IP: Center for Security Policy calls for increased "surveillance"

[Dave Farber <farber@cis.upenn.edu>]

>
>From: Declan McCullagh <declan@well.com>
>
>
>[I always enjoy papers from the Center for Security Policy, which has been
>in the forefront of ban-crypto attempts and never saw a military budget
>increase it didn't like. Now it proposes a new federal panel called CFFB be
>created to increase "surveillance" of American investors and businessmen in
>the hopes of snaring some wily Communist Chinese. --Declan]
>
>
>
>Source:  Center for Security Policy
>http://www.security-policy.org/papers/1999/99-C86.html
>
>Publications of the Casey Institute
>of the Center for Security Policy
>No. 99-C 86
>
>   PERSPECTIVE
>  
>30 July 1999
>  
>Key Commission Reports, Rep. Bachus Call For Security-Minded Surveillance
>of U.S. Capital Markets: Possible Next Steps
>
>(Washington, D.C.): Two important bipartisan reports have recently
>concluded that there is an urgent need to achieve greater transparency
>concerning the efforts being mounted by international "bad actors" to
>garner funds from the U.S. debt and equity markets. Clearly, in light of
>the ominous findings of the Cox Committee and the Deutch Commission,
>the Nation can no longer afford to ignore such penetrations of our capital
>markets. The question now is: What can be done to implement the two
>panels' important recommendations in this area?
>
>The William J. Casey Institute of the Center for Security Policy has long
>believed that the place to start would be with the adoption of measures
>that would permit better monitoring of Chinese and other suspect foreign
>government-affiliated entities attempts to enter the U.S. capital markets,
>both directly and through SEC loopholes such as "Rule 144 A" and
>"Regulation S."
>
>The Cox Committee's Assessment
>
>The House Select Committee chaired by Rep. Chris Cox (R-CA) put it
>bluntly: China is funding at least some of its nefarious activities on the
>U.S. capital markets. One of the most important insights contained in
>over 980 pages of declassified analysis concerning the extent of Chinese
>penetration of America's security infrastructure and economy is to be
>found in a short, but stunning, paragraph on page 57 of Volume I.
>
>   The Securities and Exchange Commission collects little
>   information helpful in monitoring PRC commercial activities
>   in the United States. This lack of information is due only in part
>   to the fact that many PRC front companies are privately-held and
>   ultimately - if indirectly - wholly-owned by the PRC and the
>   Chinese Communist Party itself. Increasingly, the PRC is using
>   U.S. capital markets both as a source of central government
>   funding for military and commercial development and as a
>   means of cloaking U.S. technology acquisition efforts by its
>   front companies with a patina of regularity and
>   respectability. (Emphasis added.)
>
>In fact, recent data indicates that state-owned Chinese entities have
>raised roughly $13.5 billion through offering dollar-denominated bonds
>world-wide since 1980.(1) As the Casey Institute has long argued,(2) these
>general purpose funds -- extended on relatively inexpensive terms -- can
>be easily diverted to fund activities inimical to U.S. security interests of
>the type referenced in the select committee's report.
>
>As a result, a sizeable number of American citizens are undoubtedly --
>and unwittingly -- now engaged in helping finance Chinese military
>development and illicit technology acquisition efforts, possibly including the
>improved accuracy, range and lethality of ICBM's targeted against our
>cities.
>
>A Case in Point: CITIC
>
>The Cox Committee had the benefit of access to classified information
>regarding Chinese operations here and abroad. The problem it identified in
>the foregoing section, however, has been evident even in "open source"
>materials: "Bad actors" long ago broke the code on funding some of their
>activities via the U.S. capital markets. In fact, the Casey Institute first
>identified one of the most egregious examples of this new national
>security challenge in early 1997 -- the financial machinations of China
>International Trade and Investment Corporation (CITIC), headed by the
>notorious PRC arms dealer Wang Jun.(3)
>
>The 26 May 1999 edition of the Financial Times noted that the Cox
>Committee described CITIC as "Wang's investment vehicle which...[is]
>the most powerful conglomerate in China." It goes on to note that Wang
>also serves as chairman of Polytechnologies, an arms trading company
>that is described as the most profitable of the corporate structures owned
>by the Chinese army."
