United States General Accounting Office

GAO Report to the Chairman, Committee on

National Security, House of

Representatives

April 1997 COOPERATIVE

THREAT REDUCTION

Status of Defense

Conversion Efforts in

the Former Soviet

Union

GAO/NSIAD-97-101

GAO United States

General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

B-276297 

April 11, 1997

The Honorable Floyd Spence

Chairman, Committee on National Security

House of Representatives

Dear Mr. Chairman:

In response to your request, we reviewed the Department of Defense’s

(DOD) program to help convert defense industries in the former Soviet

Union to commercial enterprises.1

 At the time of our review, DOD had

undertaken 20 conversion projects, and the Defense Enterprise Fund had

completed agreements to undertake 4 projects. Our specific objectives

were to assess (1) the effect of defense conversion efforts on the

elimination or reduction of military activities and production capabilities

in former Soviet weapons of mass destruction enterprises, (2) the status of

defense conversion projects and funding, and (3) conformance of the

Defense Enterprise Fund’s management practices to its grant agreement

and the Fund’s operating expenses.

Background DOD’s program to convert former Soviet Union defense industries to

commercial enterprises is part of the Cooperative Threat Reduction

program, which DOD has supported since 1992 to reduce the weapons of

mass destruction (WMD) threat.2

 The program’s priority objectives include

helping to (1) destroy nuclear, biological, and chemical weapons;

(2) transport and store weapons that are to be destroyed; and (3) prevent

weapon proliferation. In addition to these objectives, the Cooperative

Threat Reduction Act of 1993 authorized DOD to establish a program to

help demilitarize former Soviet Union defense industries and convert

military technologies and capabilities to commercial activities. The Soviet

Union had an enormous defense industrial complex that reportedly

consisted of 2,000 to 4,000 production enterprises, research and

development facilities, and research institutes and employed between

9 million and 14 million people.3

 Although the main objective of the

Cooperative Threat Reduction Act focused on WMD reduction, the act did

1

The former Soviet Union countries that participate in this program are Belarus, Kazakstan, Russia,

and Ukraine.

2

This report is the latest in our series of reviews of the Cooperative Threat Reduction program. See

Related GAO products for a list of other reports.

3

O’Prey, Kevin P. A Farewell to Arms: Russia’s Struggles With Defense Conversion. New York:

Twentieth Century Fund Press, 1995, page 15.

Page 1 GAO/NSIAD-97-101 Cooperative Threat Reduction
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not specifically require the defense conversion program to target WMD

capability. Nonetheless, DOD targeted WMD industries for conversion with

the goals of stimulating foreign and domestic investment in the former

Soviet Union and demonstrating that partnerships between private U.S.

companies and former Soviet enterprises can succeed.

The Office of the Secretary of Defense, along with several government

agencies, developed a list of 150 WMD-related enterprises in Belarus,

Kazakstan, Russia, and Ukraine to be candidates for defense conversion

projects. According to DOD, the list consists of enterprises that were

associated with the research, development, or production of WMD; their

delivery systems; or subsystems or components. DOD defined WMD to

include nuclear, biological, and chemical weapons; guided missiles and

aircraft that can deliver these weapons; and weapon platforms, such as

aircraft carriers, land-based missile launchers, surface ships, submarines

that carry nuclear-equipped guided missiles, and aircraft. Also, firms

associated with the production of command, control, and communications

equipment for military forces linked to those weapons, as well as with the

production of systems that provide strategic defense or counter strategic

bombers, were eligible for inclusion on the list.

The Defense Special Weapons Agency (DSWA)—formerly the Defense

Nuclear Agency—implements the defense conversion programs and

contracts under the guidance of the Deputy to the Assistant Secretary of

Defense for Cooperative Threat Reduction. In 1994 and 1995, DSWA

established and awarded contracts for the DOD-managed projects. For

most of these projects, DSWA contracted with U.S. firms to assist specified

former Soviet Union firms. Typically, the former Soviet Union and U.S.

firms established a joint venture to provide a civilian good or service,

using U.S. private and government funds and former Soviet facilities and

labor. The 20 defense conversion projects included 4 projects intended to

provide housing for demobilized Strategic Rocket Force personnel in

Belarus, Russia, and Ukraine.4

 These projects were undertaken because

those countries required that housing be provided for Strategic Rocket

Force personnel before their units could be demobilized.

The Cooperative Threat Reduction Act of 1993 also authorized the

creation of a private, not-for-profit fund that would continue the defense

conversion efforts begun by DSWA. The Defense Enterprise Fund (DEF) was

incorporated in June 1994 as a government-funded enterprise to provide

4

The Cooperative Threat Reduction Act of 1993 includes the provision of housing for former military

personnel of the former Soviet Union.

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financial support for the demilitarization of industries and conversion of

military technologies and capabilities into civilian activities. DEF received

its initial funding through a $7.7 million grant from DSWA. The grant

agreement specifies the management requirements for DEF and articulates

DSWA oversight responsibilities. DEF is currently required to select firms for

defense conversion from DOD’s list of 150 WMD-related enterprises or notify

DSWA if it selects a firm that is not on this list. DOD initially proposed

$118 million in government-funded capitalization for DEF; however,

according to DOD officials, the U.S. government capitalization of DEF is

currently envisioned to end at $71 million. The grant agreement

encourages DEF to seek private capital investment, and DEF is currently

developing plans to create a private equity fund. In accordance with the

grant agreement, DSWA is authorized to approve DEF’s plans.

Our review did not include an evaluation of DSWA’s management of the 

20 individual contracts for defense conversion projects, or an evaluation of

how DOD developed the list of 150 firms that it considered to be

WMD-related enterprises.

Results in Brief Given the vast size of the former Soviet Union’s weapons complex and the

numerous variables involved in trying to assess and quantify military

production capacity—including unknown factors such as possible

modernization or consolidations at other locations—we were unable to

confirm that the defense conversion projects we reviewed had any direct

impact on eliminating or reducing weapons of mass destruction or other

military production capacity in the former Soviet Union. Nonetheless, of

the 24 projects we reviewed, 20 had indigenous partners that DOD

identified as firms that had been engaged in producing weapons of mass

destruction, and one project involved converting resources that were still

engaged in producing weapons of mass destruction. Our analysis also

showed that at least 11 projects had directly used buildings formerly

engaged in activities related to weapons of mass destruction, and at least 

8 projects had employed former workers from weapons of mass

destruction-related activities at the newly established enterprises.

According to DOD officials, the defense conversion projects are providing

assistance to firms that have large numbers of underutilized and often

unpaid employees. DOD officials hope that the projects will become

commercially viable and that the indigenous parent firms will invest

additional resources that might have otherwise been used for producing

weapons of mass destruction or other military hardware.

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Five of the 24 defense conversion projects were no longer operating at the

time of our review. The remaining 19 projects have made varying degrees

of progress in setting up commercial businesses, but eight of the projects

had not begun production. Four of the projects that had reached

production were moving forward, and for one of these projects the U.S.

partner bought the Russian partner’s share of the joint venture. Three of

the four housing projects are complete but have not established

commercial enterprises. Two of the housing projects were construction

projects and were not intended to generate ongoing businesses. As of

March 1997, DOD had notified Congress that it planned to spend a total of

$179.7 million on defense conversion projects and had disbursed

$143 million, including $51.7 million granted to the Defense Enterprise

Fund.5

 As of December 1996, the Fund had committed $22.6 million to

eight investment projects and had invested $16.6 million.

The Defense Enterprise Fund has complied with many elements of the

grant agreement with the Defense Special Weapons Agency, but it has not

finalized some key grant requirements, and the Agency has not enforced

compliance. The Defense Special Weapons Agency’s oversight of the Fund

has been less rigorous than the level provided for by the grant agreement.

The Defense Special Weapons Agency and the Defense Enterprise Fund

have not established the required evaluation benchmarks necessary for

DOD to measure the success of the Fund, and the Fund’s long-range plan

for attracting private capital has yet to be finalized. DOD officials told us

that the Defense Special Weapons Agency was attempting to resolve these

issues. The Defense Enterprise Fund’s operating expenses have totaled

$6.8 million since its inception, which is roughly consistent with the

spending of other U.S. government-sponsored enterprise funds in Central

and Eastern Europe and the former Soviet Union.

Impact of Defense

Conversion Aid on

WMD Industries

As previously stated, when the Soviet Union dissolved, it left behind an

enormous defense industrial complex consisting of 2,000 to 4,000

production enterprises—some of which were massive

conglomerates—that employed 9 million to 14 million workers. To assess

whether any individual defense conversion project had an impact on

reducing this residual production capacity would have required a complete

analysis of the former Soviet Union’s defense industry. The defense

conversion projects often involved the use of a single building that was

part of a massive industrial complex, and we would have had to account

for such things as possible plant modernization or consolidation of

5

DEF received $20 million of this amount in September 1996.

