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A Tangled Web: When State Agencies Do Business Overseas

by Jock O'Connell

Email: jockoconnell@gmail.com

This is the author's text of an article that appeared in the June 2000 issue of Comstock's Business magazine.

What have Russian mobsters, Chinese intelligence agencies, Colombian drug lords, and the notorious international terrorist Osama Bin Laden to do with the California Public Employees Retirement System or the California Department of Transportation?

Absolutely nothing, we hope. But can we be certain? Not necessarily, according to growing number of federal and state government officials as well as national security experts.

The problem is that, as the United States grows more and more enmeshed in the global economy, chances are increasing that public agencies will buy goods from or even invest in foreign businesses. In the vast majority of cases, these firms will be perfectively legitimate, law-abiding commercial enterprises that are nothing more (or less) than they purport to be. However, as we shall see, California officials may occasionally come upon companies whose real lines of business are inimical to U.S. values and interests.

That is the concern of people like Roger W. Robinson, a vice president in Chase Manhattan Bank's international division before serving as a National Security Council aide in the Reagan White House. In a January appearance at the state capitol, Robinson explicitly cautioned the California Legislature's Joint Legislative Audit Committee (JLAC) that state agencies — public employee pension funds, in particular -- could unwittingly encounter foreign companies that have ties to "potentially hostile national militaries and intelligence services or have links to proliferation activities, money laundering, organized crime, technology theft, arms smuggling, state sponsors of terrorism and other global ‘bad actors.'"

Robinson is scarcely alone in directing attention to such risks. Indeed, a growing -- and remarkably bipartisan -- chorus of voices has been expressing similar concerns, especially in the aftermath of the publication last spring of a report by the Congressional Select Committee on U.S. National Security and Military/Commercial Concerns with the People's Republic of China [PRC]. Chaired by California Rep. Christopher Cox (R-Newport Beach), the committee looked into the activities of companies thought to be linked to, if not under the direct control of, Chinese military and intelligence agencies. The panel concluded that: "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 technology acquisition by its front companies with a patina of regularity and respectability."

The precise extent of the threat is hard to assess, however. As the Cox Report observed, the Securities and Exchange Commission, the federal agency chiefly responsible for safeguarding the integrity of the nation's financial markets, "collects little information helpful in monitoring PRC commercial activities in the United States." What pertinent information might be collected by the Central Intelligence Agency or the National Security Agency is not routinely disseminated outside of the core intelligence community.

China, to be sure, is not the only country accused of using clandestine methods to obtain access to U.S. capital, sophisticated technology, or trade secrets. Shortly after the release of the Cox Report, a federal commission chaired by former CIA director John Deutch issued an equally disquieting account of the aggressive attempts of several foreign governments (notably Iran, Iraq, Syria and North Korea) and international terrorist groups (primarily those associated with Osama Bin Laden) to acquire the means for waging chemical, biological, and even nuclear war.

Like the Cox Committee, the Deutch Commission uncovered compelling evidence of the use of seemingly legitimate businesses to mask military and espionage activities. Further echoing the Cox Report, the Deutch Commission observed: "There is currently no national security-based review of entities seeking to gain access to our capital." As a result, the commission's report counseled, "investors are unlikely to know that they may be assisting in the proliferation of weapons of mass destruction by providing funds to known proliferators."

The Cox and Deutch investigations created an uproar on Capitol Hill and in the media that quickly spread to California, where state officials and legislators have been questioning the overseas investment policies of the California Public Employees Retirement System (CalPERS) and the purchase of foreign-made steel by the California Department of Transportation (CalTrans).

CalPERS and the ‘Red Chips'

A controversy -- still not entirely resolved -- involving CalPERS' overseas investments was sparked by a July 27 article in Investor's Business Daily that ran under the headline: "Chinese Army's Ties To U.S. Money: Do Calif. Pension's Investments Risk Retirements?" Based on information contained in the Cox Report, the article alleged that the CalPERS had invested millions of dollars in so-called "Red Chip" companies, firms headquartered outside of China but believed to be closely tied to Chinese military or intelligence operations. The article, by reporter John Berlau, specifically cited four companies suspected of having intimate ties with Beijing. These were Cosco Pacific Ltd., China Resources Enterprises, Citic Pacific Ltd., and Citic Ka Wah Bank.

