U.S. Warns New China Law Jeopardizes Hong Kong’s Special Status

Top U.S. officials warned Friday that China’s push to introduce new national security laws in Hong Kong could jeopardize the city’s special trade status and spark investor flight after President Donald Trump said his government would react “strongly” to the anti-sedition measures.

Secretary of State Michael Pompeo indicated Friday that the U.S. would reconsider exemptions that shield Hong Kong exports from tariffs that apply to Chinese goods if Beijing moves forward with “its disastrous proposal” to impose new restrictions on the island.

And Kevin Hassett, one of Trump’s top economic advisers, said his staff was studying possible retaliatory measures: “We’re absolutely not going to give China a pass,” Hassett said in an interview Friday with CNN. “All the options are on the table.”

The admonitions came as China signaled it was undeterred by international condemnation of its plans to bypass Hong Kong’s legislature and implement new national security laws that residents of the city fear will erode freedoms of speech, assembly and the press. The announcement marked an escalation of Bejing’s efforts to exert more control over Hong Kong, after months of sometimes-violent protests that gripped the city last year.

But pro-democracy activists quickly called for protests to oppose the plan, setting up another summer of unrest for President Xi Jinping, who is struggling to tame the coronavirus outbreak and keep the most populous nation in the world from a protracted economic decline.

“Any decision impinging on Hong Kong’s autonomy and freedoms as guaranteed under the Sino-British Joint Declaration and the Basic Law would inevitably impact our assessment of One Country, Two Systems and the status of the territory,” Pompeo said in a statement.

Hassett also warned that steps to change Hong Kong could prove “very costly to China and the people of Hong Kong” because outside investors may stop viewing the city as “the financial center that it is.” In a subsequent interview with Fox Business Network, he said investors were unlikely to invest “in a place where they’re basically, you know, sneering at the rule of law.”

“I would expect that they’re going to have serious capital flight problems in Hong Kong, if they follow through this, they will no longer be the financial center of Asia, and that they themselves will pay very, very heavy costs,” Hassett said.

Trump’s national security adviser, Robert O’Brien, also cautioned that China’s efforts could put Hong Kong’s status “under various customs unions” as well as “privileges that Hong Kong accrues because it’s considered a free system” at risk. And O’Brien hinted the U.S. might look to coordinate possible retaliation with its allies.

“If China moves forward and takes strong action with this new national security law against the people of Hong Kong, America will respond,” O’Brien said Thursday night in an interview with Fox News. “I think other countries in the world will respond including the United Kingdom and our allies and friends.”

U.K. Prime Minister Boris Johnson’s spokesman said the British government wants to clarify exactly what China has proposed — but warned it expects Beijing to respect the Hong Kong’s autonomy.

China’s announcement spurred a rare moment of bipartisan agreement on Capitol Hill. Republican senator Pat Toomey of Pennsylvania and Democratic senator Chris Van Hollen of Maryland on Thursday introduced legislation that would sanction individuals interfering with Hong Kong’s autonomy. That could include not only Chinese officials working to push the new laws through but also police officers and local officials who crack down on protests in the city.

Last year, U.S. lawmakers passed a bill that requires the secretary of state to annually re-certify Hong Kong’s autonomy to preserve its special trade and commercial status. Pompeo delayed that review — saying he wants to see what happens at the National People’s Congress gathering where China is expected to introduce the new national security laws — and Trump could move to revoke Hong Kong’s special trade status.

The MSCI Hong Kong Index fell 6.8% on Friday, marking the worst day for Hong Kong stocks since the global financial crisis. Real estate firms were the worst hit amid concern over potential outflows and curbed spending, with Sino Land Co. and Link REIT plunging the most since 2008. The Hang Seng Index sank 5.6%, while the Hong Kong dollar weakened to a six-week low.

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Small Firms Join Rush to Return Bailouts After Rules Revisions

A publicly-traded pharmaceutical company in New Jersey returned a $4.8 million coronavirus-relief loan it had planned to use to retain its 219 employees. Executives decided that guidance from federal officials suggested no public company would qualify for the aid.

But in Oregon, a publicly-traded technology firm with 200 employees decided to keep its $5 million loan, despite similar concerns.

Same guidance, different decisions. Attempting to clarify Congress’s hastily-written Paycheck Protection Program, the Trump administration issued rules and guidance that stirred new confusion, whipsawed borrowers and led dozens of firms to return loans.

Tough talk from Treasury Secretary Steven Mnuchin about potential criminal penalties for rule-breakers has also contributed to a climate of caution around a $669 billion program meant to help small businesses outlast the Covid-19 pandemic.

Now, with a deadline to return PPP loans without penalties just days away, firms and their advisers have had to grapple with rules that seem to run counter to the law they’re based on.

“The guidances and interim rules are really changing the underlying law,” said James P. Joseph, a partner at the law firm Arnold & Porter. “I have been a tax lawyer for 31 years, and I’ve never seen anything like it. They are building the plane while it’s in the air.”

Payrolls Focus

One example: As enacted on March 27, the law that created PPP allowed borrowers to use its low-interest, forgivable loans of as much as $10 million for a range of expenses beyond just paying workers, such as refinancing debt. But since then, the Treasury Department and Small Business Administration have issued rules that limit spending mostly to payroll.

