Defense Industrial Security: Weaknesses in U.S. Security Arrangements With Foreign-Owned Defense Contractors
Released: 1996-02-20T00:00:00

Letter

Introduction

In the last decade, weapon systems have increasingly been developed, produced, and marketed internationally through government-sponsored cooperative development programs and a variety of industry linkages. These linkages include international subcontracting, joint ventures, teaming arrangements, and cross-border mergers and acquisitions. Also, the Department of Defense (DOD) and other agencies have shared certain highly classified information with allied governments. U.S. government policy allows foreign investment as long as it is consistent with national security interests. Foreign companies from many countries have acquired numerous U.S. defense companies and have legitimate business interests in them. Some of these foreign-owned companies are working on highly classified defense contracts, such as the B-2, the F-117, the F-22, and military satellite programs.

Recognizing that undue foreign control or influence over management or operations of companies working on sensitive classified contracts could compromise classified information or impede the performance of classified contracts, DOD requires that foreign-owned U.S. firms operate under control structures known as voting trusts, proxy agreements, and special security agreements (SSA). Each of these agreements requires that the foreign owners select and DOD approve cleared U.S. citizens to be placed on the board of directors of the foreign-owned company to represent DOD’s interests by ensuring against (1) foreign access to classified information without a clearance and a need to know and (2) company actions that could adversely affect performance on classified contracts.

Government Required Security Controls

In February 1995, the government issued the National Industrial Security Program Operating Manual (NISPOM) to replace the DOD Industrial Security Manual and various agencies’ industrial security requirements. The NISPOM’s section dealing with foreign ownership, control, or influence (FOCI) contains many provisions on voting trusts, proxy agreements, and SSAs similar to those in the DOD Industrial Security Regulation (ISR). The ISR will continue to apply in its current form until it is amended to reflect the NISPOM.

Both the ISR and NISPOM require a company to obtain a facility clearance before it can work on a classified DOD contract and prescribe procedures for defense contractors to protect classified information entrusted to them. DOD’s policy provides that a firm is ineligible for a facility clearance if it is under FOCI. However, such a firm may be eligible for a facility clearance if actions are taken to effectively negate or reduce associated risks to an acceptable level. When the firm is majority foreign-owned, the control structures used to negate or reduce such risks include voting trusts, proxy agreements, and SSAs.

The Defense Investigative Service (DIS) administers the DOD Industrial Security Program and is required to conduct compliance reviews of defense contractors operating under voting trusts, proxy agreements, and SSAs. This oversight function requires a DIS security inspection of the cleared facility every 6 months and an annual FOCI review meeting between DIS and the trustees of the foreign-owned firm. These reviews are aimed at ensuring compliance with special controls, practices, and procedures established to insulate the facility from foreign interests.

Voting Trusts

Under a voting trust agreement, the foreign owners transfer legal title to the stock of the foreign-owned U.S. company to U.S. citizen trustees. Under the ISR and NISPOM, voting trusts must provide trustees with complete freedom to exercise all prerogatives of ownership and act independently from the foreign owners. Under the ISR and NISPOM, five actions may require prior approval by the foreign owner: the sale or disposal of the corporation’s assets or a substantial part thereof; pledges, mortgages, or other encumbrances on the capital stock of the corporate mergers, consolidations, or reorganization; the dissolution of the corporation; or the filing of a bankruptcy petition.

Under the ISR, the trustees were to act independently without consultation with, interference by, or influence from the foreign owners, but the NISPOM allows for consultation between the trustees and foreign owners.

Proxy Agreement

The proxy agreement is essentially the same as the voting trust, with the exception of who holds title to the stock. Under the voting trust, the title to the stock is transferred to the trustees. Under the proxy agreement, the owners retain title to the stock, but the voting rights of the stock are transferred to the DOD-approved proxy holders by a proxy agreement. The powers and responsibilities of the proxy holders are the same as those of the trustees under a voting trust. From a security or control perspective, we saw no difference between the voting trust and the proxy agreement. DOD and company officials stated that from the companies’ perspective, the difference between these two agreements is largely a tax issue.

Special Security Agreement

The third type of control structure for majority foreign-owned firms is the SSA. Unlike a voting trust or proxy agreement, the SSA allows representatives of the foreign owner to be on the U.S. contractor’s board of directors. This representative, known as an inside director, does not need a DOD security clearance and can be a foreign national. In contrast, outside directors are U.S. citizens and must be approved by and obtain security clearances from DOD. Under DOD policy, outside directors are to ensure that classified information is protected from unauthorized or inadvertent access by the foreign owners and that the U.S. company’s ability to perform on classified contracts is not adversely affected by foreign influence over strategic decision-making.

Because SSAs allow the foreign owners a higher potential for control over the U.S. defense contractor than proxies or voting trusts, firms operating under SSAs are generally prohibited from accessing highly classified information such as Top Secret and Sensitive Compartmented Information. However, DOD can grant exceptions to this prohibition and can award contracts at these highly classified levels if it determines it is in the national interest.

Visitation Agreement

DOD.

The visitation agreement was to identify the representatives of the foreign owners allowed to visit the cleared U.S. firm, the purposes for which they were allowed to visit, the advance approval that was necessary, and the identity of the approval authority. In 1993, DOD eliminated visitation agreements as separate documents and incorporated visitation control procedures as a section of each voting trust, proxy agreement, and SSA.

Agreements Are Negotiated and Vary

Voting trust agreements, proxy agreements, SSAs, and their attendant visitation agreements are negotiated between the foreign-owned company and DOD. Although DOD has boilerplate language that can be adopted, according to a DOD official, many cases have unique circumstances that call for flexible application of the ISR provisions. DOD’s flexible approach leads to negotiations that can result in company-specific agreements containing provisions that provide stronger or weaker controls. Generally, the foreign owners negotiate to secure the least restrictive agreements possible.

DOD has approved more lenient visitation agreements and procedures over time. A DOD official explained that DOD’s flexible approach to FOCI arrangements and the resulting negotiations have probably caused the visitation controls to become relaxed. Each negotiated visitation agreement that relaxed controls became the starting point for subsequent negotiations on new agreements as the foreign-owned companies’ lawyers would point to the last visitation agreement as precedent. We recognize the need to tailor the agreements to specific company circumstances and to permit international defense work, but the lack of a baseline set of controls in the agreements made DIS inspections very difficult, according to DIS inspectors.

