Report to the Subcommittee on

Readiness and Management Support,

Committee on Armed Services, U.S.

Senate

United States General Accounting Office

GAO

March 2002 DEFENSE TRADE

Lessons to Be Learned

from the Country

Export Exemption

GAO-02-63
Page i GAO-02-63 Defense Trade

Letter 1

Results in Brief 2

Background 3

Exporters Are Implementing the Exemption Inconsistently 5

Ensuring Export Compliance Is Difficult 8

Experience with the Canadian Exemption Could Assist in Ongoing

Negotiations 11

Conclusions 13

Recommendations for Executive Actions 14

Agency Comments and Our Evaluation 15

Scope and Methodology 16

Appendix I Chronology of Selected Defense Cooperation

Agreements between the United States and Canada 19

Appendix II Summary of Enforcement Cases That Supported the

Need for Change in the Canadian Exemption 21

Appendix III Comparison of Recent Changes to the Canadian

Exemption–1994, 1999, 2001 24

Appendix IV Comments from the U.S. Department of State 27

Appendix V Comments from the U.S. Customs Service 33

Appendix VI GAO Contact and Staff Acknowledgments 35

GAO Products on Defense Trade and Export Controls 36

Contents
Page ii GAO-02-63 Defense Trade

Tables

Table 1: Chronology of Selected Defense Cooperation Agreements

between the United States and Canada 19

Table 2: Comparison of Recent Changes to the Canadian

Exemption–1994, 1999, and 2001. 24
Page 1 GAO-02-63 Defense Trade

March 29, 2002

The Honorable Daniel Akaka

Chairman

The Honorable James M. Inhofe

Ranking Minority Member

Subcommittee on Readiness

 and Management Support,

Committee on Armed Services

United States Senate

To control the export of defense items, the U.S. government generally

requires exporters to obtain a license from the State Department.1

However, a license is not required for the export of many defense items to

Canada.2

 Currently, the Canadian exemption is the only country-specific

exemption to the licensing requirement. The exemption was temporarily

scaled back when unauthorized re-exports and diversions to nations of

concern occurred. It was renegotiated and changes were made in an

attempt to address security concerns. In May 2000, the U.S. government

announced the Defense Trade Security Initiative,3

 which included a

proposal to grant Canadian-like export licensing exemptions to other

qualified countries. Since the initiative was announced, the State

Department has been negotiating such exemptions with the United

Kingdom and Australia. Because the exemption for Canada may serve as

the model for these and other countries, you asked that we review how the

exemption has been implemented and enforced and whether the

experience offers any lessons learned.

 1

 Under the authority of the Arms Export Control Act (22 U.S.C. secs. 2751 et seq), the State

Department administers the International Traffic in Arms Regulations that govern the

export and temporary import of defense articles and services. The regulations identify the

defense articles and services that are controlled on the U.S. Munitions List (22 C.F.R., secs.

120-130).

2

 The State Department is authorized to regulate commercial defense trade under the Arms

Export Control Act, including exemptions to licensing requirements. State’s regulations

allow many unclassified defense articles, such as artillery projectors and military vehicles,

and some defense services, to be exported to Canada without a license. While these items

are exempt from licensing requirements, they are still subject to the act.

3

 For more information on the Defense Trade Security Initiative, see U.S. General

Accounting Office, Defense Trade: Analysis of Support for Recent Initiatives,.

GAO/NSIAD-00-191 (Washington, D.C.: Aug. 31, 2000).

United States General Accounting Office

Washington, DC 20548
Page 2 GAO-02-63 Defense Trade

Exporters in some instances have been implementing the Canadian

exemption inconsistently. For example, some items, such as smokeless

ammunition powder and technical data, are being exported using the

exemption by some exporters while others are applying for licenses.

Moreover, some exporters are interpreting reporting requirements about

the use of the exemption differently. While the State Department has

issued some guidance to assist exporters in interpreting and complying

with the regulations, it has in some cases given inconsistent answers to

exporters and U.S. Customs Service officials when questions were raised

about particular situations.

The U.S. government has some mechanisms in place to help reduce the

risk of defense items being inappropriately exported, but there are

limitations associated with them. The State Department encourages

exporters to voluntarily disclose violations and develop compliance

programs, but primarily relies on U.S. Customs as the chief enforcer. U.S.

Customs examines export documentation, performs physical inspections

of items being exported, and investigates potential export violations.

However, export documentation is not always complete or submitted,

inspections of shipments are limited, and investigations of potential

violations are time-consuming and difficult to prosecute. U.S. Customs

officials attributed these and other enforcement weaknesses largely to a

lack of information and resources, including inspectors to staff ports. In

addition, there are competing demands on the agency, which include the

prevention of terrorism, and the interdiction of illicit drugs, illegal

currency, and stolen vehicles.

The experience with the Canadian exemption shows that three areas need

to be addressed when negotiating and executing license exemptions with

other countries. First, there needs to be upfront agreement on such issues

as what items are to be controlled, who can have access to controlled

items, and how to control these items through each country’s respective

export laws and regulations. Second, the U.S. government needs to

monitor agreements to assess their effectiveness and ensure that

unanticipated problems have not arisen. Third, enforcement mechanisms

need to be in place to monitor exporters’ compliance with the exemption

and enable prosecution of violators.

We are making recommendations to the State Department to review its

guidance for exporters and develop lessons learned from the Canadian

exemption and to U.S. Customs to assess whether additional actions can

be taken to strengthen export enforcement activities. In commenting on a

draft of this report, the State Department generally concurred with our

Results in Brief
Page 3 GAO-02-63 Defense Trade

assessment that under the exemption the compliance and enforcement

process primarily relies on the exporters’ actions. State said it would

continue to review its guidance and training programs and work closely

with U.S. law enforcement agencies to assess lessons learned from the

exemption. Customs concurred with the recommendations and will take

appropriate actions by December 31, 2002.

Under the authority of the Arms Export Control Act, State requires

exporters to obtain licenses for defense exports unless an exemption

applies. State has long exempted the export of many unclassified defense

items to Canada without prior department approval. While these items are

exempt from licensing requirements, they are still subject to the provisions

of the Arms Export Control Act. Exporters who use the exemption and

violate any provisions of the Act are subject to fines, penalties, or

imprisonment, if convicted. State requires exporters to register with its

Office of Defense Trade Controls; determine whether the articles or

services they are exporting are covered by the exemption; in most cases,

obtain written documentation stating that exports are to be used for a

permitted purpose; and inform the recipient that items are not to be reexported without prior authorization from State.

The Canadian exemption, first codified in 1954,4

 grew out of the unique

geographic relationship and strong economic trading partnership between

the United States and Canada and their mutual interest in the defense of

North America. The two countries share the world’s longest unfortified

border. They are also each other’s largest trading partner. The countries

are committed to maintaining a strong integrated North American defense

industrial base to help fulfill their defense and security responsibilities to

the North Atlantic Treaty Organization and the North American Aerospace

Defense Agreement, as well as for common defense of national territories.

Appendix I provides a chronology of selected defense and economic

agreements between the United States and Canada since 1940.

The Canadian exemption has evolved since inception in terms of scope.

For example, earlier versions allowed the export and import of arms,

ammunition, and implements of war, and the export of unclassified

 4

 22 CFR sec. 75.36, effective January 1,1954. This was the first time that chapter 1 of Title

22,“Foreign Relations” stated that shipments to Canada were exempt from licensing

requirements.

