As to the issue of safeguards against misuse of project funds © Cy or insider information by the Agency, the Chief CCS has told the Committee that compartmentation, the honesty of the Chief of CCS, . and display of the portfolios to appropriate congressional commit- ‘tees are what have prevented or will prevent such abuse. Houston agreed jwith the three safeguards outlined by the CSS Chief. However, he ladded a fourth: When we were investing in stock, I would have the list of stock, the portfolio, reviewed by our con- _ tract people, and if I found we had any contract relationship with any of the companies involved, we'd either refuse to -- Well, a couple of times our invest- ment ‘advisor recommended a stock which I knew we had big contracts with, and I told the board no, this in- volves a conflict of interest. We won't touch it. And if we had anything from the Agency contract office that indicated a relationship, we would either sell the stock or wouldn't buy it. Houston believes that the wmpley should continue in some form. One reason is that "assets are few and far between." The acquisi- tion of a board of directors, the establishing of accounts, basic credibility and relations with the jurisdiction in which the entity is located are not easy things to do according to Houston. This creates the "tendency, once you've got something that looks good, to hang on to it." He would recommend in this regard that the ‘Agency be constantly forming new companies and phasing out old ones on a rotational basis so that the same complex would not remain for security reasons. HY 50955 Doacld:32423532 Page 141
$7 -=e- So it's not easy but I still think that they should make the effort. [The Chief ccs] knows my views on this pretty well, and we ‘re all worried about the security of the damn thing. But we don't know another way to do it. He believes that the current method while not perfect is the best that can be devised. The problem, of course, is that the genera~- tion of funds for these companies must. literally be shown to be legitimate and non-governmental if the beneficiaries are to be protected. Consequently, if the government were to create an office that would funnel money to these companies without the ‘benefit of investment, this would create the risk that a trace- back investigation by a foreign power could discover that the entity is being funded by. the U.S. government. Houston closed by “ saying that he would invite any controls that Congress would choose to put on the mechanism in terms of insuring propriety. he Chief of COS hin Gebel chase Heng he zh AM aUtINER cn “uihpeenet hand ao an tah afer suhich ne ern) (1-47-76, The toy HW 50955 Docld: 324235532 Page 142
S, @@y THE AIR PROPRIETARIES Lawrence R. Houston, the former General Counsel of the Agency, was involved in the establishment of the first set of proprietaries of the Agency back in the late 1940's and early 1950's. As noted later on in section 10, page , Houston has concluded that . ‘proprietaries should be a mechanism of last resort. He asserts that the Agency learned this in part "the hard way and almost all of the lessons involved probably came out one way or the other in connection with a major aviation proprietary in the Far East. Others had there own special problems, but I think the Air America complex had pretty near everything." | The theory of the acquisition of Air America in 1949 was denial of the assets to the Red Chinese. The CIA first arranged advances to the company to keep them going when they were running short of cS cash in 1949. These advances were used up and were actually credited to the purchase price eventually. The airline at that time had | been organized by General Claire Chennault and Whiting Willauer. It was a joint venture with the Chinese Minister of Transport and was called Civil Air Transport. Houston described it as follows: ° This normal aviation organization, this would have no meaning at all, was completely at all, it would have not standing in international law, aviation rights, or any of that. But it worked for what they wanted, which was to take supplies up-country into inland China and then to bring back whatever cargo they could get commer- cially: tallow, hides, bristles, all that sort of trade, and then they traded that off for their own account. And for awhile the operations was fairly successful, the C-47's and C-46's. To finance this activity and to facilitate the trading of produce, their lawyer, Thomas Corcoran, had organized a company. That company was known as C.A.T. Ine. In addition there was a Panamanian co HW 50955 Docld: 32423532 Page 143