Agreements Were Not Designed to Protect Unclassified Export-Controlled Technologies

Almost all the foreign-owned U.S. firms we reviewed possessed unclassified information and technologies that are export-controlled by the Departments of State and Commerce. DOD deemed some of these technologies to be militarily critical, such as carbon/carbon material manufacturing technology and flight control systems technology. Many classified defense contracts involve classified applications of unclassified export-controlled items and technologies. The ISR and most agreements were not designed to protect unclassified export-controlled information. As such, DIS does not review the protection of unclassified export-controlled technology during its inspections of cleared contractors. In fact, the U.S. government has no established means to monitor compliance with and ensure enforcement of federal regulations regarding the transfer of export-controlled technical information. In light of what is known about the technology acquisition and diversion intentions of certain allies (see ch. 2) and the high degree of contact with foreign interests at foreign-owned U.S. defense contractors (see ch. 3), enforcement of export control regulations is important. The new NISPOM reflects this concern and requires trustees in future voting trusts, proxy agreements, and SSAs to take necessary steps to ensure the company complies with U.S. export control laws.

Fifty-Four Firms Operate Under Voting Trusts, Proxy Agreements, or SSAs

As of August 1994, 54 foreign-owned U.S. defense contractors were operating under voting trusts, proxy agreements, or SSAs. Six of these companies operate under voting trusts, 15 under proxy agreements, and 33 under SSAs. These 54 firms held a total of 657 classified contracts, valued at $5.4 billion. The largest firm operating under these agreements (as measured by the value of the classified contracts it held) is a computer services company that operates under a proxy agreement and held classified contracts valued at $2.5 billion. The foreign owners of the 54 firms are from Australia, Austria, Canada, Denmark, France, Germany, Israel, Japan, the Netherlands, Sweden, Switzerland, and the United Kingdom. Currently, three of the companies are wholly or partially owned by foreign governments.

Objective, Scope, and Methodology

Our review was conducted at the request of the former Chairman and Ranking Minority Member, Subcommittee on Oversight and Investigation, House Committee on Armed Services (now the House Committee on National Security). Our objective was to assess the structure of voting trusts, proxy agreements, and SSAs and their implementation in the prevention of unauthorized disclosure of classified and export-controlled information to foreign interests. We did not attempt to determine whether unauthorized access to classified or export-controlled data/technology actually occurred. Rather, we examined the controls established in the ISR, the draft NISPOM, and the agreements’ structures and the way they were implemented at each of 14 companies we selected to review.

We discussed security issues involving foreign-owned defense contractors and information security with officials from the Office of the Deputy Assistant Secretary of Defense (Counterintelligence, Security Countermeasures and Spectrum Management); DIS; and information security officials from the Air Force, the Army, and the Navy. We also discussed the performance of Special Access and Sensitive Compartmented contracts by foreign-owned companies with an official from the office of the Assistant Deputy Under Secretary of Defense (Security Policy). To obtain information on the threat of foreign espionage against U.S. defense industries, we interviewed officials and reviewed documents from the Central Intelligence Agency (CIA), Defense Intelligence Agency (DIA), and Federal Bureau of Investigation (FBI).

In selecting the 14 companies for our judgmental sample, we included 5 companies that were wholly or partially owned by foreign governments. We selected the nine additional foreign-owned firms on the basis of (1) the sensitivity of the information they held, (2) agreement types, (3) country of origin, and (4) geographic location. One company we reviewed operated under a voting trust, five operated under proxy agreements, and six operated under SSAs. In addition, one firm transitioned from an SSA to a proxy agreement during our review, and we found that another firm operated under a different control structure, a memorandum of agreement (MOA). Table 1.1 shows the countries of ownership and agreement type of the companies we reviewed.

This judgmental sample reflects the distribution of agreement type and country of ownership of the 54 companies operating under voting trusts, proxy agreements, and SSAs. However, due to the small size of our sample and the nonrandom nature of its selection, the results of our review cannot be projected to the universe of all companies operating under these agreements.

We were initially told that an aerospace company operated under an SSA, and selected the company for our sample based on foreign government ownership of companies that are its partial owners. We subsequently learned that the company operated under a unique arrangement—an MOA . Because of the foreign government ownership component and the sensitivity of the information accessed by this aerospace company, we retained the company in our sample. When we present statistics in our report on the number of companies operating under voting trusts, proxy agreements, and SSAs and the number of contracts they hold and the contracts’ value, this company is not included in those numbers.However, we include the company in the discussions of control structures and their implementation (see chs. 3 and 4). In those instances, we specifically refer to the MOA.

We compared the agreements of the 14 companies to each other and to boilerplate agreements provided by DIS. We also examined the agreements’ provisions to determine if they met the requirements of the ISR, the regulation in force at the time. We examined the visitation approval procedures and standard practice procedures manuals at the companies we reviewed to determine how the companies controlled foreign visitors and their access to the cleared facilities. We also interviewed company management, security personnel, and the company trustees to determine how they implemented the agreements. To assess implementation of the agreements, we reviewed annual company implementation reports, board of directors minutes, defense security committee minutes, visitation logs, international telephone bills, and various internal company correspondence and memorandums. To assess trustee involvement, we interviewed trustees and reviewed visitation approvals, as well as trustee meeting minutes, which showed the frequency of meetings, individuals’ attendance records, and topics of discussion. We also discussed each company’s implementation of the agreements and its information security programs with the cognizant DIS regional management and inspectors and reviewed their inspection reports.

Access Limitation

During our review, we had limited access to certain information. Foreign-owned contractors were working on various contracts and programs classified as Special Access Programs or Sensitive Compartmented Information. We were told by an official from the Office of the Assistant Deputy Under Secretary of Defense (Security Policy) that in some instances, it is not possible to acknowledge the existence of such contracts to individuals who are not specifically cleared for the program.

As a result, we may not know of all foreign-owned firms involved in highly classified work.

DOD provided written comments on a draft of this report. The complete text of those comments and our response is presented in appendix I. We performed our review from August 1992 through February 1995 in accordance with generally accepted government auditing standards.

Espionage Threat and Information at Risk

Some close U.S. allies actively seek to obtain classified and technical information from the United States through unauthorized means. Through its National Security Threat List program, the FBI National Security Division has determined that foreign intelligence activities directed at U.S. critical technologies pose a significant threat to national security. As we testified before the House Committee on the Judiciary in April 1992, sophisticated methods are used in espionage against U.S. companies.Unfortunately, the companies targeted by foreign intelligence agencies may not know—and may never know—that they have been targeted or compromised. “The risk in each of these situations is that foreign entities will exploit the relationship in ways that do not serve our overall national goals of preserving our technological advantages and curtailing proliferation. These goals generally include keeping certain nations from obtaining the technical capabilities to develop and produce advanced weapon systems and from acquiring the ability to counter advanced US weapon systems. In cases where U.S. national interests require the sharing of some of our capabilities with foreign governments, security safeguards must ensure that foreign disclosures do not go beyond their authorized scope. Safeguards must also be tailored to new proliferation threats and applied effectively to the authorization of foreign investment in classified defense industry and the granting of access by foreign representatives to our classified facilities and information.”