>
>In addition to this overt link between finance and national security, Wang
>has been implicated in a scheme to smuggle roughly 2000 AK-47's to
>West Coast street gangs and, again according to the Financial Times,
>"was also connected to over $600,000 in illegal campaign donations made
>to the DNC [in 1996] through Charlie Trie."
>
>The Cox report explicitly states that Wang Jun has "been directly involved
>in illegal activities in the United States." He is now reportedly unable to
>obtain a visa to enter this country pending the resolution of these
>allegations. Given these extraordinary facts, why has his company
>maintained unfettered access to as much as $800 million in the
>U.S. bond market since 1985 (not to mention some $2.5 billion in
>yen-denominated bonds out of Japan)? Why, moreover, do U.S. and
>Japanese pension and mutual funds and other investors continue
>to hold CITIC paper in their portfolios?
>
>A Second Opinion Confirms the Diagnosis
>
>This concern was directly expressed in a congressionally mandated study
>of the threat posed by proliferation -- and American options for dealing
>with this danger -- completed on 14 July under the direction of former
>Director of Central Intelligence John Deutch. Indeed, the Deutch
>Commission devoted a significant portion of the "Economic Leverage"
>section of its report to this concern, stating: "It is clear that the United
>States is not making optimal use of its economic leverage in combating
>proliferators....For example, the Commission is concerned that
>known proliferators may be raising funds in the U.S. capital
>markets."
>
>The Deutch report effectively confirmed the warning about
>non-transparency in the capital markets conveyed by the Cox Committee:
>
>   "Because there is currently no national security-based
>   review of entities seeking to gain access to our capital
>   markets, investors are unlikely to know that they may be
>   assisting in the proliferation of weapons of mass destruction by
>   providing funds to known proliferators. Aside from the moral
>   implications, there are potential financial consequences of
>   proliferation activity -- such as the possible imposition of trade and
>   financial sanctions -- which could negatively impact investors."
>   (Emphasis added.)
>
>Enter Rep. Bachus
>
>Building upon the relevant conclusions of the Cox and Deutch reports, a
>senior member of the House Banking and Financial Services Committee,
>Representative Spencer Bachus (R-AL), has introduced legislation
>entitled "The U.S. Market Security Act of 1999" (H.R. 2204). This bill,
>which is co-sponsored by Representative Dennis Kucinich (D-OH),
>would create an Office of National Security at the Securities and
>Exchange Commission and task it with providing quarterly reporting to
>key congressional committees concerning the names of foreign
>government-controlled or -affiliated entities which are seeking to enter the
>U.S. capital markets.
>
>This modest, but important, "fact-finding" office would better equip
>American fund managers, Wall Street executives, Members of Congress
>and federal officials and state treasurers to understand better the
>dimensions and implications of this problem. It is to be hoped in particular
>that such a measure would help to catalyze security-minded "due
>diligence" among investment banks and fund managers. The Casey
>Institute commends Reps. Bachus and Kucincih for their vision and
>leadership in seeking to strengthen transparency and disclosure with
>respect to this Nation's capital markets and those of our allies.
>
>What's To Be Done?
>
>The Deutch Commission recommended that the United States examine
>options to remedy the largely unprecedented tapping of the U.S. debt and
>equity markets by potential adversaries of this country: "Options should
>include ways to enhance transparency, such as requiring more
>detailed reporting on the individuals or companies seeking access
>of disclosure of proliferation-related activity, as well as
>mechanisms to bar entry of such entities into the U.S. capital
>markets."
>
>The Casey Institute believes that the following are among the specific
>measures that deserve immediate consideration:
>
>   Public-Private Sector Partnership: The Treasury Department,
>   together with the relevant NSC and intelligence community
>   officials, could assist the private sector (read, Wall Street) in
>   designing on a voluntary basis a mechanism for national
>   security-oriented risk assessments. This could -- and should -- be
>   done as part of the overall "due diligence" process routinely
>   undertaken by U.S. investment banks and other fund managers.