Sor, ~ B - corporation which was involved that did most of the funding. There was also an envy known as the Civil Air Transport."to further complicate the picture, at this time Chennault and Willauer were also negotiating with the Chinese CNAC, for the takeover of their _planes and equipment.'' Chennault and Willauer came to the Agency in connection with that operation in the Spring of 1949. At that point the Nationalist Chinese were being "squeezed down south by the Communists and they were really backing down toward Shanghi, restricting their area of operation and consequently the produc- tivity of their commercial venture." Chennault and Willauer indi- cated to the Agency that unless they got .help they would have to go out of business. . The agency held a series of meetings in which it was determined that it had a need for some air transport for some of its operations O particularly involving arms and ammunition and consequently the | Agency needed a contract with someone. And so we entered into an arrangement, I think in about September of 1949 whereby we would advance them, the figure of $750,000 sticks in my mind, against which we could draw for actual use of the planes at an agreed on rate. . . . And we did draw down, I think, all the flying time and expended the $750,000 between September and about January, at which time we suspended any further payments or draw-downs. I think the money was exhausted. Chennault and Willauer came to Washington about January or February of 1950 and through a series of negotiations, the Agency agreed to advance them more funds, taking at the same time an option to purchase the assets of Civil Air Transport, with the liabilities left to their account. Any unused portion of the advances were to be credited to the purchase price. They then operated through the eo HW 50955 Docld: 32423532 Page idd
Spring of 1950 under this arrangement and Chennault and Willauer "came in in the Summer of 1950 and said again they were in desperate straits for funds." Once again a series of meetings was held at. which the prognosis was that the operations in the Far East would have a continuing need for secure airlift and also, there was a general estimate that the loss of this airlift to the Chinese Communists would give them a considerably greater advantage than then possessed because they had almost no airlift of their own at that time. ‘The Agency then made the decision that they would exercise the option given there was no objection otherwise." The Agency felt that it was necessary to get the concurrence of the Department of State. Frank G. Wisner, at that time the Head of the Office of Policy Coordination (OPC) which Was respon- sible for conduct of covert actions as opposed to clandestine in- 'S) telligence, and Mr. Houston visited Mr. Livingston Merchant, who was Assistant Secretary of State for the Far East. He and I went to see Mr. Merchant and explained the situation. And Mr. Merchant reminded us. that it was basic U.S. policy not to get the government in compe- tition with U.S. private industry. But under the parti-. cular circumstances, in particular as there was really -no.U.S. private industry involved in the area, and they agreed it was important to divide the assets to the Red Chinese. State would go along on the understanding that we would divest ourselves of the private enterprise as soon as such a divestment was feasible, and all of the circumstances that might obtain. Of course, the divestiture of these entities did not actually occur until 1975. And, indeed, some of the entities still as yet have not been divested. Mr. Houston noted, however, that: ry HW 50955 Doecld: 32423532 Page 145 |
We did not disregard that guidance because after very considerable use of this asset during the early ‘50's, there was-a question of whether to continue it, and the matter was taken up in the National Security Counsel. And Allan Dulles, as Director, opposed that we continue the ownership and control of the assets of Air America, as it then was known including the subsidy as needed. And there was a subsidy at that time. It was about $1,200,000 per year.* This consideration by the National Security Counsel as to whether or not to continue to retain this asset and Mr. Dulles‘ recommenda- tion that it be retained occurred in 1956. During this period of time the business of the air proprietary consisted almost entirely of Agency cargo carriage under contracts which were usually using a military designation. The company was not organized, according to Houston, to fly common carriage and had no status in the international air business. 'e) The evidence indicates that during this period of time, there were two struggles going on. One was where control should lie in the Agency and the other was the policies to be applied to the operation of the company itself. The struggle within the Agency ranged all the way from sort of quiet management discussions as to what was good management, to:sometimes rather vociferous auguments of whose in charge here. And the operators always said, ‘well, we need to call the shots because it's our operation. : And this is what we were running into all the time, of red hot operators opposed to what we would consider good management. . ¥-fiouston indicated that there had been a subsidy running to the entities since 1949. "$1.2 million represented about the maximum . subsidy given until, I believe, about 1958 was the turning point, and from 1958 0n, there was no subsidy as such that went into it." The reason for that, of course, was that-the air complex had become “money-making.” ~ . HW 50955 Docld:32423532 Page 146.
