Export Controls: Challenges with Commerce's Validated End-User Program May Limit Its Ability to Ensure That Semiconductor Equipment Exported to China Is Used as Intended
Published: 2008-09-25T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Semiconductors are key components in weapons systems and consumer electronics. Since semiconductors have both civilian and military applications, U.S. export control policy treats the equipment and materials used to manufacture semiconductors as "dual-use" items, and controls the export of these items through licensing requirements to sensitive destinations such as China. You requested that we update our 2002 report on China's semiconductor manufacturing capabilities to address the (1) evolution of China's capabilities since 2002, (2) changes to U.S. export control policies over the sale of semiconductor manufacturing equipment and materials to China since 2002, and (3) the advantages and limitations of these changes.
section_title: What GAO Found
paragraphs: The gap between U.S. and Chinese commercial semiconductor manufacturing capabilities, as measured by the feature size of the semiconductors produced, rapidly narrowed between 1994 and 2002. Since 2002, China's semiconductor manufacturing capabilities have continued to advance but remain one generation behind state-of-the-art semiconductors produced in the United States. China's most advanced semiconductor manufacturing companies continue to rely on equipment and materials from the United States, Europe, and Japan to improve their manufacturing capabilities. However, China has developed an indigenous capacity to build some types of advanced semiconductor manufacturing equipment, which may soon provide companies in China with a domestic source of equipment capable of producing semiconductors that are close to state of the art. Since 2002, U.S. export control policies over semiconductor equipment and materials to China have become more "end-user" focused, with the introduction of the Validated End-User (VEU) program, a parallel licensing framework that allows select pre-screened Chinese end-users to receive controlled items, including some semiconductor equipment and materials, without a license. The Department of Commerce anticipated that the VEU program would facilitate trade to China and enhance U.S. security; however, challenges with program implementation may limit Commerce's ability to ensure items are being used as intended. Specifically, Commerce has not reached a VEU-specific agreement with the Chinese government for conducting on-site reviews of validated end-users, a mechanism cited by Commerce as critical for ensuring program compliance. Instead, as a stopgap measure, Commerce is attempting to conduct VEU on-site reviews under a 2004 agreement. In addition, Commerce lacks procedures for conducting on-site reviews, though the validated end-user program was introduced in June 2007.

section_title: Letter
paragraphs: For nearly five decades, the semiconductor industry has served as the  foundation of the U.S. high-tech economy and, in turn, provided the United  States with a strategic military advantage. However, as semiconductor  production and its supporting industries move overseas to countries such  as China, the ability of the United States to maintain this advantage may be  threatened. Semiconductors, commonly known as integrated circuits or  computer “chips,” are often used in weapons systems as well as consumer  electronics such as computers, cell phones, and televisions. The  manufacture of semiconductors takes about 2 months, requires a complex  process involving more than 250 steps, and uses hundreds of millions of  dollars in sophisticated equipment and materials. Since semiconductors  have both civilian and military applications, U.S. export control policy  treats semiconductor equipment and materials as “dual-use” items, and  controls the export of these items through licensing requirements to  sensitive destinations such as China. According to the Department of  Commerce, this policy is consistent with the objective of facilitating high- technology trade with civilian customers, while hedging against China’s  rapid military modernization.
In 2002, we reported that China had narrowed the gap between the  capabilities of its semiconductors and state-of-the-art U.S.-made  semiconductors from 10 years to 2 years. Moreover, we found that the  growing sophistication of China’s semiconductor manufacturing facilities  had improved its ability to develop more capable weapons systems and  advanced consumer electronics. Since 2002, China has continued efforts to  develop its domestic semiconductor industry. Concurrently, the United  States has made adjustments to its policies and procedures governing the  sale and transfer of semiconductor equipment and materials to China.
In light of these developments, you requested that we update our 2002  report to address the (1) evolution of China’s semiconductor  manufacturing capabilities since 2002, (2) changes to U.S. export control  policies over the sale of semiconductor manufacturing equipment and  materials to China since 2002, and (3) advantages and limitations of these  changes to U.S. export controls. In addition, this report describes progress  the Departments of Commerce and Defense have made to address our prior  recommendations.
To conduct this review, we analyzed the relevant statutes, regulations, and  presidential directive pertaining to export controls for China; interviewed  officials in Washington, D.C., from the U.S. Departments of Commerce  (Commerce), Defense (DOD), Energy (DOE), and State (State); analyzed  Commerce licensing data; and reviewed information provided by  Commerce on end-use checks in China. We interviewed representatives  and reviewed information from the U.S. and Chinese semiconductor and  semiconductor equipment and materials industries, officials from the trade  associations representing each industry, academics with expertise in  China’s semiconductor industry, and members of the intelligence  community. We traveled to Beijing and Shanghai, China, and visited  companies that have been approved to receive semiconductor equipment  and materials under the Validated End-User program or have received  these items under export licenses. We also attended SEMICON China—a  semiconductor industry trade show with more than 900 U.S., Chinese, and  other foreign companies represented—and met with three Chinese  companies involved in semiconductor manufacturing. We determined that  the data presented in this report are sufficiently reliable for the purpose for  which they are presented.
We conducted this performance audit from October 2007 to September  2008, in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives. Appendix I contains a more  detailed description of our scope and methodology.
subsections: section_title: Background
paragraphs: The semiconductor manufacturing equipment and materials industry  produces a variety of equipment, chemicals, gases, films, and other  materials critical to manufacturing integrated circuits. According to  Semiconductor Equipment and Materials International (SEMI), the $86  billion global semiconductor manufacturing equipment and materials  industry provides the equipment necessary for a $256 billion  semiconductor manufacturing industry (see fig. 1). This industry in turn  produces the computer chips needed by many other industries, including a  $1.6 trillion electronics industry. Semiconductors are devices that enable  computers and other products such as cell phones to process and store  information. Producing semiconductors is a multistep sequence of  photographic and chemical processes during which electronic circuits are  gradually created on a wafer made of pure semiconducting material, most  commonly silicon. For example, the equipment used to manufacture  semiconductors performs tasks such as depositing a thin chemical film on  wafers, and selectively removing the film by etching it away, creating  microscopic transistors.
The technological complexity of semiconductors is indicated by the feature  size (the density of the etched lines) on the wafer. Smaller feature sizes  measured in nanometers allow for more components to be integrated on a  single semiconductor, thus creating more powerful semiconductors. Each  reduction in feature size—for example, from 90 nanometers to 65  nanometers—is considered a move to a greater level of technological  sophistication, or a move to the next “generation” of manufacturing  technology.
Consistent with multilateral export controls, the U.S. government classifies  semiconductor manufacturing equipment and materials as dual-use items  because they have both commercial and military uses. Under the authority  granted in the Export Administration Act of 1979, Commerce’s Bureau of  Industry and Security (BIS) administers export controls for dual-use items  through the requirements contained in the Export Administration  Regulations (EAR). Under these regulations, exporters are to either  obtain prior government authorization from BIS in the form of a license,  general authorization, or license exception, or determine that a license is  not needed before exporting dual-use items. The EAR establishes a  framework for regulating the export of dual-use items by identifying the  characteristics and capabilities of items that may require export licenses.  These characteristics and capabilities are contained in the Commerce  Control List, which provides detailed specifications for about 2,400 dual- use items, divided into 10 categories (see app. II for a list of the 10  categories). Each category is subdivided into five groups designated by  letters A through E (see app. II for a list of the five groups). For example,  semiconductors and semiconductor manufacturing equipment and  materials fall under Category 3 (electronics), with manufacturing  equipment placed in Category 3B (test, inspections, and production  equipment) and materials placed in Category 3C (materials).