>
>   A 'CFIUS' for Foreign Financing: The President could, by
>   executive order, establish a Committee on Foreign Financing
>   and Borrowing (CFFB), to be co-chaired by Treasury and the
>   National Security Council, to evaluate suspect foreign
>   government-related entities seeking to enter the U.S. capital
>   markets. Such a body could be modeled after the Committee on
>   Foreign Investment in the U.S. (CFIUS) which is required, within
>   90 days, to analyze the national security ramifications of
>   prospective mergers and acquisitions of U.S. companies and, if
>   necessary, undertake a more thorough investigation of the
>   implications of these transactions. CFIUS is required to submit a
>   report and recommendations to the President based on its findings.
>   If the President deems the prospective merger or acquisition to be
>   a threat to U.S. national security, he may restrict or block the
>   venture.
>
>   Alternatively, Congress could take the lead in creating a CFFB by
>   amending the Defense Production Act of 1950 to provide the
>   President with the authority to prohibit access to the U.S. capital
>   markets of any entity that is determined to be a threat to the
>   national security interests of the United States. (This CFIUS model
>   would help guarantee that the free flow of capital into and out of
>   the U.S. is only interrupted in the event of demonstrated national
>   security concerns.)
>
>   SEC Rule Changes: The Congress could also make an important
>   contribution to implementing the Deutch Commission's
>   recommendation to "ensure that we have in place the legal
>   mechanisms required to exercise [financial] leverage" by amending
>   the Securities Exchange Act of 1933 to require more detailed
>   information in prospectuses regarding the specific identity and
>   activities of foreign government-related firms (and their
>   subsidiaries and affiliates) applying for entry into the U.S. capital
>   markets.
>
>   Currently, the Registration Statement Requirements for Non-U.S.
>   Companies only includes financial-related risk disclosure (Form-1 -
>   Part I). Such a new layer of national security "risk assessment"
>   notification would take into account prospective relationships with
>   entities which have participated -- or are alleged to have
>   participated -- in proliferation, espionage, technology theft,
>   weapons production, organized crime, drug or arms smuggling and
>   other proscribed activities. This amendment could also address
>   SEC loopholes like "Regulation S" and "Rule 144 A" which allow
>   U.S. investors to purchase foreign paper through a less-regulated
>   backdoor.(4)
>
>   Enact the Bachus Bill: Given the SEC's prominent role in
>   protecting U.S. investors, Congress should, in addition, move
>   swiftly to adopt the "U.S. Market Security Act of 1999," thereby
>   establishing an Office of National Security at the Commission
>   charged with monitoring the names of foreign
>   government-affiliated entities seeking to enter the U.S. debt and
>   equity markets. The Office of the National Security could, as
>   deemed necessary, ultimately serve a liaison function with a new
>   CFFB and relevant Congressional committees with respect to
>   suspect enterprises.
>
>   The "early warning" provided by this new office by merely listing
>   foreign government-related enterprises headed toward our markets
>   could help ensure the accuracy and completeness of required
>   prospectuses and other documentation attendant to securities
>   offered to U.S. investors, including those issued via Rule 144 A.
>   As incomplete disclosure or deliberately misleading information in a
>   prospectus can be legally actionable, this new SEC office could
>   actually serve to help safeguard U.S. investment banks and other
>   market players from future blow-back.
>
>   Improved Congressional Oversight: Congress should increase
>   its ability to monitor the interplay between foreign
>   government-related firms and U.S. financial institutions and funds.
>   This could be accomplished either by creating a new permanent
>   subcommittee charged with such oversight (e.g., a Subcommittee
>   on Financial Security Affairs) or by charging one or more existing
>   committees (i.e., the Intelligence, Banking, International/Foreign
>   Relations or Governmental Affairs/Government Reform
>   committees) with this function.
>
>'Bad Actors' Are Unlikely Easily to Move to Other Markets
>
>Detractors of these types of measures have strongly argued that any
>government intervention with respect to foreign access to the U.S. capital
>markets would merely cause such foreign entities to divert their
>fund-raising efforts to other markets that require less-stringent reporting
>requirements and risk assessments. It is certainly true that no measure
>intended to address this burgeoning national security challenge would be
>perfect or problem-free. Nonetheless, it is oversimplified to assert that
>foreign capital markets would easily compensate if greater transparency
>in the U.S. market made it less hospitable to the fund-raising efforts of
>"bad actors."