All are familiar names to Western intelligence and law enforcement agencies. Both Cosco (China Ocean Shipping Company) and Citic (China International Trust & Investment Corp.) had been implicated in a 1996 incident when customs officials found 2,000 automatic weapons destined for West Coast street gangs aboard a Cosco ship at the Port of Oakland. Citic's chairman is now persona non grata in the U.S. as a result of the gun smuggling episode. In 1998, federal lawmakers troubled by Cosco's reported connections to the Chinese military prevented the company from leasing a former U.S. naval base adjacent to the Port of Long Beach. For its part, China Resources has long been fingered as a front for Chinese espionage activities, especially in Hong Kong during the period of British rule.

CalPERS response to the Investor's Business Daily allegations was swift and vehement. The chairman of the pension fund's investment committee, Charles Valdes, said that Berlau's conclusions were based on "innuendo and conjecture" and that his article represented "McCarthyism at its worst." Valdes maintained that assertions that the Chinese military receives some benefit from the firms mentioned in the article were "inaccurate, as an analysis of public information on this subject shows."

Valdes' benign interpretation of the information that is publically available about Citic, Cosco, and China Resources was soon disputed by members of the State Legislature. Where Valdes sought to portray the companies as legitimate businesses with long- established roots in Hong Kong (until July 1, 1997, a British Crown Colony), Sen. Raymond Haynes (R-Riverside) claimed he had information to the contrary.

Haynes, one of the legislature's most conservative figures, pointed to an expose published in the South China Morning Post in 1998 which it identified nearly 200 Hong Kong companies with direct or indirect ties to the Chinese People's Liberation Army (PLA) and to Chinese espionage services. The newspaper, Hong Kong's leading English- language daily, also predicted an increase in the number of mainland groups with military or aerospace business connections. "The links of PLA Inc. and defense and aerospace conglomerates run deep into corporate Hong Kong, giving them access to international markets and technology," the report warned. If nothing else, the Morning Post story raised serious questions about the integrity of the 70 Chinese companies listed on the Hong Kong Stock Exchange in which CalPERS had invested over $750 million (as of December 1999).

On September 10, Haynes wrote to Assemblyman Scott Wildman (D-Glendale), chairman of the Joint Legislative Audit Committee, to request a formal audit to determine whether CalPERS has invested pension funds in companies with ties to the Chinese government, the Chinese People's Liberation Army, or its military intelligence operations. "I am concerned that investments in such companies could pose financial risks for state employees and retirees, as well as serious security risks to the United States," Haynes said in his letter.

Wildman, in turn, wrote to James E. Burton, CalPERS' CEO, with a lengthy list of questions about CalPERS' overseas investment policies and practices. But before Burton had a chance to respond, another CalPERS investment issue flared up on the other side of the world. This one involved not espionage but slavery and international terrorism. At its center was Talisman Energy Inc., a Canadian oil exploration company with operations in the Sudan. It is a case that also illustrates how injudicious investments can have deleterious financial as ethical and national security implications.

The government of Sudan has been identified by the U.S. State Department as a sponsor of international terrorism directed at American targets abroad. The Sudanese government has also been engaged in waging a genocidal war -- one that has featured the taking of slaves -- against the non-Muslim population in the country's southern provinces. For much of 1999, a bipartisan coalition of religious freedom and human rights groups had been accusing Talisman of lending support to the Sudan regime in return for oil exploration rights. Among other evidence, Talisman's critics cited remarks attributed to the Speaker of Sudan's Parliament, who said that oil revenues generated from Talisman's operations in Sudan had been earmarked for the country's armed forces.