Contractors owned by companies and governments of these same allied countries are working on classified DOD contracts under the protection of voting trusts, proxy agreements, and SSAs. These companies perform on DOD contracts developing, producing, and maintaining very sensitive military systems, and some of them have access to the most sensitive categories of U.S. classified information.

Information at Risk

Contracts requiring access to classified information at the levels shown in table 2.1 have been awarded to foreign-owned U.S. defense contractors.

The following are examples of some sensitive contract work being performed by the 14 foreign-owned U.S. companies we reviewed: development of computer software for planning target selection and aircraft routes in the event of a nuclear war (a Top Secret contract); maintenance of DOD’s Worldwide Military Command and Control System ((WWMCCS) - the contract was classified TS, SCI, and COMSEC because of the information the computer-driven communications system contains); production of signal intelligence gathering radio receivers for the U.S. production of command destruct receivers for military missiles and National Aeronautics and Space Administration rockets (to destroy a rocket that goes off course); production of carbon/carbon composite Trident D-5 missile heat shields; production of the flight controls for the B-2, the F-117, and the F-22.

Some of the contracts these foreign-owned U.S. companies are working on are Special Access Programs. Due to the special access requirements of these contracts, the contractors could not tell us what type of work they were doing, what military system the work was for, or even the identity of the DOD customer.

Some of the contracts performed by companies we examined involve less sensitive technologies. For example, one company we visited had contracts requiring access to classified information because it cast valves for naval nuclear propulsion systems, and it needed classified test parameters for the valves. Another firm operating under an SSA is required to have a Secret-level clearance because it installs alarm systems in buildings that hold classified information.

In addition to classified information, most of the 14 foreign-owned companies we reviewed possessed unclassified technical information and hardware items that are export-controlled by the State or Commerce Departments. DOD deemed many of these technologies to be militarily critical.

U.S. Intelligence Agencies Identified Economic Espionage Efforts of Certain Allies

Reports and briefings provided during 1993 by U.S. intelligence agencies showed a continuing economic espionage threat from certain U.S. allies.Eight of the 54 companies operating under voting trusts, proxy agreements, and SSAs and working on classified contracts are owned by interests from one of these countries. The following are intelligence agency threat assessments and examples illustrating this espionage.

Country A

According to a U.S. intelligence agency, the government of Country A conducts the most aggressive espionage operation against the United States of any U.S. ally. Classified military information and sensitive military technologies are high-priority targets for the intelligence agencies of this country. Country A seeks this information for three reasons: (1) to help the technological development of its own defense industrial base, (2) to sell or trade the information with other countries for economic reasons, and (3) to sell or trade the information with other countries to develop political alliances and alternative sources of arms. According to a classified 1994 report produced by a U.S. government interagency working group on U.S. critical technology companies, Country A routinely resorts to state-sponsored espionage using covert collection techniques to obtain sensitive U.S. economic information and technology. Agents of Country A collect a variety of classified and proprietary information through observation, elicitation, and theft.

The following are intelligence agency examples of Country A information collection efforts:

An espionage operation run by the intelligence organization responsible for collecting scientific and technologic information for Country A paid a U.S. government employee to obtain U.S. classified military intelligence documents.

Several citizens of Country A were caught in the United States stealing sensitive technology used in manufacturing artillery gun tubes.

Agents of Country A allegedly stole design plans for a classified reconnaissance system from a U.S. company and gave them to a defense contractor from Country A.

A company from Country A is suspectecd of surreptitiously monitoring a DOD telecommunications system to obtain classified information for Country A intelligence.

Citizens of Country A were investigated for allegations of passing advanced aerospace design technology to unauthorized scientists and researchers.

Country A is suspected of targeting U.S. avionics, missile telemetry and testing data, and aircraft communication systems for intelligence operations. It has been determined that Country A targeted specialized software that is used to store data in friendly aircraft warning systems.

Country A has targeted information on advanced materials and coatings for collection. A Country A government agency allegedly obtained information regarding a chemical finish used on missile reentry vehicles from a U.S. person.

Country B

According to intelligence agencies, in the 1960s, the government of Country B began an aggressive and massive espionage effort against the United States. The 1994 interagency report on U.S. critical technology companies pointed out that recent international developments have increased foreign intelligence collection efforts against U.S. economic interests. The lessening of East-West tensions in the late 1980s and early 1990s enabled Country B intelligence services to allocate greater resources to collect sensitive U.S. economic information and technology.

Methods used by Country B are updated versions of classic Cold War recruitment and technical operations. The Country B government organization that conducts these activities does not target U.S. national defense information such as war plans, but rather seeks U.S. technology. The motivation for these activities is the health of Country B’s defense industrial base. Country B considers it vital to its national security to be self-sufficient in manufacturing arms. Since domestic consumption will not support its defense industries, Country B must export arms. Country B seeks U.S. defense technologies to incorporate into domestically produced systems. By stealing the technology from the United States, Country B can have cutting-edge weapon systems without the cost of research and development. The cutting-edge technologies not only provide superior weapon systems for Country B’s own use, but also make these products more marketable for exports. It is believed that Country B espionage efforts against the U.S. defense industries will continue and may increase. Country B needs the cutting-edge technologies to compete with U.S. systems in the international arms market.

The following are intelligence agency examples of Country B information collection efforts: In the late 1980s, Country B’s intelligence agency recruited agents at the European offices of three U.S. computer and electronics firms. The agents apparently were stealing unusually sensitive technical information for a struggling Country B company. This Country B company also owns a U.S. company operating under a proxy agreement and performing contracts for DOD classified as TS, SAP, SCI, and COMSEC.

Country B companies and government officials have been investigated for suspected efforts to acquire advanced abrasive technology and stealth-related coatings.

Country B representatives have been investigated for targeting software that performs high-speed, real-time computational analysis that can be used in a missile attack system. Information was obtained that Country B targeted a number of U.S. defense companies and their missile and satellite technologies for espionage efforts. Companies of Country B have made efforts, some successful, to acquire targeted companies.