Exports of semiconductor manufacturing equipment and materials to  China are primarily controlled for national security and antiterrorism  reasons. Appendix III describes the specific equipment and materials that  require a license for export to China. For these items, the overall policy of  the United States is to approve exports for civilian end uses but generally to  deny exports that will make a direct and significant contribution to Chinese  military capabilities.
Semiconductor manufacturing equipment and materials, as well as other  sensitive dual-use items, also are controlled under the multilateral  Wassenaar Arrangement. Forty countries are signatories to the  arrangement, including Germany, Japan, The Netherlands, and the United  States. Formed in 1996, the Wassenaar Arrangement succeeded the  Coordinating Committee for Multilateral Export Controls. Most advanced  semiconductor equipment and materials are included on the Wassenaar  Arrangement’s Basic List, which controls items that are “major or key  elements for indigenous production, use, or enhancement of military  capabilities.” One type of equipment, metal organic chemical vapor  deposition (MOCVD) reactors, which may be used to produce radiation- hardened electronics for use in commercial and military applications, is  included on the Wassenaar Arrangement’s Sensitive List. No  semiconductor equipment or materials are included on Wassenaar’s Very  Sensitive List. One of the arrangement’s principal goals is to prevent  “destabilizing accumulations” of advanced dual-use items and technologies  through the reporting of export information by its members. The  Wassenaar Arrangement lacks a “no undercut” rule, under which a member  would agree not to permit the export of any listed item or items that had  been officially denied an export license by another member. Rather than  having a no undercut rule, Wassenaar members exchange information on  denied transactions as the sole means of trying to achieve its goals.  Although the United States may not authorize a license for a specific piece  of semiconductor manufacturing equipment to China, other Wassenaar  members are not restricted from selling that same item themselves.
section_title: China’s Semiconductor Manufacturing Capability Has Steadily Advanced
paragraphs: Since 2002, China’s ability to produce commercial semiconductors has  steadily advanced but remains approximately one generation behind the  United States. As of July 2008, China’s most advanced semiconductor  manufacturing company can produce integrated circuits with a feature size  of 65 nanometers, compared with U.S. companies that are producing  semiconductors with 45-nanometer feature sizes. China’s ability to produce  advanced integrated circuits continues to depend on whether it can obtain  equipment, manufacturing technology, and materials from other countries.  However, China has begun developing an indigenous capacity to build  some types of advanced semiconductor manufacturing equipment, which  may enable it to reduce its dependence on some foreign-sourced  equipment. Lastly, China also can obtain semiconductor manufacturing  equipment on the used market. Although this equipment cannot be used for  state-of-the-art production, it nonetheless contributes to China’s  production capacity.
subsections: section_title: U.S. and Chinese Manufacturing Capabilities Continue to Advance
paragraphs: In 2002, we reported that, between 1986 and 2001, China had narrowed its  technology gap from a span of five generations (or 10 years) behind U.S.  commercial state-of-the-art production to approximately one generation (1  to 2 years). Since 2002, commercial state-of-the-art production has  continued to advance. Companies in the United States now produce  integrated circuits with a feature size of 45 nanometers, while the most  advanced company in China is producing integrated circuits with a feature  size of 65 nanometers—approximately one generation apart. Companies in  China produce different types of integrated circuits, including  microprocessors and various types of memory. Figure 2 shows the  advances made by companies in the United States and China from 1994  through 2007.
Although companies in China are capable of producing near-state-of-the-art  commercial integrated circuits, they mainly produce integrated circuits  that are several generations old and are used for internal consumption in  China’s consumer electronics industry. These integrated circuits are used in  products such as cell phones, TVs, DVD players, and personal computers.  In 2006, SEMI estimated that 82 percent of China’s production capacity  produces integrated circuits that are four to seven generations (ranging  from 500 to 180 nanometers) behind state-of-the-art manufacturing, and  approximately 7 percent of integrated circuits produced are one or less  generations (90 nanometers and below) behind current state-of-the-art  capabilities.
section_title: China Still Relies on Imports of Foreign Equipment, Materials, and Partnerships with Foreign Entities to Fuel Technology Advances
paragraphs: Commercial Chinese semiconductor manufacturing companies are still  largely dependent on foreign sources of equipment and materials to fuel  technology advances. Currently, European, Japanese, and U.S. companies  are the leading suppliers of semiconductor manufacturing equipment for  facilities producing advanced integrated circuits. Additionally, to advance  its technological capacity, China has partnered with foreign companies or  created incentives for foreign companies to locate to China.
China continues to rely on imports of semiconductor manufacturing  equipment from Europe, Japan, and the United States for production of  advanced integrated circuits. The demand is being driven by several  advanced integrated circuit manufacturers, including Semiconductor  Manufacturing International Corporation (SMIC), Hua Hong NEC, and  Hynix-ST. In 2006, spending in China on semiconductor equipment from  foreign sources was approximately $1.6 billion, according to SEMI. This  accounted for nearly 97 percent of the value of all equipment purchases  from foreign and domestic sources. China also relies on foreign material  imports, including gases and chemicals, to manufacture semiconductors.  Although China produces these items, according to industry experts, it  does not produce them in sufficient quantity or quality to meet its domestic  demand. As China increases its integrated circuit production capacity, its  materials consumption also grows, increasing its reliance on imported  materials.
China also relies on partnerships with foreign companies to fuel its  technology developments. Through joint ventures or incentive programs to  encourage international companies to locate to China, China has gained  access to more advanced technology than it previously had or could  produce on its own. In 2002, we reported that five of China’s eight newest  major integrated circuit manufacturing facilities were established through  joint ventures and the other three were wholly owned foreign companies.  One of the five facilities, a semiconductor manufacturing facility owned by  Motorola, a wholly owned U.S. company, was sold to SMIC in 2003. The  foreign-owned and publicly traded SMIC is the largest and most advanced  integrated circuit company in China. China has continued to acquire  advanced technology through partnerships. For example, SMIC obtained  advanced manufacturing know-how on the production of integrated  circuits specifically for memory through a cooperative arrangement with a  German company, Infineon, in 2006. Moreover, in December 2007, SMIC  obtained a license from IBM, a U.S.-based company, to use its 45- nanometer manufacturing technology in the production of integrated  circuits for mobile applications such as cell phones. Likewise, HynixST,  another new facility in China established in 2006, which is a joint venture  between Korea’s Hynix and Switzerland’s STMicroelectronics, also  provided China with advanced commercial integrated circuit memory  technology.
section_title: China Is Developing Domestic Capacity to Build Some Types of Semiconductor Manufacturing Equipment
paragraphs: China is developing the domestic capability to build some types of  semiconductor manufacturing equipment, which might eventually reduce  its dependence on foreign-sourced equipment. Currently, China has more  than 50 companies that produce equipment for semiconductor  manufacturing, 2 of which, Advanced Micro-Fabrication Equipment and  North Microelectronics, produce equipment to manufacture advanced  integrated circuits, according to SEMI. Equipment made by these  companies is found in some of China’s most advanced fabrication facilities  such as SMIC, although the equipment is being tested still and is not being  used to manufacture integrated circuits for commercial purposes. Chinese- made equipment constitutes a small but growing share of domestic  equipment purchases. In 2006, SEMI estimates that semiconductor  manufacturers in China purchased $56 million in domestically produced  equipment, about 3 percent of all equipment purchases by Chinese  manufacturers, but more than double the value of domestic equipment  purchases made in 2003.