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production lines. This assessment would also have required knowledge of

the initial baseline production capacity. Such an analysis was beyond the

scope of this review. We were unable to confirm that the defense

conversion projects we reviewed had any direct impact on eliminating or

reducing WMD or other military production in the former Soviet Union.

Nonetheless, our review showed that 20 of the 24 conversion projects

included enterprises that DOD considers related to WMD, and according to

DOD and joint venture officials 1 of these projects involved converting

resources that were still engaged in WMD-related production. Defense

conversion assistance establishes projects that typically occupy

abandoned buildings and create a small number of jobs at large former

Soviet Union firms where workers are often underutilized and unpaid.

According to DOD officials, defense conversion efforts are aimed at

redirecting resources at former Soviet Union enterprises to peaceful

endeavors. The officials recognize that only a portion of nearly all former

Soviet Union firms that are receiving assistance will participate in a

defense conversion project. However, DOD officials hope that the projects

will become commercially viable and additional resources will be invested

that might otherwise have been used for producing WMD or other military

hardware.

We found that many of the projects used abandoned buildings of large

WMD-related conglomerates. At least 11 of the 24 defense conversion

projects used former WMD-related buildings, and in 1 case active WMD

production was occurring in a building up to the time that the defense

conversion project began. Further, at least eight projects used former

WMD-related employees. Three housing construction projects in Belarus

and Ukraine did not include WMD-related firms. Table 1 shows information

on DSWA’s and DEF’s conversion efforts.

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Table 1: Type of WMD Conversion at 20 DSWA and 4 DEF Projects in the Former Soviet Union

Number of projects Number of projects

Project sponsor 

and country

Total

number of

projects

WMD

buildings

converted

WMD

buildings not

converted

Unable to

determine

WMD

workers

employed

WMD

workers not

employed

Unable to

determine

DSWA

Belarus 4 2 1 1 0 1 3

Kazakstan 4 2 2 0 4 0 0

Russia 5a 2 1 2 0 1 4

Ukraine 7 5 2 0 3 2 2

DEFb

Russia 4 0 2 2 1 1 2

Total 24 11 8 5 8 5 11

Note: This information was obtained through discussions with officials from DSWA, DEF, U.S. joint

venture partners, and former Soviet Union industry. In some cases, these officials were not able to

tell us whether the workers or buildings converted from military production had been engaged in

WMD-related work.

aAt two projects in Russia, no physical defense conversion occurred because one project was

never fully established and one housing project was just beginning.

bFour additional DEF projects were not included in our review because they were approved by

DEF’s board of directors after we began our work (two in Kazakstan and two in Russia). Two of

the four were initiated by DSWA, and DEF has made investments to the projects to provide

necessary capital.

Information on the defense conversion projects we reviewed follows.

Appendix I provides additional information on DSWA-managed projects in

Belarus, Kazakstan, Russia, and Ukraine. Appendix II provides details on

DEF’s conversion projects.

Belarus Of the four DSWA-managed projects in Belarus, three initially established

commercial ventures at (1) a nuclear-hardened computer circuit firm, (2) a

satellite optics and reconnaissance firm, and (3) a mainframe computer

factory. The other project funded construction of housing for Strategic

Rocket Force personnel and therefore did not establish a defense

conversion enterprise.

Kazakstan The four DSWA-managed projects in Kazakstan are involved in establishing

commercial ventures at (1) a firm responsible for converting an

abandoned Soviet military command and control facility, (2) the

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Kazakstan National Nuclear Center, (3) a production factory for

submarine-launched missiles, and (4) a biological weapons production

enterprise. The missile factory project was able to convert the entire firm

from an active WMD missile producer to a commercial manufacturer of

cryogenic vessels.

Russia Of the five DSWA-managed projects in Russia, three established commercial

partnerships at (1) a radar and avionics firm, (2) an electronics firm that

made gear for space and military applications, and (3) a military avionics

firm. One project to establish a soda bottling plant at a cruise missile

enterprise was canceled. The housing project is just commencing, and

plans are to include an aerospace enterprise that was involved with cruise

missiles and intercontinental ballistic missile systems, an aerospace

materials organization, and a firm that specialized in solid rocket motors.

The four DEF projects that we reviewed were all in Russia. These projects

are to establish commercial ventures at (1) a nuclear weapons research

and development firm, (2) a manufacturer of environmental control

systems for MIG aircraft, (3) a manufacturer of components of nuclear

submarines, and (4) a firm that designed and manufactured missile

guidance systems.

Ukraine Of the seven DSWA-managed projects in Ukraine, five established

commercial ventures at (1) a manufacturer of radio components, including

guidance systems; (2) a manufacturer of guidance and control systems;

(3) a firm that designed and tested radio equipment and instrument

systems for missiles and satellites; (4) a firm that produced control

systems for missiles and space systems; and (5) a manufacturer of

aerospace and military electronics equipment. One housing project used

firms that built and designed missile silos and military bases. The second

housing project used a firm that made parts for the Black Sea fleet but had

no relationship to WMD.

Progress of Defense

Conversion Projects

Defense conversion projects are at varying stages of development. As of

February 1997, four projects had reached production and appeared to be

moving forward, and in one case the U.S. partner bought the Russian

partner’s share of the joint venture. Other projects are experiencing

business difficulties. DOD notified Congress of its plans to spend almost

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$179.7 million, of which $143 million had been disbursed as of March 1997

for all defense conversion projects.

DSWA and DEF Projects Two DSWA projects in Kazakstan, one DSWA project in Ukraine, and one DEF

project in Russia have reached production and appear to be moving

forward. However, five projects in Belarus, Russia, and Ukraine are no

longer operating, and the remaining projects face obstacles. Some projects

are still in the early stages of formation and will require time to mature,

others face legal and bureaucratic challenges that are common in starting

a commercial venture in the former Soviet Union, and others will likely

need further capital investment to be successful. Table 2 categorizes the

status of the 24 projects that we reviewed.

Table 2: Status of Defense Conversion Projects

Number of projects

Status

DSWA

Belarus

DSWA

Kazakstan

DSWA

Russia

DSWA

Ukraine

DEF

Russia Total

No longer operating 3 0 1 1 0 5

Not reached production but no

apparent obstacles 0 0 0 1 3 4

Not reached production and

has major obstacles 0 2 1 1 0 4

Reached production and

has major obstacles 0 0 2 1 0 3

Reached production and

moving forward 0 2 0 1 1 4

Housing projects 1 0 1 2 0 4

Total 4 4 5 7 4 24

Belarus The three defense conversion projects DSWA initiated in Belarus in

mid-1994 are now dormant or no longer operating. Two of those projects

had reached production, but the businesses eventually failed. According to

the U.S. partners in these projects, a poor political and economic

environment and a lack of understanding between the U.S. and Belarus

governments led to these failures. U.S. partners explained that Belarus

government officials believed they would receive monetary assistance

from the U.S. government. The Belarus enterprises and government did

not understand that assistance would come through U.S. private firms in

the form of equipment and business assistance. The housing project begun

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in 1995 was completed in April 1997. This project did not have the

objective of converting a defense enterprise.

Kazakstan Four DSWA projects began in Kazakstan, in 1995, and they are progressing

at varying rates. One is facing bureaucratic obstacles, and the U.S. and

Kazakstan partners are having difficulties reaching agreements. Two of the

projects have obtained additional funding from DEF to help move their

commercial ventures forward. One of these projects has recently begun

production, whereas the other faces a major obstacle and needs licenses

to pursue a telecommunications business. One project that converted a

submarine missile factory into a cryogenic vessel factory is now producing

and selling its products in Europe, and company officials expect a profit

after the first year.

Until recently, DEF projects were solely in Russia. However, DEF has signed

agreements for two defense conversion projects in Kazakstan.

Russia In 1994 and 1995, five DSWA-managed projects began in Russia. One project

has been canceled, three face major obstacles before they can become

commercially successful, and one is a housing project that is just getting

started. The canceled project was intended to establish a soda bottling

factory, but the Russian and American partners could not reach

agreement. As a result, DSWA spent only $195,000 of the $5.1 million

contract. The Russian participants in this project reported that the

experience of working with an American company was beneficial to

increasing their understanding of American business, and they

subsequently negotiated business partnerships with other American

companies.