Country C

The motivation for Country C industrial espionage against the United States is much like that of Country B: Country C wants cutting-edge technologies to incorporate into weapon systems it produces. The technology would give Country C armed forces a quality weapon and would increase the weapon’s export market potential. The Country C government intelligence organization has assisted Country C industry in obtaining defense technologies, but not as actively as Country B intelligence has for its industry. One example of Country C government assistance occurred in the late 1980s, when a Country C firm wanted to enter Strategic Defense Initiative work. At that time, the Country C intelligence organization assisted this firm in obtaining applicable technology.

Country D

The Country D government has no official foreign intelligence service. Private Country D companies are the intelligence gatherers. They have more of a presence throughout the world than the Country D government. However, according to the 1994 interagency report, the Country D government obtains much of the economic intelligence that Country D private-sector firms operating abroad collect for their own purposes. This occasionally includes classified foreign government documents and corporate proprietary data. Country D employees have been quite successful in developing and exploiting Americans who have access to classified and proprietary information.

The following are examples of information collection efforts of Country D:

Firms from Country D have been investigated for targeting advanced propulsion technologies, from slush-hydrogen fuel to torpedo target motors, and attempting to export these items through intermediaries and specialty shipping companies in violation of export restrictions. Individuals from Country D have been investigated for allegedly passing advanced aerospace design technology to unauthorized scientists and researchers.

Electronics firms from Country D directed information-gathering efforts at competing U.S. firms in order to increase the market share of Country D in the semiconductor field.

Country E

Intelligence community officials stated that they did not have indications that the intelligence service of Country E has targeted the United States or its defense industry for espionage efforts. However, according to the 1994 interagency report, in 1991 the intelligence service of this country was considering moving toward what it called “semi-overt” collection of foreign economic intelligence. At that time, Country E’s intelligence service reportedly planned to increase the number of its senior officers in Washington to improve its semi-overt collection—probably referring to more intense elicitation from government and business contacts.

The main counterintelligence concern cited by one intelligence agency regarding Country E is not that its government may be targeting the United States with espionage efforts, but that any technology that does find its way into Country E will probably be diverted to countries to which the United States would not sell its defense technologies. The defense industry of this country is of particular concern in this regard.

It was reported that information diversions from Country E have serious implications for U.S. national security. Large-scale losses of technology were discovered in the early 1990s. Primary responsibility for industrial security resides in a small staff of the government of Country E. It was reported that this limited staff often loses when its regulatory concerns clash with business interests. The intelligence agency concluded that the additional time needed to eradicate the diversion systems will consequently limit the degree of technological security available for several years. The question suggested by this situation is, if technology from a U.S. defense contractor owned by interests of Country E is transferred to Country E, will this U.S. defense technology then be diverted to countries to which the United States would not sell?

Assessment of Control Structures

Foreign ownership or control of U.S. firms performing classified contracts for DOD poses a special security risk. The risk includes unauthorized or inadvertent disclosure of classified information available to the U.S. firm. In addition, foreign owners could take action that would jeopardize the performance of classified contracts. To minimize the risks, the ISR and NISPOM require voting trusts and proxy agreements to insulate the foreign owners from the cleared U.S. defense firm or SSAs to limit foreign owners’ participation in the management of the cleared U.S. firm. The ISR also required visitation agreements to control visitation between foreign owners and their cleared U.S. firms. The new industrial security program manual does not address visitation control agreements or procedures. DOD eliminated separate visitation agreements in favor of visitation procedures in the security agreements themselves.

In May 1992, a former Secretary of Defense testified before the House Committee on Armed Services that under proxy agreements and voting trusts, the foreign owners of U.S. companies working on classified contracts had “virtually no say except if somebody wants to sell the company or in very major decisions.” He indicated that for the purposes of the foreign parent company, proxy agreements and voting trusts are essentially “blind trusts.” Further, he testified that a number of companies were “functioning successfully” under SSAs.

Of the three types of arrangements used to negate or reduce risks in majority foreign ownership cases, SSAs were the least restrictive. Accordingly, SSA firms pose a somewhat higher risk associated with classified work. The ISR and the NISPOM generally prohibit SSA firms from being involved in Top Secret and other highly sensitive contracts, but allow for exceptions if DOD determines they are in the national interest. SSA firms we reviewed were working on 47 contracts classified as TS, SCI, SAP, RD, and COMSEC. In addition, we observed that ISR-required visitation agreements permitted significant contact between the U.S. firms and the foreign owners.

Higher Degree of Risk With SSA Structure

Unlike voting trusts and proxy agreements, which insulate foreign owners from the management of the cleared firm, SSAs allow foreign owners to appoint a representative to serve on the board of directors. Called an “inside director,” this individual represents the foreign owners and is often a foreign national. The inside director is to be counterbalanced by DOD-approved directors, called the “outside directors.” The principal function of the outside directors is to protect U.S. security interests.

Inside directors cannot hold a majority of the votes on the board, but because of their connection to the foreign owners, their views about the company’s direction on certain defense contracts or product lines reflect those of the owners. Depending on the composition of the board, the inside director and the company officers on the board could possibly combine to out vote the outside directors. In addition, unlike voting trusts and proxy agreements, the SSAs we examined allow the foreign owner to replace “any member of the [SSA company] Board of Directors for any reason.” DOD recently provided us with new boilerplate SSA language that will require DIS to approve the removal of a director.

Foreign owners of SSA firms can also exercise significant influence over the U.S. companies they own in other ways. For example, at two SSA firms we examined, the foreign owners used export licenses to obtain unclassified technology from the U.S. subsidiary that was vital to the U.S. companies’ competitive positions. Officers of the U.S. companies stated that they did not want to share these technologies, but the foreign owners required them to do so. Subsequently, one of these U.S. companies faced its own technology in a competition with its foreign owner for a U.S. Army contract.

SSA Firms Working on Contracts Requiring Access to Top Secret, Special Access, and Other Sensitive Information

Because of the additional risk previously mentioned, companies operating under SSAs are normally ineligible for contracts allowing access to TS, SAP, SCI, RD, and COMSEC information. However, during our review, 12 of the 33 SSA companies were working on at least 47 contracts requiring access to this highly classified information.

Before June 1991, DOD reviewed an SSA firm to determine whether it would be in the national interest to allow the firm to compete for contracts classified TS, SCI, SAP, RD, or COMSEC. New guidance was issued in June 1991 requiring the responsible military service to make a national interest determination each time a highly classified contract was awarded to an SSA firm. We found only one contract-specific national interest determination had been written since the June 1991 guidance. According to DOD officials, the other 46 highly classified contracts performed by SSA companies predated June 1991 or were follow-on contracts to contracts awarded before June 1991. Since information on some contracts awarded to SSA companies is under special access restrictions, DOD officials may be authorized to conceal the contracts from people not specifically cleared for access to the program. We, therefore, could not determine with confidence if the requirement for contract-specific national interest determinations was carried out.

