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Military Offsets: Regulations Needed to Implement Prohibition on Incentive Payments (Letter Report, 08/12/97, GAO/NSIAD-97-189).

Pursuant to a congressional request, GAO reviewed the Department of
State's implementation of the Feingold Amendment, a statutory
prohibition governing incentive payments on offset programs, focusing on
the: (1) status of the State's efforts to issue implementing
regulations; and (2) need for such regulations.

GAO noted that: (1) the Department of State has made little progress in
developing regulations implementing the Feingold Amendment because of
internal disagreements over which organizational component should draft
implementing language and the low priority assigned to completing this
task; and (2) regulations are needed to clarify key definitions
contained in the law and establish how State will implement the law's
enforcement and penalty provisions

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-97-189
     TITLE:  Military Offsets: Regulations Needed to Implement 
             Prohibition on Incentive Payments
      DATE:  08/12/97
   SUBJECT:  Foreign military sales
             International trade regulation
             Foreign military sales policies
             International trade restriction
             Foreign military sales contracts
             Department of Defense contractors
             Export regulation
IDENTIFIER:  Foreign Military Sales Program
             
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Cover
================================================================ COVER


Report to the Honorable
Russell D.  Feingold, U.S.  Senate

August 1997

MILITARY OFFSETS - REGULATIONS
NEEDED TO IMPLEMENT PROHIBITION ON
INCENTIVE PAYMENTS

GAO/NSIAD-97-189

Military Offsets

(707268)


Abbreviations
=============================================================== ABBREV

  AECA - Arms Export Control Act
  DOD - Department of Defense
  EAA - Export Administration Act
  FMS - foreign military sales

Letter
=============================================================== LETTER


B-277280

August 12, 1997

The Honorable Russell D.  Feingold
United States Senate

Dear Senator Feingold: 

This report responds to your request for information on the
implementation of the statutory prohibition governing incentive
payments on offset programs, known as the "Feingold Amendment."\1
Specifically, you asked us to address (1) the status of the
Department of State's efforts to issue implementing regulations and
(2) the need for such regulations. 


--------------------
\1 Section 733 of P.L.  103-236, April 30, 1994, amended the Arms
Export Control Act (AECA) by inserting a prohibition on incentive
payments, 22 U.S.C.  2779a. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

The Department of State has made little progress in developing
regulations implementing the Feingold Amendment because of internal
disagreements over which organizational component should draft
implementing language and the low priority assigned to completing
this task.  Regulations are needed to clarify key definitions
contained in the law and establish how State will implement the law's
enforcement and penalty provisions. 


   BACKGROUND
------------------------------------------------------------ Letter :2

Foreign governments obtain U.  S.  military items and services in two
major ways--U.S.  government sales under the foreign military sales
(FMS) program and commercial sales by individuals and business
entities.  The Department of State approves (1) the sale of items and
services sold under the FMS program and (2) export licenses for
military items sold by contractors as a direct commercial sale.\2

Offsets are a range of industrial and commercial compensations
provided to foreign governments and firms as inducements or
conditions for the purchase of U.S.  military goods and services. 
Offset arrangements are not new to defense export sales.  The use of
offsets began in the late 1950s in Europe and Japan.  In 1984, we
reported that offsets were a common practice and that demands for
offsets on defense sales would continue to increase.\3 In 1996, we
reported that demands for offsets in defense export sales had
increased; countries that previously pursued offsets were demanding
more and countries that previously did not require offsets required
them as a matter of policy.\4

The Feingold Amendment, enacted in April 1994, prohibits U.S. 
contractors from making incentive payments to a U.S.  company or
individual to induce or persuade them to buy goods or services from a
foreign country that has an offset agreement with the contractor.\5
It only applies to defense articles or services "sold under" the
AECA.  It does not apply to commercial sales, which are licensed
under, but not sold under, the AECA.  However, for consistency
purposes, the majority of the seven defense contractors we contacted
said that they act as if the amendment applies to both FMS and direct
commercial sale contracts.  Violations of the Feingold Amendment are
punishable by civil fines (not to exceed the greater of $500,000, or
five times the amount of the incentive payment) and administrative
sanctions. 

