The U.S. Bureau of Industry and Security (BIS) this month imposed its second-highest penalty ever, settling with Silicon Valley’s Applied Materials Inc. and its South Korean subsidiary for $252 million over their exports of restricted semiconductor manufacturing equipment to China.
BIS alleged that Applied Materials, one of the world’s largest suppliers of that strategically critical tech, had partially built dozens of systems in the U.S., shipped them to Korea for completion and then sent them without a license to Semiconductor Manufacturing International Corporation (SMIC), China’s premier semiconductor foundry. BIS had put heightened export requirements on SMIC in 2020, adding it to the Entity List for “evidence of activities between SMIC and entities of concern in the Chinese military industrial complex.”
But publicly traded Applied Materials, which stood to lose significant profits if it stopped selling to SMIC, didn’t overlook those export controls.
Rather, it paid the price for what it called a “misunderstanding” of how the U.S. rules work.
Partially state-owned SMIC is similarly essential in China’s semiconductor push, and Applied Materials has sold “semiconductor-related products” to SMIC since its own founding in 2000, BIS wrote in its Feb. 11 order on the case. Between 2016 and 2020, it said, SMIC had purchased 180 semiconductor manufacturing tools worth a total of approximately $1.4 billion.
“This is an area that the Chinese government sees as crucial for both its economic development and its military. Chips go into consumer electronics, which is China’s bread and butter, but chips also go into missiles, drones and other weapons systems,” said Collmann Griffin, counsel at Miller & Chevalier and a former senior policy official both at BIS and at the Treasury Department’s Office of Foreign Assets Control. “One of the biggest barriers to entry for chip fabrication is semiconductor manufacturing equipment, such as the products that Applied Materials makes.”
The restrictions: In September 2020, BIS added SMIC to its Military End-User List and sent Applied Materials an “is-informed” letter notifying it that a license was now “required to export, reexport, or transfer in-country” to SMIC certain items subject to the Export Administration Regulations (EAR). Among the restricted items was semiconductor manufacturing equipment, including the ion implanters that Applied Materials is known for.
BIS alleged that Applied Materials, one of the world’s largest suppliers of that strategically critical tech, had partially built dozens of systems in the U.S., shipped them to Korea for completion and then sent them without a license to Semiconductor Manufacturing International Corporation (SMIC), China’s premier semiconductor foundry. BIS had put heightened export requirements on SMIC in 2020, adding it to the Entity List for “evidence of activities between SMIC and entities of concern in the Chinese military industrial complex.”
But publicly traded Applied Materials, which stood to lose significant profits if it stopped selling to SMIC, didn’t overlook those export controls.
Rather, it paid the price for what it called a “misunderstanding” of how the U.S. rules work.
The backstory
Applied Materials, founded in 1967, today designs and manufactures systems that it says form “the foundation of virtually every new semiconductor and advanced display in the world,” making them “essential to advancing AI and accelerating the commercialization of next-generation chips.”Partially state-owned SMIC is similarly essential in China’s semiconductor push, and Applied Materials has sold “semiconductor-related products” to SMIC since its own founding in 2000, BIS wrote in its Feb. 11 order on the case. Between 2016 and 2020, it said, SMIC had purchased 180 semiconductor manufacturing tools worth a total of approximately $1.4 billion.
“This is an area that the Chinese government sees as crucial for both its economic development and its military. Chips go into consumer electronics, which is China’s bread and butter, but chips also go into missiles, drones and other weapons systems,” said Collmann Griffin, counsel at Miller & Chevalier and a former senior policy official both at BIS and at the Treasury Department’s Office of Foreign Assets Control. “One of the biggest barriers to entry for chip fabrication is semiconductor manufacturing equipment, such as the products that Applied Materials makes.”