Although three projects face major obstacles before they can become

commercially successful, DOD officials noted that these challenges are no

different from those facing other investments in Russia. One project was a

contract awarded to a U.S. partner to help a Russian firm develop

hardware and software for an air traffic control system. The future of this

project mostly depends on the award of a Russian government contract for

an air traffic control system. The second project produced hearing aids but

has had difficulty finding a market for its products. The third project

initiated a dental chair production line and was seeking to establish a

bottling line for disinfectant, but the project needs additional investment

capital to move forward. The housing project is in its initial stages and will

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involve the conversion of Russian defense enterprises and the

establishment of indigenous housing assembly and component

manufacturing capabilities. Once these manufacturing lines are

established, DOD plans to construct an unspecified number of homes for

demobilized Strategic Rocket Force personnel with any remaining funds.

Three of the four DEF projects that we reviewed in Russia were in their

early stages of development; therefore, it was premature to draw

conclusions about their future progress. One of the projects has not drawn

on DEF’s investment because the market for the product has not matured

and investment at this point could result in a loss. It is not yet clear if this

project will move forward, but no money has been spent. The fourth DEF

project has reached production and is moving forward; however, the

Russian partner is no longer involved because the U.S. partner purchased

its share of the venture. According to DEF officials, this project had a

successful outcome. In addition, DEF has signed agreements for two other

defense conversion projects in Russia, bringing the total number of DEF

investments to eight, as of February 1997.

Ukraine In Ukraine, DSWA initiated seven projects, five defense conversion projects

and two housing projects in 1994 and 1995. As of March 1997, one project

has not reached production but has no apparent obstacles, two projects

have major obstacles to overcome, and one has reached production and is

moving forward. According to the U.S. companies involved in these joint

ventures, some delays can be attributed to Ukrainian government

bureaucracy—obtaining proper funding and permits and following

designated customs procedures. Also, Ukrainian companies involved in

the joint ventures believed that DSWA contract funding would be paid

directly to them rather than to the joint venture or the U.S. partner. The

fifth defense conversion project, which had planned to establish a cellular

phone production line at an aerospace and military electronic enterprise,

is no longer operating. To restore this project’s viability, DOD is currently

attempting to identify a new American partner. The two housing projects

for Strategic Rocket Force personnel are completed, and the defense

conversion enterprises that were created from these projects are no longer

operating.

DSWA and DEF Spending DOD notified Congress of plans to spend nearly $179.7 million on defense

conversion projects. It has disbursed $143 million, including $51.7 million

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that was granted to DEF. Table 3 shows defense conversion spending as of

March 1997.

Table 3: DSWA Defense Conversion

Spending as of March 1997 Dollars in millions

Notified Obligated Disbursed

Belarus $20.0 $19.8 $18.7

Kazakstan 15.0 14.2 11.4

Russia 38.0 33.0 13.5

Ukraine 55.0 54.4 47.7

DEF granta 51.7 51.7 51.7

Total $179.7 $173.1 $143.0

Note: Included in these figures is $66 million that had been obligated to housing projects in

Belarus, Russia, and Ukraine. Of the $66 million, $45 million has been disbursed.

aDSWA has disbursed all obligated funds to DEF, but the table does not show the amounts DEF

had committed or spent.

As of December 1996, DEF had committed $22.6 million of its $51.7 million

DSWA grant to eight defense conversion projects and had invested

$16.6 million in conversion projects. DEF anticipates an additional U.S.

government grant of $15 million in fiscal year 1997 from the State

Department’s Freedom Support Act funds.6

DEF Management

Issues and

Expenditures

DEF has complied with many elements of its grant agreement with DSWA,

but DEF has not finalized all requirements, and DSWA has not followed

through on compliance. DEF’s operating expenditures have totaled

$6.8 million since its inception in June 1994. Our analysis indicates that

this is roughly equivalent to the rate of spending for operating expenses of

other U.S. government-sponsored enterprise funds in Central and Eastern

Europe and the former Soviet Union.

DEF Grant Agreement

Issues

The June 1994 grant agreement between DSWA and DEF requires DSWA to

conduct semiannual progress reviews of DEF unless both entities agree

otherwise. The agreement also stipulates that DSWA will make

6

A State Department official told us that the Department may provide another $5 million later in fiscal

year 1997 or in fiscal year 1998. The Department will allocate the funds to the U.S. Agency for

International Development, which will transfer them to DSWA for execution under an amendment to

the existing grant agreement.

Page 11 GAO/NSIAD-97-101 Cooperative Threat Reduction
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approximately three visits annually to DEF’s home and field offices.7 As of

December 1996, DSWA had conducted two semiannual progress reviews

that were held in DEF’s Boston office. A program manager also told us that

he made one visit to the site of the Kirovsky-Zavod joint venture in 

St. Petersburg, Russia. The results of the semiannual reviews were not

documented in any systematic way and, according to a DSWA official, were

informal. The minutes of DEF’s board meetings do not contain any

discussion of the results of these reviews, and the board members we

talked to did not recall any briefings or discussions of such reviews. DEF

officials and board members stated, however, that DEF and DSWA were in

frequent communication and thus did not need more frequent or

formalized reviews.

In January 1997, DSWA officials told us that they would begin conducting

oversight in a more rigorous and formalized way and would perform the

semiannual reviews and the required office visits. Accordingly, in

February 1997, the DSWA program manager conducted a semiannual review

and office visit in Richmond with DEF officials and has planned two trips to

DEF’s new field offices in Moscow and St. Petersburg.

In addition, DEF has not developed the performance benchmarks that the

grant agreement requires be established in consultation with DSWA.

8

 The

agreement requires DEF to establish a statement of objectives that includes

benchmarks to facilitate the assessment of DEF’s expected

accomplishments. As of February 1997, DEF had developed an objectives

statement but had not established benchmarks to assess whether and to

what extent DEF’s expected accomplishments were being achieved. The

grant agreement states that DEF’s success will be evaluated by the extent to

which it meets or contributes to its objectives, such as the successful

demilitarization of a defense industry and the development of a number of

key joint business initiatives between U.S. and former Soviet Union private

firms. The absence of these benchmarks makes it difficult to assess DEF’s

success or failure.9

 In March 1997, DOD officials drafted benchmarks for

7

Until April 1996, DEF had home offices in Richmond, Virginia, and Boston, Massachusetts. In April,

DEF closed the Boston office. DEF has recently opened field offices in St. Petersburg and Moscow,

Russia.

8

DEF has established portfolio indicators to evaluate its investments, such as rates of return achieved,

milestones for equipment and licenses procured, and exit mechanisms. DEF calls these indicators

benchmarks, but they differ from the benchmarks required by the grant agreement, which require

measuring progress toward the objectives of demilitarization and defense conversion.

9

In the future, DOD will have to consider the Government Performance and Results Act of 1993, which

requires all federal agencies to establish systems for measuring whether agency programs are meeting

their intended objectives.

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DEF and told us that these benchmarks, once coordinated with DEF, would

be included in the requirements for the semiannual progress reviews.

In May 1995, DSWA amended the grant agreement to require DEF to submit a

long-range plan by September 1995 that, at a minimum, would address

how DEF intends to become self-sufficient by 1998. DEF has not yet

presented a specific plan to DSWA for approval; however, DOD officials

stated that DEF will do so on March 31, 1997. DEF plans for self-sufficiency

include attracting private capital, and, according to a DEF official, DEF

expects to be investing private funds by 1998. DEF management presented

a plan to its board of directors in December 1996 and provided preliminary

briefings to DOD officials on the plan’s essential elements in December

1996 and January 1997. The proposed plan involves establishing a private

equity fund with $15 million of DEF capital and shared management, an

arrangement similar to that used by the Polish-American Enterprise Fund

in establishing its private equity fund. The private equity fund will focus on

enterprises undergoing industrial and technological conversion, but will

not be strictly limited to defense conversion projects.10 However,

consistent with the legislation establishing DEF, investments by DEF in this

fund must support programs for demilitarization of industries and defense

conversion.

It has been difficult for U.S. government-sponsored enterprise funds to

attract private capital; only the first 2 funds—the Polish-American Fund

and the Hungarian-American Fund—of the 11 that the government has

sponsored in Central and Eastern Europe and the former Soviet Union

have been able to do so. To attract private capital, enterprise funds must

have a successful record of investments. The Hungarian-American Fund

began to look for private capital in 1991 and was finally successful in 1996.

The investment of private capital can provide fund management with an

opportunity to earn incentive compensation based on earnings over and

above the grant ceiling of $150,000 for fund managers.11

DEF Operating Expenses The aggregate level of DEF’s operating expenses is consistent with that of

other U.S. government-sponsored enterprise funds in Central and Eastern

Europe and the former Soviet Union. DEF expended $6.8 million between

10A DEF official stated that the private fund will not make any nondefense-related investments until

DEF funds are fully invested in defense conversion projects.

