Export Controls: U.S. Agencies Need to Assess Control List Reform's Impact on Compliance Activities
Released: 2012-04-23T00:00:00


Highlights: section_title: Why GAO Did This Study
paragraphs: To protect its national security and commercial interests, the United States has implemented an export control system to limit sensitive technologies from falling into the wrong hands. The Department of State regulates U.S. defense exports and the Department of Commerce regulates dual-use exports that have commercial and military applications. Each agency uses a separate control list of items that may require a license to export. Agencies use compliance activities to prevent the diversion or misuse of exported items against U.S. interests or allies. Misuse can occur through illicit transshipment, the diversion of items from their origin through an intermediary country to an unauthorized destination. In 2010, the President announced reforms to the export control system.

This review examines (1) agencies’ compliance activities to address transshipment risk and (2) the extent to which U.S. agencies assessed the impact of export control reforms on the resource needs for compliance activities. GAO analyzed U.S. licensing data for 13 transshipment countries and visited Hong Kong, Singapore, and the United Arab Emirates.

section_title: What GAO Found
paragraphs: U.S. agencies engaged in export controls use various compliance activities to prevent the diversion or misuse of exported items against U.S. interests or allies and reduce illicit transshipment risk. Compliance activities include (1) vetting transactions prior to export, (2) analyzing shipping data and monitoring the end use of items, and (3) educating companies and foreign governments about illicit transshipment risks. To vet transactions, agencies review license applications for the export of controlled items, consult multiple lists of entities known or suspected of violating export control laws or regulations, and screen foreign end users to determine their eligibility to receive items without a license. Agencies also review shipping records to identify patterns of abuse and to plan end-use checks—visiting foreign companies to verify the approved use and location of exported items on both licensed items and those eligible for export without a license. From 2008 to 2010, Commerce conducted 56 percent of its end-use checks on unlicensed exports. In the 13 transshipment countries, unlicensed exports accounted for about 94 percent of unfavorable end-use check determinations, which indicates that the end use or end user of an export were not appropriate. For example, some unlicensed items transshipped illicitly to Iran through Hong Kong were used to build improvised explosive devices used against Coalition troops in Iraq. When an unfavorable determination is made, the Department of Commerce (Commerce) or Department of State (State) may take further action, such as denying a license or referring involved entities to enforcement agencies for investigation and possible penalties. To educate U.S. companies and foreign governments about illicit transshipment risks, Commerce and State review the internal controls of companies’ compliance programs; conduct outreach to U.S. companies to inform exporters of their responsibilities to comply with export control laws and regulations; and provide training to foreign governments.

Agencies have not fully assessed the potential impact that control list reforms may pose for the resource needs of their compliance activities. Agencies estimate that Commerce will receive between 16,000 and 30,000 additional license applications as a result of proposed reforms to move less sensitive items from State to Commerce. Agency documents state that this step would allow them to focus resources on items most critical to national security and may make compliance easier for exporters because Commerce imposes fewer requirements than State’s controls. However, Commerce has not assessed the impact this added responsibility would have on its end-use check resource needs. Also, under the reforms, fewer items may require export licenses, thereby reducing uncertainty as to whether export sales will be approved. Some agency officials suggested potential risks, such as an increased need for more end-use checks and the loss of information from reviewing exports through the licensing process prior to export. The agencies have not yet assessed the impact of these potential risks on their resource needs.

section_title: What GAO Recommends
paragraphs: GAO recommends that Commerce and State should assess the potential impact of control list reforms on the resource needs of their compliance activities. Commerce and State concurred with GAO’s recommendation.

section_title: Letter
paragraphs: To further its national security and economic interests, the United States  controls the export of sensitive defense and dual-use items (having both  commercial and military applications) to foreign governments and  commercial entities. Such items can range from sophisticated technology  designed for military use, such as F-15 aircraft, to unsophisticated and  commonly available electronic switches that have ultimately been used in  improvised explosive devices by terrorists in Iraq and Afghanistan. The  U.S. government seeks to limit the risk of sensitive items falling into the  wrong hands, while allowing legitimate trade to occur and uses the export  control system to balance these U.S. interests. Multiple federal agencies  administer the laws, regulations, and processes that make up the  regulatory compliance and enforcement framework governing the export  control system. Primarily, the Department of State (State) regulates  defense exports, and the Department of Commerce (Commerce)  regulates dual-use exports. Each agency maintains a separate list of  items to be controlled and exported with a license after government  review, or without a license under designated exceptions.

The U.S. government also conducts activities to encourage compliance  with its export control laws and to prevent the diversion or misuse of  exported items against U.S. interests or allies. Compliance activities  include reviewing export license applications to decide whether to  approve or deny them, visiting foreign companies to verify the approved  use and location of exported items—referred to as end-use checks—and  conducting courses for exporters—called outreach—to inform them of  their responsibilities to comply with export control laws and regulations.  Of particular concern to the agencies conducting compliance efforts is  illicit transshipment of items—the transfer of merchandise from its place  of origin through an intermediary country—to an unauthorized final  destination such as Iran.efforts because it poses a significant risk to the safe transfer of sensitive  U.S. technologies to authorized end users.

Our reports to Congress and testimony at congressional hearings have  highlighted the need for export control reform. We have called for, among  other things, a strategic reexamination of existing programs within the  U.S. export control system to identify needed changes and ensure the  advancement of U.S. interests. In 2010, the United States announced a  fundamental reform of its export control system, by proposing, among  other things, to reduce the numbers and types of items requiring  government review and licensing before export. Members of Congress  raised concerns that, absent efforts to first address compliance and  enforcement shortfalls, reform of the system could exacerbate current  weaknesses, including the risk of illicit transshipment.

In this review, we (1) examined how U.S. agencies use compliance  activities to address the risk of illicit transshipment and (2) analyzed the  extent to which U.S. agencies assessed the impact of the export control  reform on the resource needs of compliance activities. This is the fourth in  a series of four reports we have issued on this subject since November  2010. Our first report identified the extent to which agencies’ actions and  the proposed export control framework addressed findings in our previous  reports in the areas of export control lists, licensing, enforcement, and  information technology. Our second report, issued on March 14, 2012,  was a version of this report containing information designated “For Official  Use Only.” Our third report, issued on March 27, 2012, covered the  enforcement of U.S. export controls in light of the Export Control Reform  Initiative.

To address the two objectives of this review, we analyzed licensing, end- use monitoring, and other data from Commerce, State, and the  Department of the Treasury (Treasury) for 13 transshipment countries  and locations. We also drew a random, nongeneralizable sample of 56  Commerce end-use checks and 21 State end-use checks to determine  how results from those activities were incorporated into other compliance  activities. We identified export control compliance activities that  Commerce, State, and Treasury conduct to encourage compliance with  export control laws and to prevent the diversion or misuse of exported  items against U.S. allies or interests. We identified these compliance  activities through interviews with agency officials and review of  documentation. Appendix II lists and describes the eight compliance  activities that we reviewed. We met with U.S. officials of Commerce, the  DOD, State, and Treasury, and representatives of companies in  Washington, D.C., and with U.S. embassy and foreign government  officials in Hong Kong, Singapore, and the United Arab Emirates (UAE).  We reviewed documentation on agency actions taken to encourage  compliance actions and interviewed U.S. government officials, including  representatives of Commerce’s Bureau of Industry and Security (BIS);  DOD’s Defense Technology Security Administration; State’s Directorate  of Defense Trade Controls (DDTC); and Treasury’s Office of Foreign  Assets Control (OFAC). We also spoke with export control reform task  force members and reviewed recent White House press releases on the  export reform initiatives. U.S. agencies engage in a variety of activities  intended to foster compliance with U.S. export control law and  regulations, and other activities to enforce these laws and exact penalties  for violating them. We did not review enforcement activities that address  investigations, civil and criminal penalties, seizures, indictments,  prosecutions, or convictions as our third report addressed these activities.  Commerce provided us with transshipment-related information that it  controls as being “For Official Use Only.” We have not included that  information in this report but have instead incorporated it into a “For  Official Use Only” report that is not publicly available. Appendix I  discusses our scope and methodology in more detail.