Background
Page 4 GAO-02-63 Defense Trade

technical data without a license. Later versions changed the coverage to

include defense services and increased the types of items requiring a

license.

In April 1999, State revised its regulations to clarify when the exemption

could be used and limited the defense items that could be exported under

the exemption.5

 State took this action based on its analysis that exports

were being re-exported from Canada to countries of concern without U.S.

government approval and that controls over arms and ammunition

transfers needed strengthening.6

 Nineteen criminal investigations and

seizure cases related to the Canadian exemption were identified, including

3 diversions to China, Iran, and Pakistan and 16 attempted diversions to

these and other nations of concern or technical regulatory violations. For

example, a major U.S. defense company exported U.S.-controlled

communication equipment to its Canadian facility under the exemption

and then re-exported the equipment to Pakistan without U.S. government

approval. In another case, an Iranian intelligence group established a

company in Canada and was accused of attempting to use the exemption

to acquire U.S.-controlled components for the Hawk missile system.

Appendix II summarizes these and other cases.

In addition, State received 23 voluntary disclosures7

 from exporters who

inappropriately used the Canadian exemption. For example, in a few

instances, exporters admitted providing technical manuals and software

engineering support without obtaining State approval. State consulted

with the Department of Defense about these cases and indicated that had

these exporters submitted the appropriate license applications, they would

have likely been denied. In another instance, an exporter submitted a

voluntary disclosure after being contacted by law enforcement officials. In

this case, the U.S. exporter was ineligible to export because the firm was

debarred and under criminal investigation for diversions of military

equipment to Iran and other locations.

 5

 As a result of the April 1999 changes, numerous items—such as spacecraft and missiles—

previously exported under the exemption required an export license.

6

 At the 1998 Summit of the Americas, the United States, Canada, and other countries

agreed to strengthen controls over arms and ammunition transfers to better protect the

hemisphere’s common security. As part of this effort, State reviewed its regulations to

ensure that firearms and ammunition were subject to licensing requirements.

7

 Most of these voluntary disclosures were reported to State after the April 1999 revision to

the Canadian exemption.

Enforcement Concerns

Led to Negotiations about

the Exemption
Page 5 GAO-02-63 Defense Trade

In response to export concerns identified by State, the U.S. and Canadian

governments negotiated changes to their respective export control

systems. The Canadian government changed its export control laws and

regulations to cover all items currently controlled on the U.S. Munitions

List,8

 established a registration system in April 2001 for persons and

entities in Canada eligible to receive U.S.-controlled items under the

exemption, and required U.S. government approval for re-export of U.S.

controlled items from Canada or transfer of these items within Canada. In

turn, State again revised the Canadian exemption effective May 30, 2001.

This revision in general broadened the exemption to cover temporary

imports of unclassified defense items, some defense services, and some

additional items, but continued to exclude other items such as Missile

Technology Control Regime9

 items. Since the conclusion of the

negotiations, the U.S. and Canadian governments have met and continue

to exchange information on enforcement and border security issues not

fully addressed during the negotiations.

We found instances where exporters have been implementing the

Canadian exemption inconsistently. Some items, such as technical data

and smokeless ammunition powder, are being exported under the

exemption by some exporters and not by others. These inconsistencies

may result in the same item being licensed by State in some instances and

not licensed in others, which may put some exporters at a disadvantage

and lessen government oversight of exports.

For example, exporters followed different processes when they exported

technical data. Before April 1999, some exported technical data under the

exemption for offshore procurement10 activities, based on their

interpretation of the regulations.11 However, State officials said that

 8

 The U.S. Munitions List identifies the defense articles, services, and related technical data

controlled by State.

9

 The Missile Technology Control Regime was established to limit the proliferation of

rocket and unmanned air vehicle systems capable of delivering nuclear, biological, and

chemical weapons of mass destruction and their associated equipment and technology.

10 An offshore procurement occurs when a U.S. company transfers unclassified technical

data to a foreign company that has indigenous capability to produce the defense item

outside the United States. After the foreign company produces the defense item, it is

returned to the United States.

11 22 CFR sec. 124.13 (e).

Exporters Are

Implementing the

Exemption

Inconsistently
Page 6 GAO-02-63 Defense Trade

exporters were required to obtain approval before they could export the

data to Canada. In April 1999, State revised the regulations to clarify that

the export of technical data for offshore procurement activity requires a

license. After this regulatory revision, a number of companies or their

subsidiaries voluntarily disclosed to State that they had inappropriately

exported technical data or defense services for offshore procurement and

other activities using the exemption. Since that time, some exporters said

they were unclear about when they could export technical data and

defense services under the May 2001 revised exemption because the

language in the regulations was subject to interpretation. For example, we

were told that design data under the new exemption was broadly defined,

and in some instances has been interpreted as either subject to the

exemption or requiring a license. Appendix III highlights the complexities

of the regulatory language and major changes made to the Canadian

exemption in recent years.

Some exporters have been interpreting the May 2001 reporting

requirements differently. This, in turn, can decrease the government’s

visibility over sensitive exports. For example, exporters using the

Canadian exemption are now required by the International Traffic in Arms

Regulations to provide State “a semi-annual report of all their on-going

activities authorized under this section.”

12 Two exporters interpreted the

phrase “under this section” to mean that the requirement solely pertained

to defense services because it fell under the paragraph of the regulations

entitled “Defense services exemption.” These exporters, therefore,

reported activities exclusively involving defense services. Another

interpreted the language to refer to all activities occurring under the

Canadian exemption, including those related to defense articles and

technical data, as well as defense services. When we discussed this matter

with State officials, they said that the second interpretation was correct

and that the report should encompass all activities and not just defense

services.

Some exporters also said they were unclear about certification

requirements. The regulations require exporters to obtain written

certification from Canadian companies that “the technical data and

defense service being exported” will be used only for a specified activity.13

Some exporters said they obtain this certification when exporting defense

 12 22 CFR sec. 126.5 (c)(5).

13 22 CFR sec. 126.5 (c)(3).
Page 7 GAO-02-63 Defense Trade

articles in addition to technical data and defense services, following

preface language in the Federal Register notice that changed the

regulation in May 2001. One company we spoke with said that it only

obtains this certification for defense services. Another company noted

that when it tried to get a Canadian company to fill out the certification for

a defense article being exported to Canada, the Canadian government told

the company that only the regulations are legally binding, and

certifications should be provided only for defense services and technical

data. State officials said that this interpretation was correct, and the

certification only needed to be obtained for defense services and technical

data. It is important that exporters correctly interpret these requirements,

since the certifications enable exporters to document their compliance

with regulations.

The effectiveness of the process depends on the exporters making the

right decisions when interpreting regulations. However, State has an

important role to play in responding to inquiries about exports. In some

instances, we found that State provided inconsistent answers in situations

where exporters or U.S. Customs officials responsible for enforcing export

regulations raised questions to State about particular situations. For

example:

• One exporter who had been shipping smokeless ammunition powder using

the exemption was stopped by U.S. Customs for inspection on several

occasions. Each time, U.S. Customs asked State if the exemption could be

used. The first two times, State said yes, but on a subsequent occasion, it

determined the powder was a Missile Technology Control Regime item

and required an export license. This exporter has since obtained numerous

licenses for this item. Another exporter shipping the same type of powder

to Canada was also stopped by U.S. Customs for inspection. One time,

State told U.S. Customs that the powder required a license and another

time said the item was not a Missile Technology Control Regime item and

was, therefore, exempt.14

• One exporter had planned to temporarily import aerial target aircraft for

North Atlantic Treaty Organization (NATO) ongoing training exercises that

were being conducted in the United States and informed U.S. Customs in

 14 Questions regarding smokeless powder represented about 5 percent of Customs’

referrals to State involving exports to Canada between April 12,1999, and December 31,

2000.
Page 8 GAO-02-63 Defense Trade

advance that it was going to do this under the exemption. Under the

changes made to the exemption in May 2001, such items are allowed to be

imported temporarily. However, in this case, State denied the use of the

exemption. State officials acknowledged this mistake to U.S. Customs, and

told us that it occurred inadvertently, immediately after the exemption

change. Nevertheless, at the time, the exporter cancelled its plans, which

in turn, led to the cancellation of the remaining NATO training exercises.