Despite recent advances, China cannot domestically produce all of the  equipment needed to manufacture advanced semiconductors. For example,  China lacks a domestic source of lithography equipment, which is used to  imprint circuits on semiconductor materials and is necessary to advance  reductions in feature size. The United States also lacks a domestic source  of state-of-the-art lithography equipment. The last remaining competitive  U.S. manufacturer, Silicon Valley Group, was sold to a Dutch company in  2001. Japan and The Netherlands are currently the global leaders in the  manufacture of lithography equipment.
section_title: China’s Purchases of Used Equipment Expand Its Production Capacity
paragraphs: China is able to expand its capacity for manufacturing integrated circuits  through used semiconductor manufacturing equipment purchases.  Although purchases of used equipment do not enhance China’s ability to  produce advanced integrated circuits, they do provide China with an  ongoing source of equipment to expand its production capacity.  Additionally, used equipment may enable the production of integrated  circuits for China’s military since military systems generally are designed  around older technology, not state-of-the-art semiconductors. For instance,  we reported in 2002 that China’s most sophisticated production facilities,  although about 2 years behind U.S. state of the art, were nonetheless  capable of producing integrated circuits that were more advanced than  those used in some of the most advanced U.S. weapons. Both U.S. and  Chinese production capabilities have advanced since 2002, but the same  paradigm—military systems generally are designed around older  technology—still exists. Thus, China’s ability to manufacture less  sophisticated chips through purchases of used equipment potentially  enhances its military capabilities.
section_title: Commerce’s VEU Program in China Marks a Shift toward an End-User-Based System of Export Controls for Semiconductor Equipment and Materials
paragraphs: Before the introduction of the VEU program, export licenses provided the  only mechanism by which U.S. companies could ship most advanced  semiconductor manufacturing equipment and materials to China. Export  licenses are assessed individually by an interagency team based on such  factors as the item, its intended end use, and the end-user. A license also  may contain conditions, including the requirement for postshipment  verification, to ensure the item is used as intended. The VEU program,  introduced in June 2007, marks a shift toward a more end-user-based  system of export controls by allowing select, pre-screened Chinese entities  to receive certain controlled items, including semiconductor  manufacturing equipment and materials, without a license. The program  established recordkeeping requirements to provide assurance that items  exported under the VEU program are being used as intended, and  recipients must agree to host discretionary on-site reviews by U.S.  government personnel.
subsections: section_title: Export Licenses Provided the Only Means to Export Advanced Semiconductor Equipment and Materials to China before Introduction of the VEU Program
paragraphs: Before Commerce introduced the VEU program in 2007, export licenses  provided the only means for U.S. companies to export most advanced  semiconductor equipment and materials to China. An export license  authorizes the export, reexport, or transfer of a specific item or items to a  specified recipient. Commerce administers the export licensing system  for dual-use exports, including semiconductor equipment and materials,  with input from DOD, State, and DOE. Each agency makes a  recommendation to approve, deny, or return a license application without  action. Disagreements over the disposition of a license are resolved  through a dispute resolution process. The intelligence community can  provide information to the interagency review team on prospective end- users, although they do not make licensing recommendations.
Interagency reviewers consider a number of factors in evaluating export  license applications for semiconductor equipment and materials to China,  including the type and quantity of items to be shipped, the end-user and  stated end use, and foreign availability. To establish the identity and  reliability of prospective recipients, reviewing agencies may request that  Commerce check the “bona fides” of the recipient of the technology prior  to shipment, also known as a prelicense check. They also may condition  approval of a license on the exporter or end-user meeting certain  conditions. For instance, a license condition might specify how an item  should be used or require that Commerce conduct a postshipment  verification check on the recipient of the item.
section_title: The VEU Program Allows Export of Some Semiconductor Equipment and Materials to China without a License
paragraphs: The VEU program, announced by Commerce in June 2007, marks a shift to  a more end-user-based system of export controls for semiconductor  equipment and materials by allowing the export of some items to China  without a license. The VEU program operates in parallel to the existing  export control framework and is designed for “trusted” Chinese companies  with a long licensing history and a record of using U.S.-controlled items for  civilian end uses. Among the first five companies certified as validated end- users in October 2007, three are authorized to receive semiconductor  equipment or materials.
Prospective validated end-users, or others applying on their behalf, must  submit an application to Commerce that includes, among other things, a list  of items they wish to receive under the VEU authorization, the locations  where these items will be received, and a commitment to accept on-site  visits by U.S. government personnel. In evaluating applications,  Commerce conducts a four-part internal review that includes:  Compliance. Verifies whether the applicant has met all the regulatory  requirements specified in the EAR, confirms the applicant’s ownership  and organizational structure, reviews the candidate’s licensing and  compliance history, and assesses the candidate’s proposed compliance  plan.
Enforcement. Confirms whether information presented in the  candidate’s application materials is consistent with its licensing and  enforcement history and whether there is any adverse enforcement  information on the applicant.
Item and end use. Analyzes the items requested by the applicant and  their appropriateness given the stated end use and the company’s  business activities.
Intelligence. Vets parties to the application through the intelligence  community.
Once Commerce’s internal review has been completed, applications are  reviewed by an End-User Review Committee (ERC), which is comprised of  representatives from the Departments of Defense, Energy, and State  (generally the same agencies that review export license applications), and  other agencies as appropriate. In reviewing an end-user for eligibility, the  ERC considers a range of factors, such as the entity’s exclusive engagement  in civil end-use activities, its record of compliance with U.S. export  controls, its ability to meet the VEU program’s recordkeeping  requirements, its relationship with U.S. and foreign companies, and its  willingness to host on-site reviews by U.S. government personnel to ensure  program compliance. According to a Commerce official, applicants need to  demonstrate that they either have or will have the requisite controls and  data collection systems in place to ensure compliance with the terms of the  VEU program. Such controls would provide Commerce with a high degree  of confidence that on-site reviews will yield useful information. Validated  end-users should also have systems in place to demonstrate that items  imported under the VEU program are used for civilian purposes. For  example, validated end-users may have systems in place that are capable of  tracking customer orders so that Commerce can verify customer lists  during on-site reviews. Commerce allows VEU applicants the flexibility to  determine how they will demonstrate that they are capable of meeting  these internal control and recordkeeping requirements.
If necessary, the ERC also may request a preapproval visit to assess an  entity’s suitability for validated end-user status. According to officials from  Commerce, no preapproval visits were conducted for the first five Chinese  entities approved for validated end-user status because members of the  ERC were already familiar with the companies through their extensive  licensing history. A unanimous vote is required by the ERC to approve  validated end-user status or add items to an existing authorization.  Revocation of an authorization or removal of items from an existing  authorization is by majority rule. Disagreements among agencies on the  ERC are managed through a dispute resolution process similar to the  procedures used for export license applications. For a comparison of the  similarities and differences between a license and the VEU authorization,  see appendix IV.
section_title: The Individual Licensing System and VEU Program Use Different Approaches to Ensure That Equipment Exported to China Is Used as Intended
paragraphs: The individual licensing system and VEU program employ different  approaches to ensure that U.S. exports of semiconductor equipment and  materials to China are used as intended. Under the individual licensing  system, Commerce scrutinizes each individual application for the  appropriateness of the item and the end-user, often attaches conditions to  the license stipulating how an item may be used, and conducts  postshipment verification (PSV) checks. Under the VEU program,  Commerce ensures that items are used as intended by vetting validated  end-users, stipulating conditions to approved entities, and confirming  compliance with these conditions through periodic records checks and  discretionary on-site reviews.
Under the individual licensing system, most licenses for semiconductor  manufacturing equipment are issued with conditions that require the  recipient to abide by certain requirements. For example, a license  authorizing the export of semiconductor manufacturing equipment to a  Chinese entity might restrict the equipment to civilian end-uses or prohibit  the equipment from being used to produce integrated circuits with  components smaller than a certain feature size. Because U.S. exporters are  the licensees under this system, they are required to communicate the  specific license conditions to Chinese recipients or other parties to whom  the conditions may apply.