11DEF’s grant agreement states that employees may earn no more than $150,000 per year from grant

funds, and any compensation in excess of the ceiling may be paid from sources other than grant funds.

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June 1994 and December 1996 for operating expenses.12 Table 4 shows

that DEF’s expenditure rate falls within the range experienced for all

enterprise funds and for those of similar size.13 Table 5 shows DEF’s

expenses by category for the last 2 fiscal years. Consistent with most U.S.

government-sponsored international enterprise funds, project expenses

(legal, accounting, and consulting) and personnel compensation constitute

the largest share of DEF’s operating expenses.

Table 4: Operating Expenses Among

Enterprise Funds as of

September 1996

Dollars in millions

Fund Grant commitment

Annualized operating

expenses as a

percentage of grant

commitment

Polish-American Fund $264 1.09

Albanian-American Fund 30 1.78

U.S.-Russia Fund 440 1.90

Western Newly Independent States

Fund 150 3.13

Baltic-American Fund 50 3.14

Bulgarian-American Fund 55 3.33

Central Asian Fund 150 3.38

Defense Enterprise Fund 71 3.77

Czech and Slovak American Fund 65 4.20

Hungarian-American Fund 70 4.38

Romanian-American Fund 50 4.53

Note: We calculated the percentage of operating expenses by annualizing each fund’s expenses

since inception and compared that amount to the grant commitment for each fund.

12This amount includes $113,000 in operating expenses incurred for the period June through

September 1994.

13There are several ways to evaluate administrative expenses, including comparisons to average

performing assets, investment income, and grant amount. Because of DEF’s relatively early stage of

development and the availability of consistent data, we used operating expenses to grant amount to

make this comparison.

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Table 5: DEF Operating Expenses by

Category for Fiscal Years 1995 and

1996 FY 1995 FY 1996

Dollars in thousands

Operating expenses Amount Percent Amount Percent

Project expenses $406 20 $1,556 34

Employee compensation and benefits 700 34 1,033 22

Bad debt provision 0 0 600 13

Travel and related expenses 222 11 293 6

Legal and accounting 214 11 240 5

Occupancy 71 4 193 4

Consulting 96 5 141 3

Raising private capital 10 0 118 3

Insurance 49 2 42 1

Communications 38 2 56 1

Taxes and licenses 37 2 44 1

Office supplies 32 2 53 1

Depreciation and amortization 27 1 108 2

Miscellaneous 121 6 170 4

Total $2,023 100 $4,647 100

Recommendation In addition to the recent efforts DOD has initiated to strengthen its

oversight of DEF, we recommend that the Secretary of Defense direct that

performance benchmarks be established, as required by DOD’s grant

agreement with DEF; a long-range plan for attracting private capital be

prepared by DEF and approved by DOD; and semiannual progress reviews

and the required office and field visits be performed.

Agency Comments

and Our Evaluation

DOD and DEF provided written comments on a draft of this report. DOD

concurred with our report and recommendation and noted its plans to

implement our recommendation. DEF did not expressly disagree with our

report or recommendation but stated that Congress did not intend for its

oversight to be carried out in the same manner as oversight of a typical

U.S. Agency for International Development or DOD grantee. We generally

agree with DEF on this matter; therefore, our recommendation is limited to

compliance with the oversight requirements of the grant agreement itself.

DEF also stated that it has controlled its expenses better than our report

suggests. To evaluate DEF operating expenses, we used the most consistent

and readily available data for all 11 U.S. government-sponsored enterprise

Page 15 GAO/NSIAD-97-101 Cooperative Threat Reduction
B-276297 

funds. DOD’s and DEF’s comments are presented in appendixes III and IV,

respectively.

Scope and

Methodology

To determine the status of ongoing defense conversion projects and better

understand their potential WMD impact, we reviewed 20 DSWA and 4 DEF

defense conversion projects that had been approved at the time we began

our review in early July 1996. We did not review the four DEF projects that

were approved after we began our review. In reviewing these conversion

projects, we examined records and interviewed officials at DSWA, DOD, DEF,

and U.S. private firms involved in the defense conversion projects. We also

visited several locations in Russia and Kazakstan and we interviewed U.S.,

Russian, and Kazakstan government and private officials and toured sites

of 12 projects to observe first-hand the (1) buildings, (2) condition of the

projects and equipment being used, and (3) current stage of development.

During these visits, we attempted to confirm the prior uses of buildings

being employed for these projects and the previous roles of employees. In

Belarus and Ukraine, we relied on statements and documents provided by

DSWA and U.S. contractors. For all projects, we relied on the views of

officials associated with the projects regarding how each project plans to

overcome obstacles, achieve production, and sell products.

In assessing the WMD attributes and the ability of each project to convert

WMD capability, we did not review the DSWA and DEF processes for selecting

defense conversion projects. For the purposes of this review, we accepted

DOD’s judgment that the list of 150 firms included WMD-related enterprises.

We were not able to independently verify the WMD relationships of

conversion projects and we relied on DSWA, DEF, U.S. contractor, and joint

venture officials to provide accurate information. In Kazakstan and Russia,

we spoke with joint venture officials who are former employees of WMD

enterprises because the facilities that we saw no longer produced WMD

components. In Belarus and Ukraine, we relied on information from DSWA

project managers and industry officials to understand former capabilities

of former Soviet Union enterprises. In all cases, we used multiple

independent sources to draw our conclusions.

In reviewing DEF management practices and operating expenses, we

interviewed and obtained documents from DEF and DOD officials on DEF’s

policies, procedures, and practices. We reviewed DEF’s grant agreement,

bylaws, corporate policies, and procedures. These documents established

criteria for assessing DEF’s management practices. We analyzed various

DEF project and expense files. We also spoke with selected DEF investment

Page 16 GAO/NSIAD-97-101 Cooperative Threat Reduction
B-276297 

partners. We obtained documents from the U.S. Agency for International

Development on policies and expenditures of other enterprise funds. We

used data from these funds to establish a basis for determining the

consistency of DEF expenses with other funds.

We conducted our review between July 1996 and March 1997 in

accordance with generally accepted government auditing standards.

We are sending copies of this report to the Secretaries of Defense and

State, the President of the Defense Enterprise Fund, and other appropriate

congressional committees. We will also make copies available to others on

request.

Please contact me on (202) 512-4128 if you or your staff have any

questions concerning this report. Major contributors to this report are

listed in appendix V.

Sincerely yours,

Harold J. Johnson, Associate Director

International Relations and Trade Issues

Page 17 GAO/NSIAD-97-101 Cooperative Threat Reduction
Contents

Letter 1

Appendix I 

DSWA-Managed

Conversion Projects

20

Belarus Defense Conversion Projects 20

Kazakstan Defense Conversion Projects 22

Russia Defense Conversion Projects 27

Ukraine Defense Conversion Projects 32

Appendix II 

DEF Conversion

Projects

38

Kirovsky-Zavod 38

Nauka 38

Khlopin Radium Institute 39

Mashinostroyenia 39

Appendix III 

Comments From the

Department of

Defense

41

Appendix IV 

Comments From the

Defense Enterprise

Fund

43

Appendix V 

Major Contributors to

This Report

50

Related GAO Products 52

Tables Table 1: Type of WMD Conversion at 20 DSWA and 4 DEF

Projects in the Former Soviet Union

6

Table 2: Status of Defense Conversion Projects 8

Table 3: DSWA Defense Conversion Spending as of March 1997 11

Table 4: Operating Expenses Among Enterprise Funds as of

September 1996

14

Page 18 GAO/NSIAD-97-101 Cooperative Threat Reduction
Contents

Table 5: DEF Operating Expenses by Category for Fiscal Years

1995 and 1996

15

Figures Figure I.1: Abandoned Infirmary at a Biological Weapons Factory

Where Construction of a Pharmaceutical Production Line Has

Begun

23

Figure I.2: Cryogenic Pressure Vessel Production at a Former

Missile Production Facility

24

Figure I.3: Building Originally Constructed for a Soviet Defense

Conversion Project That Now Houses a U.S.-Kazakstan Printed

Circuit Board Production Line

25

Figure I.4: Abandoned Soviet Command and Control Base Where

One Project Occupies a Building

27

Figure I.5: Hearing Aid Production at a Former Integrated Circuit

Production Building

29

Figure I.6: Dental Chair Production Line at a Former

Manufacturer of Portable Naval Radiation Decontaminators

31

Abbreviations

DEF Defense Enterprise Fund

DOD Department of Defense

DSWA Defense Special Weapons Agency

WMD weapons of mass destruction

Page 19 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix I 

DSWA-Managed Conversion Projects

The Defense Special Weapons Agency (DSWA) managed 20 defense

conversion projects in Belarus, Kazakstan, Ukraine, and Russia. Typically,

DSWA contracted with private U.S. firms to initiate projects at former

weapons of mass destruction (WMD) industries in the former Soviet Union.