An exemption places the burden of proper implementation on exporters.

Nevertheless, exporters said they needed guidance from State to assist

them through the process of deciding what to export and what not to

export under the exemption, as well as what activities to report. State

officials said that exporters are to rely on the regulations as their guide.

However, State has recently provided additional guidance through a

question-and-answer guide the department prepared with industry to

answer common questions about the May 2001 revisions to the exemption.

This guidance answers some questions but does not lay out specific, clear

criteria for deciding what is allowable under the exemption.15 State has

also provided outreach in conjunction with the Canadian government on

changes associated with the Canadian exemption and regularly sponsors

additional training through the Society for International Affairs.16 In March

2002, State began an in-house training program on export licenses and

agreements. Further, State issues advisory opinions on specific exports

when requested by the exporter,17 but such opinions are specific to a

particular export and are revocable. Clear and commonly understood

guidance may help State and U.S. Customs officials answer questions that

surface during inspections.

Although an item may be exempt from State review and approval, it is still

subject to U.S. export control law. Under an exemption, the burden for

reviewing the legitimacy of the transaction shifts from State to the

exporter. Therefore, a large part of the compliance and enforcement

process under the Canadian exemption relies on the actions of exporters.

While the U.S. government has some mechanisms in place to ensure that

 15 State previously prepared guidelines to help exporters determine licensing requirements

for Canada, in conjunction with the regulations, but these guidelines do not reflect the May

2001 revision.

16 The Society for International Affairs training covers various topics on export licensing

and compliance processes.

17 22 CFR sec. 126.9.

Ensuring Export

Compliance Is

Difficult
Page 9 GAO-02-63 Defense Trade

exporters are ultimately complying with export law and regulations, the

government faces limitations in using these mechanisms. For example,

export documentation is not always submitted or complete, border

inspections are limited, and violations are difficult to prosecute. U.S.

Customs officials cite other priorities and lack of staff and other resources

as reasons for limitations in enforcement. Without more effective

enforcement, the U.S. government is at greater risk of defense items being

exported inappropriately.

U.S. government enforcement mechanisms for defense exports are carried

out by State and U.S. Customs. State encourages exporters to develop

their own compliance programs and to voluntarily disclose when they

have violated the exemption.18 State may direct a company to perform an

internal control compliance audit or, if warranted, may seek civil

penalties, administrative actions, sanctions, or referrals to the Justice

Department. While State oversees these activities, the department

primarily depends on U.S. Customs for many enforcement efforts. U.S.

Customs, in turn, has various mechanisms to ensure that exporters meet

regulatory requirements. For example, U.S. Customs examines export

documentation, specifically the Shipper’s Export Declaration.19 U.S.

Customs inspectors may perform a physical inspection of an export

crossing the border, and its agents investigate potential export violations.

In addition, the Department of Justice can prosecute exporters who are

suspected of violating export control laws.

We identified a number of limitations for the compliance and enforcement

process related to the Canadian exemption.20 For example, U.S. Customs

inspectors are not assured that they are receiving all export declarations

as required nor are declarations always complete or accurate when they

are submitted. Inspectors at the ports we visited noted that exporters

often provide vague descriptions of what they are exporting, which makes

 18 22 CFR sec. 127.12.

19 Exporters are required to submit a Shipper’s Export Declaration to U.S. Customs upon

exiting a U.S. port and provide copies to State. Sometimes the submission to U.S. Customs

is done in advance, since exporters make advance arrangements to ship their goods via sea

or air. The U.S. government uses this form to collect export information and compile U.S.

trade statistics, as well as to assess export compliance. State has not systematically

collected or analyzed information on the declarations to determine compliance.

20 Some of these limitations also apply to the enforcement process for licensed defense

items.

Limitations in Compliance

and Enforcement
Page 10 GAO-02-63 Defense Trade

it difficult to determine whether it is a defense item subject to the

Canadian exemption. In addition, we also found that physical inspections

on exports are limited. In fact, U.S. Customs officials said that they inspect

less than 1 percent of exports.

These limitations are attributed to a lack of information and resources and

competing demands within U.S. Customs, which include interdiction of

illicit drugs, illegal currency, and stolen vehicles, and since September 11,

2001, terrorism prevention. Of some 7,500 inspectors, about 400 are

assigned to export enforcement activities at 301 ports. One port we visited

had resorted to “borrowing” port staff from inbound operations

inspections to inspect items being exported. Another port had only one

person dedicated full time to export activities. When that inspector was

not on duty, no one at the port inspected exports.

According to Customs inspectors, staffing limitations make it extremely

difficult for them to examine export declarations that cite the Canadian

exemption. Inspectors are to perform several time-consuming tasks to

ensure proper use of the exemption. For example, inspectors said that

they should verify that an exporter is registered with State by querying

U.S. Customs’ Automated Export System.21 They should check whether a

company has a record of prior export violations by searching the Treasury

Enforcement Communications System database. And they should verify

that the item cited on the export declaration is eligible for exemption by

reading the International Traffic in Arms Regulations or consulting with

the U.S. Customs’ Exodus Command Center. These tasks may be

especially difficult to complete at land ports since declarations are

presented at the time of crossing.

After the terrorist attacks of September 11, 2001, the U.S. Customs

Commissioner stated that terrorism prevention had replaced drug

interdiction as the agency’s top priority. U.S. Customs subsequently

redeployed nearly 100 inspectors to increase security along the U.S.-

Canadian border. On December 10, 2001, a new program called Project

Shield America was launched, focused on preventing international

terrorist organizations from obtaining sensitive U.S. technology, weapons,

and other equipment that could help carry out attacks on America. Some

 21 The export declaration currently does not require the exporter to provide its registration

number, which forces an inspector to take more time to search the database for the name

of the company. However, State officials informed us that they are working with U.S.

Customs to require the exporter’s registration number on the export declaration.
Page 11 GAO-02-63 Defense Trade

inspectors we spoke with said that after the September 11 terrorist

attacks, U.S. Customs increased coverage along the northern border by

realigning inspectors, temporarily employing National Guardsmen, and

increasing inspectors’ overtime. However, these inspectors are primarily

focused on passengers entering and exiting the country, rather than

inspections of defense exports.

U.S. Customs inspectors do not have updated guidance from Customs

headquarters that would enable them to conduct inspections effectively.

U.S. Customs developed and distributed its primary guidance to inspectors

in 1993. This guidance provides an overview of U.S. export laws and

regulations, including information on State licensing requirements and a

synopsis of the Canadian exemption. U.S. Customs has also recently

prepared and distributed a memorandum addressing the May 2001

Canadian exemption requirements. However, the 1993 guidance and the

recent memorandum do not discuss inspection techniques for identifying

questionable exports. A draft update prepared in 1999 provides some

inspection guidance, but it has not been finalized or distributed to

inspectors. Some inspectors said that this draft could be useful but had

insufficient information when inspecting shipments at land ports.

