of Detroit, by all rights should have a robust business, selling its wares to many different customers for many uses. But Kincaid is among a legion of small manufacturers across the country fighting an uphill battle to keep making things in the United States. One challenge, many say, is trying to keep up with federal export controls set by regulators in Washington.
The controls are supposed to help the United States walk the tightrope between national security and business interests, but the exponential speed of technological progress and the inherent complexity of the manufacturing process make writing transparent and lasting regulations difficult, and the Obama administration has undertaken an effort for reform.
Big companies such as Northrop Grumman, Boeing and General Electric have sophisticated export compliance operations that help them navigate Washington’s labyrinth of regulations and avoid becoming ensnared in a foreign military’s hunt for sensitive technology.
Kincaid has nothing like that. In an economy struggling to shake off the doldrums of the global recession, just keeping the lights on takes up most of his time, he says. K&F, which he says registers about $3.5 million in annual sales, recently laid off four people and cut workweeks back to four days. “Things have been dropping off in the last six to eight months,” says Kincaid, who keeps a binder of business lost to China in his tiny windowless office. “We’re getting orders, but they’re less.”
At this rate, he says, “I think I’ll be out of business in 10 years.”
Small business in a small town
People who grew up in the Midwest would instantly recognize K&F’s small-town home of Frasier. It has a Kmart, auto body repair shops, a hobby shop and a delicatessen wholesaler not far from K&F’s plant. Kincaid will occasionally have “popcorn Fridays,” when he brings in a vintage-style popcorn maker for his employees, who are making do on fewer hours.
“We don’t pay much,” Kincaid says. “But what are we gonna do?”
Every circuit board put out by Kincaid’s 24,000 square feet of industrial space begins as an invoice and a computer file from a customer.
Once Kincaid’s staff processes the order to its specifications, the circuit board is carved out of large, flat sheets of copper that are stacked in the factory. Those sheets move through the production process, much of which has been automated through the years, and much of which requires messy chemicals that are strictly regulated by federal guidelines. At the end, each component undergoes rigorous testing.
This is, in short, exactly the type of manufacturing shop facing the fiercest competition from overseas, where cheap labor is a distinct advantage. Complying with strict export regulations comes at a cost, but in this regard government officials and industry experts see the circuit-board business as a bit of an outlier: Whereas many companies view export regulations as a burden, the circuit industry tends to take on the most stringent controls as a “made in the U.S.A.” badge of honor.
Kincaid says that if the invoice tells him that the board is ITAR (shorthand for the State Department’s International Traffic in Arms regulations), he knows he cannot manufacture it in China, where production is cheaper. The easy solution would seem to be to avoid ITAR orders, which require production in an approved country.
Building the boards in the United States costs Kincaid “100 to 400 percent” more, he says, but he did not hesitate to fill out the paperwork five years ago and pay the fee, which is now more than $2,000, to become an ITAR-registered manufacturer because he appreciated the made-in-the-United-States sentiment and thought that it might “bring some of the work back.”
Doing so both deepened and complicated his business prospects.
People in the circuit-board industry draw an analogy between boards for military use and a book full of classified information. It is not the technology that goes into making a board or a book that is sensitive but rather the information contained inside.
Fern Abrams, director of government relations and environmental policy at the industry trade group IPC, says ITAR regulations ought to list circuit boards in the munitions section. “It’s almost a basic common-sense measure if you understand — and most people don’t — how much information is in a circuit board,” she said.
Not only that, but knowing the layout of the board, even if the components or data have yet to be affixed, could yield valuable intelligence for a hostile organization. Understanding the circuit-board design for an avionics system, for example, could allow a foreign military to reverse-engineer key elements of the system’s design, according to an IPC white paper by Peter Lichtenbaum, a Washington lawyer and former assistant secretary of commerce for export administration.