We conducted this performance audit from August 2010 to April 2012 in  accordance with generally accepted government auditing standards.  These 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.
subsections: section_title: Background
subsections: section_title: Export Control System
paragraphs: The current U.S. export control system seeks to limit sensitive items from  falling into the wrong hands and, at the same time, allow legitimate trade  to occur. The export control system is governed by a complex set of laws,  regulations, and processes and multiple federal agencies administer its  regulatory framework and ensure compliance. State and Commerce each  have a role in U.S. export licensing. Generally, exporters may submit a  license application to State if their items are controlled on the U.S.  Munitions List (USML) or to Commerce if their items are controlled on the  Commerce Control List (CCL) to receive export approval. Exemptions are  permitted under various circumstances, such as allowing for the export of  certain items to Canada without a license. Even though many dual-use  items do not require a license for export to most destinations, they are still  subject to U.S. export control laws. All items subject to the Export  Administration Regulations (EAR), whether or not on the CCL, require  exporters to comply with the EAR. As part of the application review  process, State and Commerce consult with other agencies, including  DOD. Exporters require a license for most arms exports. In 2010,  Commerce processed 21,660 export licenses, and State processed  82,937 export licenses. Additionally, offices within State, Commerce,  Treasury, and the Departments of Homeland Security and Justice  conduct compliance activities to identify potential violations or prevent  them before they occur; they also conduct export control enforcement  activities to identify and penalize violations after they occur. When  compliance activities, such as end-use checks, result in unfavorable  determinations, Commerce or State may take further action, such as  denying a license or referring involved entities to enforcement agencies  for investigation and possible penalties. Enforcement also strives to  prevent or deter the illegal export of defense and dual–use items, such as  controlled components that were shipped to countries like Iran, which  were later found in weapons and devices used against U.S. forces in Iraq.  Export control enforcement activities include inspecting items to be  exported, investigating potential export control violations, and pursuing  and imposing criminal and administrative penalties against violators.

The imposition of economic sanctions has been a long-standing tool for  addressing a range of national security threats. As of February 2012,  OFAC maintains primary responsibility for administering more than 20  separate sanctions programs. These sanctions programs include (1)  country-based programs that apply sanctions to an entire country—such  as Iran, or Sudan; and (2) targeted, list-based programs that address  individuals or entities engaged in specific types of activities such as  terrorism, proliferation of weapons of mass destruction (WMD), or  narcotics trafficking. For example, according to Treasury officials, they  use the authorities under the International Emergency Economic Powers  Act and Executive Order 13224 to designate those who provide support  to terrorists, freezing any assets they have under U.S. jurisdiction and  preventing U.S. persons from doing business with them.

section_title: Export Control Reform Initiative
paragraphs: In August 2009, the President announced that he was directing a  comprehensive review of the U.S. export control system. This review  found that the U.S. export control system has a complicated structure with  multiple agencies and control lists, which has led to jurisdictional  confusion and hindered the ability of allies to cooperate with U.S. forces.  In April 2010, the administration announced a reform framework that  would create an export control system that is more effective, transparent,  and predictable by creating a single control list, licensing agency,  enforcement agency, and information technology system for licensing.  The administration also found that licensing procedures and conditions  are not consolidated or uniform across agencies, with various agencies  monitoring and enforcing export controls.separate information systems, some of which are paper-based, which are  not accessible to all agencies involved.

The current process relies on  Our past work has highlighted the need for export control reform through  reports to Congress and testimony at congressional hearings. Over the  last decade, GAO has made a number of key findings and  recommendations directed to State, Commerce, DOD, Homeland  Security, Justice, and Treasury, to improve the U.S. export control  system. Some of the issues we identified include a lack of systematic assessments, poor interagency coordination, and inefficiencies in the  license application process.

The administration plans to begin implementing export control reforms  through interim changes that can be carried out by regulation or executive  order. Reforms requiring legislative action—creation of a single licensing  agency, control list, and enforcement agency—will come last and had not  been proposed as of March 2012. As of February 2012, the  administration has taken steps to implement export control reform  including proposing regulations to move controlled export items from the  USML to the CCL, and clarifying which items pertain to each list, and  establishing an Export Enforcement Coordination Center by executive  order.

section_title: Transshipment and Diversion
paragraphs: In July 2010, a senior State official testified that transshipment hubs (i.e.,  countries or areas that function as major hubs for the legitimate trading  and shipment of cargo) with weak controls on imports, exports, and  reexports represent an important vulnerability to efforts to prevent illicit  proliferation-related trade. Our previous work identified cases of illicit  transshipment involving parties in UAE, Singapore, and Malaysia. As  congressional attention focused on transshipment, members also raised  concerns about the resources needed for compliance activities,  domestically and overseas. For example, in the same July 2010 hearing,  a member expressed concern that only one Commerce individual was stationed in the UAE to conduct end-use checks for dual-use exports.According to U.S. officials, Iran has obtained U.S. military and dual-use  goods that have been illegally transshipped by firms and individuals  through locations in numerous countries, including the UAE, Malaysia,  and Singapore. The goods included components for U.S.-built fighter  aircraft, electronics, and specialized metals. To address the problem, U.S.  agencies have conducted undercover investigations to detect Iranian  procurement networks, prosecuted criminal cases against at least 30  firms and individuals for transshipping or attempting to transship goods to  Iran, and provided export control training and support to the UAE and  other countries.

section_title: Compliance Activities Address Illicit Transshipment Risk in Three Areas
paragraphs: U.S. agencies engaged in export controls use multiple compliance  activities to reduce illicit transshipment risk. These activities include (1)  vetting transactions prior to export by screening applications against four  categories of lists of parties of concern, among other steps, (2) analyzing  shipping data and monitoring end use of items, and (3) educating  companies and foreign governments about the risks of illicit  transshipment, although State’s outreach efforts have been largely  inactive since 2008.
subsections: section_title: U.S. Agencies Vet Transactions Prior to Export
paragraphs: To address illicit transshipment risks, agencies vet parties to transactions  prior to export in three ways. First, agencies examine license applications  to assess the transaction. Second, they vet individual parties to the  transaction by, for example, confirming their credentials before issuing a  license (a prelicense check). Third, agencies screen applicants to identify  trusted end users for the Validated End-User (VEU) program.

When deciding to approve or deny an export license application,  Commerce and State evaluate it against several factors, including an  assessment of all parties to the transaction and how the recipient plans to  use the item. Commerce factors the risk of illicit transshipment into the  license application review process through a risk assessment tool that  assigns a weighted score to an application, based on the level of concern  associated with the listed party, country, product, and exporter. A high  score may prompt further investigation and an end-use check by  Commerce or embassy officials. In technical comments on a draft of this  report, Commerce stated that the risk assessment tool would affect the  license review process only when Commerce determined that a  prelicense check would be necessary. In those cases, Commerce  incorporates transshipment risk in the license application review process  by dividing countries into three categories of risk, with the third category  including countries identified as transshipment points. Commerce’s list of  highest risk countries includes 7 of the 13 transshipment countries in our  review. For fiscal years 2008 through 2010, Commerce reviewed 63,304  license applications worldwide, 19,693 (31 percent) of which were for  exports to the 13 transshipment countries we identified. It approved 84  percent of license applications for these transshipment countries, denied  1 percent, and returned 15 percent of the applications to exporters  without taking action on them. Appendix III contains additional  information on the number of license applications that Commerce and  State reviewed for the 13 transshipment countries between fiscal years  2008 and 2010.

State conducts a case-by-case review of export license applications  against established criteria or “warning flags” for determining potential risk  of exporting USML items to foreign recipients. As part of the license  review process, State may conduct a prelicense end-use check to provide  more information on the transaction before it acts on the license  application. State’s guidance on conducting end-use checks (known as  Blue Lantern monitoring) identifies three broad categories that may trigger  an end-use check, including whether there are indicators for  transshipment through multiple countries or companies. 2008 through 2010, State reviewed 164,998 license applications  worldwide and 28,550 for exports to the 13 transshipment countries (17  percent of all applications). It approved 86 percent of license  applications for these countries, denied 1 percent, returned without  action 13 percent, and suspended or revoked 1 percent of preexisting  licenses.