One Company Operates Under an Alternative Agreement

One company performs on contracts classified as TS, SCI, SAP, RD, and COMSEC under an alternative arrangement called an MOA. The MOA (a unique agreement) was created in 1991 because the company has classified DOD contracts and, although foreign interests do not hold a majority of the stock, they own 49 percent of the company and have special rights to veto certain actions of the majority owners.

Normally, under the ISR, minority foreign investment in a cleared U.S. defense contractor required only a resolution of the board of directors stating that the foreign interests will not require, nor be given, access to classified information. DOD did not consider the board resolution appropriate for this case, partially because of the board membership of the foreign owners and their veto rights over certain basic corporate decisions. The company board of directors consists of six representatives appointed by the U.S. owners and one representative for each of the four foreign minority interests. Any single foreign director can block any of 16 specified actions of the board of directors. These actions include the adoption of a company strategic plan or annual budget as well as the development of a new product that varies from the lines of business set forth in the strategic plan. In addition, any two foreign directors can block an additional 11 specified actions. These veto rights could give the foreign interests significantly more control and influence over the U.S. defense contractor in certain instances than would be permitted in an SSA. In 1991, DIS objected to an agreement less stringent than an SSA because of the veto rights of the foreign directors and, unlike an SSA, an MOA does not require any DOD-approved outside members on the board of directors. However, the Office of the Under Secretary of Defense for Policy determined that the company would not be under foreign domination and that the MOA was a sufficient control.

DOD reexamined the MOA during a subsequent (1992) foreign investment in the company and made some modifications. Although the MOA does not provide for outside members on the board, it does require DOD-approved outside members on a Defense Security Committee to oversee the protection of classified and export-controlled information. The first version of the MOA did not give the outside security committee members the right to attend any board of directors meetings. Under the revised (1992) version of the MOA, the outside security committee members still do not have general rights to attend board meetings; however, their attendance at board meetings is required if the foreign interests are to exercise their veto rights. Also, the first version of the MOA did not require any prior security committee approval for representatives of the foreign interests to visit the cleared U.S. defense contractor. The newer version requires prior approval when the visits concern performance on a classified contract.

Visitation Agreements Give Foreign Owners a High Degree of Access

“In every case where a voting trust agreement, proxy agreement, or special security agreement is employed to eliminate risks associated with foreign ownership, a visitation agreement shall be executed . . .” “The visitation agreement shall provide that, as a general rule, visits between the foreign stockholder and the cleared U.S. firm are not authorized; however, as an exception to the general rule, the trustees, may approve such visits in connection with regular day-to-day business operations pertaining strictly to purely commercial products or services and not involving classified contracts.”

The visitation agreements are to guard against foreign owners or their representatives obtaining access to classified information without a clearance and a need to know.

At all 14 companies we reviewed, visitation agreements permitted the foreign owners and their representatives to visit regarding military and dual-use products and services. The visitation agreements permitted visits to the U.S. company (1) in association with classified contracts if the foreign interests had the appropriate security clearance and (2) under State or Commerce Department export licenses.

The large number of business transactions between the U.S. defense contractors and their foreign owners granted representatives of the foreign owners frequent entry to the cleared U.S. facilities. Eight of the 14 firms we reviewed had contractual arrangements with their foreign owners that led to a high (often daily) degree of contact. In one case, the U.S. company sold and serviced equipment produced by the foreign firm, so the two firms had almost continual contact at the technician level to obtain repair parts and technical assistance. During a 3-month period in 1993, this company approved 167 extended visit authorizations.

At one SSA firm we reviewed, 236 visits occurred between the U.S. firm and representatives of the foreign owners over a 1-year period, averaging about 7 days per visit. At a proxy company, there were 322 approved requests for contact with representatives of the owners during a 1-year period; 94 of the requests were blanket requests for multiple contacts over the subsequent 3-month period. Not all foreign-owned defense contractors had this degree of contact with representatives of their foreign owners. One SSA firm had only 44 visits with representatives of its foreign owners during a 1-year period.

Some visitation agreements permitted long-term visits to the cleared U.S. companies by employees of the foreign owners. Five companies we reviewed had employees of the foreign owners working at the cleared U.S. facilities. In a number of these cases, they were technical and managerial staff working on military and dual-use systems and products under approved export licenses. One company covered by a proxy agreement had a foreign national technical manager from the foreign parent firm review the space and military technologies of the U.S. defense contractor to determine if there were opportunities for technical cooperation with the foreign parent firm. At another firm we reviewed, representatives of the foreign partners are permanently on site. At yet another company, a foreign national employee of the foreign parent company worked on a computer system for the B-2 bomber and had access to export-controlled information without the U.S. company obtaining the required export license.

Lack of Post-Visit Reporting Requirements

Post-visit contact reports are the primary means for DIS and the trustees to monitor the substance of contacts between the foreign-owned U.S. contractor and representatives of its foreign owners. Such records should be used to determine if the contact with representatives of the foreign owners was appropriate and in accordance with the ISR and the visitation agreement. Some visitation agreements do not require employees of the U.S. firm to document and report the substance of the discussions with employees of the foreign parent firm. At three of the firms we reviewed, the only record of contact between employees of the U.S. company and the foreign owners were copies of forms approving the visit. However, at other foreign-owned U.S. defense contractors, post-visit contact reports were available for DIS to review when it inspected the firms and when DIS held its annual agreement compliance review with the foreign-owned companies.

Telephonic Contacts Not Controlled

The ISR, the NISPOM, and most of the visitation agreements we reviewed do not require telephonic contacts between the U.S. defense contractor and representatives of its foreign owners to be controlled and documented. One of the firms covered by a proxy agreement documented 1,912 telephonic contacts between the U.S. company and representatives of its foreign owners for a 1-year period. After examining telephone bills at other companies, we found 1 SSA company had over 550 telephone calls to the country of the foreign owners in 1 month. Company officials said these calls were primarily to representatives of the foreign owners. In contrast, our review of telephone bills at another SSA company showed only 47 telephone calls to the country of the foreign owners during 1 month in 1993.

If an individual intends to breach security, it would be easier to transfer classified or export-controlled information by telephone, facsimile, or computer modem than it would be in person. Documenting telephone contacts would not prevent such illegal activity, but might make it easier to detect. During our review, DIS also recognized this and asked companies to establish a procedure for documenting telephonic contacts with representatives of their foreign owners.