To verify compliance with license conditions and prevent the diversion of  equipment and materials to unauthorized end-users, the United States also  conducts PSV checks on a case-by-case basis in China. According to  Commerce officials, several criteria are used to determine which entities  will be subject to PSVs, including information on the exporter and end-user,  the sensitivity of the item, and the quantities in question. During PSV  checks, Commerce special agents or other U.S. government personnel visit  importers or end-users to confirm the use and location of the items listed  on the license. Commerce’s PSV guidelines require that the agent physically  inspect the items or the records that detail their disposition, verify that the  items are located at the specified facility, and confirm that the equipment is  being used for the purposes stated on the license. Agents also are  instructed to document cases where there are indications of impropriety or  whether the company’s answers to questions are evasive.
Before 2004, the United States was able to conduct only a limited number  of PSV checks on semiconductor equipment and materials in China  because the Chinese government restricted the number and scope of PSV  checks that it would allow. In 2004, the United States and China signed an  EUVU that established protocols for PSV checks and expanded the number  of checks that the United States would be allowed to conduct.  Nevertheless, PSV checks on semiconductor equipment and materials in  China remain limited. From fiscal years 2002 through 2007, Commerce  approved 1,466 licenses for the export of semiconductor equipment and  materials to China. Nine hundred-three, or about 62 percent, of these  licenses contained a condition requiring Commerce to conduct a PSV  check. Commerce restricted GAO from reporting the number of PSV  checks conducted in China overall and for semiconductor equipment and  materials in China, for the purposes of this report. Although this  information has previously been available in public sources, Commerce  asserted that publicly disclosing this data would give export violators or  potential violators, both in the United States and abroad, sensitive  information, including information revealing Commerce’s focus within  particular countries and on the kinds of items it checks most often.
In contrast, under the VEU program, Commerce intends to ensure that  semiconductor equipment and materials are used as intended by requiring  that validated end-users maintain a record of transactions, conducting  periodic reviews of recorded exports under the VEU authorization, and  undertaking discretionary on-site reviews to verify compliance with the  terms of the program. Unlike individual export licenses, validated end-user  status is awarded directly to entities in China, and these entities are  responsible for meeting the program’s requirements. The EAR requires that  all validated end-users legally certify that items obtained under the VEU  program will be used only at approved facilities and exclusively for civilian  end-uses. Furthermore, the advisory opinions issued by Commerce to  each validated end-user stipulate additional requirements that are similar  to license conditions. For example, advisory opinions may detail specific  recordkeeping, reporting, and customer screening requirements, or restrict  the type and technical parameters of semiconductors that can be  manufactured using equipment or materials shipped under the  authorization.
To ensure compliance with the terms of the VEU program as outlined in the  EAR and individual advisory opinions, the Commerce official responsible  for the VEU program stated that the department is already conducting or  plans to conduct three layers of reviews. First, Commerce is conducting  mandatory, semiannual reviews of each validated end-user. The  information for the review is obtained from a variety of sources including  public data, mandatory reporting by the validated end-user, and  assessments provided by the intelligence community and BIS’s  enforcement unit. Second, Commerce is conducting an additional review of  each validated end-user 6 months after it receives its first shipment under  the VEU program and for every 6 months going forward. This review  includes the same elements as the first review, but also includes an  examination of data obtained from the Census Bureau’s Automated Export  System and U.S. exporters on transactions under the VEU authorization.  Third, based on the results of these two reviews, the ERC may decide to  conduct an on-site review with the validated end-user. According to  Commerce, the procedures for on-site reviews will be determined on a  case-by-case basis, as dictated by the specific circumstances of the  validated end-user.
section_title: Challenges with VEU Program Implementation May Limit Commerce’s Ability to Ensure That Semiconductor Equipment and Materials Are Used as Intended
paragraphs: The VEU program has yet to produce the advantages anticipated by  Commerce, and challenges with program implementation may limit  Commerce’s ability to ensure that items shipped under the program are  being used as intended. Commerce has yet to realize trade gains and  enhanced national security because few U.S. exporters have taken  advantage of the VEU program. Moreover, Commerce has not reached a  VEU-specific agreement with the Chinese government for conducting on- site reviews of validated end-users, a key mechanism for ensuring program  compliance. Instead, as a stopgap measure, Commerce is attempting to  conduct VEU on-site reviews under a 2004 agreement. Commerce also  lacks procedures for selecting and conducting on-site reviews, though it  introduced the VEU program in June 2007.
subsections: section_title: Anticipated Advantages Have Not Yet Been Fully Realized Due to Limited Use of the VEU Program
paragraphs: Commerce anticipated that one of the advantages of the VEU program is  that it would facilitate trade in controlled items to China by removing  licensing requirements for the export of certain items to “trusted” Chinese  customers with a history of using exports responsibly. According to  Commerce, the program would foster trade by reducing the administrative  burden associated with seeking an export license for U.S. exporters and  enabling validated end-users to obtain items more easily than their  domestic competitors. Two companies that received validated end-user  authorization stated that the program facilitates long-term planning by  eliminating some of the uncertainties associated with obtaining an export  license from the U.S. government and other administrative requirements.  Additionally, the program allows validated end-users to obtain certain  equipment from U.S. companies without having to rely on the exporter to  obtain a license, according to a validated end-user.
Commerce also anticipated that the VEU program would reduce the  volume of licenses required for transactions involving known end-users. In  turn, this would enable Commerce to dedicate more resources to  transactions and end-users that are less well known, and thus enhance  security. However, according to the Director of Commerce’s Office of  Technology Evaluation, the department has a finite amount of resources  and an increasing number of export licenses to process from year to year.  Thus, he noted that it is unclear whether a potential reduction in licensing  volume resulting from increased shipments under the VEU program would  allow Commerce to increase scrutiny over lesser-known end-users or  merely enable Commerce to maintain current levels of oversight. In  addition, although Commerce anticipated that one of the program’s  benefits would be to increase scrutiny over lesser known end-users,  according to the Chairperson of the ERC, it was unclear whether increased  shipments under the VEU program would coincide with additional PSV  checks for end-users that receive items under individual export licenses  due to the multiple considerations involved in scheduling and carrying out  PSV checks.
The advantages of the VEU program anticipated by Commerce have not yet  been realized because few U.S. exporters have shipped items to China  under the authorization. Commerce’s ability to realize the anticipated  benefits of the VEU program hinges on whether or not exporters choose to  use the VEU authorization rather than an individual license. Recognizing  the high volume and dollar value of U.S. exports to certain companies in  China, Commerce designed the VEU program with the goal of reducing the  number of licenses to these types of companies. For instance, according to  Commerce, the first five companies designated as validated end-users  accounted for 18 percent of the value of licensed trade with China in 2006.  Commerce anticipates that approval of a second set of five companies  could increase that number to 40 percent. However, as of June 2008, only  one of the three validated end-users authorized to receive semiconductor  equipment and materials had received any items under the program.   Furthermore, according to Commerce, since the first validated end-users  were authorized in October 2007, approximately 6 percent of the total  exports of semiconductor manufacturing equipment to China have taken  place under the VEU program, whereas 94 percent were conducted under  an export license. In addition, according to the Chairperson of the ERC,  since the VEU program was authorized, three licenses were issued for  items that could have been shipped under the VEU program.