Treasury does not review licenses for the 13 transshipment countries  because none of these countries is an embargoed or sanctioned country.

Blue Lantern end-use monitoring entails the prelicense, postlicense, or postshipment  inquiries or “checks” undertaken to verify the legitimacy of a transaction and to provide  “reasonable assurance” that the recipient complies with the requirements imposed by the  U.S. government with respect to use, transfers, and security of defense articles and  defense services; and that such articles and services are being used for the purposes for  which they were provided.

However, it assesses illicit transshipment risk when it licenses goods to  several destinations, such as Iran and Sudan, in its administration of U.S.  embargoes and sanctions. According to Treasury officials, OFAC screens  end users in the license review process against the sanctions lists it  administers because it assesses the risk of illicit transshipment or of  reexport when placing individuals on these lists.

Commerce, State, and Treasury each maintain several screening lists  that inform the licensing process by providing information on entities of  concern to licensing officers and the public. These lists encompass a  range of designations including those related to proliferation of WMD,  terrorism, and actions contrary to U.S. national security and foreign policy  interests. We reviewed four categories of lists outlined in table 1 below.

Entity List: Commerce’s considerations for additions to the Entity List  include the end use of allegedly transshipped items. For example, on  October 31, 2011, the End-User Review Committee added a firm  located in Hong Kong and Singapore for diverting U.S.-origin items  from Hong Kong to Iran. The diversion was part of the efforts of a  larger procurement network that arranged for the transshipment of  radio frequency modules from Singapore to Iran for use in improvised  explosive devices found in Iraq. Placement of an individual’s name on  the Entity List notifies exporters of a potential licensing requirement or  a ban on exports. In August 2008, Commerce expanded criteria for  addition to the Entity List to allow an entity to be placed on the list if  there is reasonable cause to believe, based on specific and articulable  facts, that the entity has been involved, is involved, or poses a  significant risk of becoming involved in activities that are contrary to  the national security or foreign policy interests of the United States. As  of December 2010, at least 56 percent of the 359 entities on the Entity  List were from the 13 transshipment countries in our review.

Unverified List: The Commerce Unverified List is a public list that  includes the names and countries of foreign entities that were parties  to transactions for which Commerce could not conduct a prelicense  check or postshipment verification (PSV) due to factors outside of  U.S. government control. The list informs the licensing process by  providing exporters with information about entities of concern. For  example, we determined that, of the 36 persons or entities currently  on the Unverified List, 78 percent are from the 13 transshipment  countries we reviewed. When Commerce established the Unverified  List in 2002, it advised exporters that the participation of a person on  this list in any proposed transaction would raise a ‘‘red flag’’ for  exporters under established guidance. Commerce stopped updating  the Unverified List after it expanded the scope of the Entity List in  August 2008 and is considering eliminating the Unverified List in  2012. Commerce officials said that they will review the Unverified List  and assess the 36 entities currently on it against criteria for inclusion  on the Entity List, transferring them, if warranted, on a case-by-case  basis. Commerce will monitor the entities that are not transferred  through its internal Watch List.

State and Treasury Sanctions Lists: State and Treasury publish lists  of individuals sanctioned under various statutes for activities relating  to concerns ranging from nonproliferation to drug enforcement.  Treasury officials indicated that both direct exports and  transshipments from the United States to a sanctioned entity or to an  embargoed country without authorization constitute diversion and are  thus violations. For example, in December 2008, Treasury sanctioned  an Iranian shipping line for facilitating the transport of cargo and  employing deceptive shipping practices to advance Iran’s nuclear and  missile programs. Additionally, Treasury designated the company’s  subsidiaries in four transshipment countries—China, Malta,  Singapore, and UAE. Of the 4,929 designations on the Specially  Designated Nationals (SDN) list, 167 were from the 13 transshipment  countries.

State and Commerce Watch Lists: State and Commerce screen  parties named in a license application against internal Watch Lists,  which include participants added because of illicit transshipment risk.  Specifically, Commerce and State both add names of entities  identified through unfavorable end-use checks, including names of  entities from transshipment countries, to the Watch Lists. According  to State and Commerce, officials check all names on every export  license application against their Watch Lists. As of September 2011,  State’s Watch List contained 100,248 entities, of which 8,731 (about 9  percent) were from the 13 transshipment countries we reviewed. As of  November 2011, the Commerce Watch List contained 36,849 active  entities, of which 8,309 (about 23 percent) were from the 13  transshipment countries we reviewed. Appendix IV details the  numbers of entities from each transshipment country listed on State  and Commerce Watch Lists for 2011. To confirm that the results of  end-use checks are incorporated into the license application review  process, we analyzed a random, nongeneralizable sample of 21 State  end-use checks and 56 Commerce end-use checks during our site  visits in Hong Kong, Singapore, and the UAE. We submitted 11  unfavorable checks to State to determine the actions in response to  the unfavorable determinations. State placed or updated the  placement of 9 of the 11 entities identified in these unfavorable end- use checks on agency watch lists and referred 6 to State’s  enforcement division for possible investigation. For Commerce,  according to its Watch List guidance, all companies that receive  unfavorable prelicense checks or PSVs are placed on the Watch List.  However, for the 26 end-use checks with unfavorable results that we  submitted to Commerce, we could not confirm that Commerce placed  the names of the associated entities on its Watch List.

Agencies may also conduct a prelicense check to verify the credentials of  a party in advance of approving a license. A prelicense check may  include a site visit to the proposed end user or consignee. Commerce and  State may also seek the input of other agencies, particularly DOD, to vet  transactions by reviewing end-user history and other factors.

Commerce screens applicants for a variety of factors, including reexport,  to identify trusted end users for the VEU program. The VEU is an export  licensing framework that allows validated end users to receive eligible  items on the Commerce Control List without a license. As of November  2011, Commerce conferred VEU status on 11 companies from 2  countries, China—one of the 13 GAO-designated transshipment  countries—and India. The End-User Review Committee considers factors  such as the entity’s record of compliance with U.S. export controls and its  willingness to host on-site reviews by U.S. government personnel to  ensure program compliance. Commerce also vets potential recipients of  VEU authorizations with the law enforcement and intelligence  communities. In addressing illicit transshipment risk, Commerce requires  VEU applicants to adhere to conditions on diversion, retransfer, and  reexport of specified items.

section_title: Agencies Address Illicit Transshipment Risk by Analyzing Shipping Data and Monitoring End Use of Items
paragraphs: To confirm exporters’ and recipients’ adherence to U.S. export control  requirements, Commerce and State analyze shipping data and conduct  end-use checks of items exported overseas. They use these activities to  confirm compliance with export control requirements by verifying the end  use of controlled items and by reviewing export documentation for  potential violations.

Both Commerce and State analyze shipping information to identify illicit  transshipments and other potential violations of export control laws. The  Census Bureau maintains shipping information on U.S. exports in the  Automated Export System, the primary instrument for collecting export  trade data. The U.S. government requires exporters to file shipping  information with the system for any items subject to Commerce or State  control, whether they need licenses or are eligible for exceptions.

Commerce uses data from the Automated Export System to determine  exporter’s compliance with the EAR on items subject to licensing  requirements, select candidates for end-use checks, and target other  compliance and enforcement activities. In addition, Commerce used  available Automated Export System and international Customs data to  develop a methodology that assesses the potential risk of illicit diversion  of items on the Commerce Control List. This methodology is part of a  Commerce developed Transshipment Identification Strategy that also  included the publication of seven best practices for preventing diversion  through transshipment points. U.S. agencies have assessed a risk of illicit  transshipment from Hong Kong to mainland China, from UAE to Iran, and  from China to Iran.