National Industrial Security Manual Has No Requirement for Visitation Agreements

We were initially told the NISPOM section dealing with foreign ownership, control, and influence would replace the FOCI section of the ISR. The new manual does not address visitation control agreements or procedures to restrict visitation between the cleared U.S. defense contractor and representatives of its foreign owners. Instead, it appears to allow unlimited visitation. However, in its comments on our report, DOD stated that the ISR will be retained and revised to reflect the NISPOM. DOD also said that the revised ISR will require visitation approval procedures, but instead of separate visitation agreements, these procedures will be incorporated into each voting trust, proxy agreement, and SSA.

Conclusions

Under the ISR and the new NISPOM, majority foreign-owned facilities cleared to perform classified contracts must enter into agreements with DOD to negate, or at least reduce to an acceptable level, the security risks associated with foreign ownership, control, and influence. Voting trusts and proxy agreements are designed to insulate cleared U.S. defense firms from their foreign owners. SSAs limit the foreign owners’ participation in company management. None of these security arrangements is intended to deny U.S. defense contractors the opportunity to do business with their foreign owners. However, the frequent contact engendered by legitimate unclassified business transactions can heighten the risk of unauthorized access to classified information. Also, existing visitation agreements and procedures permit a high degree of contact. Often this contact is at the technical and engineer level where U.S. classified information could most easily be compromised. The draft NISPOM does not address visitation controls, but DOD has stated that a visitation approval procedures section will be included in the revised ISR.

Assessment of Control Implementation

At a few of the 14 companies we reviewed, DOD-approved trustees were actively involved in company management and security oversight. At most of the companies, however, the trustees did little to protect classified or export-controlled information from access by foreign owner representatives. At proxy agreement companies, we observed cases where foreign owners were exercising more control than the ISR allowed and foreign-owned U.S. defense firms whose independence was degraded because of their financial reliance on the foreign owners. We also observed that some DOD-approved trustees appeared to have conflicts of interest. Finally, DIS did not tailor its inspections of these foreign-owned facilities to specifically address FOCI issues or the implementation of the control agreements, but has recently promulgated new inspection guidelines to address these issues.

Little Involvement by Trustees in Security or Company Management Oversight

Some DOD-approved trustees were more actively involved in management and security oversight than others. For example, at some companies, the trustees retained, and did not delegate, their responsibility for approving all visits by representatives of the foreign owners as required in the visitation agreements. The more active trustees also reviewed post-visit contact reports and interviewed a sample of technical staff who met with the foreign owners’ representatives to ascertain the substance of their discussions, questioned potentially adverse business conditions caused by arrangements with the foreign parent, and attended business meetings at the company more often than quarterly.

At most of the companies we reviewed, however, the trustees (or proxy holders or outside directors) did little to ensure that company management was not unduly influenced by the foreign owners or that the control structures in the security agreements were being properly implemented. Instead, they viewed their role as limited to ensuring that policies exist within the company to protect classified information. At six of the firms we reviewed, monitoring the security implementation and the business operations of the company by the trustees ranged from limited to almost nonexistent. In only two of the firms did the trustees appear to be actively involved in company management and security oversight.

The need for trustee oversight of the business management of foreign-owned companies was highlighted at one SSA firm we examined. At this company, the foreign owners exercised their SSA powers to replace two successive director/presidents of the U.S. company. The first claimed he was terminated because he attempted to enforce the SSA. The second president contested his dismissal because the outside directors were not given prior notice of the owners’ intent to replace him. The owners stated that in both cases, poor business performance was the cause for termination and, in these cases, the outside directors agreed. Nevertheless, outside directors need to remain actively involved in monitoring the companies’ business management to ensure that foreign owners exercise these powers only for legitimate business reasons and not for reasons that could jeopardize classified information and contracts.

Implementation and monitoring of the information security program was usually left to the facility security officer (FSO), an employee of the foreign-owned U.S. company. At the companies we reviewed, a variety of personnel served as FSO, including a general counsel, secretaries, and professional security officers. In any case, the FSO often performed the administrative functions of security and lacked the knowledge to determine the proper parameters for the substance of classified discussions, given a cleared foreign representative’s need to know. This limitation and the FSO’s potential vulnerability as an employee of the foreign-owned company pose a risk without active trustee involvement.

Another potential problem associated with trustees relinquishing implementation and monitoring responsibilities to the FSO was illustrated at an SSA firm we reviewed. At the SSA firm, the FSO wanted to establish a new security procedure, but was overruled by the president of the foreign-owned U.S. defense company. In this instance, the FSO had enough confidence in the outside directors to go to them and complain. The outside directors agreed with the need for the new control and required its implementation. In this case, the outside directors led the officials of the foreign-owned firm to believe that the new security measure was an outside director initiative. If the circumstances and individuals had been different, the FSO might have lacked the confidence to seek the assistance of the outside directors.

At the foreign-owned companies we reviewed, trustees were paid between $1,500 and $75,000 a year. In return for this compensation, the usual trustee involvement was attendance at four meetings annually. Typically, one of the trustees is designated to approve requests for visits with representatives of the foreign owners. This additional duty involves occasionally receiving, reviewing, and transmitting approval requests by facsimile machine.

The ISR requires that a trustee approve visitation requests. However, in most of the firms we reviewed, trustees only directly approved visits between senior management of the U.S. firm and the foreign parent firm. The FSO approved visits below this senior management level, including visits with the technical and engineering staff; the trustees only reviewed documentation of these visits during their quarterly trustee meetings, if at all. In addition, when required, most post-visit contact reports lacked the detail needed for the trustees or DIS to determine what was discussed between the foreign-owned company and the owners’ representatives. Trustee inattention to contact at the technical level is of particular concern, since that is where most of the U.S. defense contractor’s technology is located, not in the board room where senior management officials are found.

Trustees rarely visited or toured the foreign-owned company’s facility to observe the accessibility of classified or export-controlled information, except during prearranged tours at the time of their quarterly meetings. The trustees also rarely interviewed managerial and technical staff to verify the level and nature of their contact with employees of the foreign parent firm. Government officials suggested that trustees at two companies involve themselves in a higher degree of monitoring. Some flatly refused and stated that they have held important positions in government and industry and feel that it is not their role to personally provide such detailed oversight.

The ISR requires that proxy holders and trustees of voting trusts “shall assume full responsibility for the voting stock and for exercising all management prerogatives relating thereto” and that the foreign stockholders shall “continue solely in the status of beneficiaries.” However, as an example of minimal proxy involvement, at one proxy company the three proxy holders only met twice a year. Only one of the three proxy holders was on the company’s board of directors, and the board had not met in person for 4 years. All board action was by telephone, and the board’s role was limited to electing company officers. The proxy holders’ were minimally involved in selecting and approving these company officials. The parent firm selected the current chief executive officer (CEO) of the company and the proxy holders affirmed this selection after questioning the parent firm about the individual’s background. The FSO was required to approve all visits to this firm by employees of the foreign parent rather than the proxy holders as required by the ISR.