U.S. Customs headquarters and Justice Department officials told us that it

is difficult to investigate and prosecute violations of export control laws.

In particular, prosecution of export violations under the exemption are

difficult because it is hard to obtain evidence of criminal intent—

especially since the government does not always have the documents to

demonstrate the violation of the exemption, such as the Shipper’s Export

Declaration. Even with the documents, some U.S. Customs agents told us

that cases involving the Canadian exemption normally involved

undercover operations to obtain evidence of criminal intent, and these

cases often took a long time to complete.

The United States and Canada have had a long history of exporting items

under a licensing exemption, and both countries have said the exemption

is beneficial for facilitating defense trade and advancing mutual defense.

However, when the U.S. government found that some exports under the

Canadian exemption were being diverted to countries of concern, the

United States and Canada had to come to the negotiating table and reach

agreement, making sure that they could balance achieving compatibility of

their export control systems with maintaining national sovereignty over

export control laws and regulations. Based on the experience with the

Canadian exemption, the United States will likely need to address three

Experience with the

Canadian Exemption

Could Assist in

Ongoing Negotiations
Page 12 GAO-02-63 Defense Trade

areas when negotiating and executing similar exemptions with other

countries.22 First, upfront agreement is needed on such issues as what

items are to be controlled and who can have access to these controlled

items. Second, the U.S. government needs to monitor agreements to

assess their effectiveness and ensure that unanticipated problems have not

arisen. Third, enforcement mechanisms need to be in place to monitor

exporters’ compliance with the exemption and enable prosecution of

violators.

First, countries need upfront agreement on a number of key issues.

• Agreement on what defense items to control. For example, Canada did

not control the same defense items that the U.S. government controlled.

This included radiation-hardened microelectronic circuits and nuclear

weapons design and test equipment, which could be exported from

Canada without a Canadian license. Countries need to have the same

starting point for controlling items so that enforcement efforts could be

concentrated on the same items.

• Agreement on what types of items, including technical data and defense

services, could be exported under the exemption. Items excluded from the

exemption would require licenses. For example, during the Canadian

exemption negotiations, discussions centered on whether Missile

Technology Control Regime Items could be exported under the exemption

or required a license.

• Agreement on who can have access to controlled articles, technical data,

and services, and whether items exported under the exemption can be

sent to dual nationals and temporary workers and still be compliant with

the laws of both countries. When negotiating the Canadian exemption, this

discussion centered on whether dual nationals and temporary workers

could have access to U.S.-controlled items and what type of system, such

as an exporter registration system, needed to be established to identify

who has access to controlled items.

 22 On May 24, 2000, the U.S. government unveiled 17 proposals known as the Defense Trade

Security Initiative, which included a proposal to extend Canadian-like exemptions to

qualified countries to facilitate defense cooperation and trade. The U.S. government has

since begun negotiations with the United Kingdom and Australia. Further, the Security

Assistance Act of 2000 (Pub.L. 106-280, Oct. 6, 2000) requires that exemptions with

countries other than Canada be based on legally binding agreements that meet specified

requirements and facilitate law enforcement efforts.
Page 13 GAO-02-63 Defense Trade

• Resolving conflicts between the export regulations and legal requirements

of each country. For example, U.S. law requires that U.S. government

approval is needed before controlled items can be re-transferred within a

country or re-exported to another country. U.S. government officials said

that unauthorized re-exports were the major reason for the negotiations

with Canada.

• The applicability of U.S. export control law to U.S. defense items that are

incorporated into products that are made in another country. In the U.S.-

Canadian negotiations, discussions centered on how far-reaching U.S.

export control requirements are once U.S. items are incorporated in

foreign products and then re-exported.

Second, the Canadian exemption experience shows that once agreements

have been reached, the U.S. government needs to periodically evaluate the

exemption to assess the effectiveness of agreed upon measures and ensure

that unanticipated problems do not arise. The U.S. and Canadian

governments spent over 2 years negotiating a new exemption and are now

working on implementation issues. For example, under new provisions,

the Canadian government established a registration system to reduce the

risk of transfer to unauthorized individuals and facilitate the Canadian

defense industry’s access to U.S.-controlled items. Questions remain,

however, about how it will be implemented and who needs to be

registered. U.S. government officials said that verification of the registrant

is key for compliance and enforcement activities.

Finally, enforcement mechanisms need to be in place to ensure export

compliance with the exemption. As discussed earlier, U.S. Customs

inspectors are not always assured that exporters are submitting required

export documentation or that the documentation is complete and

accurate, which limits their enforcement efforts. The Department of

Justice, in a letter to State, echoed this concern regarding negotiations for

additional exemptions and also stated that foreign law enforcement

cooperation is needed to provide evidence for successful prosecutions.

Resource constraints also create challenges for the law enforcement

community. In the end, establishing criteria and lessons learned from

current experiences would assist in evaluating whether on-going and

future negotiations are successful or if additional issues need to be

addressed. State officials acknowledged that there are lessons to be drawn

from the Canadian experience.

The Canadian exemption relies on exporters to comply voluntarily with

export regulations and to disclose when they have not followed those Conclusions
Page 14 GAO-02-63 Defense Trade

regulations. As such, a system of effective checks and balances is needed

to maximize the U.S. government’s assurance that defense items are being

appropriately safeguarded. This includes making sure that exporters have

sufficient guidance to enable them to make the right decisions and that

exporters, in turn, provide required information to the U.S. government for

oversight and enforcement efforts. It also includes making sure that

enforcement mechanisms work as effectively as possible.

Extending exemptions to other countries may aggravate problems if the

U.S. government does not learn from its experiences. New exemptions

may increase the risk of exporters misinterpreting the regulations and

create additional opportunities for exporters to inconsistently apply the

exemption. In addition, broadening the exemption could further

exacerbate enforcement efforts for an already overburdened law

enforcement agency. Accordingly, the U.S. government can benefit from

the lessons learned from U.S.-Canadian negotiations when extending

similar exemptions to other countries.

To enhance the exemption process, we recommend that the secretary of

state direct the Office of Defense Trade Controls to review guidance and

licensing officer training to improve clarity and ensure consistent

application of the exemption. The State Department should also direct the

Office of Defense Trade Controls to provide this guidance to U.S. Customs

Service for dissemination to field inspectors and agents so that consistent

information about the exemption is provided to exporters.

To strengthen enforcement activities, we recommend that the

commissioner of the U.S. Customs Service assess the threat of illegal

defense exports at all ports along the northern border and evaluate

whether reallocation of its inspectors, additional training, or other actions

are warranted to augment the capability of inspectors to enforce export

regulations. We also recommend that U.S. Customs update, finalize, and

disseminate its guidance on defense export inspection requirements to all

inspectors.

To facilitate future country exemption negotiations, we recommend that

the secretary of state work with the Department of Justice and U.S.

Customs Service to assess lessons learned from experience with the

Canadian exemption and ensure that these are incorporated in any future

agreements.