State also uses shipping information as part of its end-use monitoring  program to identify illicit transshipments and other forms of diversion.  Specifically, State officials said that they check shipping information  against approved license applications for discrepancies when considering  whether to initiate an end-use check and use such information to verify  the exporter’s use of license exemptions. For example, in fiscal year  2009, State reported reviewing 35,000 shipments to Canada made under  an exemption specific to that country. As a result of that review, State  reported initiating eight end-use checks to verify the credentials of end  users who were listed on State’s Watch List. State determined that the  export in question did not result in a diversion. Like Commerce, State  obtains shipping data from the Automated Export System maintained by  the Census Bureau, pursuant to a Memorandum of Understanding with  that organization. As the Memorandum of Understanding expired in  November 2011, State and Census must complete a new Memorandum  of Understanding for State to continue receiving this shipping data,  according to a senior Census Bureau official. A State official stated that  they continued to receive the shipping data between November 2011 and  February 2012, but Census stopped providing this data, pending  completion of a new Memorandum of Understanding, according to the  Census Bureau official.

Commerce and State address illicit transshipment risk by verifying the  end use of controlled items. Guidance for both agencies identifies illicit  transshipment as a factor to consider in assessing the need for end-use  checks.

Commerce may conduct an end-use check on any item subject to the  EAR that is exported. Commerce’s authority to conduct PSV checks is  established in the Export Administration Act of 1979, which provides the  legal and administrative basis for U.S. controls on dual-use exports and is  supplemented by the EAR. According to Commerce, PSV checks  strengthen assurances that exporters, shippers, importers, and end users  comply with the terms of export license and licensing conditions.

Commerce conducts PSV checks to confirm that the dual-use item  arrived at its destination and is being used as intended. Commerce  Export Control Officers (ECO), special agents, or other U.S. government  personnel visit companies overseas to meet with importers or end users  in an attempt to verify the use and location of these items.

Our analysis of end-use checks, where Commerce made a favorable or  unfavorable determination, indicated that Commerce focused its efforts  on transshipment countries; it conducted 57 percent of 1,412 end-use  checks for fiscal years 2008 to 2010 in the 13 transshipment countries we  reviewed. Of these checks, 33 percent were unfavorable. Appendix V  provides additional data on end-use checks for the 13 transshipment  countries. The three locations where we conducted site visits—Hong  Kong, Singapore, and UAE—represented about 36 percent of Commerce  end-use checks conducted globally for this period and nearly 62 percent  of unfavorable determinations worldwide.

To address transshipment concerns in Southeast Asia, Commerce  stationed an ECO in Singapore, with regional responsibilities in Malaysia,  Indonesia, Thailand, and the Philippines to conduct end-use checks,  among other duties. Commerce end-use check guidance indicates that  ECOs should be aware of warning signals, including whether a consignee  is aware of relevant restrictions to the reexport or retransfer of the item.  For fiscal years 2008 through 2010, Commerce conducted 49 percent of  all its end-use checks in five locations: UAE, Hong Kong, Singapore,  Taiwan, and China. Moreover, Commerce determined that 62 percent of  all unfavorable end-use checks for this period occurred in three of these  locations: Hong Kong, the UAE, and Singapore.

For the purposes of this report, unlicensed exports include exports requiring no prior  government review, including items subject to the EAR eligible for license exceptions. for 70 percent of all such checks worldwide. Figure 1 shows the numbers  of Commerce PSVs conducted on unlicensed exports in the 13  transshipment countries.

Commerce can conduct a PSV on any exported item for any reason  related to a compliance concern, such as an enforcement investigation,  intelligence information, or other information that analysts have available  to them. Additionally, in technical comments on a draft of this report,  Commerce stated that PSVs on licensed exports are more likely to result  from commodity or regional concerns, including transshipment, which will  prompt further scrutiny to ultimate or intermediate consignees even  though they are known not to be the end user.

Between 2008 and 2010, 223 (94 percent) of the 238 Commerce  unfavorable postshipment checks in transshipment countries were on  unlicensed exports. Unfavorable postshipment checks on unlicensed  exports in the 13 transshipment countries accounted for 88 percent of all  unfavorable postshipment checks in these countries in 2008 and rose to  97 percent in 2010. (See fig. 2.)

Items exported without a license may pose risks to U.S. national security,  according to U.S. government officials. These items include those not on  the CCL and those on the CCL that do not require a license to certain  destinations. For example, agencies discovered that U.S. electronics  components and devices were used to build improvised explosive devices  that were deployed against Coalition forces in Iraq after they were illicitly  transshipped to Iran through Hong Kong. According to Commerce  officials, the U.S. government established an interagency task force  consisting of several defense intelligence units, and Treasury’s Financial  Crimes Enforcement Network, to address the threat posed by these  devices.

EAR items subject to license requirements have also been transferred  without a license to unauthorized destinations through transshipment  points. It is the policy of the U.S. government to facilitate U.S. exports to  legitimate civilian end users in the People’s Republic of China (China),  while preventing exports that would enhance the military capability of that  country. Commerce officials stated that integrated electronic circuits have  been diverted to China (a destination requiring a license for these items)  through Hong Kong (where no license is required). A senior Commerce  official stated that certain types of integrated electronic circuits contribute  to China’s military advancement.

The Arms Control Export Act, as amended in 1996, requires, to the extent  practicable, that end-use monitoring programs provide reasonable  assurance that recipients comply with the requirements imposed by the  U.S. government in the use, transfer, and security of defense articles and  services. In addition, end-use monitoring programs are to provide  assurances that defense articles and services are used for the purposes  for which they are provided. Accordingly, under State’s monitoring effort  known as the Blue Lantern program, State conducts end-use monitoring  of direct commercial sales of defense articles and services and related  technology. Specifically, a PSV is used (1) to confirm whether licensed  defense goods or services exported from the United States have been  received by the party named on the license and (2) to determine whether  those goods have been or are being used in accordance with the  provisions of that license.

Our analysis of State end-use checks under its Blue Lantern program  showed that State focused a smaller portion of its end-use checks on  transshipment countries than did Commerce. According to U.S. and Hong  Kong government officials, the risk of illicit transshipment of dual-use  exports is higher than for military exports, in part because proliferators  hide their relatively small number of proliferation-related transactions— most of which involve dual-use items—within a large volume of fast- moving commercial goods. For fiscal years 2008 through 2010, State  conducted 26 percent of the total number of end-use checks in the 13  transshipment countries we reviewed; 22 percent of these checks were  unfavorable. In conducting end-use checks, State guidance indicates that  end-use check officers are required to determine that the proposed end  user appears to be a reliable recipient of sensitive U.S. defense articles,  technology, or services, and that the end user is familiar with U.S.  restrictions with respect to use, transfer, or reexport. See appendix V for  more detailed information on Commerce and State end-use checks.

section_title: Agencies Educate U.S. Exporters and Foreign Governments about Illicit Transshipment Risks, but One Program Is Largely Inactive
paragraphs: To educate companies and foreign governments about illicit  transshipment risks, agencies have programs to review the internal  controls of U.S. companies’ compliance programs, conduct outreach to  U.S. companies and universities, and provide training to foreign  governments.

Commerce helps firms address illicit transshipment risk by conducting an  informal review of firms’ compliance programs at the firms’ request.  Commerce reviews the written procedures and internal controls for a  company’s compliance program against Commerce’s Export  Management Compliance Program guidelines to help it develop an  internal control program that can thwart diversion of technologies to  countries of concern. The Export Management Compliance Program  guidance identifies indicators of risks posed by transshipment, such as  insufficient compliance safeguards throughout the shipping process and  unverified end destination addresses. In fiscal year 2010, Commerce  conducted 18 reviews of corporate written compliance programs and  conducted two 2-day and three 1-day seminars on developing an export  management and compliance program in various U.S. cities.

Commerce and State officially have outreach programs to educate  industry on issues, including illicit transshipment risks. Commerce’s  outreach program expanded in 2011 to increase its focus on illicit  transshipment, but State’s program is largely inactive. Between January  and November 2011, Commerce has conducted approximately 24  outreach events across the United States. Commerce has added a  training session on its Best Practices for Preventing Unlawful Diversion of  U.S. Dual-Use Items Subject to the Export Administration Regulations,  Particularly through Transshipment Trade, published in August 2011,  which identifies seven best practices that guard against diversion risk,  particularly through transshipment. A Commerce official stated that, due  to the ongoing risk of illicit diversion of controlled items subject to the  EAR, Commerce has added the best practices component to outreach  events.