Through an intermediary, State Street Global Advisors, CalPERS had been buying stock in Talisman since at least 1994. By October 1, 1999, it had amassed nearly 250,000 shares (with a market value of approximately $7.5 million) in the Canadian firm. By then, however, institutional investors throughout the country were beginning to reconsider their holdings in Talisman. As a series of major stockholders responded to the political pressure by placing huge sell orders, the price of Talisman stock plummeted.

CalPERS was a bit late to the sell-off, however. When it finally moved at the end of December to divest itself of its stock in Talisman, share prices had fallen well below their level of just a few weeks earlier. Overall, CalPERS did realize a substantial profit from its long-term investment in Talisman over the years. Still, had it sold off its holdings at the first whiff of trouble early last fall, it would have come out another $2 million ahead.

Burton responded to the JLAC information request on January 24 with a voluminous compendium of information, the gist of which was that the giant pension fund relied on outsiders to vet its individual investments. As Burton explained: "CalPERS contracts with external investment management firms for all of its international equity and international debt investments. Individual issue selection, or purchase and sale decisions, is specifically delegated to the external managers based on their strategy, style, and expertise."

Burton's reply did not satisfy Haynes. "I want to see us put our values ahead of the bottom line," the senator said in a telephone interview in early March. He remains intent on pressing for a thorough inquiry into CalPERS' overseas investment policies and practices. He also wants to see that inquiry yield recommendations for insuring that CalPERS steers clear of similar bad actors in the future.

Likewise unhappy with CalPERS' ability to distinguish legitimate business enterprises from bad apples is Phil Angelides. As state treasurer, Angelides is a statutory member of CalPERS' governing Board of Administration. While Senators Haynes and Wildman have been probing CalPERS overseas investment policies from the outside, Angelides has been busily waging an internal fight for reform.

Over lunch at Frank Fat's last September, Angelides related his amazement at the cavalier attitude of some CalPERS board members toward the fund's investments in developing countries. He was especially irritated by a decision CalPERS had made just weeks earlier to place $50 million with an investment fund that explicitly targeted aerospace and defense firms in Asia's emerging markets. "What were they thinking?" Angelides asked, shaking his head. "Are we financing companies who might sell arms to people American troops may have to face some day," he asked.

During the past several months, Angelides has actively pushing for a new investment standards that stress certain non-financial criteria. "We have a clear fiduciary duty to state employees and retirees to maximize our investment returns," he said in a recent interview. "But that does not mean ignoring evidence that certain companies, however profitable, may be engaged in activities contrary to U.S. interests."

CalTrans and ‘Red Steel'

The 1989 Loma Prieta earthquake prompted -- albeit at what has turned out to be an excruciatingly leisurely pace -- steps to insure that the state's bridges and highways could better withstand the stress of large tremors. Perhaps the seismic retrofit project most noticeable to Sacramento-area residents traveling to the Bay Area involves the two spans that carry I-80 high over of the Carquinez Straits at Vallejo. What most travelers probably don't know is the controversial provenance of the steel being used in shoring up these bridges. It came from Shanghai.

Labor union representatives have been critical of the deal that awarded the steel contract to a Chinese firm. Dick Zampa, president of the District Council of Ironworkers, argued that steel bought with American tax dollars should be produced by U.S. companies employing American steelworkers. He noted that the difference between the two lowest bids on the Carquinez retrofit project ($29,000 on a $62 million project) was more than attributable to the cheaper cost of the imported steel. Zampa and other labor officials indicated his belief that the steel from Shanghai was actually being ‘dumped' (i.e., sold below the cost of production) in the U.S. However, no formal charges have been filed with the U.S. International Trade Commission, which is charged with investigating such allegations.

There was also something else about this deal labor officials said they found disturbing. According to Scott Wetch of the State Building and Construction Trades Council of California, the major iron ore producer in China is a prison labor camp. "We find it hard to believe that the raw material and other components used in the manufacture of steel imported from China for the Carquinez project did not involve prison labor at some point in the production process, " Wetch said. He noted that use of such steel would violate a state law that prohibits the use of goods produced by slave, prison or child labor in public works projects.