As Abrams sees it, the trouble for businesses like Kincaid’s isn’t compliance with export controls but the uneven application of the controls. For instance, her organization has seen identical bid requests “with one stamped ITAR and one not stamped ITAR,” she says. So if one company complies and the other does not, then the noncompliant manufacturer seizes a significant competitive advantage, assuming no one comes calling from the departments of State, Commerce or Treasury — three agencies with different computer systems, missions and cultures, but all with responsibilities in export controls.
Complex export controls
It can be a slog to determine whether, where and under what conditions a company can sell its product overseas. First, an exporter must have a detailed understanding of what it is selling far beyond a salesperson’s talking points.
Suppose Kincaid’s K&F makes a circuit board for a telecom company selling an antenna that could be used for military or civilian purposes.
The telecom company must determine whether it is subject to Commerce or State Department regulations that account for a host of contingencies. For example, a Commerce Department license is required for national security reasons to send certain items if they have “an acoustic carrier frequency outside the range from 20 kilohertz to 60 kilohertz,” according to the regulations.
An exporter selling such a piece of equipment would not need a license to sell its product to obvious allies, such as Australia, but could need one for trade partners such as India.
If, however, the antennae is designed for a sensitive military vehicle, the licensing jurisdiction falls to the State Department. Its restrictions for military items are far more stringent. Unlike Commerce regulations, the State Department requires explicit authorization to export almost every product that falls under ITAR. So a defense contractor sending equipment for U.S. military use on a battlefield abroad must obtain its authorization to “export” its product to a foreign country.
And what of Kincaid’s responsibility? “If a customer never says ITAR,” Kincaid says, “that board can be sent to a foreign country, as far as we’re concerned.” Lichtenbaum, the lawyer who has done work for the circuit-board industry, says the responsibility to comply with regulations falls to the exporter. So when K&F sends a batch of circuit boards to a customer who intends to export, that customer is expected to know where the boards are going and who will use them.
Determining the end user and use of a product can be difficult enough in a globalized economy, but the sophisticated cat-and-mouse games played by countries such as China and Iran can raise the risks to levels for which small manufactures are unprepared.
One common technique for a country seeking sensitive material is to set up a shell company in a shipping center such as Singapore and “ping” U.S. companies in an attempt to find one that will inadvertently export sensitive technology. It is a classic part of the intelligence game, where countries go to multiple places to gather disparate pieces of a larger puzzle. So even an honest small company can find itself in trouble should a barred entity — person, company or country — get its hands on technology the U.S. government deems a security risk.
The penalties for running afoul of the regulations are significant. Companies could face fines of up to $250,000 per violation. And for criminal violations, in which prosecutors must prove intent, penalties can reach $1 million and 20 years in prison per violation.
Eric L. Hirschhorn, undersecretary of commerce for industry and security, said that his department recognizes a difference between purposeful violations and mishaps. “If a company has made a decent effort to have an internal compliance program and somebody makes a mistake, I think that should be treated very differently than somebody out there saying, ‘Everybody does it and they’ll never catch me,’ ” Hirschhorn said. “I’m pushing hard to make sure that we are mindful of that distinction.”
Companies around the country are scrambling to get up to speed on the regulations because of a noticeable uptick in enforcement. The Justice Department established a national export control coordinator to enforce criminal violations in 2007, while the Commerce Department employs more than 100 special agents with arrest authority. To sharpen the point, the Commerce Department published a 56-page document in 2010 called “Don’t Let This Happen To You!”; it outlines all of the ways exporters can get themselves in legal trouble. The departments of Commerce, State and Treasury operate help lines for guidance on the complex regulations, but some businesses worry that calling them can raise suspicions.
Reforming the regulations
The export control system’s complexity has dogged every post-Cold War president, says Brandt Pasco, a lawyer and founding member of the National Security Council Task Force on Export Control Reform who has helped write new regulations that the government began publishing for industry comment late last year. In 2009, President Obama launched his own export control reform initiative, complete with a Web site, blog and fact sheets. Pasco says that Obama’s directive to staff was simply to “make it better.”