State’s program to visit companies has been largely inactive since 2008.  This program had considered transshipment risks and was in place to  determine whether companies were properly exercising their regulatory  responsibility in licensing and compliance. State also used the information  gathered from visits to adjust or revise U.S. regulations and practices.  State visited more than 60 companies between October 2005 and  September 2008. While State has made two such visits since 2008, the  visits were made to companies due to ongoing enforcement actions,  rather than mainly for outreach.

State also addresses illicit transshipment risk by conducting export control  training of foreign governments through its Export Controls and Border  Security (EXBS) program. In determining the countries of focus for EXBS,  State conducts country-by-country threat assessments to determine the  points of greatest risk, assessing risk factors in a given country, including  the risks of diversion, production, and proliferation. EXBS categorized as  a diversion risk 9 of the 13 transshipment countries we examined; 7 of   In fiscal years  those countries are currently EXBS partner countries.2009 and 2010, EXBS conducted training in the UAE, which included a  seminar on how to investigate, survey, detect, and interdict unauthorized  transfers of items. EXBS announced in its 2011 Strategic Plan that transit  and transshipment trade will be a priority, and EXBS will work with each  shipment hub to build its capacity to target transit and transshipment  cargo efficiently, without negatively affecting legitimate trade and  competitiveness.

section_title: Agencies Have Not Fully Assessed Potential Impact of Control List Reforms on Resource Needs for Compliance Activities
paragraphs: State and Commerce have not fully assessed the potential impact of  reforming the agency control lists and transferring items from State to  Commerce on the resource needs of their compliance activities.  Assessing impact includes analyzing the potential benefits and risks of  the control list reforms, but the agencies lack information on how control  list changes will impact their resource needs for conducting compliance  activities. They expressed the view that some benefits would likely  include a reduced compliance burden for industry and enhanced national  security for the United States by focusing on items, destinations, and end  users of concern. In the one assessment that it performed, Commerce  estimated financial benefits of one regulatory change but did not assess  any potential risks to compliance activities beyond licensing. In contrast,  several compliance officials stated that risks could include the burden on  Commerce’s and State’s capacity to monitor the end use of an increased  number of items and the loss of information prior to export resulting from  fewer license requirements. However, the agencies did not evaluate the  implications of these risks on their resource needs.
subsections: section_title: Agencies Propose to Move Items from State to Commerce and to Introduce a New License Exception
paragraphs: As an interim step to creating a single control list, the administration  proposed revising the list of items controlled by Commerce and State.  Thus, Commerce proposed a rule in July 2011 establishing a structure to  move items from the USML to the CCL that the President has determined  no longer need to be controlled on that list. As we previously reported,  an interagency task force created export control criteria to determine the  items and technologies that should be controlled by Commerce or State.  A DOD-led interagency team is currently revising the lists so controlled  items will be identified using objective criteria such as horsepower, speed,  and accuracy rather than maintaining an item on the USML simply  because, historically, its form and fit has associated it with a military item.  Those items that do not remain on the USML after this review will move to  Commerce’s jurisdiction. As of January 2012, State has proposed  revisions to 5 of 20 categories of military items. The 5 categories include  items such as tanks, aircraft, and submersible vessels. Proposed  revisions to 4 of the 5 USML categories would change the USML controls  on generic parts, components, accessories, and attachments that are  specifically designed or modified for a defense article to control specific   Items whose  types of parts, components, accessories, and attachments.functions provide immediate tactical utility without modification will remain  on the USML, while all other items would move to the CCL.

Those items moved to the CCL may also become eligible for export for  ultimate government end use to the destinations identified on a new  license exception known as the Strategic Trade Authorization (STA). In  June 2011, Commerce finalized this new license exception to allow  exports of certain items without a license to countries determined to be  low risk. These items would be subject to certain notification  requirements. Specifically, the STA authorizes certain exports that  Commerce now controls for multiple reasons to 36 destinations, many of  which are NATO allies or export control regime participants. Further, the  exception authorizes certain exports to an additional eight countries but  limits the exception for items that Commerce now controls for national  security reasons only. These countries include four transshipment  countries that we reviewed, Hong Kong, Singapore, Malta, and Taiwan.  The licensing exception imposes additional requirements, such as  directing the exporter, reexporter, or transferor to exchange information  with the recipient regarding the applicable control list category number,  and stating that the export occurs under the STA exception to mitigate the  risk of reexport to an unauthorized destination or end user.

section_title: Agencies Have Not Fully Assessed Potential Impact of Control List Reforms on All Compliance Activities but Have Assessed the Estimated Resource Impact on License Review
paragraphs: U.S. agencies have not fully assessed the potential impact that export  control reform of control lists might pose for the resource needs of the  range of compliance activities agencies undertake, as suggested by  federal internal control standards and executive branch requirements.  State and Treasury officials confirmed that they have not conducted such  an assessment. In technical comments on a draft of this report,  Commerce stated that it had conducted an assessment of compliance  activities and that it is hiring eight dedicated compliance officers.  However, Commerce provided no evidence of such an assessment.  Moreover, Commerce’s fiscal year 2013 Congressional Budget  Justification did not identify the need for compliance officers in its request  for 24 additional licensing officers. Although the administration intends to  move up to 30,000 license applications from State’s to Commerce’s  jurisdiction, Commerce is targeting only 850 end-use checks in each of  fiscal years 2013 and 2014, the same number it targeted for fiscal year  2012. Federal standards call for, among other things, a regulatory  analysis to include the following three basic elements: (1) a statement of  the need for the proposed action, (2) an examination of alternative  approaches, and (3) an evaluation of the benefits and costs—quantitative  and qualitative—of the proposed action and the main alternatives  identified by the action. The evaluation of benefits and costs is to be  informed by a risk assessment. In November 2011, Commerce’ s  Inspector General identified Commerce’s need to ensure adequate  resources to monitor compliance and to detect and prevent diversions of  controlled technology in the context of export control reform as among its  top management challenges for fiscal year 2012.

Risk assessment is one of five standards for an internal control system  that provides reasonable assurance that an organization will achieve  effective and efficient operations, reliable financial reporting, and  compliance with applicable laws and regulations. Commerce has not  analyzed the impact of the reform on its compliance activities beyond  estimating the number of State licenses that will move to its jurisdiction  and potential resources needed to address them. State also has not  assessed the risks of reform proposals on its compliance activities.  According to a State official, current export control reform efforts are  focused on revising the USML. The State official noted that, as items are  moved from the USML to the CCL, the department will have better insight  into potential impacts and will be able to assess resource needs.

Agencies have stated some potential benefits for national security and for  exporters as a result of reform. However, agencies did not provide an  analysis supporting the expected benefits. According to agencies’  statements, the U.S. government would have greater interoperability with NATO and other allies; be able to focus its resources on sensitive technologies, destinations,  and end users of higher risk than those found in NATO counterparts  or other allies; and benefit from an enhanced defense industrial base by reducing the  current incentives for foreign companies to avoid U.S. parts and  components.

State and Commerce documents identify the following four potential  advantages to industry of moving items from the USML to the CCL: relief from more stringent USML requirements, such as registration  fees and the need to obtain manufacturing and technical assistance  agreements;  reduction of license requirements;  simplification of license application procedures; and  increased availability of exceptions.