These private firms often used their own capital as investments in these

projects.

Belarus Defense

Conversion Projects

DSWA planned to spend $20 million on four defense conversion projects in

Belarus. Three of the projects involved U.S. firms and Belarus

defense-related entities—Belomo Optics and Mechanical Manufacturing

Association, Integral Research and Production Amalgamation, and Minsk

Computer. One project is to provide housing to demobilized Strategic

Rocket Force personnel.

Belomo • Contract amount and date: $960,000 awarded in April 1994.

• Former defense capability: Producer of satellite and aerial

reconnaissance optics, night vision optics, lasers, simulators, and tank and

armored vehicle optics.

• Former employment level: 40,000 at height of production; 20,000 in

1993.

• Purpose of joint venture: To manufacture and sell laser pointer devices.

• Defense building conversion: Refurbished a 12,900-square foot

production area. The site may have manufactured parts for a missile

homing device.

• Joint venture production: Produced 19,023 laser pointers, which are

used by speakers in presentations.

• Joint venture employment: 88 former defense workers. We could not

confirm if these employees worked on WMD-related projects.

• Obstacles: Not applicable.

• Status of project: Ceased operations in 1996. Falling retail prices for the

laser pointers and increased competition from suppliers in Asia created a

situation in which the venture could no longer compete.

Integral • Contract amount and date: $5.8 million awarded in April 1994.

• Former defense capability: Producer of nuclear-hardened chips for the

Soviet military. According to the U.S. partner of the project, Integral

produced 40 percent of the chips on the Soviet Union’s missile guidance

systems. Integral also produced integrated circuits, transistors, electronic

watches, and microwave and pulse diodes.

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DSWA-Managed Conversion Projects

• Former employment level: 33,000 in September 1993.

• Purpose of joint venture: To produce low end integrated circuits.

• Defense building conversion: Converted a 26,400-square foot facility,

located in the center of Integral’s complex, that had been used for military

production. The facility made microprocessors that could be used in

guidance systems.

• Joint venture production: Began production and delivery of integrated

circuits in May 1995.

• Joint venture employment: 250 former defense workers.

• Obstacles: Not applicable.

• Status of project: No longer operational. Because of a poor business

environment, the American partner withdrew from the joint venture.

Minsk Computer • Contract amount and date: $2.5 million awarded in September 1994.

• Former defense capability: Manufacturer of mainframe computers for

the Soviet military. Before the breakup of the former Soviet Union, over

85 percent of Minsk Computer’s work was for the military. DSWA reported

in 1993 that Minsk Computer had no defense work and had laid off

40 percent of its employees.

• Former employment level: 10,000 at the height of production.

• Purpose of joint venture: To produce solid-state battery chargers,

power supplies, transformers, and wireless communications modems for

computer network systems.

• Defense building conversion: Converted a 17,200-square foot facility

that was used for military production. We were not able to determine if

this facility had been used for WMD-related activities.

• Joint venture production: Produced solid-state battery chargers, power

supplies, and transformers. Developed 25 prototype wireless

communications modems.

• Joint venture employment: 168 former defense workers employed.

• Obstacles: Not applicable.

• Status of project: No longer operational.

Housing • Contract amount and date: $9.9 million awarded in May 1995.

• Former defense capability: No commercial venture is being established

as part of this project.

• Former employment level: Not applicable.

• Purpose of joint venture: To build 171 apartments for demobilized

Strategic Rocket Force personnel and their families.

• Defense building conversion: Not applicable.

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DSWA-Managed Conversion Projects

• Joint venture production: Not applicable.

• Joint venture employment: Not applicable.

• Obstacles: None.

• Status of project: Completed in April 1997.

Kazakstan Defense

Conversion Projects

DSWA notified Congress of its intent to spend $15 million on four defense

conversion projects in Kazakstan. These projects are between U.S. firms

and Kazakstan defense-related entities—Biomedpreparat, Gidromash, the

National Nuclear Center, and Kazinformtelecom.

Biomedpreparat • Contract amount and date: $2.7 million awarded in March 1995.

• Former defense capability: Biological weapons research and

production. According to joint venture officials, Biomedpreparat produced

organisms such as Ebola and Anthrax.

• Former employment level: 700 at its peak in the mid-1980s; 200 in

October 1996.

• Purpose of joint venture: To manufacture and distribute vitamins,

pharmaceuticals, and antibiotics.

• Defense building conversion: Renovations have begun on

Biomedpreparat’s infirmary (see fig. I.1), which was used as the facilities’

decontamination unit and will house initial pharmaceutical production.

Joint venture officials also hope to use a waste treatment building for

future production.

• Joint venture production: The joint venture has bottled vitamins that

were manufactured in the United States to use for its initial marketing

efforts. The initial production line is not yet complete.

• Joint venture employment: In October 1996, 14 former Biomedpreparat

workers were employed, and 80 to 100 former workers may be employed

once full production is ready.

• Obstacles: This project faces major challenges because government

obstacles remain and the U.S. and Kazakstan partners are having

difficulties reaching agreements. Also, facility renovations are not

complete, and necessary equipment is not in place.

• Status of project: Renovations on the infirmary are being completed, and

pharmaceutical manufacturing equipment is being shipped to Kazakstan to

set up a production line.

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DSWA-Managed Conversion Projects

Figure I.1: Abandoned Infirmary at a

Biological Weapons Factory Where

Construction of a Pharmaceutical

Production Line Has Begun

Gidromash • Contract amount and date: $3 million awarded in March 1995.

• Former defense capability: Built components of missile delivery

systems and manufactured engine casings. Approximately 85 to 90 percent

of production had been devoted to defense, and 10 percent was related to

WMD. The WMD production was focused on the manufacture of

submarine-launched missiles and various prototypes. The plant

manufactured the entire missile device, except for the nuclear component.

When defense conversion efforts were commencing in Kazakstan in 1994,

40 percent of the plant was being utilized for the production of

antisubmarine rockets and missiles.

• Former employment level: 2,200 in 1988; 1,400 in 1994.

• Purpose of joint venture: To manufacture a wide array of standard and

specialty pressure vessels, including cryogenic pressure vessels, valves,

and other products for the oil, gas, and petrochemical industry.

• Defense building conversion: Converted 699,700-square feet of

Gidromash’s production space (see fig. I.2). Some equipment from

Gidromash’s former production lines was utilized, whereas other

equipment was junked. Joint venture officials pointed out that one large

lathe used for missile production was outside rusting.

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DSWA-Managed Conversion Projects

• Joint venture production: The cryogenic vessel production line opened

in July 1996. The project has firm orders for 150 cryogenic vessels and

produces them at a rate of 3 to 4 a week.

• Joint venture employment: 374 former Gidromash workers.

• Obstacles: None.

• Status of project: Production has begun, and the joint venture is

growing. Anticipated sales are $5 million to $6 million in 1996, $12 million

to $15 million in 1997, and $20 million to $40 million by 2000.

Figure I.2: Cryogenic Pressure Vessel

Production at a Former Missile

Production Facility

National Nuclear Center • Contract amount and date: $4 million awarded in March 1995.

• Former defense capability: The National Nuclear Center is a Kazakstan

government organization that was established after the fall of the Soviet

Union to carry out basic research in the field of nuclear energy. The center

is responsible for sites that conducted nuclear weapons testing and

research while the Soviet Union was intact. It also manages several

research reactors.

• Former employment level: 2,000 employees in 1995.

• Purpose of joint venture: To establish a printed circuit board

production and marketing business.

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DSWA-Managed Conversion Projects

• Defense building conversion: The project’s main facility is located in

Kurchatov, Kazakstan, which is just outside the Semipalatansk nuclear test

site and is located on the grounds of the National Nuclear Center (see 

fig. I.3). This facility was constructed as a Soviet Union defense conversion

project in the late 1980s. The second facility occupies an administrative

office building just outside the grounds of the National Nuclear Center

near Almaty, Kazakstan. These buildings were not used for any

WMD-related activities.

• Joint venture production: Production began recently.

• Joint venture employment: 28 National Nuclear Center workers were

employed as of October 1996. Additional center workers are to be hired as

production demands warrant.

• Obstacles: None.