Company officials that received validated end-user status offered several  reasons for not yet fully using the authorization. One company official  stated that they were upgrading their administrative systems and planned  to switch from their Special Comprehensive License to the VEU program in  the fall of 2008. Another validated end-user cited a global economic  slowdown in their industry as a reason for not taking advantage of the VEU  program. Finally, another company official with validated end-user status  noted that some of its suppliers have elected to use existing individual or  special comprehensive licenses to avoid the administrative burden and  time requirements associated with obtaining an additional End-User  Statement from the Chinese government, as recently requested by  Commerce. The EAR does not require that validated end-users obtain End- User Statements for shipments received under the authorization.  However, in April 2008, Commerce requested that the first five validated  end-users seek End-User Statements from the Chinese government to  facilitate on-site reviews.
section_title: Challenges with VEU Implementation May Limit Commerce’s Ability to Conduct On-site Reviews
paragraphs: Commerce may not be able to ensure that semiconductor equipment and  materials exported to China are used as intended because it has not  negotiated a VEU-specific agreement with the Chinese government for  conducting on-site reviews under the VEU program and lacks specific  procedures for carrying out these reviews. On-site reviews are not a  mandatory program requirement; rather, they are discretionary based on  an assessment of each validated end-user by the ERC. Commerce has  stated though that on-site reviews are a key mechanism for ensuring that  validated end-users comply with the terms of the authorization and that the  ability to conduct meaningful on-site reviews will be a critical factor in  Commerce’s long-term support of the program.
However, Commerce may be limited in its ability to conduct on-site reviews  of validated end-users because it has not negotiated a VEU-specific  agreement with the Chinese government for conducting these reviews. In  October 2007, the Chinese Ministry of Commerce announced that Chinese  entities were prohibited from hosting foreign governments, including the  U.S. government, for interviews or investigations related to export controls  without its permission. The Chinese government has also asked that  Commerce refrain from approving any new, additional validated end-users  until the two sides can agree on terms for conducting on-site reviews of  validated end-users. A senior official from the Chinese Ministry of  Commerce stated to us during a March 2008 meeting that the Ministry  wants on-site reviews to be conducted either according to the terms of the  2004 EUVU, or under a newly negotiated U.S.-China agreement specific to  the VEU program. In the absence of a new agreement specific to the VEU  program, Commerce has requested to conduct one on-site review pursuant  to the terms of the 2004 EUVU as a stopgap measure. However, to conduct  on-site reviews under the 2004 agreement, Commerce relies on the  voluntary compliance of validated end-users to obtain End-User  Statements from the Chinese Ministry of Commerce, as this requirement  was not included in the regulations establishing the VEU program.  According to Commerce, Chinese officials were receptive to its request for  an on-site review, but MOFCOM and Commerce have agreed to postpone  the check under the existing EUVU mechanism, as negotiations on the  VEU-specific protocol are still in progress.
Commerce’s ability to ensure that items shipped under the VEU program  are being used as intended is further limited by a lack of procedures for  selecting and conducting the on-site reviews. Commerce officials stated  that criteria that could be considered for on-site review selection include  the volume of items shipped, the geographic location of the validated end- user, the civil or military utility of the authorized items, foreign or U.S.  company ownership, the facility’s licensing history, and intelligence  reporting. In April 2008, 10 months after Commerce approved the VEU  program, draft procedures for selecting end-users for on-site reviews were  disseminated to ERC members. However, as of September 2008,  interagency agreement on these procedures had not been reached.  Moreover, Commerce has not developed procedures for conducting on-site  reviews. During our field work in March 2008 in China, Commerce’s export  control officer in Beijing noted that it was unclear how on-site reviews  would be conducted because she was unaware of procedures governing  them. Thus, even if the Chinese Ministry of Commerce grants permission to  conduct an on-site review, it is unclear how the review would be conducted  in the absence of any final procedures. Commerce asserted that it plans to  develop on-site review procedures on a case-by-case basis to ensure that  each on-site review is tailored to a particular validated end-user.
section_title: Agency Actions to Address Prior GAO Recommendations
paragraphs: We assessed progress that the Departments of Commerce and Defense  have made to address the recommendations from our 2002 report. In 2002,  we recommended that Commerce and DOD conduct a foreign availability  assessment to determine if semiconductor equipment and materials of  comparable quality are available in quantities that would render U.S. export  controls on these items ineffective. We also recommended that Commerce  and DOD assess the cumulative effects that exports of semiconductor  equipment and materials to China have had on the U.S. economy and  national security. Although Commerce and DOD have not formally  assessed the foreign availability of semiconductor equipment and  materials, Commerce has taken some steps to meet the intent of our  recommendation by using information on foreign availability to inform  export controls and make licensing decisions for these items. Neither  Commerce nor DOD has conducted assessments on the cumulative effect  of U.S. semiconductor-related exports to China.
subsections: section_title: Commerce Evaluates Foreign Availability When Assessing Controls and Making Licensing Decisions
paragraphs: Commerce and DOD have not conducted a formal foreign availability  assessment for semiconductor manufacturing equipment and materials,  but Commerce does use the information on foreign availability that it  obtains from other sources to inform export controls and licensing  decisions for these items, and thus met the intent of our recommendation.  Commerce stated that the key reason for not conducting a foreign  availability assessment of semiconductor manufacturing equipment and  materials is that semiconductor equipment manufacturers have not  requested one. Commerce also noted that there is substantial public  information on foreign availability of semiconductor manufacturing  equipment and materials in China. In response to our prior  recommendation, Commerce noted that, while the EAR allows the U.S.  government to initiate a foreign availability assessment, this provision is  intended primarily to be used by industry to challenge overly restrictive or  ineffective export controls.
In recent years, semiconductor equipment manufacturers have not  requested Commerce to conduct a foreign availability assessment because  the assessments require a significant amount of effort, and previous efforts  have not resulted in the decontrol of any equipment. For instance, SEMI  indicated that it submitted, for the United States to discuss at Wassenaar, a  number of proposals to decontrol items, which were unsuccessful.  Furthermore, SEMI indicated that the scope of the issue regarding controls  over semiconductor manufacturing equipment is too large for them to  undertake without a serious commitment from the U.S. government.
Commerce has taken steps to address our 2002 recommendation, however,  by evaluating foreign availability when assessing export controls and  making licensing decisions related to semiconductor manufacturing  equipment and materials. Information provided by a number of sources— including technical advisory groups, the public, and reviews of license  applications—informs both export controls and licensing decisions. For  example, Commerce receives information about foreign availability from  its technical advisory committee and uses this information to develop  proposals during multilateral discussions and for Commerce Control List  reviews. The proposals could result in the addition or elimination of a  control. For example, according to Commerce, a number of adjustments or  liberalizations to controls for semiconductor manufacturing equipment and  materials have occurred as a result of this input.
Commerce also seeks information regarding foreign availability from the  public. For example, during the development of the China military end-use  rule, Commerce originally planned to control 47 items. Commerce  published a notice in the Federal Register seeking information, including  whether or not the items they were seeking to control were available in  foreign markets. In response to the feedback it received and analysis it  conducted, Commerce reduced the list of items controlled from 47 to 31.  Included among the items were several types of lower-level semiconductor  manufacturing equipment that Commerce determined were available from  sources outside Wassenaar.
Commerce also noted that, as China has emerged as a significant  semiconductor manufacturer over the past decade, U.S. export control  officials have become knowledgeable about different “players” in China as  well as the various sources of supply for controlled semiconductor  manufacturing equipment. According to Commerce, officials incorporate  this information into the licensing review process. Commerce also stated  that a formal foreign availability study would reveal limited additional  information that Commerce does not already have access to through  existing sources.