Commerce assessed the potential impact of control list reform on its  resources only for the compliance activity of license application review.  Commerce documents indicate that, as of July 2011, it did not have the  workforce in place to accommodate the 16,000 to 30,000 additional  license applications estimated to result from the move of a significant  number of items from the USML to the CCL without causing backlogs and  delays. In March 2012, Commerce established a new office to adjudicate  license applications and conduct other actions for items moved from the  USML, and it has begun to solicit applicants to staff the office.  Furthermore, according to a Commerce cost benefit analysis, the new  STA license exception would help remove the burdens associated with  applying for a license and reduce the uncertainty associated with the  license application review process. Commerce’s Bureau of Industry and  Security (BIS) estimated that approximately 2,300 licensed transactions  would have been eligible for the STA exception in 2010. Therefore, BIS  estimated that the public benefit to foregoing the license application  review for those transactions eligible for the STA exception could result in  a savings ranging from $1.5 million to $5.1 million per year. BIS also  stated that the license exception would reduce uncertainty by removing  the need for U.S. exporters to inform prospective buyers of U.S.  technology that sales are contingent upon government approval for each  transaction. BIS also estimated that the license exception would benefit  the government by allowing Commerce to focus its licensing resources on  transactions of greater risk than those eligible for the STA exception. BIS  officials stated that the STA exception would not increase costs to the  government.

section_title: Agency Officials Identified Two Potential Risks of Reform for Compliance Activities, but Agencies Have Not Assessed Implications of These Risks on Resource Needs
paragraphs: Although U.S. agencies have not fully assessed the risks and resource  implications that reform of export control lists may present in  implementing compliance activities, agency officials conducting those  activities identified two potential risks. These include an increased  workload at Commerce from the transfer of thousands of license  applications from State’s to Commerce’s jurisdiction, as well as the loss of  information from the licensing process prior to export. Neither Commerce  nor State has conducted a detailed risk assessment of the impact of the  reforms on any of the compliance activities they undertake besides  licensing and their associated workforce needs. Standards for Internal  Control in the Federal Government indicates that internal controls should  provide for an assessment of the external and internal risks the agency  faces and that management needs to address.

A Commerce official also stated that a reduction in exports needing  licenses would likely make compliance activities, such as end-use  monitoring, more difficult because officials use export licenses for some of  the information they rely on. Without such information, U.S. officials  conducting end-use checks might need to expend more time and  resources obtaining the needed information, according to the official. In  fact, Commerce has focused more end-use checks on unlicensed items.  We found that unlicensed exports may also pose resource implications for  compliance activities concerning specific transshipment countries—Hong  Kong, Singapore, and Taiwan. Items exported to these countries might be  eligible to use a license exception for certain controlled items. Thus, some  exports would avoid the need for prior government approval for each  transaction. Commerce officials said that they might mitigate any risks  that this might pose by shifting resources to target and increase  compliance actions, such as outreach and shipping data analysis. In  technical comments on a draft of this report, Commerce stated that it  conducts end-use checks on unlicensed items now without significant  difficulty and does not understand the basis for the conclusion that  unlicensed exports may also pose resource implications for compliance  activities concerning specific transshipment countries. However, BIS  reported as recently as 2011 that it is considering requiring exporters to  include additional information in the Automated Export System for  unlicensed exports. Requiring this information, according to BIS, would  allow it to determine more quickly the accuracy of a claimed use of  authority to ship without a license or pursuant to a license exception, in  some transactions. In addition, this information would enable BIS to target  its end use checks of exports more effectively because it could select  items of the greatest significance without extensive follow-up information  from the exporter. By taking advantage of the additional information, BIS  indicated that it could make more effective use of its enforcement  resources.

A State compliance official said that losing the information generated by  license applications would make tracking entities and commodities that  are at risk more difficult and resource intensive. State officials also noted  that, if reform resulted in the removal of some license requirements for  certain goods, then State would need to shift its emphasis on reviewing  license application data to reviewing shipping data. Currently, most  defense items require a license for export. However, in certain instances,  arms may be exported without a license (i.e., under an exemption) but are  still subject to the Arms Export Control Act. Fewer license requirements  would mean that more compliance verification would need to be  conducted after the item has shipped, thereby increasing the need for  PSVs, according to the official.

section_title: Conclusions
paragraphs: U.S. export control agencies generally address illicit transshipment risk in  implementing their compliance activities, and Commerce, in particular,  has focused on this risk by performing increased end-use checks in  transshipment countries and on excepted or unlicensed items. Moreover,  several of the agencies’ compliance activities are interdependent. For  example, the results of unfavorable postshipment verifications provide  entity names for agencies to add to the sanctions and Watch Lists, and  Watch Lists provide names that should be flagged for further scrutiny  during the license review process. Therefore, changes that affect one  compliance activity may also affect others. Despite this interdependence  of compliance activities, agencies have not fully assessed the potential  impact of the reform initiative that licensing and control list reforms may  pose for resource needs. The administration’s framework to reform U.S.  export controls, with initial changes to Commerce and State control lists,  may significantly affect the entire export control system. Moving numbers  of items from State’s control list to Commerce’s list will shift the licensing  burden for addressing concerns over misuse or diversion of these items  in such countries from one agency to another. Moreover, control list  reform may also shift the burden among various compliance activities in  ways that cannot be anticipated without assessing the impact on  resources of such changes for each activity.

section_title: Recommendations for Executive Action
paragraphs: As the administration moves forward with its control list reforms, we  recommend that the Secretaries of Commerce and State, in consultation  with other relevant agencies, assess and report on the potential impact,  including the benefits and risks of proposed export control list reforms, on  the resource needs of their compliance activities, particularly end-use  monitoring.

section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to Commerce, DOD, State, and  Treasury for their review and comment. Both Commerce and State  provided written comments, which we have reprinted in appendixes VI  and VII, respectively. DOD and Treasury did not provide comments on  the draft. Commerce and State also provided technical comments, which  we incorporated in this report, as appropriate.

Commerce and State agreed with our recommendation to assess and  report on the potential impact of export control list reforms on the  resource needs of their compliance activities. State said that it will be in a  better position to evaluate the resource needs for compliance activities, to  include end-use monitoring, as decisions are made on moving items from  the USML to the CCL. It stated that its intent to dedicate all necessary  resources to compliance activities commensurate with the requirements  of a revised USML remains unchanged.

Commerce stated that, to the extent that information is available, BIS has  used licensing data, public comments, and interagency expertise to  address both benefits and risks of moving items from the USML to CCL.  However, Commerce provided no evidence that it completed such an  assessment or that it assessed the benefits and risks of control list reform  changes on the range of other compliance activities discussed in this  report. Nonetheless, the availability of such information shows that such  an assessment can be done.

Commerce also stated that several references throughout this report refer  to the USML as “more stringent” and state that the CCL “imposes fewer  requirements than State’s controls.” Commerce said it would be more  accurate to say that the CCL’s flexibility provides more options in  protecting national security interests. However, State reported in its  August 2011 Final Plan for Retrospective Analysis of Existing Rules that  defense articles that do not require the stringent controls of the Arms  Export Control Act will be moved to the jurisdiction of Commerce, where  the licensing burden on exports can be dramatically reduced. Also, we  reported in 2008 that, in most cases, Commerce’s controls over dual-use  items are less restrictive than State’s controls over arms. Many items  controlled by Commerce do not require licenses for export to most  destinations, while State-controlled items generally require licenses for  most destinations. Also, some sanctions and embargoes only apply to  items on State’s U.S. Munitions List and not to those on the CCL.

We are sending copies of this report to the appropriate congressional  committees; the Secretaries of Commerce, Defense, State, and the  Treasury; and other interested parties. In addition, the report is available  at no charge on the GAO website at http://www.gao.gov.

If you or your staff members have any questions about this report, please  contact me at (202) 512-9601 or at melitot@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 key contributions to this  report are listed in appendix VIII.

section_title: Appendix I: Scope and Methodology
paragraphs: In this review, we (1) examined how U.S. agencies use compliance  activities to address the risk of illicit transshipment and (2) analyzed the  extent to which U.S. agencies assessed the impact of the export control  reform on the resource needs of compliance activities. Commerce  provided us with transshipment-related information that it controls as  being “For Official Use Only.” We have not included that sensitive  information in this report but have instead incorporated it into a “For  Official Use Only” report that is not publicly available. To examine how  U.S. agencies use compliance activities to address the risk of illicit  transshipment, we reviewed documents from the Departments of  Commerce, State, the Treasury, and Defense, including guidance,  staffing information, and Congressional Budget Justifications. We also  interviewed officials at each agency. We then identified examples of  cases for each compliance activity where agency documents or officials  indicated that they implemented the compliance activity to address illicit  transshipment risk. We also analyzed available data, including licensing  statistics, numbers of end-use checks for 13 transshipment countries,  numbers of designations on various lists for entities from the 13 GAO- designated transshipment countries, numbers of 13 transshipment  countries that are partner countries for Export Control and Related Border  Security program training, Department of Commerce correspondence to  Validated End-User designees, and agency outreach materials for  companies. We also reviewed relevant laws and regulations, interviewed  U.S. and host country officials, and analyzed end-use monitoring and  licensing data. To identify 13 transshipment countries, we examined prior  GAO work on transshipment and external diversion; congressional  testimony; countries with a Commerce Export Control Officer in place;  input from the Departments of State, Commerce, Justice, and Homeland  Security; countries with entities on either the Entity List or Unverified List;  and a listing of the world’s busiest transshipment ports. We interviewed  host government officials in Hong Kong and Singapore to obtain  information on joint efforts with the U.S. government to mitigate illicit  transshipment risks.

