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Huawei and ZTE's ties to China concern House

by William McConnell  |  Published October 9, 2012 at 1:26 PM

Two top Chinese telecommunications companies are likely to find it even harder to acquire U.S. companies or do business in this country after the House Intelligence Committee released Monday a report questioning the companies' ties to the Chinese government .

The lawmakers accused Beijing of "aggressively" trying to steal trade secrets and other sensitive data from American companies.

In their report, Reps. Mike Rogers (R-Mich.) and C.A. Dutch Ruppersberger (D-Md.) recommended that U.S. companies considering doing business with Huawei Technologies Co. and ZTE Corp. find other vendors.

Huawei has long been in the sights of U.S. national security regulators and has had several deals killed because of national security concerns. Much of the concern about Huawei stems from its founder Ren Zhengfei, a former director of the People's Liberation Army's Information Engineering Academy. The company's critics contend his ties to the military continue.

ZTE, the fifth-largest producer of telecommunications equipment in the world, has had a lower public profile, but ZTE USA manufactures mobile phones and broadband devices for multiple wireless carriers including AT&T Inc., Cricket, MetroPCS Communications Inc., Sprint Nextel Corp., Boost Mobile, Virgin Mobile USA, T-Mobile, TracFone and Verizon Wireless.

ZTE has been criticized for alleged attempts to bribe officials in Norway and the Philippines to win national contracts. In December 2010 it also sold the state-owned Telecommunication Company of Iran a system for eavesdropping on phone and Internet communications that could help Iran monitor and track political dissidents.

The report encourages U.S. companies to take into account the long-term security risks associated with either company providing equipment or services to U.S. telecommunications infrastructure.

Additionally, the report recommends that Huawei and ZTE equipment or component parts be excluded from electric power grids; banking and finance systems; natural gas, oil, and water systems; rail and shipping channels and other critical infrastructure.

The lawmakers argued that because modern critical infrastructure is "incredibly connected" and depends on computerized control systems, the "risk is high" that a failure or disruption in one system could have a devastating ripple effect throughout American society and that these two state-connected companies cannot be trusted not to plant eavesdropping and backdoor threats into the systems. They also contend both companies failed to cooperate fully with the committee's 11-month investigation.

"Any bug, beacon, or backdoor put into our critical systems could allow for a catastrophic and devastating domino effect of failures throughout our networks," Rogers said.

"As this report shows, we have serious concerns about Huawei and ZTE, and their connection to the communist government of China. China is known to be the major perpetrator of cyber espionage, and Huawei and ZTE failed to alleviate serious concerns throughout this important investigation. American businesses should use other vendors," he added.

The report comes as recent attempts by Chinese investors to acquire U.S.-based assets -- including Cnooc Ltd.'s planned $19.4 billion acquisition of Canadian oil and gas producer Nexen Inc.-- are being examined skeptically by U.S. regulators. The Nexen deal is currently being investigated by the Treasury Department-led Committee on Foreign Investment in the U.S. Another controversial deal is the purchase of Oregon wind farm assets by Ralls Corp., which is suing the U.S. government after President Obama blocked the sale on CFIUS's recommendation.

There is also increasing restiveness among lawmakers unhappy with the Chinese government's trade policies, which they say include government subsidies to boost that country's product sales abroad while employing restrictions that deny U.S. and other foreign countries' goods unfettered access to Chinese markets.

Many of those critics have called on the U.S. to retaliate by denying Chinese acquisitions and contracts here.

The report is likely to exacerbate tension with Chinese officials, who are becoming increasingly irritated over actions taken by CFIUS, which they say has unfairly singled out Chinese buyers for tougher scrutiny than other foreign buyers.

Huawei reacted angrily to the report. "Despite our best efforts, the committee appears to have been committed to a predetermined outcome," the company said in a prepared statement. "The United States is a country ruled by law, where all charges and allegations should be based on solid evidence and facts. The report conducted by the House Permanent Select Committee on Intelligence ... failed to provide clear information or evidence to substantiate the legitimacy of the Committee's concerns."

Huawei's most recent deal here, its plan to buy assets of 3Leaf Systems Inc., unraveled after CFIUS recommended that President Obama block it. Huawei had acquired the Santa Clara, Calif., company in May 2011 without first seeking CFIUS approval, a move CFIUS experts said was foolish given that the agency has blocked previous Huawei deals.

Stephen Mahinka, a partner with Morgan, Lewis & Bockius LLP who has represented numerous clients before CFIUS, said in addition to damaging Huawei and ZTE prospects in the U.S., the report will make other Chinese investors wary of attempting to do business here.

"The report will have a substantial adverse effect with respect to the valuation of Chinese investment in the U.S.," he said.

Although Mahinka said the report is very specific in its criticism of these two companies, Chinese investors will likely perceive the report as an attack on all Chinese investment here.

"I've been telling them that the concerns raised about Huawei or ZTE related to those companies' structures and their unique factors but it's difficult to convince potential investors or acquirers they would see a different or mostly positive reception before CFIUS," he said.

Huawei insisted it cooperated with the House committee in an "open and transparent manner, and engaged in good faith interaction" by making its top management available for multiple face-to-face meetings in Washington, Hong Kong and Shenzhen with committee members.

"We opened our R&D area, training center, and manufacturing center to the committee and offered a wealth of documentation, including the list of members of the Board of Directors and the Supervisory Board over the past 10 years, and the annual sales data since our establishment in 1987; we also made the list of our shareholding employees, the shares they hold, as well as information about our funding resources and financial operations available to the committee," the company said.

The committee, however, challenged Huawei's assertions, noting the investigation was launched after Huawei penned an open letter to the U.S. government in Februry 2011 denying that it posed any security concerns and offering to open itself to investigation.

In the subsequent inquiry, the committee said the companies failed to provide adequate documentation about a number of key lines of inquiry, including:

  • Their histories, management structures and their initial ties to the Chinese government and military or the Communist party.

    The extent to which the Chinese government or Communist party exerts control over corporate decisions, operations and strategy.

    Whether the companies are "national champions" given unfair special advantages by the Chinese government.

  • The presence of each company in the U.S. and how much influence their parent companies have over U.S. units.
  • The companies' compliance with international agreements on intellectual property rights, sanctions against Iran and other rogue nations and other legal obligations.

    The companies' responses to those issues were "inadequate and unclear," the committee said. Despite repeated requests from the lawmakers, the committee said few internal documents were provided to substantiate the companies' answers and those that were provided "could rarely be authenticated or validated."

    In some cases, the companies stated that they were unable to provide the documents because their release must first be approved by the Chinese government. "The fact that Chinese companies believe that their internal documentation or information remains a 'state secret' only heightens concerns about Chinese government control over these firms and their operations," the report said.

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    Tags: 3Leaf Systems Inc. | AT&T Inc. | Boost Mobile | CFIUS | Cnooc Ltd. | Committee on Foreign Investment in the U.S. | Cricket | Dutch Ruppersberger | House Intelligence Committee | House Permanent Select Committee on Intelligence | Huawei Technologies Co. | Information Engineering Academy | MetroPCS Communications Inc. | Mike Rogers | Nexen Inc. | People's Liberation Army | President Obama | Ralls Corp. | Ren Zhengfei | Sprint Nextel Corp. | T-Mobile | TracFone | Treasury Department | Verizon Wireless | Virgin Mobile USA | ZTE Corp. | ZTE USA

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