[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 US. 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 [EMAIL PROTECTED] with this text: subscribe politech More information is at http://www.well.com/~declan/politech/ --------------------------------------------------------------------------