In examining the end-use monitoring compliance activity, we reviewed  Departments of State and Commerce end-use monitoring activities  through reviewing relevant program guidance, including State’s Blue  Lantern Guidebook, and cables associated with selected end-use checks.  We interviewed officials in State’s Directorate of Defense Trade Controls  who administer the Blue Lantern program and reviewed export licenses.  We also traveled to Singapore, Hong Kong, and the United Arab Emirates  (UAE) to interview Blue Lantern points of contact and Commerce Export  Control Officers. In examining State and Commerce end-use checks, we  conducted an analysis of global end-use check data for fiscal years  2008–2010 and data on those checks conducted in transshipment  countries. We also reviewed a random, nongeneralizable sample of end- use checks records during our overseas visits to Hong Kong, Singapore,  and UAE, during which we obtained information from State and  Commerce officials on how they conduct end-use checks. We reviewed  21 State Blue Lantern end-use checks from fiscal year 2009 and 2010 in  Hong Kong and Singapore. Twelve of these 21 checks resulted in  unfavorable determinations, and we confirmed that actions had been  taken in 11 of those cases. For State end-use checks in UAE, we relied  on a related GAO engagement (GAO-12-89) that reviewed State end-use  monitoring in the UAE among other countries. We reviewed 56  Commerce end-use checks from fiscal year 2009 through the third  quarter of 2011 in Hong Kong, Singapore, and UAE.the parties on the State and Commerce Watch Lists that were from the 13  transshipment countries we reviewed.

We determined that the licensing data, end-use check data, and Watch  List data were sufficiently reliable for the purpose of describing how U.S.  agencies use compliance activities to address the risk of illicit  transshipment. For the Departments of State and Commerce licensing  data, we interviewed knowledgeable agency officials in coordination with  other ongoing GAO reviews of export controls. We also reviewed  technical manuals related to both departments’ licensing databases and  determined that they were both sufficiently reliable for us to report overall  statistics for how many licenses were issued for fiscal years 2009 and  2010, around the world, and for the number of licenses issued in this time  period for transshipment countries. For end-use monitoring data, we also  interviewed agency officials, consulted agency manuals, and compared  the number of checks we received with data published by the agency. We  determined that the end-use check information provided by the agency  was reliable for the purposes of describing how agencies monitor the end- use of items to address the risk of illicit transshipment. For State and  Commerce Watch List data, we interviewed agency officials about the  sources of information they incorporate into the Watch List and reviewed  the guidance agencies use in updating the Watch List. We determined  that the data was sufficiently reliable for the purpose of describing how  agencies monitor the end-use of items to address the risk of illicit  transshipment.

To analyze the extent to which agencies assessed the potential impact of  the export control reform initiative for the resource needs of compliance  activities, we reviewed the proposed export control reform initiatives,  White House press releases on the export reform initiatives, relevant  executive orders, Federal Register notices, comments from the public,  relevant laws and regulations, and agency documentation and studies on  the proposed impact of the reform initiative on their compliance activities.  We interviewed agency officials and interagency and export control  reform task force members to gather information on the proposed reform  initiatives and agency assessments of the benefits and risks posed by  those initiatives. To gather industry input into the potential impact of  proposed Export Control Reform initiatives, we met with industry  representatives from: (1) The Aerospace Industry Association, (2) The  National Council on International Trade Development, (3) The National  Association of Manufacturers, and (4) the American Chamber of  Commerce in Singapore.

We conducted this performance audit from August 2010 to April 2012 in  accordance with generally accepted government auditing standards.  These 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: Appendix II: Descriptions of Compliance Activities
paragraphs: Compliance activities provide information for exporters, licensing officials,  and enforcement agencies to assess the validity of particular export  transactions or to identify potential violations or prevent them before they  occur. We identified eight export control compliance activities that the  Departments of Commerce, State, and Treasury conduct to encourage  compliance with export control laws and to prevent the diversion or  misuse of exported items against U.S. allies or interests. Table 2  identifies and describes those eight compliance activities that are relevant  to transshipment.

section_title: Appendix III: License Application Review
paragraphs: When deciding whether to approve or deny an export license application,  the Departments of State and Commerce evaluate it against several  factors, including an assessment of all parties to the transaction and how  the recipient plans to use the item. Table 3 shows the total number of  Commerce and State license applications for fiscal years 2008 through  2010 worldwide and for the 13 transshipment countries that we reviewed,  as well as their status for this period.

section_title: Appendix IV: List Maintenance
paragraphs: U.S. export control agencies maintain lists that inform the licensing  process by providing key information on entities of concern to licensing  officers and the public. The top three locations with the most entities of  concern, in order, were China, the UAE, and Hong Kong for the State  Watch List and China, Hong Kong, and UAE for the Commerce Watch  List. Figure 3 shows the numbers of parties on State’s and Commerce’s  Watch Lists from the 13 transshipment countries that we reviewed. As of  September 2011, State’s Watch List contained 100,248 parties, of which  8,731 (about 9 percent) were from the 13 transshipment countries we  reviewed. As of December 2011, the Commerce Watch List contained  36,849 active entities, of which 8,309 (about 23 percent) were from the 13  transshipment countries we reviewed.

section_title: Appendix V: End-Use Monitoring
paragraphs: For fiscal years 2008 through 2010, Commerce conducted about 57  percent of the total number of end-use checks in the 13 transshipment  countries we reviewed. (See fig. 4.)

For fiscal years 2008 through 2010, State conducted about 26 percent of  the total number of end-use checks in the 13 transshipment countries we  reviewed; 22 percent of these checks were unfavorable (see fig. 5).

section_title: Appendix VI: Comments from the Department of Commerce
paragraphs: Following are GAO’s comments on the Department of Commerce’s letter  dated March 9, 2012.
subsections: section_title: GAO Comments
paragraphs: 1.  Commerce stated that its new Munitions Control Division will include  24 personnel; eight of these 24 will be compliance specialists who will  work within the organization to monitor items shipped. These  compliance specialists will work with enforcement analysts to identify  entities to conduct both end-use checks overseas and U.S. company  onsite audits. However, the rationale for these eight compliance  specialists is unclear. Commerce’s fiscal year 2013 budget request  listed only 24 licensing officers and Commerce did not provide us with  any analysis to show that these would include specifically 8  compliance specialists. In addition, while the administration intends to  move up to 30,000 license applications from State to Commerce’s  jurisdiction, Commerce is targeting only 850 end-use checks for each  fiscal year 2013 and 2014, which is the same number as for fiscal  year 2012. 2.  Commerce stated that, to the extent that information is available, BIS  has used licensing data, public comments, and interagency expertise  to address both benefits and risks of moving items from the USML to  CCL. It stated that the benefits include moving less sensitive  munitions items, mostly parts and components, to a more flexible  licensing regime. However, Commerce provided no evidence that it  completed an assessment of benefits and risks, nor that it assessed  the benefits and risks of control list reform changes on the range of  other compliance activities this report discussed. Nonetheless, the  availability of such information shows that such an assessment can be  done. 3.  Commerce stated that our report makes several references to the  USML as “more stringent” and that the CCL “imposes fewer  requirements than State’s controls.” Commerce said it would be more  accurate to say that the CCL’s flexibility provides more options in  protecting national security interests. However, State reported in its  August 2011 Final Plan for Retrospective Analysis of Existing Rules  that defense articles that do not require the stringent controls of the  Arms Export Control Act will be moved to Commerce’s jurisdiction,  where the licensing burden on exports can be dramatically reduced. In  addition, we reported in 2008 that, in most cases, Commerce’s  controls over dual-use items are less restrictive than State’s controls  over arms. Many items that Commerce controls do not require  licenses for export to most destinations, while State-controlled items  generally require licenses for most destinations. Also, some sanctions  and embargoes only apply to items on State’s USML and not to those  on the CCL.