The restrictions: In September 2020, BIS added SMIC to its Military End-User List and sent Applied Materials an “is-informed” letter notifying it that a license was now “required to export, reexport, or transfer in-country” to SMIC certain items subject to the Export Administration Regulations (EAR). Among the restricted items was semiconductor manufacturing equipment, including the ion implanters that Applied Materials is known for.
- Then, that December, BIS added SMIC to the Entity List, along with five of its subsidiaries. That meant BIS licensing requirements now applied to all items under the EAR.
It wasn’t.
The violations
Over a 20-month period, BIS alleged, Applied Materials and its subsidiary went on to commit 56 violations of the EAR, involving tech worth $126 million in total.- Engaging in prohibited conduct (54 charges): Between March 23, 2021 and June 3, 2022, Applied Materials “caused the reexport” of 54 U.S.-origin ion implanters from its Korean subsidiary to Entity Listed SMIC without a license, BIS said.
- Attempting to engage in prohibited conduct (2 charges): In November 2020 and again in July 2022, Applied also “attempted to cause the reexport” of ion implanters without obtaining a license, BIS said. The agency does not state why the attempted reexports, each valued at approximately $3.9 million, did not go through.
The Beijing branch of Semiconductor Manufacturing International Corporation (SMIC), as seen in 2020. (VCG via Getty Images)
What had gone wrong
When BIS sent Applied Materials its September 2020 letter, the company and its subsidiaries had scrambled, internal communications reviewed by BIS showed.The previous spring, Applied Materials’ Global Trade Group had begun “discussing a brand new, ‘dualbuild’ process,” in anticipation of possible export controls on key foreign customers. In that new process, Applied Materials’ production facility in Massachusetts would partially assemble the company’s ion implanters, then send them and the remaining components to its subsidiary in South Korea for completion and testing.
The thinking: Applied Materials had “incorrectly concluded,” BIS said, “that if an item is ‘substantially transformed’ in a foreign country, that was sufficient for the item to qualify as foreign-made for purposes of the EAR and the item therefore would not be subject to the EAR provided that the EAR’s de minimis and foreign direct product rules also did not apply.”
- But U.S. export controls don’t mention a “substantial transformation” provision like tariffs case law and regulations do.
“In other contexts, this analysis makes sense,” Griffin said. “The EAR says that ‘U.S.-origin’ items are within its scope, but the regulations don’t define the term ‘origin.’ … [Applied Materials] here took that test from an adjacent area of law and applied it in the EAR.”
- The problem: The policy considerations for those two regulatory areas are totally different. “Tariffs are essentially excise taxes intended to protect domestic industry from foreign imports. Traditionally, they were not focused on national security issues,” like export controls on semiconductor tech are, Griffin said.
Mitigating factors: None mentioned. BIS said its penalty, equal to twice the transactions’ total value ($126 million), was “the maximum allowed by statute,” an outcome that Griffin noted is “rare.”
In addition to the fine, BIS said, Applied Materials “agreed to conduct multiple audits of its export compliance program and make annual certifications to BIS.” The company and its Korean subsidiary also terminated the compliance employees and trade and production executives “responsible for the illegal shipments.”
- Silver lining? The settlement at least headed off further scrutiny: Applied Materials said afterward that the Justice Department and the Securities and Exchange Commission had “notified Applied that they have closed their related investigations without action.”
Closing thought
Russia’s invasion of Ukraine, Griffin said, has demonstrated why controls on chipmaking equipment are “so important from a national security perspective.”“Until recently, it was possible not to realize how widespread chips that are made with American technology, software and tools are and how important they are for our adversaries’ weapon systems. This is especially true for folks outside of government,” he said. “But now that the Ukrainians have taken apart thousands of Russian, Iranian and North Korean drones and seen either U.S.-branded chips or chips made with U.S. technology in nearly every single weapon, it’s a peek under the hood of how important chipmaking technology and, as relevant here, chipmaking equipment really are.”
The bottom line for businesses?
“When you’re talking about something with such significant national security importance,” Griffin said, “you have to make sure that your legal analysis is airtight.”
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