Wetch conceded, however, that he had no specific proof that prisoners had a hand in manufacturing the steel used in the Carquinez retrofit. Instead, he cited testimony George J. Weise, the head of the U.S. Customs Service, made before Congress in May 1997. Addressing the problem of imports from facilities that use prison labor, Weise told the congressional panel that China is "currently by far the country most frequently associated with the export of prison labor-made goods to the United States. "

The Carquinez steel flap led Assemblywoman Patricia Wiggins (D-Santa Rose) to introduce a "Buy California" bill, AB 214, which would have required that all materials purchased for California public works projects be produced in the United States unless the cost of doing so would be 25 percent higher than the lowest bid involving foreign products. It would also have given California-based firms a five-percent bidding preference.

The legislature passed the Wiggins measure during the final days of its session last summer, despite strenuous objection from business groups, international trade groups, and the state Department of Finance. A month later, however, Gov. Davis vetoed the measure, citing among other concerns that a domestic purchase requirement could add millions to the price of restoring California's infrastructure.

But the story does not end there. Five months after vetoing AB 214, Gov. Davis announced he had decided to permit the use of federal transportation funds they state controlled for the retrofit or outright replacements of three other major Bay Area spans: the Richmond-San Rafael Bridge, the Benicia-Martinez Bridge, and the SF-Oakland Bay Bridge. The significance of this action was definitely not lost on the labor union officials who had been lobbying the governor for just this sort of action. Their reason for jubilation? Unlike state law, the federal transportation act features a "Buy America" provision whenever federal funds are used. So the practical effect of the governor's action is to ensure that the estimated $2.3 billion in contracts to be let on the three major Bay Area bridge projects will be subject to the same sort of domestic purchase preference he had rejected as too costly in vetoing AB 214.

Conclusion

What, if anything, should be done to prevent state agencies from doing business with foreign companies that violate human rights or engage in activities that threaten U.S. national security?

Congressman Spencer Bachus (R-Alabama), chairman of the House subcommittee responsible for investigating irregularities in the nation's financial system, has proposed one possible solution. Along with Rep. Dennis Kucinich, an Ohio Democrat, Bachus has introduced "The U.S. Market Security Act" (H.R. 2204). The measure calls for the establishment of an Office of National Security within the Securities and Exchange Commission to monitor foreign government-affiliated entities that are accessing this country's debt and equity markets.

As an interim measure, Bachus and Kucinich asked the General Accounting Office to prepare a report identifying foreign companies that might pose a threat to American national security interests. They plan to share this report with state and local officials, and Treasurer Angelides has already indicated his desire to see CalPERS divest itself of any investments in any companies the GAO identifies.

A more lasting solution is apt to engender lingering controversy. Haynes leans toward a formal system, supported by a federal government monitoring service of the sort envisioned by Bachus and Kucinich. Critics of this approach argue, however, that the cure may be worse than the disease. The bureaucratic edifice needed to perform "due- diligence" investigations of foreign companies to insure their legitimacy would be daunting, costly and intrusive. In the end, it might accomplish what many currently fear — a greater involvement of American and foreign espionage services in the gathering of commercial intelligence.

Such a potentially intrusive and cumbersome solution for vetting all foreign investments by CalPERS (as well as the California State teachers Retirement System or CalSTRS) may be unnecessary according to Angelides: "We're dealing with a false distinction here between investment criteria which stress financial performance and criteria which emphasize social or ethical goals." He cited recent studies CalPERS has commissioned that reveal a very close correlation between democratic countries with freedom of the press and basic standards of worker protection on the one hand, and a solid economic performance on the other. The bottom line for Angelides: "There's no shortage of investment opportunities both here and abroad that permit us to discharge our fiduciary responsibilities while also satisfying our moral and ethical concerns."

Copyright 2000 By J.A. O'Connell


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