Recommendations for

Executive Actions
Page 15 GAO-02-63 Defense Trade

In written comments on a draft of this report, State generally concurred

with our assessment that a large part of the compliance and enforcement

process under the Canadian exemption relies on the actions of the

exporters. In response to our recommendation on guidance and training,

State said it will continue its on-going update of its exporter guidance and

its training programs. State provided a number of examples of the types of

guidance and training it plans to continue to provide exporters on the

Canadian exemption. As part of its efforts to update, we believe State

should still assess whether its guidance and training are clear and

commonly understood by those who need to use them. In concurring with

our recommendation on assessing lessons learned, State said it will

continue to work closely with U.S. law enforcement agencies to assess

lessons from the Canadian exemption to facilitate future country

exemption negotiations. However, State did not identify the specific steps

it would take to ensure that lessons are actually shared and that

knowledge gained will be acted upon in the future. As we stated in our

report, enforcement and compliance problems could be exacerbated

without full consideration of lessons learned under the Canadian

exemption when extending similar exemptions to other countries. State

comments are reprinted in appendix IV, along with our evaluation of them.

In its written comments, Customs concurred with our recommendations to

(1) assess the threat of illegal exports along the northern border and

evaluate whether reallocation of resources and other actions are

warranted and (2) update, finalize, and disseminate guidance on defense

export inspection requirements. Customs said it will complete these

actions no later than December 31, 2002. Customs stated that it conducts

yearly threat assessments for the entire country and provides training on

various issues, but such activities require a commitment of funds. In

addition, Customs stated that we did not address the Automated Export

System, which it said has assisted the agency in enforcement efforts.

Finally, Customs indicated that lack of manpower and funding for

enforcement is problematic for enforcing the Canadian exemption or other

defense exports. Customs added that new exemptions for other countries

will be increasingly difficult to enforce effectively. We did not include a

detailed discussion of the Automated Export System because regulations

requiring mandatory filing of export declarations through this system had

not been finalized. At the time of our review, most inspectors we

contacted were not using the automated system for the majority of

enforcement functions related to the Canadian exemption. Customs’

comments are reprinted in appendix V.

Agency Comments

and Our Evaluation
Page 16 GAO-02-63 Defense Trade

We collected and reviewed selected defense cooperation agreements

establishing the special defense relationship between the United States

and Canada, developed a regulatory history of the Canadian exemption,

and prepared a comparative analysis of the various changes to the

Canadian exemption since inception. We also discussed the history and

objectives of the exemption with officials at State, the Department of

Defense, U.S. and Canadian industry associations, and the Canadian

government.

To ascertain how exporters use the exemption, we reviewed the Arms

Export Control Act and International Traffic in Arms Regulations to

understand the rules governing the U.S.-Canadian exemption process.

Because there is no centralized database identifying exporters that use the

Canadian exemption, we analyzed State’s licensing and registration data

for Canada and obtained recommendations from agency officials, industry

associations, and others to develop a list of companies that export to

Canada. We then selected 12 companies that used the exemption and

conducted structured interviews regarding their process and the criteria

for exporting under the exemption. These companies represented various

small, medium, and large exporters and freight forwarders. We also

corroborated information with other U.S. companies and two Canadian

industry associations that hosted roundtable discussions for us with 10

Canadian companies.

To determine how U.S. government mechanisms for ensuring compliance

with export law and regulations operate, we interviewed State and U.S.

Customs officials to obtain explanations about their mechanisms. We

reviewed State regulations and briefing materials related to the Canadian

exemption and U.S. Customs’ draft handbook, standard operating

procedures, and training materials. We visited four U.S. Customs ports to

observe the inspection process and reviewed seizure case files to

determine the nature of noncompliance with the exemption, and another

U.S. Customs’ port to discuss enforcement issues with officials in the

Office of Special Agents in Charge of Investigations. We also interviewed

officials at U.S. Customs headquarters in the Office of Field Operations

and Special Investigations’ Exodus Command Center. We analyzed U.S.

Customs’ enforcement cases to determine the nature of the

noncompliance that led to the change in the April 1999 version of the

exemption, along with disclosures of noncompliance with the exemption

that were submitted to State by exporters. We also discussed enforcement

challenges surrounding the exemption with Justice Department officials.

Scope and

Methodology
Page 17 GAO-02-63 Defense Trade

To develop observations about future exemption proposals for other

countries, we reviewed issues covered in the Canadian exemption

negotiation, prior GAO reports on defense trade and export controls, and

other documents related to efforts to obtain similar exemptions with other

countries. We also asked senior State officials about lessons learned in the

Canadian negotiations that may be pertinent for on-going or future

negotiations of similar Canadian-like exemptions with other countries.

We requested information and documentation from State related to a

number of areas, including the history of the exemption, changes in its

scope and reasons for such changes, and issues covered during

negotiations that resulted in the May 2001 Canadian exemption. As

discussed with your staff, we experienced significant delays in obtaining

documents from State. For example, the department took approximately 6

months to provide us with an initial set of 37 documents and an additional

2 months to provide the remaining information that we requested. These

delays caused numerous follow-ups with State officials, needlessly

occupying time for both State officials and us. More than 90 telephone

contacts or E-mails alone pertained to the status of our document request.

The delays and lack of State cooperation extended the amount of time

needed to respond to this request. We plan to address these issues in a

follow-up letter to the secretary of state.

We performed our work between October 2000 and February 2002 in

accordance with generally accepted government auditing standards.

We will send copies of this report to the chairmen and ranking minority

members of the Senate Committee on Foreign Relations, the House

Committee on International Relations, and the House Committee on

Armed Services. We will also send copies to the secretaries of state,

defense, treasury, and justice; the commissioner, U.S. Customs Service;

and the director, Office of Management and Budget. This report will also

be made available on GAO’s home page http: www.gao.gov.
Page 18 GAO-02-63 Defense Trade

If you or your staff have questions concerning this report, please contact

me at (202) 512-4841. Others making key contributions to this report are

listed in appendix VI.

Katherine V. Schinasi

Director, Acquisition and Sourcing Management
Appendix I: Chronology of Selected Defense

Cooperation Agreements between the United

States and Canada

Page 19 GAO-02-63 Defense Trade

The United States and Canada have demonstrated their mutual

cooperation by entering into more than 2,500 agreements and

arrangements over the years. The following are selected defense and

economic agreements since 1940.

Table 1: Chronology of Selected Defense Cooperation Agreements between the United States and Canada

Year

Established Agreements Synopsis of Agreements

August 18,

1940

Ogdensburg Declaration This declaration formed the basis for defense cooperation between the United

States and Canada. The Permanent Joint Board on Defense was founded to

conduct studies relating to sea, land, and air problems, covering personnel and

material, and to consider the defense of the northern half of the Western

Hemisphere.

April 20, 1941 Hyde Park Declaration A joint statement between the U.S. president and Canada’s prime minister agreeing

that each country should provide the other with the defense articles it is best able to

produce during war mobilization and that each country should coordinate its

production programs.

February 12,

1947

U.S./Canada Joint

Statement on Defense

Cooperation

A joint statement by both countries’ leadership reiterating that the wartime

cooperation between the armed forces of the two countries should continue to the

extent authorized by law through the postwar period in the interest of efficiency and

economy for joint security.

April 12, 1949 Exchange of Notes on the

Joint Industrial Mobilization

Committee

The notes established the Joint Industrial Mobilization Committee to coordinate each

country’s Industrial Mobilization Plans that would effectively use the production

facilities of both countries.

September 20,

1950

Statement of Principles for

Economic Cooperation

An agreement by the United States and Canada to coordinate the production and

resources of both countries to achieve a common defense. Among other things, it

required a coordinated program of requirements, production, and procurement

between the two countries and instituted coordinated controls over the distribution of

scarce raw materials and supplies.