The management of the air proprietary at this time was in the OPC structure and was therefore responsive to operations. An example of some of the problems which were created as a result of this is the acquisition in August of 1950 of the entity. Houston was participating in the negotiations. He had been in- vited to do so by Frank Wisner. OPC was a curious organization. Determined as being attached to the Agency for quarters and rationing with policy guidance from State, which was an impossible situation. Very nice fellows were doing the negotiating with Wisner -- Frank Lindsay and Chad Breckinridge, who. is now dead. Frank Lindsay has been head of ITEK and quite unknown to me, when they made the agreement to © purchase carrying out the option, they gave the vendors the right to repurchase at any time within two years. And I thought this was.really inconsistent with our whole position. And during the next two years they negotiated out that repurchase agreement and in its place substituted an agreement to give them a first refusal, if we were to dispose of the airline. That first refusal plagued us for years. They use to make all sorts of extraordinary claims 2) , _ under it and it was never exercised and eventually it was sort of forgotten when Chennault and Willauer died. It ran to them personally, whether it ran to them and two others personally, and they all are dead now. But this. shows a part of the learning curve, which was. thing we were going through. It also became clear that the organi- zation of the airline was really impossible, it's sort've semi-formal partnership with the Ministry of Transportation or the Ministry of Communications (of the Nationalist Chinese Government) .* That basically describes the preliminary situation from the period 1950 through 1954. It was in 1954 that George Doole first came onboard as a consultant. Doole and Houston went to the Far East in the summer of 1954 to observe the operation. "George went out there - "The Nationalist Chinese had by this time retreated to Taiwan, they maintained a maintenance base tied to Hainan ‘Fhe maintenance base - at that time was on a LST and a great big steel barge. And we brought the LST and the steel barge up to Kiaoshung, and it was really extra-~ ordinary what a maintenance job they did on what was almost impossible co facilities. I went down and was enormously impressed by the difficul- ‘ties and how well they had overcome them,’ mW Jiiausiiv'. HW 50955 Docld: 32423532 Page 147
lan specifically to look at the organization of the Airline.” In this regard, it is noted that at the time the Agency purchased the Air- “line it had formed a Delaware corporation to buy it which was first called the Airdale Corporation, counsel for which was Brackley Shaw. Shaw and Doole were both very concerned about the technical organization or lack of it, of the operation. Doole demonstrated to Houston ‘ to my satisfaction that it was an absolute situa- tion and that no-one out there had the slightest understanding of the problem or what they were up against, or wanted to do anything about it (in terms of airline management). As a result of this Shaw and Doole planned the organization which they thought was necessary for the future .of the operation. Hugh Grundi was installed as President of the corporation by the end of 1954.. Management responsibility internally was given to Lyle Shan- non "who was a management type, although he was assigned to the DDO, or by that time it might have been the DDP." The upshot of this review by the Agency was that the theory of running the airline was that it would be managed by manage- ment to be responsive to Operations."but not managed by Opera- tions.” | In order to improve its cover “the Chinese not only were wil- ling, but at that time wanted it to be the airline that showed the flag of China."". This was done on overt records through Civil Air Transport Company, Ltd., which was the subsidiary of Pacific Corp- ‘oration. Pacific Corporation held title to 40 percent of the HW 50955 Docld:32423532 Fage 1486