• Status of project: Project officials plan to sell printed circuit boards on

the world market. The U.S. partner, an established firm in the electronics

industry, will use its marketing resources to sell initial products. The

project has brought in the Defense Enterprise Fund (DEF) as an investor to

have enough capital to initiate production. DEF has committed a total of

$2.5 million to this project and invested $500,000.

Figure I.3: Building Originally

Constructed for a Soviet Defense

Conversion Project That Now Houses

a U.S.-Kazakstan Printed Circuit Board

Production Line

Kazinformtelecom • Contract amount and date: $5 million awarded in January 1995.

• Former defense capability: Kazinformtelecom is responsible for

maintaining the Saryshagan missile testing site. The site controlled

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Appendix I 

DSWA-Managed Conversion Projects

satellites, monitored intercontinental ballistic missiles, regulated early

detection and tracking systems, and tested surface-to-air and antiballistic

missiles. Kazinformtelecom officials explained that this site, which was

abandoned by the Russian military in 1994, was one of three central Soviet

command and control sites and that it controlled satellite communications

for the Soviet military.

• Former employment level: 3,000 military and 2,000 civilian workers

were employed at the Saryshagan site.

• Purpose of joint venture: To establish an international and domestic

wireless telecommunications service in Kazakstan and have wireless

communications in 11 Kazakstan cities.

• Defense building conversion: The Saryshagan site is 1 of 11 sites

operated by the joint venture but is the only site with a defense conversion

application. The building at the abandoned Saryshagan base was

unoccupied, and the project was using a former Soviet satellite dish that

had been abandoned (see fig. I.4).

• Joint venture production: Telecommunications service has not yet

begun. The establishment of service depends on the equipment being in

place and the granting of necessary government licenses.

• Joint venture employment: 52 local national employees.

Kazinformtelecom officials explained that about 25 of these people, 20 of

whom are engineers, worked at the Saryshagan site before conversion.

The joint venture will hire up to 250 additional people once obstacles are

overcome.

• Obstacles: As of February 1997, three significant obstacles needed to be

overcome before the project could become fully functional. First, no

resolution had been reached on an interconnect agreement with

Kazaktelecom. Second, the Kazakstan government had granted a license to

the venture for data communications, but it had not granted a license for

voice communications. Until a voice communications license is obtained,

it will not be possible to operate a profitable business. Third, one

subcontractor had not delivered necessary equipment.

• Status of project: Much of the equipment is in place, and the project

officials are trying to overcome the obstacles. DEF has become an investor

in this project.

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DSWA-Managed Conversion Projects

Figure I.4: Abandoned Soviet

Command and Control Base Where

One Project Occupies a Building

Russia Defense

Conversion Projects

DSWA notified Congress of its intent to spend $38 million on five defense

conversion projects in Russia. Four of these projects are between U.S.

firms and Russian defense-related entities—GOSNIIAS, Istok, Leninets,

and Mashinostroyenia. One project is to provide housing to demobilized

Strategic Rocket Force personnel and establish joint ventures with three

defense-related entities—Kompozit, Mashinostroyenia, and Soyuz.

GOSNIIAS • Contract amount and date: $4.1 million in July 1994.

• Former defense capability: GOSNIIAS is a state-controlled enterprise

that designs and tests military avionics and carries out avionics and

weapons integration.

• Former employment level: 8,000 employees in 1992.

• Purpose of joint venture: While no joint venture was established, the

project was intended to build prototypes for air traffic control hardware

and software based on the Global Positioning System and GLONASS, the

Russian counterpart.

• Defense building conversion: Occupied a 8,600-square foot military

design facility that had previously been used for conducting mathematical

analyses concerning weapons.

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DSWA-Managed Conversion Projects

• Joint venture production: Developed a business plan and built

prototypes for air traffic control hardware and software.

• Joint venture employment: This project began with a staff of 10 defense

workers and employed as many as 60 defense workers at one time.

• Obstacles: While the partnership has developed a business plan and built

prototype hardware and software, a market has yet to develop. GOSNIIAS

and the U.S. contractor tell us that they plan to work together in

competing for a future Russian government contract for an air traffic

control system. However, the contract has yet to be tendered. This

contract could result in 200 jobs for GOSNIIAS and be worth $80 million to

$100 million.

• Status of project: Work on the DSWA contract is nearly complete, and

closeout on the contract is pending. Rockwell intends to create a

long-term relationship with GOSNIIAS and is planning on awarding

subcontracts to GOSNIIAS for a variety of efforts.

Istok • Contract amount and date: $5.7 million awarded in July 1994.

• Former defense capability: Producer of magnetrons, klystrons,

high-powered vacuum tubes, carbon dioxide lasers, electro-optical

devices, batteries, microwave devices, and solid-state electronic

components.

• Former employment level: 8,000 in 1994.

• Purpose of joint venture: To manufacture and distribute hearing aids.

• Defense building conversion: The project converted a 15,100-square

foot facility that produced highly integrated circuits. According to joint

venture officials, this defense facility was associated with WMD.

• Joint venture production: By early summer 1995, production had begun

on a hearing aid (see fig I.5) that was useful for the moderately hearing

impaired—about 50 to 60 percent of the hearing impaired population in

Russia. The joint venture is capable of producing 250,000 hearing aids

annually and initially produced about 25,000 hearing aids. The venture

purchased parts for 40,000 hearing aids, but some of the components were

in poor condition.

• Joint venture employment: 160 former defense workers. According to

Istok officials, 80 percent of the staff are engineers, but we did not

determine if they had worked on WMD-related projects.

• Obstacles: The joint venture suffered a major setback in distributing its

hearing aids. It had planned to sell the hearing aids via the Russian

government’s medical technology supply agency, which would have

distributed them to more than 200 hearing clinics around Russia. However,

the lack of government funds prompted the supply agency to only

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Appendix I 

DSWA-Managed Conversion Projects

purchase hearing aids for the severely hearing impaired—a small

population for which Istok’s hearing aid was not well suited. At that time,

the venture had no other products. The joint venture needs additional

financing to establish new production lines.

• Status of project: Istok is now planning to produce another hearing aid

and focus attention on selling it on the export market (mostly in third

world countries) as well as on the Russian market. Istok also hopes to

begin production on a hearing aid aimed at severely hearing impaired

individuals. The joint venture has asked DSWA to provide additional funding

to help move the venture forward.

Figure I.5: Hearing Aid Production at a

Former Integrated Circuit Production

Building

Leninets • Contract amount and date: $2 million in June 1994.

• Former defense capability: Manufacturer of airborne radars and other

radio electronic equipment. Leninets officials claimed that they also made

specialized equipment, such as chips for high-frequency radars used in

MIG and Sukoi aircraft. Leninets consists of 16 factories, 10 research

organizations, and 50 small enterprises.

• Former employment level: Unknown.

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DSWA-Managed Conversion Projects

• Purpose of joint venture: To remanufacture dental chairs, distribute

new dental equipment, and bottle solutions for oral infection control.

• Defense building conversion: The project is occupying a 4,600-square

foot building that formerly operated, in part, as a toy factory, but Leninets

officials stated that 55 percent of the building was devoted to

manufacturing portable naval radiation decontaminators, which were

intended for use on naval vessels after a nuclear attack. Production

stopped in 1993.

• Joint venture production: As of October 1996, the project had sold 187

remanufactured dental chairs, earning the venture about $35,000 a month

(see fig. I.6). The distribution of new dental equipment earns the project

about $80,000 a month.

• Joint venture employment: About 22 people, some of which have

manufacturing skills associated with computers and other equipment and

others are being used in accounting and marketing roles.

• Obstacles: The project has had considerable difficulty in setting up its

bottling operation, which it sees as more lucrative than the other ventures.

The bottling operation has been delayed for over 1 year due to setbacks at

the U.S. manufacturer of the bottling equipment and problems with

Russian customs. Project officials also underestimated the cost of

purchasing the equipment and refurbishing the space that they are to

occupy. As a result, the project had run out of funds at the end of 1996.

• Status of project: The project is seeking at least $250,000 to $500,000 in

new capital to start up the bottling line.

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DSWA-Managed Conversion Projects

Figure I.6: Dental Chair Production

Line at a Former Manufacturer of

Portable Naval Radiation

Decontaminators

Mashinostroyenia • Contract amount and date: $5.1 million awarded in June 1994.

• Former defense capability: Producer of cruise missiles, intercontinental

ballistic missiles, and maneuverable satellites.

• Former employment level: 9,000 in 1992.

• Purpose of joint venture: To establish a cola bottling facility.

• Defense building conversion: Plans called for the conversion of

Mashinostroyenia’s nitrogen building, which was needed to produce

missiles.