October 1, 1956 Defense Production Sharing

Agreement

The agreement was established to achieve greater integration of both countries’

military development and production capabilities while maintaining greater

standardization of military equipment, wider dispersal of production facilities, and

establishing a supply of supplemental sources. Also, this agreement established that

Canadian defense vendors would receive equal and immediate consideration on

Department of Defense procurements, just like U.S. vendors, with certain

exceptions.

May 12, 1958 North American Aerospace

Defense Command

Agreement

This agreement established an integrated command in Colorado Springs, Colorado,

that centralized operational control of shared air defenses, integrated operational

exercises, and maintained individual and collective capacity to resist air attack.

September 14,

1960

Defense Development

Sharing Agreement

This agreement was established to allow Canadian firms to perform research and

development work for the U.S. military services.

November 21,

1963

Cooperative Development

Between the United States

Department of Defense and

the Canadian Department of

Defense Production

Memorandum of

Understanding

This memorandum established a cooperative program in defense research and

development between the U.S. Department of Defense and the Canadian

Department of Defence Production. The agreement complements the Defense

Production Sharing Program and, among other things, allows Canadian firms to

perform research and development work to meet requirements of the U.S. military

services and permits the standardization and interchangeability of additional

equipment needed for the defense of both countries.

Appendix I: Chronology of Selected Defense

Cooperation Agreements between the United

States and Canada
Appendix I: Chronology of Selected Defense

Cooperation Agreements between the United

States and Canada

Page 20 GAO-02-63 Defense Trade

Year

Established Agreements Synopsis of Agreements

February 1,

1979

Coordination of Cooperative

Research and Development

Memorandum of

Understanding

This memorandum identified the means and opportunities to use the scientific and

technical resources to achieve common naval defense interests and made possible

the standardization and interoperability of systems and equipment used for the naval

defense of the two countries.

March 18, 1985 The Quebec Summit

Declaration

A declaration between the prime minister of Canada and the president of the United

States regarding international security. Both countries pledged to reduce barriers in

defense trade and to establish a freer exchange of technical knowledge and skill in

defense production. As a result of this agreement, the North American Defense

Industrial Base Organization was created March 23, 1987.

March 23, 1987 Charter for the North

American Defense Industrial

Base Organization and

Letter of Guidance to the

Executive Committee

The charter formalized cooperation among Industrial Preparedness Planning

activities within the United States and Canada. The organization is designed to

ensure that Industrial Preparedness Planning remains a visible and vital element to

strengthening the North American defense industrial base.
Appendix II: Summary of Enforcement Cases

That Supported the Need for Change in the

Canadian Exemption

Page 21 GAO-02-63 Defense Trade

In April 1999, State revised its regulations to limit the scope of the

Canadian exemption after concluding that some exporters misunderstood

the exemption and that items were being improperly exported to Canada

and re-exported from Canada to unauthorized destinations. State’s

concerns were supported by a summary of nineteen criminal

investigations and seizure cases it identified as related to the Canadian

exemption. These cases are summarized below:

1. A major U.S. defense company established a manufacturing facility in

Canada and exported defense components, technical data, and

technical manuals to this facility under the Canadian exemption. The

facility assembled components and prepared complete communication

systems for export to Pakistan and provided training for the Pakistani

army, without obtaining State-required approval for the exports. State

had previously denied the export of such systems to Pakistan because

of Congressional prohibitions on such transfers.

2. A Canadian company attempted to sell 35 OH-58 U.S.-origin helicopters

to undercover agents posing as brokers for the Iraqi government.

These helicopters were to be equipped for air-dispensing chemical

weapons. They were seized before being exported from Canada.

3. Fifty-eight M-113 armored vehicles originally sold to the Canadian

armed forces were exported without State approval, transferred to

Europe, and then to Iran.

4. An Iranian intelligence group established a company in Canada and

attempted to acquire U.S. Munitions List controlled klystron tubes,

which are specifically used for Hawk missile systems. The U.S.

government sought extradition, but was denied. The case was

eventually dismissed.

5. A Chinese national established a Canadian company and used the

Canadian exemption to acquire a focal plane array-long-range infrared

camera. The camera was shipped to China from Canada without State

approval. The same individual subsequently ordered an additional

400 cameras. As in the first instance, the Chinese national specified

that the Canadian exemption could be used.

6. Another Chinese-owned company established in Canada ordered 400

U.S. Munitions List controlled infrared cameras from a U.S. company

and stated that the Canadian exemption should be used, although this

would have been an inappropriate use of the exemption.

Appendix II: Summary of Enforcement Cases

That Supported the Need for Change in the

Canadian Exemption
Appendix II: Summary of Enforcement Cases

That Supported the Need for Change in the

Canadian Exemption

Page 22 GAO-02-63 Defense Trade

7. A U.S. company received an order for infrared equipment from a

Chinese entity. The U.S. company informed the Chinese buyer that

such equipment was controlled on the U.S. Munitions List and

restricted from export to China. Upon learning this, the Chinese buyer

suggested that the export could take place through a Canadian

company under the Canadian exemption and then be re-exported to

China.

8. A shipment of 356 U.S. Munitions List controlled turbine engine vanes

to be used for military aircraft was seized prior to export. The

shipment was destined for an Iranian national, located in Canada, who

planned to divert the vanes to Iran.

9. A Canadian company ordered U.S. military fiber optic gyroscopes,

stating that the items were to be used in Canada. A government

investigation established that the company’s owner was a Chinese

national, and the gyroscopes, to be obtained using the Canadian

exemption, were actually destined for China. Arrests were made and

the defendants were eventually convicted.

10. U.S. Munitions List controlled F-18 parts were seized in the United

States while in transit from Canada to New Zealand. State had not

authorized the re-export.

11. U.S. Munitions List controlled electronic countermeasure equipment

was intercepted in the United States when a Canadian company

attempted to export this equipment to Malaysia without U.S. export

approval.

12. A 3-year investigation uncovered an attempt to ship U.S.-origin items

to a subsidiary in Canada and then divert these items to Libya. The

items were seized, and an indictment led to a plea agreement.

13. Three U.S. rocket warheads were seized while being shipped from

Belgium to Canada. The exporter claimed the Canadian exemption on

the export documents, but the exemption did not apply because the

shipment was in transit.

14. A Canadian company shipped military vehicles to an Army facility in

the United States to test a new classified communications system.

After testing, the vehicles were to return to Canada. A Canadian

company, rather than the Canadian government, was handling the

temporary import of the vehicles. The Canadian company did not seek
Appendix II: Summary of Enforcement Cases

That Supported the Need for Change in the

Canadian Exemption

Page 23 GAO-02-63 Defense Trade

or obtain a U.S. export license for moving the vehicles back and forth

across the border. It was also learned that this Canadian company had

shipped communications equipment, which was eventually intercepted

and then seized.

15. U.S. Munitions List controlled gas grenades, projectile guns, and

projectiles were seized at the border during an attempt to ship them to

Canada while claiming the exemption, rather than under a Stateapproved license.

16. A shipment of U.S. Munitions List controlled computers and related

items were intercepted before being exported to the Sudan. The

shipment originated in Canada and was seized when transiting through

the United States.

17. U.S.-origin armored vehicle spare parts were intercepted when they

were shipped from Canada to the Middle East. The shipment was

seized when transiting through the United States without appropriate

U.S. export authority.