A July 1994 presidential memorandum delegated implementation of
Feingold Amendment functions to the Secretary of State and authorized
the Secretary to redelegate implementing responsibility within the
Department.  The Secretary, on October 5, 1994, redelegated
responsibility for implementing the Feingold Amendment to State's
Under Secretary for International Affairs (now the Under Secretary
for Arms Control and International Security Affairs). 


--------------------
\2 AECA authorizes the Department of Defense (DOD), under the FMS
program, to sell defense articles and services to foreign governments
or international organizations from existing stock (section 21), as
well as in cases where DOD procures defense articles or services from
a defense contractor for ultimate sale to the foreign country
(section 22), 22 U.S.C.  2761 and 2762, respectively.  Agreements
reached under either of these FMS arrangements are subject to
Department of State review.  Also, State controls direct commercial
sales under authority provided in section 38 of AECA, 22 U.S.C. 
2778. 

\3 Trade Offsets in Foreign Military Sales (GAO/NSIAD-84-102, Apr. 
13, 1984). 

\4 Military Offsets:  Offset Demands Continue to Grow
(GAO/NSIAD-96-65, Apr.  12, 1996). 

\5 P.L.  103-236, section 733, April 30, 1994, 22 U.S.C.  2779a. 


   LACK OF REGULATIONS ON
   PROHIBITION ON INCENTIVE
   PAYMENTS
------------------------------------------------------------ Letter :3

Three years after State was given responsibility for implementing the
Feingold Amendment, it still has no finite plan for carrying out the
legislation and has not issued implementing regulations.  According
to State officials, the following factors have contributed to the
delay:  (1) disagreement over which organizational component within
the Department should be responsible for drafting implementing
language and (2) assignment of higher priorities to other
initiatives.  Specifically, two offices serving under the Under
Secretary for Arms Control and International Security Affairs--the
Office of Arms Transfer and Export Control Policy and the Office of
Defense Trade Controls--have not been able to agree on which office
should proceed with implementation efforts.  According to State
Department officials, implementing the Feingold Amendment was a low
priority for them. 


   REGULATIONS ARE NEEDED
------------------------------------------------------------ Letter :4

There are several uncertainties regarding the Feingold Amendment that
warrant clarification in implementing regulations.  These relate to
(1) the term "incentive payments," (2) the terms "owned" and
"controlled" within the definition of "United States person," and (3)
the law's enforcement and penalty provisions. 

One of the key terms in the Feingold Amendment is the term "incentive
payments." This term is defined in the act\6 and further explained in
the conference report on the legislation.\7

As indicated in the definition, the prohibition applies to incentive
payments in the form of direct monetary compensation.  The conference
report explains that this includes cash payments, payments made by
checks, and the extension of credit or inducements to encourage the
extension of credit from a bank at lower interest rates.  The report
further explains that the legislation is not intended to prevent
defense contractors from paying (as a bonus) "success fees" to
consultants, brokers, or agents the contractors retain for the lawful
implementation of offset agreements; however, it does not explain how
brokers or agents, who often shared fees with purchasers, would need
to change their business practices.  It would be useful for State to
inform defense contractors of these important distinctions through
the issuance of regulations. 

Another uncertainty involves the definition of the term, "United
States person." The Feingold Amendment prohibits defense contractors
from making incentive payments to a United States person, which
includes companies that are "owned or controlled in fact" by a U.S. 
individual.  It is unclear exactly what facts would be sufficient to
constitute "owned or controlled" under the Feingold Amendment. 
Regulations on this point would be beneficial for defense contractors
to comply with the prohibition. 