We believe that Commerce’s efforts are sufficient to address our 2002  recommendation. Although Commerce has not conducted a formal foreign  availability study to determine whether there are comparable foreign  sources of semiconductor equipment and materials, it has used other  sources—including technical advisory committees, end-use visits, past  licensing history, and the public—to obtain similar information. Provided  that Commerce continues to be able to access this information, we do not  believe that an additional foreign availability study is necessary at this time.
section_title: Commerce and DOD Have Not Conducted Studies on the Effects of Semiconductor Manufacturing Equipment Transfers to China
paragraphs: Neither Commerce nor DOD have addressed our recommendation to  conduct assessments on the economic and security effects of U.S.  semiconductor manufacturing equipment exports to China. In September  2006, Commerce established the Office of Technology Evaluation (OTE) to  help gauge the effectiveness of U.S. export controls by conducting studies  on the cumulative effects of transfer of certain key technologies, among  other studies. In its Fiscal Year 2006 Annual Report, Commerce announced  that it planned to conduct two studies related to the semiconductor and  semiconductor manufacturing equipment industries. First, Commerce  stated that it planned to conduct an industrial base assessment on U.S.  integrated circuit design and manufacturing capability. According to the  Director of OTE, Commerce has initiated this study, and it is nearing  completion. Second, Commerce announced plans to conduct an evaluation  of the health and competitiveness of U.S. industry engaged in developing  critical semiconductor manufacturing equipment technology. However,  OTE decided not to conduct the evaluation; according to the former  Director of the Office of National Security and Technology Transfer  Controls, BIS discussed the possible study with representatives from the  semiconductor manufacturing equipment industry, and they collectively  decided that it was not needed.
We also noted in 2002 that Directive 2040.2 required DOD to “assess  annually the total effect of transfers of technology, goods, services, and  munitions on U.S. security regardless of the transfer mechanisms  involved.” However, the directive had not been updated since July 5, 1985,  and no such studies had been completed since the issuance of the original  directive. In July 2008, DOD released a revised “instruction” that addresses  the need for cumulative effects studies but eliminates the specific  requirement to do a study and the annual requirement. The instruction  instead calls for the Director of the Defense Intelligence Agency to provide  intelligence concerning the total effect of transfers of dual-use and defense- related technology, articles, and services on U.S. security. However, no  such studies have been completed to date, and the impact of exports of  semiconductor manufacturing equipment on U.S. national security thus  remains unclear.
section_title: Conclusions
paragraphs: U.S. export control policy aims to balance two competing interests— promoting trade to civilian end-users and denying trade in sensitive  technologies to end-users engaged in activities detrimental to national  security interests. The migration of commercial semiconductor production  to China and continued advances in China’s domestic manufacturing  capabilities illustrate the challenges inherent in meeting these dual goals.  Integrated circuits, for example, are not only inputs to consumer products  but are often used in weapons systems. Although the VEU program is  aimed at facilitating trade, Commerce built in various “safeguards” to  ensure that items are used as intended and not to enhance military  capabilities. Although the companies authorized under the VEU program  have a long history of using exports responsibly, Commerce included a  requirement for end-users to commit to accept on-site reviews to ensure  that items are used as intended and indicated that the ability to conduct  these reviews is a critical factor in its long-term support of the program.
Commerce, however, established the VEU program in June 2007 and  authorized the first five companies in October 2007, without negotiating a  VEU-specific agreement or amending the 2004 EUVU with China to  conduct the reviews. Additionally, Commerce instituted the program  without some basic mechanisms to ensure compliance with program  requirements, including criteria for selecting on-site reviews and the  procedures for conducting them. As a result, Commerce now relies on the  EUVU procedures, which require an End-User Statement, burdening  validated end-users and hindering trade facilitation. Additionally, if  validated end-users do not voluntarily seek an End-User Statement,  Commerce may not conduct on-site reviews and therefore will not be able  to provide assurance that exported items are being used as intended.
section_title: Recommendations
paragraphs: To better promote the Validated End-User program’s objective of trade  facilitation and enhanced oversight, the Secretary of Commerce should  suspend the Validated End-User program to China until a VEU-specific  agreement and procedures are established for on-site reviews. Specifically,  Commerce should (1) negotiate a VEU-specific agreement with the Chinese  government to conduct on-site reviews or amend the 2004 EUVU to include  the Validated End-User program, and (2) develop procedures for  conducting on-site reviews that are applicable to all validated end-users.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to the Departments of Commerce,  Defense, Energy, and State for their review and comment.  Commerce  provided written comments, which are reprinted in appendix V.  Defense  and State did not provide comments.  Commerce and Energy’s National  Nuclear Security Administration also provided technical comments, which  we incorporated as appropriate throughout this report.
Commerce disagreed with our recommendations, stating that the report’s  premise— that the VEU program has no adequate mechanism to oversee  exports of semiconductor equipment to China—is incorrect.  Commerce  stated that on-site reviews could be conducted under the 2004 EUVU or a  VEU-specific addendum to the EUVU, which it is currently negotiating with  the Chinese government. Commerce also asserted that procedures for  selecting on-site reviews exist, that general procedures for end-use checks  are in place, and that specific guidance for on-site reviews must be  developed on a case-by-case basis.
We have modified the report to acknowledge that Commerce intends to use  a stopgap mechanism, the 2004 EUVU, which may enable it to conduct on- site reviews for items exported under the VEU program to China. However,  this agreement requires companies to obtain an End-User Statement from  the Chinese government.  This statement is not required under the VEU  program and thus imposes an additional burden on validated end-users,  running counter to the trade-facilitating objectives of the program.  To  achieve the intended benefits of the VEU program, Commerce needs to  negotiate a VEU-specific agreement or amend the 2004 EUVU to  accommodate the distinct features of the VEU program.  We disagree with  Commerce’s assertion that it has sufficient procedures for selecting on-site  reviews and conducting end-use checks.  Commerce has consistently  stated that on-site reviews for validated end-users and end-use checks for  individual licenses are distinct activities serving different purposes.  End- use checks focus on ensuring that an item is being used for the purposes  stated in the license, whereas on-site reviews are more comprehensive.  Additionally, the procedures for selecting validated end-users for on-site  reviews are still in draft form as of September 2008, and have not been  cleared by the interagency process as Commerce implied in its comments.   Commerce would not provide us with a copy of these draft procedures.   Finally, we agree that Commerce needs additional case-by-case guidance  for on-site reviews to ensure that each review is tailored to the particular  validated end-user. However, the department also needs general  procedures to ensure that on-site reviews are conducted in a consistent  manner.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no distribution until 30 days from the report  date. At that time, we will send copies of this report to interested  congressional committees.  We will also make copies available to others  upon request. In addition, this report will be available at no charge on the  GAO Web site at http://www.gao.gov.
If you or your staffs have any questions about this report, please contact  me at (202) 512-8979 or christoffj@gao.gov. Contact points for our Offices  of Congressional Relations and Public Affairs may be found on the last  page of this report.  GAO staff who made major contributions to this report  are listed in appendix VI.
section_title: Objectives, Scope, and Methodology
paragraphs: This report discusses the (1) evolution of China’s semiconductor  manufacturing capabilities since 2002, (2) changes to U.S. export control  policies over the sale of semiconductor manufacturing equipment and  materials to China since 2002, and (3) the advantages and limitations of  these changes to U.S. export controls. In addition, this report describes  progress the Departments of Commerce and Defense have made to address  our prior recommendations.