18. U.S. components for a mobile radar system had originally been

exported to Canada under the exemption. The radar was then to be

exported to Taiwan under a Canadian license. Since the radar was of

U.S. origin, State needed to approve the export to Taiwan. However,

State approval was not obtained.

19. A U.S.-origin gas turbine engine had been exported to Sweden and

returned to the United States for repair. The engine was then sent to

Canada under the Canadian exemption for the actual repair work,

although the use of the exemption was inappropriate in this case. The

engine was seized on its return to Sweden through the United States.
Appendix III: Comparison of Recent Changes

to the Canadian Exemption–1994, 1999, 2001

Page 24 GAO-02-63 Defense Trade

The Canadian regulatory exemption is complex and has changed

substantially in recent years. The following table highlights changes

regarding what is or is not covered under the exemption and reporting or

record keeping requirements associated with the exemption.

Table 2: Comparison of Recent Changes to the Canadian Exemption—1994, 1999, and 2001.

June 10, 1994 April 12, 1999 May 30, 2001

Export Provisions

This version of the exemption allowed the

export or temporary import of unclassified

equipment or technical data without a

license under certain circumstances.

Exported items had to be used in Canada

by Canadian citizens or returned to the

United States. For items imported from

Canada, the regulation stated that the

exemption applied to a “temporary import”

that was “...for end-use in the United

States or return to Canada to a Canadian

citizen...” a

Language is mostly unchanged from the

1994 version regarding permanent and

temporary exports.b

Language changed to allow all temporary

imports from Canada of unclassified

defense articles to the United States

without a license for temporary use in the

United States and return to Canada.

Exported items must be used in Canada

by Canadian government officials acting in

official capacity or by a Canadian

registered person or returned to the United

States.c

Exceptions to the Exemption (or Items Requiring Licenses from State)

Some defense items were not covered by

the exemption, requiring a license for

export to Canada. These items included:

• Fully automatic firearms and

components and parts in Category I (a),

which are not for end use by the

Canadian federal, provincial, or

municipal government.

• Nuclear weapons, strategic delivery

systems, and all components, parts,

accessories, and attachments

specifically designed for such systems

and associated equipment.

• Nuclear weapon design and test

equipment (Category XVI).

• Naval nuclear propulsion equipment

(Category VI (e)).

• Aircraft, which includes helicopters and

drones (Category VIII (a)).

• Submersible vessels and oceanographic

and related equipment, such as

swimmer delivery vehicles, designed or

modified for military purposes (Category

XX (a) through (d)).

• Defense articles, defense services, or

related technical data for use by a

foreign national other than a Canadian.

• Defense services provided under

agreements such as manufacturing

The number of items requiring a license

expanded from the 1994 version.

Specifically, the following items were added

to the list of exceptions to the exemption:

• All Category I – Firearms. This was

broadened from the prior version to

include all firearms in Category I.

• Ammunition in Category III for the

firearms covered in Category I.

• Launch vehicles, guided missiles,

ballistic missiles, and rockets (Category

IV).e

• Military information security systems,

cryptographic devices, software and

components, and stealth (Categories XIII

(b) and XIII (j)).

• Toxicological, chemical, and biological

agents and related equipment and

radiological equipment (Category XIV (a)

through (d)).

• Spacecraft, remote sensing satellites,

and military communications satellites,

which includes global positioning

systems receiving equipment designed

or configured for military use (Category

XV (a), (b), and (c)).

• All classified articles, technical data, and

defense services defined in Category

XVII, which includes classified articles,

The following items were added to the

1999 list of exceptions to the exemption:

• All technical data and defense services

for gas turbine engine hot sections

covered under Category VI (f) and

aircraft and military aircraft engines

covered under Category VIII (b).

• Developmental aircraft, engines, and

components (Category VIII (f)).

• All Category XII (c) items such as

infrared focal plane array detectors and

image intensification and other nightsighting equipment or systems

designed, modified, or configured for

military use. This, however, excludes

any first and second generation image

intensification tube and first and second

generation image intensification nightsighting equipment.

• Some radiation hardened

microelectronic circuits (Category XV

(d)).

• Certain systems, components, parts,

and accessories for space systems and

associated equipment (Category XV

(e)).

• Miscellaneous articles, which includes

any article that has military applicability

not specifically enumerated in other

Appendix III: Comparison of Recent Changes

to the Canadian Exemption–1994, 1999, 2001
Appendix III: Comparison of Recent Changes

to the Canadian Exemption–1994, 1999, 2001

Page 25 GAO-02-63 Defense Trade

June 10, 1994 April 12, 1999 May 30, 2001

license agreements and technical

assistance agreements found in Part

124 of the International Traffic and Arms

Regulations.d

technical data, and defense services as

defined in 120.21 (manufacturing

licensing agreements) and 120.8

(defense services). f

• All U.S. Munitions list items and related

technical data on the Missile Technology

Control Regime Annex.

categories of the U.S. Munitions List

(Category XXI).

Defense Items No Longer Requiring a License

These items are now permitted under the

exemption:

• Launch vehicles, guided and ballistic

missiles, and rockets (except when

Missile Technology Control Regime

items) (Category IV)).

• Chemical and biological agent detection,

identification, and defensive equipment

(Certain parts of Category XIV (c)).

• Commercial Communications Satellites

in Category XV (a).

• GPS-receiving equipment end-items

only for export to Canada for use by the

Canadian federal government directly or

indirectly through a Canadian-registered

person (certain parts of Category XV

(c)).

• Military information security systems,

and encryption devices (except

classified defense articles) (Category

XIII (b) and (e)).

• Limited defense services, including

exports of technical data and

performance of defense services

meeting certain criteria.

Reporting and Record Keeping Requirements

The following were the reporting

requirements in the 1994 version of the

exemption.

• Exporter was required to comply with the

requirements under section 123.22

regarding the Shipper’s Export

Declaration. Specifically, with the

exception of unclassified technical data,

an exporter was required to file the

declaration with U.S. Customs or the

postmaster when using an exemption.

• Defense articles and defense services

requiring congressional notification, as

stated in parts 123.15 and 124.11 of the

International Traffic in Arms Regulations.

Although elsewhere required in the

regulations, the following requirements

were explicitly added to the Canadian

exemption:

• The exporter must be registered as an

exporter or manufacturer of defense

articles with State and meet certain

eligibility requirements, which includes

requiring the exporter to be a U.S.

person.

• The exporter must obtain written

documentation that (i) the defense article

is for end use in Canada by a Canadian

citizen, and (ii) prior U.S. government

approval will be obtained when the

article is used by non-Canadians, in

Canada, or exported from Canada to

another foreign destination.

• For all defense articles identified as

significant military equipment on the U.S.

The 2001 version of the exemption

contains the same requirements as

previous versions, with the following

changes.

• Re-export/retransfer of U.S. Munitions

List items to another user in Canada or

from Canada to another country

requires prior approval from State. This

section also discusses who is

responsible for obtaining such

approval.g

• A note discusses a requirement to

obtain a license when the exporter

knows the defense article is not being

exported to a qualified Canadian

registered person and provides

additional exemptions that are also

applicable to Canada.
Appendix III: Comparison of Recent Changes

to the Canadian Exemption–1994, 1999, 2001

Page 26 GAO-02-63 Defense Trade

June 10, 1994 April 12, 1999 May 30, 2001

Munitions List, the exporter must obtain

a non-transfer and use certificate.

