Huawei Faces U.S. Lockout on Cyberspying Threat Citation

Huawei Technologies Co. and ZTE Corp., China’s two largest phone-equipment makers, provide opportunities for Chinese intelligence services to tamper with U.S. telecommunications networks for spying, according to a congressional report released today.

Huawei Technologies Co., which has been shut out from a series of U.S. deals, will have fewer options to win American business after a House committee said the phone-equipment maker may enable Chinese spying.

“This puts an established intelligence community stamp on the idea that these are companies that pose a potential serious threat,” Stewart Baker, a former U.S. Homeland Security Department official, said. “They are going to be treated more harshly than other multinationals for the foreseeable future.”

The House Intelligence Committee yesterday urged U.S. companies to steer clear of Huawei and ZTE Corp. (000063), citing concerns that the Chinese government could install malicious hardware or software in U.S. telecommunications networks.

Despite a lobbying and public-relations push by Huawei, the report singled out China’s biggest phone-equipment manufacturer for particular attention, saying a yearlong probe turned up allegations of bribery, corruption and other illegal behavior that would be referred to the Federal Bureau of Investigation and other government agencies.

Huawei has hired six lobbying firms and spent $820,000 on lobbying in the first six months of this year, compared with $200,000 during the same period in 2011, according to U.S. Senate disclosures.

“Despite our best effort, the committee appears to have been committed to a predetermined outcome,” Huawei said in a statement yesterday after the report’s release. “The report released by the committee today employs many rumors and speculations to prove non-existent accusations.”

Campaign Issue

The report was issued as the U.S.-China economic relationship remains an issue in the presidential election campaign. President Barack Obama last month barred a Chinese- owned company from building wind farms near a U.S. Navy base in Oregon, the first time in 22 years a president has blocked a transaction as a national security risk. The ruling came amid campaign charges by Republican challenger Mitt Romney that Obama has been too soft on China.

House Intelligence Committee Chairman Mike Rogers, a Michigan Republican, and C.A. “Dutch” Ruppersberger of Maryland, the panel’s ranking Democrat, announced the probe of Huawei and ZTE last November, citing concerns about Chinese hacking into U.S. systems and theft of intellectual property.

U.S. counterintelligence officials called China the world’s biggest perpetrator of economic espionage in a report last year, saying cyber espionage is jeopardizing an estimated $398 billion in U.S. research spending.

‘Mutual Benefits’

China Foreign Ministry spokesman Hong Lei told reporters in Beijing yesterday that the U.S. is prejudiced against Chinese companies and should do more to promote trade between the two countries.

“Chinese telecommunications companies have conducted their international operations based on market-economy principles,” Hong said. “Their investments in the U.S. reflect the mutual benefits brought about by U.S.-China trade relations. We hope U.S. Congress will put aside its prejudice, respect the facts and do more to promote China-U.S. trade relations, not the opposite.”

ZTE fell 5.6 percent to close at HK$11.90 in Hong Kong trading today. The shares have dropped 51 percent this year, compared with a 14 percent gain in the benchmark Hang Seng Index.

‘Held Hostage’

Huawei is an independent, employee-owned company and “should not be held hostage” to geopolitical tensions, William Plummer, a Washington-based spokesman for the company, said on a conference call with reporters yesterday. The company hasn’t been contacted by the FBI about cyber espionage, Plummer said.

Dai Shu, a ZTE spokesman, called it “noteworthy” that “after a yearlong investigation, the committee rests its conclusions on a finding that ZTE may not be ‘free of state influence.’” That standard “would apply to any company operating in China,” Dai said in an e-mailed statement.

Still, the House report will likely keep Huawei products largely out of the U.S., according to John Slack, an analyst with Caris & Co. in San Francisco.

“Whether it’s a political canard, or if there’s real merit to these allegations, the perception is the reality,” Slack said in an interview. “If you keep Huawei out of the U.S. market, the largest market in the world, it’s pretty important.”

Back Doors

One reason lawmakers are concerned is networking equipment can be tweaked to enable widespread surveillance. Routers and switches act as traffic cops, directing data as it shuttles around the Internet and generating detailed logs. That information generally is kept by the owners of the machines, such as Internet providers, not the equipment manufacturers.

Yet the machines’ powerful eavesdropping capabilities place them into a special category of technology with broad national security implications. Lawmakers for years have expressed concerns that foreign firms could manipulate the machines’ code at the factory to spy on communications or have secret so-called back doors giving remote access to hackers.

Fears about the security of Huawei’s devices and the company’s intellectual property practices have prevented the largest U.S. telecommunications companies from buying Huawei gear, and yesterday’s report is likely to solidify existing concerns, Brian Marshall, an analyst with ISI Group in San Francisco, said in an interview.

‘Ripple Effect’

“The U.S. is going to continue to be forbidden territory for Huawei -- there hasn’t really been any penetration of major service providers,” Marshall said. “I don’t think this changes the landscape at all.”

The report could have a ripple effect of causing other governments to reconsider their relationships with Huawei and ZTE, said Ray Mota, managing partner with ACG Research in Gilbert, Arizona.

Other network-equipment makers such as Cisco Systems Inc. (CSCO) and Juniper Networks Inc. will be able to use the House report to sow doubt in customers’ minds about the security of Huawei and ZTE products and potentially lift profit margins, Mota said.

“Huawei is all about low price, and what they call ‘good- enough’ networks,” he said. “This is going to allow Cisco and Juniper to compete more fairly.”

Huawei has faced previous setbacks to its expansion efforts in the U.S. market. In 2010, then-Commerce Secretary Gary Locke expressed concern about Huawei’s participation in bids for a network upgrade by Sprint Nextel Corp. (S) The company awarded the contract worth as much as $5 billion to companies from France, Sweden and South Korea.

Bain Connection

Huawei and Bain Capital Partners LLC dropped a bid to buy computer-equipment maker 3Com Corp. in 2008 after U.S. officials opposed the transaction. Last year, Huawei unwound the purchase of patents from a computer-services company, 3Leaf Systems Inc., after U.S. objections.

The House investigation of Huawei and ZTE raises larger issues about the security of the technology supply chain in telecommunications and other industries, Frank Cilluffo, director of George Washington University’s Homeland Security Policy Institute and a former special assistant to President George W. Bush for homeland security, said in an interview.

“Huawei and ZTE are a good spotlight but it does beg bigger questions as well that we’re only coming to grips with now,” Cilluffo said.

To contact the reporters on this story: Eric Engleman in Washington at eengleman1@bloomberg.net; Jordan Robertson in San Francisco at jrobertson40@bloomberg.net

To contact the editor responsible for this story: Bernard Kohn at bkohn2@bloomberg.net

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