To describe how China’s semiconductor manufacturing capabilities have  evolved since 2002, we reviewed available literature; interviewed  government officials, industry representatives, and academics; and  reviewed information from the U.S. and Chinese semiconductor and  semiconductor equipment and materials industries. We also traveled to  China and met with companies involved in manufacturing semiconductors.  We met with officials from the U.S. Departments of Commerce  (Commerce), Defense (DOD), Energy (DOE), and State (State), as well as  members of the intelligence community. We also visited three DOE  National Laboratories, including Lawrence Livermore in Livermore,  California; Kansas City in Kansas City, Missouri; and Sandia in  Albuquerque, New Mexico. We interviewed representatives from two U.S.  semiconductor manufacturing companies—IBM and Intel. We met with  officials from the Semiconductor Equipment and Materials International  (SEMI) and Semiconductor Industry Association— the trade associations  representing each industry—in San Jose, California; Washington, D.C.; and  Shanghai, China. We also interviewed academics with expertise in China’s  semiconductor industry and semiconductor manufacturing at the  University of Maryland’s Center for Advanced Life Cycle Engineering and  the University of California, Berkeley’s Microfabrication Laboratory. We  obtained trade reports on China’s semiconductor and semiconductor  manufacturing equipment industries from SEMI and met with the reports’  authors in Shanghai, China, to discuss their methods and findings. We  determined that the data collected and analyses conducted were  sufficiently reliable for our use in this report. In addition, we visited three  companies—Applied Materials China, Hua Hong NEC, and Semiconductor  Manufacturing International Corporation—that are involved in  manufacturing semiconductors in China and have received semiconductor  manufacturing equipment and materials from U.S. exporters under export  licenses and the Validated End-User authorization. We also attended  SEMICON China—a semiconductor industry trade show with more than  900 U.S., Chinese, and other foreign companies represented. During  SEMICON China, we met with an indigenous Chinese semiconductor  equipment manufacturer, Advanced Micro-Fabrication Equipment, Inc.,  and obtained information from two other indigenous equipment  manufacturers—Beijing Seven Star HuaChuang Electronics Company,  Limited, and North Microelectronics Company, Limited.
To describe changes to U.S. policies and practices for the export of  semiconductor equipment and materials to China since 2002, we reviewed  the relevant statutes, regulations, Presidential and DOD Directives and  DOD Instruction pertaining to export controls to China and interviewed  officials from the Departments of Commerce, DOD, DOE, and State. We  also interviewed representatives of semiconductor and semiconductor  equipment companies—including Applied Materials, IBM and Intel in the  United States, and Applied Materials China, Hua Hong NEC, and  Semiconductor Manufacturing International Corporation in China—that  received controlled items under U.S. export licenses and the Validated End- User authorization. We analyzed export licensing data provided by  Commerce to describe the number of licenses approved for semiconductor  equipment and materials to China, as well as the number of licenses  containing the requirement to conduct postshipment verification (PSV)  checks, from fiscal years 2002 through 2007. We determined that these data  were sufficiently reliable for the purposes for which they are presented in  this report. We also reviewed reports provided by Commerce on the  number and outcomes of end-use checks, including prelicense and PSV  checks in China. Although Commerce provided GAO with data on end-use  checks, it restricted us from publicly reporting the number and outcomes  of PSV checks conducted in China on shipments of semiconductor  equipment and materials. According to Commerce, publicly disclosing this  data would give export violators or potential violators, both in the United  States and abroad, sensitive information, including information revealing  Commerce’s Bureau of Information and Security’s (BIS) focus within  particular countries and on the kinds of items the BIS checks most often.
To assess the advantages and limitations associated with changes to U.S.  export control policies and practices, we reviewed the regulations,  guidelines, and procedures governing export licenses and the VEU  program. We also interviewed U.S. government officials in the United  States and China, including Commerce’s export control officers in Beijing  and Hong Kong responsible for conducting end-use checks. We interviewed  representatives from Applied Materials China, Hua Hong NEC, and  Semiconductor Manufacturing International Corporation, three of the five  companies that received the validated end-user authorization and the only  entities that are permitted to receive semiconductor equipment and  materials under the authorization. Additionally, we met with and  interviewed officials from China’s Ministry of Commerce in Beijing, China.
Finally, to determine whether or not DOD and Commerce addressed our  2002 recommendations to conduct assessments related to foreign  availability and the cumulative effects of semiconductor manufacturing  equipment exports on U.S. national security, we interviewed officials from  both agencies, and reviewed regulations, directives, and an instruction, as  well as documentation related to conducting these activities. We also  discussed the topic of foreign availability with industry representatives  including SEMI, Applied Materials, and Intel to ascertain if foreign  availability continues to be a concern, as it was in 2002.
We conducted this performance audit from October 2007 to September  2008, in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
section_title: Semiconductor Manufacturing Equipment and Materials Requiring an Export License to China
paragraphs: Ion implantation equipment Used for radiation-hardened circuitry and state-of-the-art  Needed for all state-of-the-art commercial and military  electronics.  Enables the production of controlled analog-to- digital converters (ADCs), field programmable logic devices  (FPLDs), and application specific circuits (ASICs).
Needed for all state-of-the-art commercial and military  electronics.  Enables the production of controlled analog-to- digital converters (ADCs), field programmable logic devices  (FPLDs), and application specific circuits (ASICs).
Needed for all state-of-the-art commercial and military  electronics.  Enables the production of controlled analog-to- digital converters (ADCs), field programmable logic devices  (FPLDs), and application specific circuits (ASICs).
Needed for all state-of-the-art commercial and military  electronics.  Enables the production of controlled analog-to- digital converters (ADCs), field programmable logic devices  (FPLDs), and application specific circuits (ASICs).
Imprint lithography systems Needed for all state-of-the-art commercial and military  electronics.  Enables the production of controlled analog-to- digital converters (ADCs), field programmable logic devices  (FPLDs), and application specific circuits (ASICs).
Needed for all state-of-the-art commercial and military  electronics.  Enables the production of controlled analog-to- digital converters (ADCs), field programmable logic devices  (FPLDs), and application specific circuits (ASICs).
Needed for all state-of-the-art commercial and military  electronics.  Enables the production of controlled analog-to- digital converters (ADCs), field programmable logic devices  (FPLDs), and application specific circuits (ASICs).
Needed for all state-of-the-art commercial and military  electronics.  Enables the production of controlled analog-to- digital converters (ADCs), field programmable logic devices  (FPLDs), and application specific circuits (ASICs).
Needed for all state-of-the-art commercial and military  electronics.  Enables the production of controlled analog-to- digital converters (ADCs), field programmable logic devices  (FPLDs), and application specific circuits (ASICs).
Needed for all state-of-the-art commercial and military  electronics.  Enables the production of controlled analog-to- digital converters (ADCs), field programmable logic devices  (FPLDs), and application specific circuits (ASICs).
Needed for all state-of-the-art commercial and military  electronics.  Enables the production of controlled analog-to- digital converters (ADCs), field programmable logic devices  (FPLDs), and application specific circuits (ASICs).
Needed for all state-of-the-art commercial and military  electronics.  Enable the production of controlled analog-to-digital  converters (ADCs), field programmable logic devices (FPLDs),  and application specific circuits (ASICs).  These end items are  controlled under the Export Administration Regulations in ECCN  3A001 and ECCN 3A101, or under the International Traffic in  Arms Regulations Category XI.
Europe, Japan, United  States Commerce Control List, Category Three – Electronics. 15 C.F.R. Supplement No. 1 to Part 774.
MOCVD - metal organic chemical vapor deposition reactors.
MBE – molecular beam epitaxy euipment.
section_title: Comparison of Individual and Special Comprehensive Licenses, and Validated End- User Authorization
paragraphs: Individual Validated License  (IVL)
Special Comprehensive License  (SCL)
An export license authorizing a  transaction or series of  transactions between a single  exporter and recipient.
An export license authorizing multiple  exports and re-exports between a  single exporter and recipient, without  review and approval of each  transaction.
An authorization that permits the  export, re-export, and transfer to  validated end-users of any  eligible items that will be used in  a specific, eligible destination.
Generally 2 years.
4 years; may be extended for an  additional 4 years.
VEU authorizations are valid in  perpetuity unless revoked.