At the company we reviewed operating under an MOA, the Defense Security Committee consists of four company officials and the three outside members. These outside members visited the company only for the quarterly committee meetings. The president of the company, who is also the security committee chairman, set the meeting agenda and conducted the meetings. Further, his presentations to the outside members usually focused on current and future business activities rather than security matters. Any plant tours the outside members received were prearranged and concurrent with the quarterly meetings. There were no off-cycle visits to the company to inspect or monitor security operations.

Foreign Owners Acted in Capacities Beyond That of Beneficiary in Proxy Firms

To eliminate the risks associated with foreign control and influence over foreign-owned U.S. defense contractors, the ISR requires that voting trust and proxy agreements “unequivocally shall provide for the exercise of all prerogatives of ownership by the trustees with complete freedom to act independently without consultation with, interference by, or influence from foreign stockholders.” “the trustees shall assume full responsibility for the voting stock and for exercising all management prerogatives relating thereto in such a way as to ensure that the foreign stockholders, except for the approvals just enumerated, [sale, merger, dissolution of the company; encumbrance of stock; filing for bankruptcy] shall be insulated from the cleared facility and continue solely in the status of beneficiaries.”

However, at one of the proxy firms we reviewed, the foreign owners acted in more than the status of beneficiaries. The proxy firm’s strategic plan and annual budget were regularly presented to the foreign owners for review. At least once the foreign parent firm rejected a strategic plan and indicated that it would continue to object until the plan specified increased collaboration between the proxy firm and the foreign parent firm. At another time, the foreign owners had employees of this U.S. firm represent them in an attempt to acquire another U.S. aerospace firm more than 10 times the size of the proxy firm. Although decisions on mergers are within the rights of the foreign owners, during this acquisition effort, officers and employees of the U.S. defense contractor were operating at the direction of the foreign owners. In this case, because the parent firm directed staff of the proxy firm, it clearly acted as more than a beneficiary, the role to which foreign owners are limited under the ISR.

Another proxy firm has a distribution agreement with its foreign owners that restricts the proxy firm to marketing electronic equipment and services to the U.S. government. In addition, the agreement will only allow the proxy firm to service hardware that is used on classified systems. Although this distribution agreement was approved by DIS at the time of the foreign acquisition, it controls the strategic direction of the proxy firm. The proxy firm reported to DIS that it is important for the survival of the U.S. company to be able to pursue business opportunities that are currently denied by the distribution agreement.

Some Foreign-Owned Firms Are Financially Dependent on Foreign Owners

The ISR states that a company operating under a proxy agreement “shall be organized, structured, and financed so as to be capable of operating as a viable business entity independent from the foreign stockholders.” During our review, we saw examples of firms that depended on their foreign owners for financial support or had business arrangements with the foreign owners that degraded the independence of the proxy firm.

The president of one company operating under a proxy agreement told us that his company was basically bankrupt. His company is financed by banks owned by the government where the parent company is incorporated. The company’s foreign parent firm guarantees the loans, and two of the government banks are on the parent firm’s board of directors. The foreign owners paid several million dollars to the U.S. company to relocate one of its divisions. According to officials of the U.S. company, they could not otherwise have afforded such a move, nor could they have obtained bank loans on their own.

Another proxy firm had loans from the foreign owners that grew to exceed the value of the proxy firm. One proxy holder said the company would probably have gone out of business without the loans. Even with the loans, the company’s financial position was precarious. It was financially weak, could not obtain independent financing, and was considerably burdened by making interest payments on its debt to the foreign owners. During our review, a DIS official acknowledged that DIS should have addressed the risk imposed by this indebtedness.

Some Trustees Have Appearance of Conflicts of Interest

Under the ISR provisions, voting trustees and proxy holders “shall be completely disinterested individuals with no prior involvement with either the facility or the corporate body in which it is located, or the foreign interest.” At one of the companies we reviewed, a proxy holder was previously involved as a director of a joint venture with the foreign owners. These foreign owners later nominated this individual to be their proxy holder. He withheld the information about his prior involvement from DIS at the time he became a proxy holder. After DIS became aware of this relationship, it concluded that this individual was ineligible to be a proxy holder and should not continue in that role. Thereafter, the Assistant Secretary of Defense for Command, Control, Communications, and Intelligence wrote to the company about irregularities in proxy agreement implementation, such as allowing the foreign owners prerogatives that were not allowed under the proxy agreement. However, he did not address the appearance of a conflict of interest, and the individual has remained as a proxy holder.

This same proxy holder is also now the part-time CEO of the foreign-owned U.S. defense firm and received an annual compensation of approximately $272,000 (as compared to the $50,000 proxy holder stipend) for an average of 8 days’ work per month in his dual role of CEO and proxy holder. This appears to be a second conflict of interest: as CEO his fiduciary duty and loyalty to the foreign-owned company takes primacy; as proxy holder, his primary responsibility is to protect DOD’s information security interests.

In addition, at this company, the conflict between the proxy holders’ responsibility to DOD and their perceived fiduciary responsibility was illustrated during a DIS investigation into possible violations of the proxy agreement. Citing their fiduciary responsibility, the proxy holders refused to allow DIS investigators to interview employees without company supervision. The Assistant Secretary of Defense for Command, Control, Communications, and Intelligence found this action to be contrary to the firm’s contractual obligations under its security agreement with DOD.

The company just discussed is not the only one where a proxy holder also holds the title of CEO. At another firm, the proxy holder’s salary as CEO is approximately $113,000 (as compared to the $22,000 proxy holder stipend). Again, there appears to be a conflict of interest because of the CEO’s fiduciary duty and loyalty to the foreign-owned company, and his responsibility to protect DOD’s information security interests.

At another proxy firm, the lead proxy holder owns a consulting firm that has a contract with the foreign-owned U.S. company. In this case, there appears to be a conflict of interest because as proxy holder, his primary responsibility is to protect the information security interests of DOD, but as a consultant to the foreign-owned firm, it is in his interest to please the foreign-owned company.

At another firm, the agreement requires that the outside members of the security committee be independent of the foreign investors and their shareholders. The French government owns 12-1/4 percent of this U.S. company. Even though the outside members of the security committee are to protect classified and export-controlled information from this foreign government, one outside member created the appearance of a conflict of interest by representing a French government-owned firm before DOD in its efforts to buy another cleared U.S. defense contractor. This outside member also created the appearance of a conflict of interest when his consulting firm became the Washington representative for a French government-owned firm in its export control matters with the State Department.