• Joint venture production: The joint venture was never established, so it

never reached production.

• Joint venture employment: None.

• Obstacles: According to Mashinostroyenia officials, DOD selected the

project without their input, and they were not happy to have a low-skilled

project at their high-technology firm.

• Status of project: The American partner and Mashinostroyenia were not

able to work out differences, and the U.S. partner asked to be released

from the contract. DSWA agreed in April 1996 to cancel the contract and

disbursed $195,000 of the $5.1 million contract.

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DSWA-Managed Conversion Projects

Housing • Contract amount and date: $20 million awarded in June 1995.

• Former defense capability: The Russian partners for this project include

Soyuz, a firm that built turbofans for cruise missiles; Kompozit, a producer

of heat shields for missiles and space systems; and Mashinostroyenia.

• Former employment level: Kompozit employed 10,000 in 1992,

Mashinostroyenia employed 9,000 in 1992, and Soyuz employment was

unknown.

• Purpose of joint venture: To construct a housing industry in Russia and

build homes for Strategic Rocket Force personnel.

• Defense building conversion: No buildings have been selected for this

project.

• Joint venture production: Unknown at this time because the joint

venture has not been established.

• Joint venture employment: Unknown at this time because the joint

venture has not been established.

• Obstacles: Until January 1997, DOD and the Russian government were not

able to reach agreement on the scope of this project.

• Status of project: In January 1997, the Russian government and DOD

officials agreed that Russian WMD enterprises would work with an

American partner to establish five production lines. These production

lines are a modular housing assembly facility, a window and door

manufacturing facility, a low-pressure brass casting production line, an

asphalt shingle production line, and a lumber mill capable of supplying the

lumber suitable for housing construction. Remaining funds will be used to

provide housing to demobilized Strategic Rocket Force personnel.

Ukraine Defense

Conversion Projects

Between 1994 and 1995, DSWA signed contracts totaling $53.5 million to

initiate seven defense conversion projects. These projects were between

U.S. firms and Ukraine defense-related entities—Central Design Institute

and Montazhnik K, Fregat, Hartron, Kommunar, Meridian, Monolit, and

Orizon.

Central Design Institute

and Montazhnik K

• Contract amount and date: $16 million awarded in September 1994 to

construct 135 apartment units. Contract options were exercised to

construct an additional 60 units for a total cost $18.7 million.

• Former defense capability: Design and construction of defense-related

structures for the Ukrainian Ministry of Defense.

• Former employment level: Unknown, but current employment is

22,000.

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DSWA-Managed Conversion Projects

• Purpose of joint venture: To design and construct apartment units for

demobilized Strategic Rocket Force personnel and transfer modern

housing construction and production technologies to Ukraine.

• Defense building conversion: There was no defense conversion

requirement as the Ukrainian Ministry of Defense was the customer, joint

venture partner, and subcontractor for this housing project. Furthermore,

in 1991 the Ministry had established its own housing construction

complex. It is now pursuing more commercial construction activities.

• Joint venture production: Designed and constructed 195 apartment

units.

• Joint venture employment: 440 workers.

• Obstacles: None.

• Status of project: As of May 1996, all of the 195 apartment units had been

constructed and transferred to the Ministry of Defense. The joint venture

was hoping to continue with other construction projects.

Fregat • Contract amount and date: $10 million awarded in June 1994 and later

increased to $15 million.

• Former defense capability: Producer of ship parts and equipment for

the Black Sea Fleet. No ties to producing or supporting WMD.

• Former employment level: 3,200 in 1993.

• Purpose of joint venture: To produce and construct up to 261

prefabricated housing units for demobilized Strategic Rocket Force

personnel at Pervomaysk, Ukraine.

• Defense building conversion: The joint venture occupied about 150,700

square feet of one building. Former production in this building was not

related to WMD.

• Joint venture production: Produced 261 prefabricated housing units.

• Joint venture employment: Nearly 300 workers were involved in

fabricating, erecting, and finishing the housing modules.

• Obstacles: None.

• Status of project: The last of the 261 housing units were turned over to

the Ukrainian Ministry of Defense in August 1996. The joint venture had

hoped to secure domestic and foreign customers for the prefabricated

housing units, but there was no market for the product. The equipment

used to produce the units remains at the Fregat factory in Pervomaysk.

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DSWA-Managed Conversion Projects

Hartron • Grant amount and date: $5 million grant awarded in May 1994.

• Former defense capability: Hartron, the largest manufacturer of control

systems in Ukraine, developed, produced, and installed control systems

for missiles and space systems.

• Former employment level: Unknown, but current employment is 10,000.

• Purpose of joint venture: To produce instrumentation and control

systems to improve the safety and reliability of Ukrainian nuclear power

plants.

• Defense building conversion: The joint venture occupies about 10,800

square feet of space in one building. The Hartron facility, however, was

not a production facility. Instead, it was used for designing and testing

purposes. Manufacturing of the systems was done at other facilities.

• Joint venture production: The joint venture delivered its first

instrumentation and control system in May 1996 to the South Ukraine

nuclear plant.

• Joint venture employment: The joint venture hired 65 employees, but

this number could increase with production volume.

• Obstacles: The joint venture must contend with untimely customer

payments. Its customers, the Ukrainian nuclear power plants, are suffering

financial difficulties and often delay payment. The American partner

requested an extension of the grant until September 1997 and an increase

of the rate of disbursement, not the grant amount, to lower the cost of the

equipment sold to the nuclear power plants. No decision has been made

on this proposal.

• Status of project: As of October 1996, the joint venture had a backlog of

orders worth over $10 million.

Kommunar • Contract amount and date: $3.3 million awarded in January 1995.

• Former defense capability: Manufacturer of aerospace and military

electronics equipment, including missile and space guidance systems and

relays for satellites.

• Former employment level: Unknown, but current employment is 18,000.

• Purpose of joint venture: To design, manufacture, and distribute

cellular telephones in Asia and Ukraine. 

• Defense building conversion: The joint venture was to convert nearly

40,000 square feet of factory space.

• Joint venture production: None, as the contract is being closed out. The

joint venture has not been registered in Ukraine. However, Kommunar

officials still hope to pursue cellular telephone production through other

opportunities. They believe that the market for cellular telephones is

growing worldwide.

Page 34 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix I 

DSWA-Managed Conversion Projects

• Joint venture employment: Had employed 55 workers.

• Obstacles: The project is not operational. The U.S. partner lacks the

capital to proceed with the project, and Kommunar would like to form a

venture with a different firm. DOD is attempting to attract a new U.S.

partner to this project.

• Status of project: DSWA is closing out the contract with the American

partner.

Meridian • Contract amount and date: $4.1 million awarded in October 1995.

• Former defense capability: Involved in designing and testing radio

equipment and instrument systems for missiles and satellites.

• Former employment level: Unknown, but current employment is 4,800.

• Purpose of joint venture: To manufacture high-quality die cast products

for the housing, appliance, and automotive markets.

• Defense building conversion: The joint venture will eventually occupy

over 95,000 square feet of factory space in about four buildings. One

building is presently being refurbished to accommodate die casting

equipment.

• Joint venture production: The joint venture hopes to begin production

in July 1997.

• Joint venture employment: Once production begins, the venture will

employ about 250 workers.

• Obstacles: None.

• Status of project: As part of its business plan, the American partner

wants to fully capitalize the joint venture and is seeking over $11 million

from such entities as DEF, the Overseas Private Investment Corporation,

and the European Bank for Reconstruction and Development. According

to the joint venture partner, DEF has expressed interest in funding the joint

venture and is considering making an investment.

Monolit • Contract amount and date: $4.8 million awarded in October 1995.

• Former defense capability: Manufacturer of electronics for rocket

control and guidance systems.

• Former employment level: 20,000 in the 1980s according to the joint

venture partner. Employed 13,000 workers as of June 1996.

• Purpose of joint venture: To manufacture advanced instrumentation

and control systems for nuclear and conventional commercial power

stations in Ukraine and other former Soviet states.

• Defense building conversion: The production lines that occupied the

18,300-square foot facility were used to manufacture electronics for rocket

Page 35 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix I 

DSWA-Managed Conversion Projects

control and guidance systems. The facility, however, was not active when

the joint venture was formed.

• Joint venture production: Production has yet to begin. Once equipment

is installed, the venture could reach production in 6 to 8 weeks.

• Joint venture employment: The joint venture employs 25 workers.

Once production begins, the number could increase.

• Obstacles: Even though the conversion of the facility is nearly complete,

the Ukrainian State Customs Committee is not permitting joint venture

equipment to enter Ukraine despite, according to DOD officials, an

agreement between the U.S. and Ukrainian governments. Repeated

attempts to resolve this issue have proven unsuccessful. Such delays will

further impact the project schedule.

