Congressional Report on Huawei Smacks of Protectionism

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By Paula Dwyer

The House Intelligence Committee report on Huawei Technologies Co. and ZTE Corp., China's two largest phone-equipment makers, breathlessly hints at a massive national security breach in the making. The committee report, out today, says Chinese intelligence services could spy on the U.S. by using the two companies' equipment to tamper with American telecoms networks.

The companies, based in Shenzhen, China, failed to cooperate with a yearlong investigation, the report says, or to explain their U.S. business interests and relationships with the Chinese government. Therefore, they can't be trusted and should be barred from merging with or acquiring U.S. companies or getting U.S. contracts.

What the report lacks is evidence. It also smacks of protectionism, despite denials by the committee chairman, Michigan Republican Mike Rogers, that he is invoking national security to shield U.S. telecoms equipment companies from Chinese competition.

The House investigation found "credible" reports of illegal behavior by Huawei, including immigration violations, bribery and corruption. But the original allegations that triggered the investigation a year ago -- that Huawei and ZTE were installing equipment with codes to relay sensitive information back to China -- are far from proven.

There are no examples of data theft enabled by either company's telecoms gear. A classified annex to the report "adds to the committee's concerns," the report says, but doesn't call it conclusive. Instead, lawmakers cite issues that raise red flags. Some ZTE gear has a "backdoor," a way for China's spies to sneak into a network undetected, Rogers said in a press conference. Rogers also cited "numerous examples" of "beaconing," which is when routers turn on in the middle of the night and send large data packs to China.

If these are known vulnerabilities, shouldn't they be fixable? This isn't to say that Huawei should get carte blanche. Ren Zhengfei, Huawei's chief executive officer, founded Huawei in 1987 after leaving the Chinese army, and his military ties continue today, the report says. What's more, U.S. counterintelligence officials have called China the world's biggest practitioner of economic espionage. According to the report, internal Huawei documents supplied by a former employee showed the company provides "special network services'' to an entity the former employee believes is an "elite cyber-warfare unit'' within the Chinese army. The documents "appear authentic'' and suggest Huawei officials weren't forthcoming about research on the military's behalf.

But most of the report's evidence for pronouncing Huawei untrustworthy relates to its governance. The committee casts doubt, for example, on Huawei's claim to be controlled by its common shareholders. Instead, Huawei is "actually controlled by an elite subset of its management." What large, publicly traded U.S. corporation doesn't resemble that description? Not a one.

The report is also critical of Huawei for giving shareholders a write-in option for union representatives, but no similar option for directors. Even when U.S companies allow write-ins for board elections, shareholder nominees never win because management controls most of the proxies. And the House committee didn't like that the selection of board members at the Chinese companies is opaque. Again, the same could be said of most U.S. boards.

The companies said they would allow independent audits of hardware and software to ensure that devices and networks are secure. The report concludes that wouldn't work because the "pace of technology development today drives products to evolve far more rapidly than any third-party comprehensive evaluation can follow." Another reason: Vendors and equipment used for maintenance and upgrades would also need to be vetted. Moreover, any flaws intentionally inserted by a determined and clever insider would make the vetting task "virtually impossible."

Wait, wouldn't that apply to, say, Apple iPhones that are made in China? Or any of the millions of other electronic devices made in China that operate or interact with the U.S. telecoms grid?

Flaws and all, the report is likely to play a role in the presidential campaign. Both candidates -- Republican nominee Mitt Romney more than President Barack Obama, to be sure -- claim they will come down hard on Chinese trade violations. Romney says, if elected, he would designate China a currency manipulator on day one of his term.

Chinese telecoms companies already were meeting stiff resistance in the U.S. prior to the committee report. Ironically, Huawei in 2008 dropped a $2.2 billion joint bid with Bain Capital, the company Romney co-founded, to buy networking company 3Com Corp. In 2011, Huawei abandoned a deal to buy patents from a computer-services company, 3Leaf Systems Inc. The U.S. Commerce Department last year cited security issues in blocking Huawei from participating in a nationwide emergency network.

The committee surprisingly invited the companies to list their shares on a Western stock exchange. A listing would require them to be more transparent with financial data and cyber-security processes. It would also require them to comply with Western legal standards and to obey intellectual property laws. The companies should take the committee up on its offer.

(Paula Dwyer is a member of the Bloomberg view editorial board. Follow her on Twitter.)

Read more breaking commentary from Bloomberg View at the Ticker.

-0- Oct/08/2012 22:12 GMT