• Records related to these exports are to

be maintained for five years.

• A note to the exemption covered the

exporter’s responsibilities for obtaining in

writing that the Canadian end user and

end use are legitimate. It stated that if

such written documentation is not

available, the exemption may not be

used.

a

 The reference to end use of a temporary import in the United States was confusing. Apparently, the

regulations should have permitted the end-use in the United States and return to Canada.

b

 This version of the regulations continued to confusingly refer to temporary imports for end-use in the

United States.

C

 For the purpose of the Canadian exemption, a Canadian registered person is any Canadian national

(including Canadian business entities organized under the laws of Canada), dual national, and

permanent resident registered in Canada in accordance with the Canadian Defense Production Act,

and such other Canadian Crown Corporations as may be identified by State.

d A manufacturing license agreement is an agreement in which a U.S. person grants a foreign person

an authorization to manufacture defense articles abroad and involves or contemplates use and/or

export of technical data. A technical assistance agreement is for performance of defense services or

for the disclosure of technical data, as opposed to an agreement granting a right or license to

manufacture defense articles.

e

 Certain items like bombs, grenades, torpedoes, depth charges, and land and naval mines were

excluded from this license requirement.

f We noted that section 120.8 of the regulations refers to major defense equipment. Defense services

are covered in section 120.9 of the regulations.

g Although elsewhere required in the regulations, this requirement was explicitly added to the

Canadian exemption.
Appendix IV: Comments from the U.S. Department of State

Page 27 GAO-02-63 Defense Trade

Appendix IV: Comments from the U.S.

Department of State

Note: GAO comments

supplementing those in

the report text appear at

the end of this appendix.
Appendix IV: Comments from the U.S. Department of State

Page 28 GAO-02-63 Defense Trade

See comment 1.
Appendix IV: Comments from the U.S. Department of State

Page 29 GAO-02-63 Defense Trade

See comment 2.
Appendix IV: Comments from the U.S. Department of State

Page 30 GAO-02-63 Defense Trade

See comment 6.

See comment 5.

See comment 4.

See comment 3.
Appendix IV: Comments from the U.S. Department of State

Page 31 GAO-02-63 Defense Trade
Appendix IV: Comments from the U.S. Department of State

Page 32 GAO-02-63 Defense Trade

The following are GAO’s comments on the Department of State’s letter

dated March 20, 2002.

1. We clarified text to identify when inconsistencies occurred for the

export of technical data under the exemption for offshore

procurement activities. We added an example to our report showing

that some exporters are unclear about when to export technical data

and defense services under the May 2001 revision to the Canadian

exemption.

2. State indicated that it did not discourage exporters from applying for

licenses when the exemption can be used. Such a practice results in

State’s already scarce resources having to process additional licenses.

In addition, some exporters may be at a competitive disadvantage

because they are applying for a license when others may be using the

exemption when exporting the same item.

3. State said that the advice it provides to Customs through the referral

process does not represent a formal State determination. According

to Customs guidance and a Customs headquarters official, Customs

considers State’s input as a formal determination and not advice. A

decision from State is critical because it may result in a seizure of the

export.

4. As State noted, responses to referrals need to be made quickly when

items are detained at the port. State further indicated that exporters

who believe the commodity has been mischaracterized or not fully

understood are encouraged to pursue formal determination through

the commodity jurisdiction process. However, the commodity

jurisdiction process is time-consuming. Therefore, determinations

made through the commodity jurisdiction process would not resolve

the need to make quick determinations through the referral process.

5. We did not include a detailed discussion on the Automated Export

System because regulations requiring mandatory filing of export

declarations through this system had not been finalized at the time of

our review.

6. Based on discussions with State officials, we added information to the

report on State’s training and outreach efforts.

GAO Comments
Appendix V: Comments from the U.S. Customs

Service

Page 33 GAO-02-63 Defense Trade

Appendix V: Comments from the U.S.

Customs Service
Appendix V: Comments from the U.S. Customs

Service

Page 34 GAO-02-63 Defense Trade
Appendix VI: GAO Contact and

Staff Acknowledgments

Page 35 GAO-02-63 Defense Trade

Anne-Marie Lasowski, (202) 512-4146

Marion Gatling, Lillian Slodkowski, Delores Cohen, Ian Ferguson,

Bob Swierczek, and John Van Schaik also made significant contributions

to this report.

Appendix VI: GAO Contact and Staff

Acknowledgments

GAO Contact

Acknowledgments
GAO Products on Defense Trade

and Export Controls

Page 36 GAO-02-63 Defense Trade

Export Controls: Reengineering Business Processes Can Improve

Efficiency of State Department License Reviews. GAO-02-203.

Washington, D.C.: December 31, 2001.

Export Controls: Clarification of Jurisdiction for Missile Technology

Items Needed. GAO-02-120. Washington, D.C.: October 9, 2001.

Defense Trade: Information on U.S. Weapons Deliveries to the Middle

East GAO-01-1078. Washington, D.C.: September 21, 2001.

Export Controls: State and Commerce Department License Review Times

are Similar. GAO-01-528. Washington, D.C.: June 1, 2001.

Export Controls: Regulatory Change Needed to Comply with Missile

Technology Licensing Requirements. GAO-01-530. Washington, D.C.:

May 31, 2001.

Foreign Military Sales: Changes Needed to Correct Weaknesses in

End-Use Monitoring Program. GAO/NSIAD-00-208. Washington, D.C.:

August 24, 2000.

Defense Trade: Status of the Department of Defense’s Initiatives on

Defense Cooperation. GAO/NSIAD-00-190R. Washington, D.C.: July 19,

2000.

Defense Trade: Analysis of Support for Recent Initiatives.

GAO/NSIAD-00-191. Washington, D.C.: August 31, 2000.

Defense Trade: Identifying Foreign Acquisitions Affecting National

Security Can Be Improved. GAO/NSIAD-00-144. Washington, D.C.:

June 29, 2000.

Foreign Military Sales: Efforts to Improve Administration Hampered by

Insufficient Information. GAO/NSIAD-00-37. Washington, D.C.:

November 22, 1999.

Foreign Military Sales: Review Process for Controlled Missile Technology

Needs Improvement. GAO/NSIAD-99-231. Washington, D.C.: September 29,

1999.

Defense Trade: Department of Defense Savings From Export Sales Are

Difficult to Capture. GAO/NSIAD-99-191. Washington, D.C.: September 17,

1999.

GAO Products on Defense Trade and Export

Controls
GAO Products on Defense Trade

and Export Controls

Page 37 GAO-02-63 Defense Trade

Defense Trade: Weaknesses Exist in DOD Foreign Subcontract Data.

GAO/ NSIAD-99-8. Washington, D.C.: November 13, 1998.

Defense Trade: Status of the Defense Export Loan Guarantee Program.

GAO/ NSIAD-99-30. Washington, D.C.: December 21, 1998.

Defense Trade: Observations on Issues Concerning Offsets.

GAO-01-278T. Washington, D.C.: December 15, 2000.

Defense Trade: Data Collection and Coordination on Offsets.

GAO-01-83R. Washington, D.C.: October 26, 2000.

Defense Trade: U.S. Contractors Employ Diverse Activities to Meet Offset

Obligations. GAO/NSIAD-99-35. Washington, D.C.: December 18, 1998.

Defense Trade: Contractors Engage in Varied International Alliances.

GAO/NSIAD-00-213. Washington, D.C.: September 7, 2000.

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