Representatives of the  Departments of Commerce,  Defense, State, and Energy  review each license unless a  reviewing agency has delegated  its reviewing authority back to  Commerce.
Same as IVL.
A committee of representatives  from the Departments of State,  Defense, Energy, Commerce,  and other agencies, as  appropriate, approves the VEU  authorization.
Dispute resolution process  Yes, any agency that disagrees  with a licensing decision may  escalate a case.
Yes, any agency that disagrees with a  licensing decision may escalate a  case.
Yes, any agency that disagrees  with a VEU authorization  decision may escalate a case.
For items controlled for national  security reasons, type and  quantity of the item; intended  end-use of the item (military or  civilian); foreign availability; and  destination country.
Proposed end-use and end-users;  past licensing history; evidence of  continuous large volume of exports;  and compliance with U.S. export  controls.
Involvement only in civilian  activities; previous compliance  with U.S. export controls;  agreement to “preapproval” visit  and on-site reviews; and ability to  comply with program  requirements.
Commerce may place conditions  on the use of an IVL.
Commerce may place conditions on  the use of an SCL.
Commerce may specify  conditions on the use of VEU  authorization.
Formal internal control program  not required.
Internal control programs are  required for the exporter and  consignee.
Although a formal internal control  plan is not required, the applicant  must describe the system that is  in place to ensure compliance  with VEU requirements.
Individual Validated License  (IVL)
Special Comprehensive License  (SCL)
IVL holders generally are  required to retain all records  supporting their license  applications for 5 years.
SCLs include record-keeping  requirements for SCL holders and  consignees.
IVL holders have no reporting  requirements unless imposed by  a particular license. However, the  records of their exports are  subject to inspection at  Commerce’s request.
SCL holders must report semi- annually exports of certain items  controlled multilaterally under the  Wassenaar Arrangement. In addition,  the records of their exports are  subject to inspection at Commerce’s  request.
Re-exporters are required to  submit semi-annual reports to  Commerce, and exports under  the VEU program of certain items  controlled multilaterally under the  Wassenaar Arrangement must  be reported semi-annually.   Exporters and validated end- users are required to retain  records but do not have reporting  requirements unless otherwise  specified by Commerce.
Yes, end-use visits may be  conducted under a 2004  agreement between the United  States and China.
Yes, end-use visits may be conducted  under a 2004 agreement between the  United States and China.
Validated end-users agree to  host on-site reviews. Commerce  plans to conduct these reviews  under a 2004 agreement  between the United States and  China until an addendum to this  agreement or a new, VEU- specific agreement is reached.
Not all factors considering in granting a license or validated end-users are included here. Among the  other factors considered in granting a license or VEU status are those included in 15 C.F.R. §  742.4(b)() (licenses for national security items), 15 C.F.R. § 75.2(d) (Special Comprehensive  Licenses), and 15 C.F.R. § 74.15(a)(2) (Validated End-Users).
section_title: Comments from the Department of Commerce
paragraphs: The following are GAO’s comments on the Department of Commerce’s  letter dated September 5, 2008.
subsections: section_title: GAO Comments
paragraphs: 1. We have modified our draft report to indicate that Commerce intends to  use the 2004 End Use Visit Understanding (EUVU) as a stopgap  measure to conduct on-site reviews under the VEU program. However,  as we note in the following comment, this stopgap measure imposes an  additional burden on VEU-authorized companies. Moreover, the  Chinese government has not always agreed with this approach. In 2007,  China’s Ministry of Commerce issued a decree prohibiting Chinese  entities from accepting on-site reviews conducted by foreign  government personnel without its permission.  The Chinese  government also requested that the United States refrain from  approving any new validated end-users until the two countries agreed  on the terms for conducting these reviews.   2. We understand that the intent of the VEU program is to enhance and  facilitate trade between the United States and China.  Our report notes  that the VEU program would foster trade by reducing the  administrative burden associated with seeking an export license for  U.S. exporters and enabling VEU-authorized entities to obtain items  more easily than their domestic competitors.  Commerce asserted that  it can use the EUVU procedures for inspecting shipments made under  the VEU program, but it can only do so by requesting validated end- users to voluntarily obtain End-User Statements from the Chinese  government.  Such statements are required for all exports of controlled  items to China under individual export licenses that exceed $50,000.   However, these statements were not required under the VEU program  and impose an additional burden on VEU-authorized companies.  Commerce notes that the procedures for obtaining these statements  are cumbersome and conflict with the trade facilitating objective of the  VEU program. Until VEU negotiations with the Chinese government are  completed, the trade-enhancing benefits of the program may not be  realized.  3. We disagree with Commerce’s assertion that general procedures for  selecting and conducting on-site reviews do exist. First, as noted in this  report, the procedures for selecting which validated end-users will  receive on-site reviews are still in draft form as of September 2008 and  have not been cleared by the interagency process. Commerce would  not provide us with a copy of these draft procedures.  Second,  Commerce’s general procedures for conducting end-use checks are not  specific to the VEU program. Instead, they were designed for pre- license and postshipment verification checks of items shipped under  individual export licenses. End-use checks focus on ensuring that an  item is being used for the purposes stated in the license, whereas on- site reviews are more comprehensive.  In the course of our work,  Commerce repeatedly asserted that end-use checks for individual  licenses and on-site reviews under the VEU program are distinct  activities that serve different purposes. Finally, we agree that  Commerce needs additional case-by-case guidance for on-site reviews  to ensure that the review is tailored to a particular validated end-user.  However, the department also needs general procedures to ensure that  on-site reviews are conducted in a consistent manner.  4. Commerce’s comment is perplexing since the department appears to be  contending that semiconductors do not provide the United States with  a strategic military advantage. As evidence, Commerce notes that  semiconductors are included on the Wassenaar Arrangement Basic List,  rather than its Sensitive or Very Sensitive List. However, Commerce  understates the military significance of items on Wassenaar’s Basic List.  According to Wassenaar’s Basic List criteria, items to be controlled are  those which are “major or key elements for the indigenous production,  use, or enhancement of military capabilities.” Furthermore,  semiconductor manufacturing equipment is not only controlled on the  Basic List. One of the first validated end-users was authorized to  receive metal organic chemical vapor deposition reactors (MOCVD), an  item included on Wassenaar’s Sensitive List, under the VEU program in  China.  This equipment may be used to produce radiation-hardened  electronics, for use in commercial and military applications.      5. Commerce noted that we needed to make clear that the report  describes the capabilities of companies in China rather than those of  the government.  We agree and have made changes to the report to  reflect this distinction. 6. We have revised the report to clarify that, before the introduction of the  VEU program in 2007, export licenses provided the only mechanism by  which U.S. companies could ship most advanced semiconductor  manufacturing equipment and materials to China.  We also note that  since the introduction of the VEU program, the majority of  semiconductor manufacturing equipment exported to China continues  to be made under individual export licenses. We added export data to  the report showing that, according to Commerce, during the first 9  months of the VEU program, 94 percent of the total exports of  semiconductor manufacturing equipment to China were approved  under individual or special comprehensive licenses while 6 percent  were authorized under the VEU program. 7. We used the term “trusted” entities because Commerce officials used  the same language in discussions with us to describe companies that  would be approved as validated end-users. Moreover, Commerce has  used the ‘trusted” term in public statements describing the program,  including as recently as April, 2008, in testimony before Congress.   8. We have revised our reference to Chinese companies and now refer to  these companies as companies or entities in China.
section_title: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Anthony Moran, Assistant  Director; Nabajyoti Barkakati; Lynn Cothern; Julie Hirshen; Drew Lindsey;  Grace Lui; and Mark Speight made key contributions to this report. David  Dornisch, Etana Finkler, and Minette Richardson also provided assistance.