Finally, the ISR does not expressly require that outside directors serving under an SSA comply with the independence standards applicable to voting trustees and proxy holders. The reason for this omission is not clear. However, all of the SSAs we reviewed stated that individuals appointed as outside directors can have “no prior employment or contractual relationship” with the foreign owners. Since the outside directors perform the same function as voting trustees and proxy holders in ensuring the protection of classified information and the continued ability of the cleared U.S. company to perform on classified contracts, it seems reasonable that they should also be disinterested parties when named to the board and should remain free of other involvement with the foreign owners during their period of service.

DIS Inspections Did Not Focus on Foreign Ownership Issues

DIS inspectors told us that their inspections of foreign-owned U.S. defense contractors vary little from the type of facility security inspections they do at U.S.-owned facilities. Their inspections concentrated on such items as classified document storage, amount and usage of classified information, and the number of cleared personnel and their continuing need for clearances.

During the time of our review, DIS developed new guidelines for inspections of foreign-owned firms by its industrial security staff to specifically address foreign ownership issues. They call for the inspectors to examine issues such as changes to the insulating agreement, business relationships between the U.S. company and its foreign owners, foreign owner involvement in the U.S. company’s strategic direction, the number and nature of contacts with representatives of the foreign owners, and the number of foreign staff working at the facility. These guidelines were promulgated in September 1994.

DIS is beginning to implement the new inspection guidelines. According to DIS officials at the regional and field office levels, before they use the new guidelines, they must educate the inspection staff on foreign ownership issues as well as how the issues should be addressed during their inspections. They also said that implementing these new inspection procedures would probably double the length of an inspection at the foreign-owned facilities.

Currently, DIS must inspect each cleared facility twice a year, but it is having difficulty maintaining this inspection schedule. Industrial security inspectors are responsible for around 70 cleared facilities, and inspections at some larger facilities take a number of days. Doubling the inspection time at the foreign-owned facilities under the new guidelines might require some realignment of DIS resources. According to DOD officials, DIS inspections will occur no more often than annually under the NISPOM.

Recommendations

We recommend that the Secretary of Defense develop and implement a plan to improve trustee oversight and involvement in the foreign-owned companies and to ensure the independence of foreign-owned U.S. defense contractors and their trustees from improper influence from the foreign owners. As part of this effort, the Secretary should make the following changes in the implementation of the existing security arrangements and under the National Industrial Security Program. 1. Visitation request approvals: The trustees should strictly adhere to the ISR visitation agreement provision that requires them to approve requests for visits between the U.S. defense contractor and representatives of its foreign owners. This duty should not be delegated to officers or employees of the foreign-owned firm. 2. Trustee monitoring: The trustees should be required to ensure that personnel of the foreign-owned firm document and report the substance of the discussions they hold with personnel of the foreign parent firm. The trustees should review these reports and ensure that the information provided is sufficient to determine what information passed between the parties during the contact. The trustees should also select at least a sample of contacts and interview the participants of the foreign-owned firm to ensure that the post-contact reports accurately reflect what transpired. 3. Trustee inspections: To more directly involve trustees in information security monitoring, the trustees should annually supervise an information security inspection of each of the cleared facilities. The results of these inspections should be included in the annual report to DIS. 4. FSO supervision: To insulate the FSO from influence by the foreign-owned firm and its foreign owners, the trustees should be empowered and required to review and approve or disapprove the selection of the FSO and all decisions regarding the FSO’s pay and continued employment. The trustees should also supervise the FSO to ensure an acceptable level of job performance, since trustees are charged with monitoring information security at the U.S. defense contractor. 5. Financial independence: To monitor the financial independence of the foreign-owned firm, the annual report to DIS should include a statement on any financial support, loans, loan guarantees, or debt relief from or through the foreign owners or the government of the foreign owners that have occurred during the year. 6. Trustee independence: To help avoid conflicts of interest for the trustees, require them to certify at the time of their selection, and then annually, that they have no prior or current involvement with the foreign-owned firm or its foreign owners other than their trustee position. This certification should include a statement that they are not holding and will not hold positions within the foreign-owned company other than their trustee position. It should be expressly stated that these independence standards apply equally to voting trustees, proxy holders, and outside directors of firms under SSAs. 7. Trustee duties: The selected trustees should be required to sign agreements acknowledging their responsibilities and the specific duties they are required to carry out those responsibilities, including those in numbers 1 through 4. The agreement should provide that DOD can require the resignation of any trustee if DOD determines that the trustee failed to perform any of these duties. This agreement should ensure that the trustees and the government clearly understand what is expected of the trustees to perform their security roles.

Agency Comments and Our Evaluation

DOD stated that it generally agreed with the thrust of our recommendations in this report, but did not agree that the specific actions we recommended were necessary, given DOD efforts to address the issues involved. DOD said it had addressed these issues through education, advice, and encouragement of trustees to take the desired corrective actions. We and DOD have both seen instances in which this encouragement has been rejected. Because of the risk to information with national security implications, we believe that requiring, rather than encouraging, the trustees to improve security oversight would be more effective. Therefore, we continue to believe our recommendations are valid and believe they should be implemented to reduce the security risks.

DOD’s comments and our evaluation are presented in their entirety in appendix I.

Comments From the Department of Defense

The following are GAO’s comments on the Department of Defense’s (DOD) letter dated April 14, 1995.

GAO Comments

“As a general rule, visits between the Foreign Interest and the cleared Corporation are not authorized; however, the Proxy Holders may approve visits in connection with regular day-to-day business operations pertaining strictly to purely commercial products or services and not involving classified contracts or executive direction or managerial matters.” “As a general rule, visits between representatives of the Corporation and those of any Foreign Interest, are not authorized unless approved in advance by the designated Proxy Holder.” “Most agreements are silent on the authority of the DOD to terminate the arrangement or to dismiss a Proxy Holder, Trustee or outside director. While DIS is normally a party to Special Security Agreements, it is not a party to proxy or trust agreements and therefore lacks standing to intercede when appropriate.”

While DIS is a party to SSAs, if faced with outside directors who are not performing their security duties, the only means for DIS to force corrective action would be to terminate the agreement, thereby causing the company to lose its clearance, and halting all the company’s work on classified contracts. Our recommendation is a more moderate way of removing a nonperforming trustee than revoking a company’s clearance and terminating its classified contracts. We modified our recommendation in recognition of DOD’s comment that the shareholder must remove a trustee director.

Major Contributors to This Report

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