Defense Trade: Lessons to Be Learned from the Country Export Exemption
Published: 2002-03-29T00:00:00

Fast Facts:

Highlights:
section_title: What GAO Found
paragraphs: To control the export of defense items, the U.S. government requires exporters to obtain a license from the State Department. A license is not required to export many defense items to Canada, currently the only country-specific exemption to the licensing requirement. In May 2000, the U.S. government announced the Defense Trade Security Initiative, 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. Exporters have been implementing the Canadian exemption inconsistently. Moreover, some exporters are interpreting reporting requirements about the use of the exemption differently. The U.S. government has mechanisms in place to reduce the risk of defense items being inappropriately exported, but there are associated limitations. U.S. Customs officials attributed these enforcement weaknesses 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. 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.

section_title: Letter
paragraphs: To control the export of defense items, the U.S. government generally requires exporters to obtain a license from the State Department.However, a license is not required for the export of many defense items to Canada. 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, 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.
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 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.
subsections: section_title: Background
paragraphs: 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 re- exported without prior authorization from State.
The Canadian exemption, first codified in 1954, 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 technical data without a license. Later versions changed the coverage to include defense services and increased the types of items requiring a license.
subsections: section_title: Enforcement Concerns Led to Negotiations about the Exemption
paragraphs: 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.  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. 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 disclosures 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.
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, 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 Regime 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.
section_title: Exporters Are Implementing the Exemption Inconsistently
paragraphs: 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 procurement activities, based on their interpretation of the regulations. However, State officials said that 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.” 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.Some exporters said they obtain this certification when exporting defense 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.
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 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. 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.  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, 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.
section_title: Ensuring Export Compliance Is Difficult
paragraphs: 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 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.  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. 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.
subsections: section_title: Limitations in Compliance and Enforcement
paragraphs: We identified a number of limitations for the compliance and enforcement process related to the Canadian exemption. 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 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. 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 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.
section_title: Experience with the Canadian Exemption Could Assist in Ongoing Negotiations
paragraphs: 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 areas when negotiating and executing similar exemptions with other countries. 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.
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.
section_title: Conclusions
paragraphs: The Canadian exemption relies on exporters to comply voluntarily with export regulations and to disclose when they have not followed those 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.
section_title: Recommendations for Executive Actions
paragraphs: 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.
section_title: Agency Comments and Our Evaluation
paragraphs: 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.
section_title: Scope and Methodology
paragraphs: 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.
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.
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.
section_title: Appendix I: Chronology of Selected Defense Cooperation Agreements between the United States and Canada
paragraphs: 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.
section_title: Appendix II: Summary of Enforcement Cases That Supported the Need for Change in the Canadian Exemption
paragraphs: 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. 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 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 State- approved 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.
section_title: Appendix III: Comparison of Recent Changes to the Canadian Exemption–1994, 1999, 2001
paragraphs: 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.
section_title: Appendix IV: Comments from the U.S. Department of State
paragraphs: The following are GAO’s comments on the Department of State’s letter dated March 20, 2002.
subsections: section_title: GAO Comments
paragraphs: 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.
section_title: Appendix V: Comments from the U.S. Customs Service
section_title: Appendix VI: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Acknowledgments
paragraphs: Marion Gatling, Lillian Slodkowski, Delores Cohen, Ian Ferguson, Bob Swierczek, and John Van Schaik also made significant contributions to this report.
section_title: GAO Products on Defense Trade and Export Controls
paragraphs: 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.
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.