The legislation generally authorizes the exercise of the same powers
by the State Department that are provided for in certain sections of
the Export Administration Act (EAA), which is administered by the
Department of Commerce.\8 These sections contain various penalty and
sanction provisions for violations of the EAA, as well as provisions
for Commerce's enforcement of the EAA.  In implementing these
provisions, Commerce has issued detailed regulations covering such
matters as procedures for reporting violations, as well as
administrative proceedings, including rules for discovery, subpoenas,
and hearings.\9

Six of the seven defense contractors we talked with agreed on the
need to clarify the terms "owned" and "controlled" as used in the
amendment.  In addition, three of the contractors said that
clarifying the term "incentive payment" would be helpful.  In this
regard, two contractors commented that clarification is needed as to
whether some nonmonetary forms of payment (such as credit-related
inducements) are prohibited; the other said that clarification on the
circumstances under which foreign brokers can and cannot be used
would be helpful.  Additionally, two of the contractors commented on
the need to clarify that the amendment's prohibition on incentive
payments only applies to FMS contracts. 


--------------------
\6 This term is defined as meaning ".  .  .direct monetary
compensation made by a United States supplier of defense articles or
defense services or by any employee, agent or subcontractor thereof
to any other United States person to induce or persuade that United
States person to purchase or acquire goods or services produced,
manufactured, grown, or extracted, in whole or in part, in the
foreign country which is purchasing those defense articles or
services from the United States supplier.  .  ." 22 U.S.C. 
2779a(d)(2). 

\7 H.R.  Rep.  No.  103-482, at pp.  259-260 (1994). 

\8 Specifically, subsections (c), (d), (e), and (f) of section 11 and
subsection (a) of section 12, 50 U.S.C.  App.  2410 and 2411,
respectively. 

\9 These regulations can be found in 15 C.F.R.  Parts 764
(Enforcement and Protective Measures) and 766 (Administrative
Enforcement Proceedings). 


   RECOMMENDATION
------------------------------------------------------------ Letter :5

Because the Under Secretary of State for Arms Control and
International Security Affairs has not issued needed regulations for
implementing the Feingold Amendment, we recommend that the Secretary
of State establish a specific time frame for the Under Secretary to
develop the regulations to implement the Amendment.  At a minimum,
these regulations should (1) clarify the term "incentive payments,"
(2) define the terms "owned" and "controlled" as used to define a
U.S.  person, and (3) spell out how State intends to enforce the
amendment and impose and administer penalties for violations. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :6

We obtained comments on a draft of this report from the Departments
of State, Defense, and Commerce, each of which have a role in
collecting data and developing policy on offsets.  State, Defense,
and Commerce took different positions on our recommendation.  State
asserted that it was confident the Feingold Amendment was being
implemented in an appropriate fashion under existing DOD procedures,
thereby indicating that regulations were not necessary.  DOD, on the
other hand, agreed with us that regulations were needed and that
State ought to develop them.  Commerce did not express an opinion as
to whether regulations were needed, but provided a technical
correction that we have incorporated in the text. 

State indicated that it had taken its position for the following
reasons: 

  -- Existing DOD mechanisms would reveal whether commissions and
     agent fees are paid in connection with FMS contracts. 

  -- DOD frequently conducts audits of U.S.  defense contractors to
     ensure contract compliance and could become aware of illegal
     activities involving incentive payments through this process. 

  -- Information contained in notifications to the Congress of
     planned FMS contracts indicates that since the Feingold
     Amendment was enacted, no offsets have been proposed in
     connection with FMS contracts and, therefore, no incentive
     payments could have been made. 