The centerpiece of Obama’s reform initiative rests on streamlining the Commerce Control List and the U.S. Munitions List. The idea, Pasco said, is to move items from the stringent munitions regulations to the commerce list. An oft-repeated phrase in the export control world is “building a taller fence around a smaller yard.”
In his office on Constitution Avenue, Kevin Wolf, the Commerce Department’s assistant secretary for export administration, keeps a drawing to illustrate the complexity of updating the regulations. He calls it his export-control reform “iceberg,” where the licensing burden represents the tip of the ice the government sees. Lurking out of view are a number of unintended consequences for businesses, including the time and money spent to determine whether authorizations are required.
“It’s a national security problem because it’s hurting our defense industrial base,” says Hirschhorn, the commerce undersecretary. “With the decrease in the defense budget, small and medium-size businesses who make these components are selling less to DOD, and it’s difficult or impossible for them to sell overseas.”
The Obama administration also seeks to develop a unified computer system and, most ambitiously, to create one agency that would handle all export control.
Chris Wall, a Washington lawyer and former assistant secretary of commerce for export administration, sees the computer system as vital and an obvious move. “It’s below the radar. Nobody sees it, but it’s a major, major step,” Wall says.
Creating a new federal agency, on the other hand, requires legislation in a political climate where even something designed to streamline bureaucracy could be a tough sell. “The idea of consolidating every bureaucracy is dead on arrival because it’s not necessary,” Wall says.
Wall sees an analogy between the Obama administration’s health-care legislation and how it has taken on export controls. He calls it “an all-or-nothing kind of approach rather than just taking a look at what’s feasible.” He thinks the system needs to be updated but not completely shelved. Today’s regulatory framework is “like taking an old computer and using it for modern functions,” he says.
Lichtenbaum, the lawyer who has worked with the circuit-board trade group, says the Obama administration has worked hard on the issue, but he shares Wall’s concerns about the sweeping scope of reform.
“It has meant that there are some practical issues that haven’t been worked out,” Lichtenbaum said. There is a risk “that nothing significant ends up coming out of it.”
Despite his critique of the administration’s go-big approach to reform, Wall says that “a lot has happened on the export control reform front in recent months” and calls the progress on drafting regulations to transfer items from the munitions list to the commerce list “substantial.” He notes, however, that the Arms Export Control Act requires congressional notification before items can be transferred. Those details are still being worked out.
Pasco describes the stakes as “life and death” in several respects. In the wrong hands, sensitive technology can be used against U.S. forces on the battlefield. And, of course, the financial penalties for violating regulations can be crippling, especially for a small company.
Even as it has worked to reform export controls, the Obama administration has promoted a national initiative intended to double exports by 2014 and create 2 million jobs — though it is careful to separate the two goals.
With all of the disparate interest groups involved, from arms control and human rights experts to security hawks to manufacturers struggling to survive, the most prominent group that has yet to weigh in is the American public. Until now, export control reform has not been held back by the partisan rancor of other regulatory battles over the environment and the financial system. Technocrats from both parties largely have tackled the issue away from the harsh glare of cable news, blogs — and voters.
The balance regulators must strike is to build a system that protects U.S. national security, respects international human rights and allows businesses to compete.
Kincaid says he does not have the time to follow the details of export control reform but instead relies on his membership in IPC, a trade association that lobbies on behalf of the industry. In the meantime, Kincaid keeps K&F afloat through his personal relationships with suppliers, a good building lease and a modern development: domain names.
Kincaid says his nephew, Ken Burbary, persuaded him to buy domain names related to his business. “Don’t buy the company name,” Burbary told him. “Buy your product.”
And that is just what Kincaid did. By his count, he owns 70 domain names associated with the printed circuit-board industry, including the coveted circuitboards.com. Precious commodities that, it turns out, are beyond the reach of export controls.
Eighty percent of his circuit-board company’s products are made in the United States
What’s the trouble? Keeping up with export laws and ahead of foreign competitors.