Also, the law itself contained no restrictions on public companies seeking relief. But after public outrage over loans to public firms like the burger chain Shake Shack Inc., Treasury and SBA issued new guidance on April 23. It said public companies with “with substantial market value and access to capital markets” would be unlikely to qualify for PPP.

Such changes, coupled with an absence of guidance on how the Small Business Association will administer the forgiveness of loans, have prompted some to say thanks, but no thanks.

New Guidance

Aquestive Therapeutics Inc. of Warren, New Jersey, makes treatments for epileptic seizures, addiction recovery, and to manage nausea from chemotherapy. The company interpreted some of the new guidance to mean no publicly traded companies qualify — even though the firm believed it was eligible as the program “was originally written and intended.”

“As a result, we have decided that it is in the best interests of our company and our constituents to pay off the PPP loan,” the company said in a statement.

Bruce Davis, chief executive officer of technology services provider Digimarc Corp. in Beaverton, Oregon, came to the opposite conclusion. He said he was also concerned about the administration’s guidance after his company, with 200 workers, took a $5 million loan. But after triple-checking the requirements with legal and financial advisers, he decided that Digimarc met the criteria.

The administration should have been clearer about which companies wouldn’t be eligible based on the rules, Davis said.

Publicly traded companies have returned 48 loans worth more than $350 million so far, according to data compiled by FactSquared after the SBA and Treasury said firms that improperly certified that their loans were necessary could face legal trouble if they don’t give back the money by May 14.

Promoted as a lifeline to small businesses, the program provides loans worth a firm’s average monthly payroll multiplied by 2.5, but capped at $10 million. More than 4.2 million loans have been approved so far, with an average loan amount of about $125,175.

Lawsuit Filed

After the law was passed, the SBA and Treasury issued rules requiring borrowers to spend 75% of PPP loans on payroll to be eligible for loan forgiveness. But after laying off employees, many firms said they needed cash more for expenses such as rent than payroll. On Friday, a report issued by the SBA’s inspector general found that the rule “did not align with the allowable use requirements for PPP loans” under the law that created the program.

One borrower, Zumasys Inc., has sued the government over the guidelines. The San Clemente, California-based software company says that even though it has access to other credit, it’s entitled to its $750,000 PPP loan under the terms Congress set, because it truly needs the funds.

“We want the court to tell us whether or not this guidance, given by the SBA and Treasury, is valid, or is it in fact invalid and unenforceable,” said Mona Hanna, a lawyer for Zumasys with the firm of Michelman & Robinson. “We need to know.” Many companies would probably terminate workers or shut down completely rather than take on more non-forgivable debt, she said.

Creating Consternation

Mnuchin triggered more consternation among businesses in late April when he said the SBA “will be doing a full review” of loans over $2 million. A subsequent joint statement from Mnuchin and SBA Administrator Jovita Carranza said such reviews would ensue for loans for which borrowers sought forgiveness.

The SBA has said it intends to issue guidance before payback deadline about how it will review the loans to help firms “evaluate whether they may have misunderstood or misapplied” the standard for accepting them. A spokesperson didn’t respond to a request for details about how the reviews would be conducted, but said officials are quickly providing guidance to borrowers and lenders while approving loans of more than half a trillion dollars in just about five weeks.

As of Sunday, the SBA had issued more than $530 billion in new loans since April 3, more than four times the $115 billion it had outstanding at the end of 2019.

Of the new loans, almost 33,900 were for $2 million or more, based on data through May 8. The vast majority of them went to closely held businesses.

It’s unclear how many PPP borrowers will ultimately seek forgiveness, or how that process will work. The SBA missed an April 26 deadline in the law to issue a guiding rule on it, said Mary Beth Bosco, a partner at the law firm Holland and Knight.

Bad Faith

“Every time SBA comes out with a new interim rule, it seems to change the law or throw more confusion on it,” she said.

Mnuchin has said borrowers could face criminal charges if they make false certifications on loan applications. The required certifications include a statement that “current economic uncertainty makes this loan request necessary to support the ongoing operations” of the business.

The Justice Department this week brought the first criminal case related to the program, charging two New England businessmen with fraud and alleging that their applications falsely claimed employees they don’t have.

While the government can clearly prosecute fraud, it’s more difficult to bring “bad faith” cases — or those based on certifying that a loan is necessary when it really isn’t — unless they’re egregious. Bad-faith prosecutions would require proof that applicants knew they were making false statements, said Lisa Zornberg, a former chief of the criminal division of the U.S. Attorney’s Office in the Southern District of New York.

Still, it’s wise for the government to send the message that it’s going to be vigilant, she said.

“It’s good government to put out a message prophylactically that warns off would-be fraudsters or would-be ne’er-do-wells who don’t really need the money, and basically say, ‘We’re putting our eagle eyes out and we’re going to take a hard look,’” said Zornberg, now a partner at Debevoise & Plimpton LLP.

Davis, the Digimarc CEO who’s counting on his loan, had a different view.

“Nobody wants to go to jail. I mean, that’s a big hammer,” he said. “It’s really insensitive to the well-intentioned leadership of these small public companies to scare the daylights out of them when they have a need.”

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