cS equity in the corporation and. 60 percent of the equity was osten- sibly owned by the Chinese, who gave deeds of trust to the Agency .for their shares. This overt arrangement demonstrated for purposes of international law that the company was majority-owned and con- trolled by Chinese. The Chinese continued to press the company to get into the international common carriage field. The company had several DC-4's and began modest operations between Hong Kong, Taipei and Tokyo. They graduated to DC-6's, and it was at this time that the Agency first got into the question of competition with U.S. industry. Northwest was then flying to Tokyo and Seoul and to Manila, and was trying to obtain rights into Hong Kong. Don Nyrop had noted the Agency's interest in this area when he had been Chairman of the Civil Aeronautics Board in the late 1940's and the t o early 1950's. Houston told the Committee: He (Nyrop) became head of Northwest, a very tight manager, a very capable fellow, and he used to. complain that we were interfering, we were taking passengers off his airline, and we would go to him and say, we have to keep the airline in this busi- ness because the Chinese say they need an international airline. They're not ready to start their own yet. And it is necessary to its overall cover status as a going commercial concern. By 1959 Mr. Nyrop was complaining that the Agency was doing too much. Finally Nyrop decided to complain to the Civil Aeronautics Board and | the Agency agreed to place it before that Agency for a decision. A meeting was held with the entire Board, at which time Nyrop was able to make his case "for the fact that he was a private industry, he. should not be interfered with by government competition.” - HW 50955 Docld:32423532 Page 149.
a The Agency. explained its situation, the cover need, the Chinese pressures, and the fact that they were keeping the carriage to what they thought was a minimum that appearances could stand. And it ended up by one of the members of the Board turning to Nyrop and saying, Don, you ought to be glad that you don't have a really good, reliable ‘competitor in there. He said, If you were being competed with by private business, you'd have real headaches. You ought to be real glad that it's not worse than it is. And that's the end of that. Houston conceded that some passengers were going on basically CIA planes instead of Nyrop's Northwest planes. The impact, however, was minimal. Moreover, the CAB in this proceeding was advised of the dilemma. They did participate in discussions with both the Agency and the particular business entity that was making the com- ~ plaint, and the CAB, after hearing both sides, “came down on the 4 . side of the Agency after making a reasoned judgment." By this time the airline's commercial international business was not making money. A maintenance contract work, which was being done at Taiwan, however, was “normally a money~maker, and this was primarily, although not exclusively, with the U. S. Air Force."* There were management problems in terms of the maintenance aspects of this operation. This originally stemmed from the fact * The LST and barge which ‘had previously been used for maintenance purposes became inadequate. Therefore the Agency built a plant ¢n Taiwan "that is now there but has been recently disposed of to E Systems, and a very good plant it was." E Systems’ role in the acquisition of proprietary assets is detailed later. HW 50955 Docld: 32423532 Page 1506
that individuals out in the field are not particularly astute at costing their contracts. Doole gave excellent advice in this area. Moreover, Doole was quick to advise when an operation is bordering | on not being responsive to the demands of good management. Houston. cited one instance when Doole replaced a controller in the corpor- ation who was very able but “had his own ideas of bookkeeping and controls.’ Doole insisted that the corporation put in bookkeeping and controls completely consistent with U. 5S. GAB and FAA prac- tices. And of course the maintenance contracts with the military were audited constantly by the military audit teams that were | right in the plant. | By this time the Agency had organized an exemption from the Contract Renegotiation Board.on the grounds that if the renegotia-. tion personnel became too involved in the business, they might recognize that this was not a straight commercial operation and discover ‘the fact that the CIA was involved. The Agency went to the head of the Contract Renegotiation Board and got a letter from the Department of Defense asking for an exemption on what the Agency and the Department considered "perfectly legitimate grounds." Indeed, there was a basis for exemption in the Renegotiation Act if the business was entirely overseas, which was the case with this zirline.. And so, the exemption was granted on! that basis. The | Agency was concerned, however, by the fact that it had in principle made a type of profit, over 40 percent on these Air Force mainten- ance contracts, that might have well have been the subject of re- HY 50955 BDocld:327423532 Page 1451