• Status of project: The scope of the work had to be modified because

Monolit could not afford the labor and design work associated with

refurbishing the factory space to accommodate the needed equipment.

Orizon • Contract amount and date: $2.7 million awarded in October 1995.

• Former defense capability: Manufacturer of precision guidance and

control systems for military satellites.

• Former employment level: Once employed about 18,000 workers. 9,000

current employees.

• Purpose of joint venture: To produce and assemble polyvinyl chloride

windows and doors for sale in the former Soviet Union, especially

Ukraine.

• Defense building conversion: The joint venture is converting 53,800

square feet of space and will have an additional 10,800 square feet for

storage. In the building that the joint venture occupies, satellite guidance

and control systems were installed and tested. High bay areas, required for

the assembly and testing of large military satellite systems, were idle

before the establishment of the joint venture.

• Joint venture production: Production was to have begun in October

1996. Although the project schedule slipped about 5 months, the joint

venture began production in March 1997.

• Joint venture employment: 15 workers; employment is expected to

increase with the commencement of production.

• Obstacles: Orizon was to have provided the labor and materials for

modifying the building and installing the required utilities, but it did not

receive its appropriated funding from the Ukrainian government to finance

these efforts. To avoid further delays, DSWA modified the contract so that

the American joint venture partner could complete the necessary

renovations and begin production.

Page 36 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix I 

DSWA-Managed Conversion Projects

• Status of project: Production began in March 1997.

Page 37 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix II 

DEF Conversion Projects

As of July 1996, DEF had approved four investments in Russia for up to

$8.8 million. In one case, the investment was in the form of a loan and, in

three cases, in the form of an equity position. These projects are between

U.S. firms and Russian defense-related entities—Kirovsky-Zavod, Nauka,

Khlopin Radium Institute, and Mashinostroyenia.

Kirovsky-Zavod • Investment amount and date: $3 million in loans approved in

April 1995.

• Former defense capability: Manufacturer of propulsion systems for

nuclear submarines.

• Former employment level: 50,000 in 1991.

• Purpose of joint venture: To produce excavator frames for export to a

plant in Belgium.

• Defense building conversion: Converted 60,300 square feet of floor

space in a building that was previously used to manufacture pumping

turbines and was not related to WMD.

• Joint venture production: Producer of excavator frames.

• Joint venture employment: Initially employed about 80 workers, but the

number has risen to 100 and could peak at 200 by the end of 1997. It is

likely these workers were in the defense industry, but it is uncertain

whether they worked on WMD-related activities.

• Obstacles: None.

• Status of project: The plant is currently working at capacity, and the

project is expected to break even in 1997. The project is expected to pay

off its DEF loan. The U.S. partner expressed interest in expanding the

operation, but the Russian partner was not willing to do so. As a result, the

U.S. partner purchased the Russian partner’s share of the joint venture.

Nauka • Investment amount and date: $2.8 million equity investment approved

in September 1995. The project has not yet used DEF funding.

• Former defense capability: Designer of environmental control systems

for MIG aircraft.

• Former employment level: 5,000 employees.

• Purpose of joint venture: To produce and market environmental control

systems for private commercial aircraft manufacturers.

• Defense building conversion: Converted 53,800 square feet of factory

space. We were not able to confirm if this space had been used for

WMD-related activities.

• Joint venture production: Has a limited 3-year contract to make heat

exchangers (environmental control system components) for a British firm.

Page 38 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix II 

DEF Conversion Projects

• Joint venture employment: About 40 employees that were younger

hires and did not work on previous WMD projects.

• Obstacles: There is no market in Russia for domestic aircraft engines and

no aircraft are being sold; thus, no market exists for aircraft environmental

control systems.

• Status of project: The American partner has not yet drawn on the DEF

investment.

Khlopin Radium

Institute

• Investment amount and date: $1 million equity investment approved in

September 1995.

• Former defense capability: Research and development associated with

nuclear weapons, and plutonium and isotope production, among others.

• Former employment level: 1,600 in 1995.

• Purpose of joint venture: To convert Russian WMD expertise into a

commercial venture that builds and operates log sterilization and

debarking centers in Russia, which will export treated logs to the United

States.

• Defense building conversion: Unknown.

• Joint venture production: To irradiate timber of bugs and fungi so they

will be suitable for export and processing in U.S. sawmills.

• Joint venture employment: Approximately 10 scientists are working on

this project, and more Khlopin employees will be used as this project

develops.

• Obstacles: The project needs cash to get a log yard in Russia operational,

and it needs to obtain a Western timber products firm as a partner.

• Status of project: DEF has invested $500,000 of the $1 million approved.

Although the technology is not at issue, the project has not yet

demonstrated it can deliver logs. The DEF Chief Financial Officer has

temporarily become Chief Executive Officer of the joint venture.

Mashinostroyenia • Investment amount and date: $2 million equity investment approved in

February 1996.

• Former defense capability: Manufacturer of intercontinental ballistic

missiles, nuclear cruise missiles, and reconnaissance satellites.

• Former employment level: 9,000 in 1992.

• Purpose of joint venture: To convert skilled Russian military

programmers who were working in the areas of guidance and control

systems for cruise missiles and rocket launchers to commercial

programmers for software development.

Page 39 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix II 

DEF Conversion Projects

• Defense building conversion: The project will occupy space outside of

Mashinostroyenia’s security enclosure.

• Joint venture production: Expected to develop commercial software

programs for mainframe computers.

• Joint venture employment: 300 former WMD-related workers within 3 to

5 years (projected).

• Obstacles: The original Western partner withdrew from the investment.

• Status of project: DEF is seeking another Western partner.

Page 40 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix III 

Comments From the Department of Defense

Page 41 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix III 

Comments From the Department of Defense

Now on p. 15.

Now on p. 15.

Now on p. 15.

Page 42 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix IV 

Comments From the Defense Enterprise

Fund

Page 43 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix IV 

Comments From the Defense Enterprise

Fund

Page 44 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix IV 

Comments From the Defense Enterprise

Fund

Page 45 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix IV 

Comments From the Defense Enterprise

Fund

Page 46 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix IV 

Comments From the Defense Enterprise

Fund

Page 47 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix IV 

Comments From the Defense Enterprise

Fund

Page 48 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix IV 

Comments From the Defense Enterprise

Fund

Page 49 GAO/NSIAD-97-101 Cooperative Threat Reduction
Appendix V 

Major Contributors to This Report

National Security and

International Affairs

Division, Washington,

D.C.

Blake Ainsworth

Muriel J. Forster

Venecia R. Kenah

Beth Hoffman León

Pierre R. Toureille

F. James Shafer

Office of the General

Counsel

Richard Seldin

Page 50 GAO/NSIAD-97-101 Cooperative Threat Reduction
Page 51 GAO/NSIAD-97-101 Cooperative Threat Reduction
Related GAO Products

Weapons of Mass Destruction: DOD Reporting on Cooperative Threat

Reduction Assistance Has Improved (GAO/NSIAD-97-84, Feb. 27, 1997).

Weapons of Mass Destruction: Status of the Cooperative Threat Reduction

Program (GAO/NSIAD-96-222, Sept. 27, 1996).

Nuclear Nonproliferation: Status of U.S. Efforts to Improve Nuclear

Material Controls in Newly Independent States (GAO/NSIAD/RCED-96-89,

Mar. 8, 1996).

Weapons of Mass Destruction: DOD Reporting on Cooperative Threat

Reduction Assistance Can Be Improved (GAO/NSIAD-95-191, Sept. 29, 1995).

Weapons of Mass Destruction: Reducing the Threat From the Former

Soviet Union: An Update (GAO/NSIAD-95-165, June 9, 1995).

Weapons of Mass Destruction: Reducing the Threat From the Former

Soviet Union (GAO/NSIAD-95-7, Oct. 6, 1994).

Soviet Nuclear Weapons: U.S. Efforts to Help Former Soviet Republics

Secure and Destroy Weapons (GAO/T-NSIAD-93-5, Mar. 9, 1993).

Soviet Nuclear Weapons: Priorities and Costs Associated With U.S.

Dismantlement Assistance (GAO/NSIAD-93-154, Mar. 8, 1993).

Russian Nuclear Weapons: U.S. Implementation of the Soviet Nuclear

Threat Reduction Act of 1991 (GAO/T-NSIAD-92-47, July 27, 1992).

(711217) Page 52 GAO/NSIAD-97-101 Cooperative Threat Reduction
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