Stock Price Drops 5% on Announcement
Action concludes case that galvanized Congress, China bashers
It’s been six years since Loral Space & Communications Corp. disclosed what has become one of the most legendary export control enforcement cases. On January 9, the Justice Department wrapped up its investigation into Loral’s transfer of missile guidance technology to China. Loral, the world’s largest commercial satellite communications services provider, agreed to pay $14 million to settle the alleged violations of the International Traffic in Arms Regulations (ITAR). In exchange for the termination of a Justice Department investigation, the company will pay the civil fine to the State Department without admitting any wrongdoing.
In another settlement wrinkle, the company will allow the U.S. government access to its export compliance apparatus, the better to prevent future miscues.
On February 14, 1996, a three-stage Long March 3B rocket lifted off from China’s Xichang Satellite Launching Center. Even before clearing the launch tower, the rocket tipped over and continued on a flight trajectory roughly parallel to the ground on a collision course with a nearby village. Seconds later, the rocket, along with its Loral-made satellite designed to provide broadcast television service to Latin America, exploded in a force equivalent to 55 tons of TNT. According to official PRC reports, the ensuing fireball killed six people, but other estimates cite the death toll as high as 100. The event became known as the “Valentine’s Day Massacre” among those in the aerospace industry.
Unsanctioned Review
Shortly after the crash, the insurance underwriter demanded an independent investigation. In early April 1996, China Great Wall Industry Corporation, the PRC state-controlled missile, rocket, and launch provider, recruited experts to participate in the Independent Review Committee: four senior engineers from Loral, two from Hughes Space & Communications, one from Daimler-Benz Aerospace, and retired experts from Intelsat, British Aerospace, and General Dynamics. Although Loral’s outside corporate security committee recommended obtaining a U.S. government license to sanction the review effort, no such license was ever requested.
The Independent Review Committee met with PRC engineers and proceeded to generate a preliminary report. While never publicly released, the 25-page report apparently found a number of problems with the Chinese missile launch system, including the poor soldering in the rocket’s guidance system. The entire report, chock-full of juicy technical know-how, was then faxed to Great Wall Industry without a State Department license.
One month later, Loral Corporation disclosed to the State Department that it might have unintentionally violated laws regulating the transfer of high technology to China. In the wake of a third launch failure in 38 months involving a Chinese rocket carrying a U.S.- built satellite, the potential harm caused by the release of the report to the Chinese government initially appeared insignificant. What harm could one more report do? Plenty, according to State Department investigators.
China’s aerospace industry has benefited from extensive state largesse and has provided a launching pad for commercial satellites since the early 1980s. The PRC boasts a well-developed commercial and ballistic missile program with an estimated arsenal of 20 ICBMs. A key manufacturer of those ICBMs is Great Wall Industry – and many experts conclude that an improvement in the guidance systems of China’s commercial boosters would likely result in similar improvements to the Chinese nuclear missiles aimed at the United States.
After a review of their disclosures by several U.S. government offices, including the State Department, the Defense Technology Security Administration, the Defense Intelligence Agency, and other Defense Department agencies, the Department of Defense concluded that Loral “committed a serious export control violation by virtue of having performed a defense service without a license . . .” and referred the matter to the Department of Justice for possible criminal prosecution. The Justice Department probe set off a wave of investigations. The Pentagon, the State Department, and numerous congressional committees began to examine the alleged ITAR violations, and the Loral case was rapidly politicized.
When the details surrounding the Loral transfer surfaced, Republicans criticized President Bill Clinton, for being lax with national security. The allegations of White House complicity in the Loral transfers received a boost in the midst of the Justice investigation, when the Clinton administration approved yet another Loral launch using a Chinese vehicle. Critics voiced concern that Clinton approved the satellite export at the request of Loral’s chairman and chief executive officer, Bernard L. Schwartz, a major Democratic donor and a friend of the Clinton White House.
Fallout
Congressional officials seized on the amount of the Loral settlement as corroboration of their warnings about technology transfers to China. Rep. Christopher Cox (R-Cal), chairman of the congressional committee that investigated Loral’s dealings with the PRC, remarked, “This steep fine and sobering result is another reminder that effectively preventing weapons proliferation requires vigilant enforcement of export controls on military technology.”
The company announced “under the terms of the agreement the fine is to be paid over seven years, without interest, resulting in a cash impact annually of approximately $2 million. The cost of the fine (approximately $0.04 per share) will be reflected in Loral’s 2001 fourth quarter results.”
In accordance with the settlement terms, Loral has committed to beefing up its export compliance program. The company states that under the agreement, its past and future compliance costs will total at least $6 million, $2 million of which has already been spent. CEO Schwartz added that, “The company has instituted an extensive new training program, significantly expanded staff, and greatly improved oversight in the area of export control.”
The State Department will be the ultimate arbiter of this “improved oversight.” That’s because the settlement allows the government to snoop around Loral’s newly constructed export compliance system, an arrangement that is becoming commonplace in the aerospace industry. Pursuant to similar settlements, Lockheed Martin, Boeing, and McDonnell Douglas have agreed to allow the federal government access to their export systems.
Sobering Losses
In addition to the stiff penalty and costs associated with upgrading its export compliance program, Loral lost untold millions in contracts that went to their competitors during the investigations. One notable example was a lucrative industrial security award withdrawn by the Pentagon when it was discovered that Loral was still under investigation. Due to the Justice Department’s ongoing investigation into the company’s illegal transfer of technology to the PRC, Loral was restricted from the U.S. government deal. When questioned about the Pentagon’s proposal to contract with Loral, DoD Spokesman Kenneth H. Bacon, said, “I’d describe it as an embarrassment and something that was unfortunate. And I think it’s seen upstairs as an embarrassment, and it was quickly corrected.”
Loral’s losses transcend embarrassment. While the government welcomed the settlement, investors appear less enthusiastic. On the day the settlement was announced Loral’s stock fell approximately 5 percent and since the company’s initial disclosures to the State Department in May 1996, the value of its stock has plummeted roughly 83 percent. While the steep drop can’t be blamed on the export control problems alone, they certainly didn’t help the financial outlook.
Big Brother Monitoring Export Compliance
Beyond the $14 million fine, Loral agreed to spend $6 million to improve their export control management systems. The government mandated improvements are required to be must undertaken within 120 days of signing the agreement. Under the terms of the settlement Loral agreed to:
Strengthen corporate export compliance procedures to ensure that all employees – including management – are trained and knowledgeable about export control procedures
- Establish a comprehensive computerized document control system ensuring US government review of documents are subject to controls under export licenses
- The agreement states, “This system will cover all technical data and technical assistance in any form to all foreign ODTC (State’s Office of Defense Trade Controls) and DTSA (Defense Technology Security Administration), the Special Compliance Official and Loral’s General Counsel’s office.”
- Institute a confidential “hotline” allowing employees to report violations of export control laws/regulations without fear of recrimination or retaliationgovernment-mandated
- Create Procedures for Loral’s General Counsel to have oversight of all the firm’s space and missile related export activities
- Within 18 months, review implementation of the above measures and report audit findings to ODTC.
By Eric Wemple, Editor, The Export Practitioner