Our analysis indicates that DOD mechanisms, which were designed for
other purposes, can contribute relevant information to help implement
the Feingold Amendment, but they are not adequate substitutes for
having specific regulations that provide a guide for the practical
implementation of the legislation.  How the terms will be defined for
operational purposes and what the enforcement mechanisms will be have
yet to be established.  DOD also commented that while it agrees with
State that controls in place (such as contract audits) help to detect
violations, DOD's position is that a need still exists for State to
issue regulations that clarify terms and eliminate confusion. 
Moreover, according to data we obtained at the Defense Security
Assistance Agency, 17 of the congressional notifications sent between
May 1994 and September 1996 indicate that offset agreements have been
proposed in connection with FMS contracts.  We also found that
contractor data reported to Commerce for fiscal year 1995 indicate
that new offset agreements were established in connection with four
other FMS contracts.\10

Furthermore, the President delegated the responsibility for
implementing the Feingold Amendment to State, not DOD, and State has
not sought administrative relief from that responsibility. 
Therefore, we continue to believe State needs to establish a specific
timeframe for developing regulations. 

Comments from State and Commerce are reprinted in their entirety in
appendixes I and II, respectively.  DOD comments were provided orally
by the Director of Foreign Transfer, Office of the Under Secretary of
Defense for Acquisition and Technology. 


--------------------
\10 The Defense Production Act Amendments of 1992, 50 U.S.C.  App. 
2099, require that U.S.  firms entering into offset agreements
associated with contracts for the sale of defense articles and/or
services to foreign governments or companies provide Commerce certain
information regarding those agreements when they exceed $5 million. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :7

To determine the Department of State's efforts to develop and issue a
regulation to implement an April 1994 amendment to the AECA, we met
with officials from Offices of Defense Trade Controls, Arms Transfer
and Export Control Policy, and the Legal Adviser, Department of
State.  Also, by letter dated April 3, 1997, we requested the
Department of State to respond in writing as to:  (1) its intentions
to issue regulations implementing the Feingold Amendment; (2) the
current development status of the regulations and expected time frame
for publishing them; and (3) what impediments, if any, were perceived
to the effective implementation or enforcement of the amendment.  As
of June 25, 1997, the date we transmitted a draft of this report to
the Department of State for its review, State had not responded to
our April 3, 1997, letter of inquiry.  However, in its July 8th
response to a draft of this product, State addressed some of the
issues raised in our April letter. 

To address the need for implementing regulations, we reviewed the
language and legislative history of the Feingold Amendment to the
AECA establishing a prohibition against certain incentive payments. 
We also discussed the need for implementing regulations with
officials from seven major defense contractors.  We interviewed
officials from the Department of Commerce and the Defense Security
Assistance Agency to determine their role, if any, in implementing
the Feingold Amendment. 

We performed our review between March and July 1997 in accordance
with generally accepted government auditing standards. 

We are sending copies of this report to the Secretaries of State,
Defense, and Commerce; the Director, Office of Management and Budget;
and interested congressional committees.  Copies will also be made
available to others upon request. 


Please contact me at (202) 512-4383 if you or your staff have any
questions concerning this report.  Major contributors to this report
were John D.  Heere, William T.  Woods, Raymond J.  Wyrsch, and Karen
S.  Zuckerstein. 

Sincerely yours,

Katherine V.  Schinasi
Associate Director
Defense Acquisitions Issues




(See figure in printed edition.)Appendix I
COMMENTS FROM THE DEPARTMENT OF
STATE
============================================================== Letter 



(See figure in printed edition.)



(See figure in printed edition.)


The following is GAO's comment on the Department of State's letter
dated July 8, 1997. 

GAO COMMENT

1.  State's assertion that the Department of Defense (DOD) concurs
with its position is inconsistent with the comments we obtained
directly from DOD.  As discussed on page 5, DOD stated that while it
agrees with State that controls in place help to detect violations,
DOD's position is that a need still exists for State to issue
regulations that clarify terms and eliminate confusion. 




(See figure in printed edition.)Appendix II
COMMENTS FROM THE DEPARTMENT OF
COMMERCE
============================================================== Letter 


*** End of document. ***






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