>
>First, any foreign firm denied access to our debt and equity markets -- for
>demonstrated national security reasons -- would likely pay a higher
>cost for funds elsewhere. The stigma attached to such selective U.S.
>intervention could also catalyze negative reactions in other capital
>markets. For example, in the interest of helping mitigate risk exposure,
>multinational lending syndicates are often formed to meet the
>requirements of large foreign borrowers. Any security-related difficulties
>encountered in the U.S. markets could make such high-volume borrowing
>by a targeted foreign enterprise considerably more difficult, particularly
>over time. In other words, by taking the U.S. capital markets out of the
>mix, that foreign entity would likely find it more difficult to shift
>markets in
>order to fulfill the totality of its multi-year funding requirements.
>
>The Bottom Line
>
>As the William J. Casey Institute of the Center for Security Policy
>regards the free flow of capital into and out of the United States as a
>central pillar of our free market system and global leadership, it has no
>interest in remedies which smack of broad capital controls or that would
>otherwise prove unduly disruptive to our markets. This explains the
>Institute's long-standing reliance on voluntary, private-sector initiatives,
>bolstered transparency and greater awareness as the preferred means to
>remedy this new 21st century national security challenge.
>
>Having said that, inaction in the face of the yawning and ominous problem
>of penetration of the U.S. capital markets by "bad actors" is simply not an
>option. In the final analysis, American investors do not wish to be put in
>the position of unwittingly helping to fund activities harmful to their
>country's vital security interests (e.g., helping to underwrite the
>construction of ICBM's targeted at our cities). Therefore, as potential
>adversaries rapidly move away from traditional commercial bank
>syndicates and Western government funding sources in favor of the
>private capital markets, we have no choice but to take prudent, and
>hopefully non-disruptive, measures to enable such investors to make
>informed decisions, in the process safeguarding both the United States'
>capital markets and its overriding security interests.
>
>   - 30 -
>
>1. Including Chinese bond offerings in other countries, particularly
>yen-denominated bonds, this total figure jumps to roughly $25 billion.
>
>2. See the Casey Institute's Perspectives entitled Casey Initiative to
>Increase Transparency Re: Bad Actors' Efforts to Penetrate U.S.
>Capital Markets Gains Momentum (No. 99-C 80, 13 July 1999), A Job
>for C.F.I.U.S.: Proposed Chinese Buy of U.S. Telecommunications
>Assets Needs National Security Scrub (No. 99-C 75, 2 July 1999) and
>Market Confidence in 'China Inc.' Appropriately Shaken --
>G.I.T.I.C. Bond Default A taste Of What Is To Come? (No. 98-C 177,
>29 October 1998).
>
>3. See Dangerous Upshot of Clinton-Gore's China 'Bonding':
>Strategic Penetration of U.S. Investment Portfolios (No. 97-C 47, 1
>April 1997).
>
>4. Specifically, Rule 144 A can provide a kind of "safe harbor" from the
>full-disclosure requirements of the SEC for securities offered offshore.
>The effect of this rule is to allow investors in these securities to resell
>their securities without registering the securities (hence avoiding at least
>some of the "due diligence" process). See the Casey Perspective entitled
>Will China's Latest Bond Offering Penetrate U.S. Markets,
>Institutional Portfolios Through a 'Backdoor'? (No. 98-C 197, 9
>December 1998).
>
>NOTE: The Center's publications are intended to invigorate and
>enrich the debate on foreign policy and defense issues. The views
>expressed do not necessarily reflect those of all members of the
>Center's Board of Advisors.
>
>   © 1988-1999, Center for Security Policy
>
>
>
>--------------------------------------------------------------------------
>POLITECH -- the moderated mailing list of politics and technology
>To subscribe: send a message to majordomo@vorlon.mit.edu with this text:
>subscribe politech
>More information is at http://www.well.com/~declan/politech/
>--------------------------------------------------------------------------