section_title: Appendix VII: Comments from the Department of State

section_title: Appendix VIII: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
paragraphs: Thomas Melito, (202) 512-9601 or melitot@gao.gov.

section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, key contributors to this report  were Joseph A. Christoff, Director (ret.); Jeff Phillips, Assistant Director;  Richard G. Howland, Analyst-in-Charge; Mason Thorpe Calhoun; Alberto  Leff; Elena McGovern; and Lynn Cothern. Martin de Alteriis, Justin Fisher,  Mitchell Karpman, and Hai Tran provided assistance with design and  methodology, statistics, data analysis, and technical expertise,  respectively. Grace Lui provided legal support, Etana Finkler provided  graphics support, and Joyce Evans, Jeremy Sebest, and Cynthia S.  Taylor provided assistance in editing and report preparation.

section_title: Related GAO Products
paragraphs: Export Controls: Proposed Reforms Create Opportunities to Address  Enforcement Challenges. GAO-12-246. Washington, D.C.: March 27,  2012.

Persian Gulf: Implementation Gaps Limit the Effectiveness of End-Use  Monitoring and Human Rights Vetting for U.S. Military Equipment,   GAO-12-89. Washington, D.C.: November 17, 2011.

Export Controls: Improvements Needed to Prevent Unauthorized  Technology Releases to Foreign Nationals in the United States.   GAO-11-354. Washington, D.C.: February 2, 2011.

Defense Exports: Reporting on Exported Articles and Services Needs to  Be Improved. GAO-10-952. Washington, D.C.: September 21, 2010.

Persian Gulf: U.S. Agencies Need to Improve Licensing Data and to  Document Reviews of Arms Transfers for U.S. Foreign Policy and  National Security Goals. GAO-10-918. Washington, D.C.: September 28,  2010.

Export Controls: Observations on Selected Countries’ Systems and  Proposed Treaties. GAO-10-557. Washington, D.C.: June 28, 2010.

Iran Sanctions: Complete and Timely Licensing Data Needed to  Strengthen Enforcement of Export Restrictions. GAO-10-375.  Washington, D.C.: March 4, 2010.

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. GAO-08-1095. Washington, D.C.:  October 27, 2008.

Defense Trade: State Department Needs to Conduct Assessments to  Identify and Address Inefficiencies and Challenges in the Arms Export  Process. GAO-08-89. Washington, D.C.: January 8, 2008.

Nonproliferation: U.S. Efforts to Combat Nuclear Networks Need Better  Data on Proliferation Risks and Program Results. GAO-08-21.  Washington, D.C.: October 31, 2007.

Defense Trade: Clarification and More Comprehensive Oversight of  Export Exemptions Certified by DOD Are Needed. GAO-07-1103.  Washington, D.C.: October 19, 2007.

Export Controls: Challenges Exist in Enforcement of an Inherently  Complex System. GAO-07-265. Washington, D.C.: December 20, 2006.

Export Controls: Agencies Should Assess Vulnerabilities and Improve  Guidance for Protecting Export-Controlled Information at Universities.  GAO-07-70. Washington, D.C.: December 5, 2006.

Export Controls: Improvements to Commerce’s Dual-Use System Needed  to Ensure Protection of U.S. Interests in the Post-9/11 Environment.  GAO-06-638. Washington, D.C.: June 26, 2006.

Defense Trade: Arms Export Control System in the Post-9/11  Environment. GAO-05-234. Washington, D.C.: February 16, 2005.

Nonproliferation: Improvements Needed To Better Control Technology  Exports For Cruise Missiles And Unmanned Aerial Vehicles.  GAO-04-175. Washington, D.C.: January 23, 2004.

Export Controls: Post-Shipment Verification Provides Limited Assurance  That Dual-Use Items Are Being Properly Used. GAO-04-357.  Washington, D.C.: January 12, 2004.

Defense Trade: Better Information Needed To Support Decisions  Affecting Proposed Weapons Transfers. GAO-03-694. Washington, D.C.:  July 11, 2003.

Nonproliferation: Strategy Needed To Strengthen Multilateral Export  Control Regimes. GAO-03-43. Washington, D.C.: October 25, 2002.

Export Controls: Processes for Determining Proper Control of Defense- Related Items Needs Improvement. GAO-02-996. Washington, D.C.:  September 20, 2002.

Export Controls: Department of Commerce Controls over Transfers of  Technology to Foreign Nationals Need Improvement. GAO-02-972.  Washington, D.C.: September 6, 2002.

Lessons to Be Learned From the Country Export Exemption. GAO-02-63.  Washington, D.C.: March 29, 2002.

Export Controls: Clarification of Jurisdiction for Missile Technology Items  Needed. GAO-02-120. Washington, D.C.: October 9, 2001.


Question-summary annotations: questions: question: What measure did US agencies use to increase protection on exported items?
answer: U.S. agencies engaged in export controls use various compliance activities to prevent the diversion or misuse of exported items against U.S. interests or allies and reduce illicit transshipment risk. Compliance activities include (1) vetting transactions prior to export, (2) analyzing shipping data and monitoring the end use of items, and (3) educating companies and foreign governments about illicit transshipment risks.
child_questions: question: How do US agencies vet transactions?
answer: To vet transactions, agencies review license applications for the export of controlled items, consult multiple lists of entities known or suspected of violating export control laws or regulations, and screen foreign end users to determine their eligibility to receive items without a license. Agencies also review shipping records to identify patterns of abuse and to plan end-use checks—visiting foreign companies to verify the approved use and location of exported items on both licensed items and those eligible for export without a license.

question: What results did the analysis of exports yield?
answer: In the 13 transshipment countries, unlicensed exports accounted for about 94 percent of unfavorable end-use check determinations, which indicates that the end use or end user of an export were not appropriate. For example, some unlicensed items transshipped illicitly to Iran through Hong Kong were used to build improvised explosive devices used against Coalition troops in Iraq.

question: What has been done to educate U.S. companies and foreign governments about  the dangers of illicit transshipment?
answer: To educate U.S. companies and foreign governments about illicit transshipment risks, Commerce and State review the internal controls of companies’ compliance programs; conduct outreach to U.S. companies to inform exporters of their responsibilities to comply with export control laws and regulations; and provide training to foreign governments.

questions: question: What impact do agencies suspect control list reforms may have?
answer: Agencies have not fully assessed the potential impact that control list reforms may pose for the resource needs of their compliance activities. Agencies estimate that Commerce will receive between 16,000 and 30,000 additional license applications as a result of proposed reforms to move less sensitive items from State to Commerce.
child_questions: question: Would the anticipated  impact of control list reforms be positive?
answer: Agency documents state that this step would allow them to focus resources on items most critical to national security and may make compliance easier for exporters because Commerce imposes fewer requirements than State’s controls.

question: Why can there be an unaccounted for negative effect of control list reforms ?
answer: However, Commerce has not assessed the impact this added responsibility would have on its end-use check resource needs.

question: What potential risks are the control list reforms suspected to have?
answer: Some agency officials suggested potential risks, such as an increased need for more end-use checks and the loss of information from reviewing exports through the licensing process prior to export.

questions: question: How did the US address the issue of sensitive technologies being stolen by hostile entities.?
answer: To protect its national security and commercial interests, the United States has implemented an export control system to limit sensitive technologies from falling into the wrong hands.
child_questions: question: What are the roles of the two departments in charge of addressing this problem?
answer: The Department of State regulates U.S. defense exports and the Department of Commerce regulates dual-use exports that have commercial and military applications.

question: What do these two departments use to address this problem?
answer: Each agency uses a separate control list of items that may require a license to export. Agencies use compliance activities to prevent the diversion or misuse of exported items against U.S. interests or allies.

question: How can sensitive American technologies fall into the wrong hands?
answer: Misuse can occur through illicit transshipment, the diversion of items from their origin through an intermediary country to an unauthorized destination.