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How Bailing Out ZTE Damaged America’s Credibility

How Bailing Out ZTE Damaged America’s Credibility

Annie Fixler , Trevor Logan
12th June 2018 - Fortune Magazine

Last week, the U.S. Commerce Department announced an agreement to resolve a dispute with Chinese telecom company ZTE, which had violated U.S. sanctions by supplying sensitive technology to Iran. Rather than face a crippling ban on purchasing equipment from U.S. companies, ZTE agreed to pay $1 billion in fines—an unprecedented penalty from Commerce—and place $400 million in escrow to pay for any future fines the company might incur. While ZTE has also agreed to unprecedented compliance measures, the bailout does not address the company’s broader business malfeasance and risks to U.S. national security. Letting ZTE off with just a fine also undermines the deterrent power of U.S. sanctions on Iran, including those Washington is reimposing following its withdrawal from the nuclear deal.

The agreement comes after ZTE announced it would be halting operationsthanks to the U.S. barring American firms from selling to ZTE. Commerce had issued the ban after determining that ZTE violated the terms of a 2017 settlement agreement and lied to investigators. After Chinese President Xi Jinping personally intervened on behalf of ZTE, President Trump tweeted that the U.S. would work with China to help ZTE get back to business.

The $1 billion fine is significant, especially on top of the nearly $900 million ZTE paid last year as part of its previous guilty plea for violating U.S. sanctions. However, the creation of an escrow fund to pay future fines implies that the Commerce Department knows that even with the agreement’s new stringent compliance requirements, ZTE’s unchanged behaviors may get it into hot water down the road.

According to a decade-long court battle between ZTE and U.S. telecommunications company Universal Telephone Exchange (UTE) over whether ZTE illegally used privileged information, this is par for the course for ZTE. In a court document, UTE stated that ZTE “destroyed, concealed, and disavowed evidence, lied under oath, and misled their own attorneys as a matter of course.” UTE further claimed that other lawsuits in New York and Texas show ZTE to be a “notoriously corrupt organization” that engages in “egregious criminal behavior.”

ZTE’s obstruction of justice apparently comes with the backing of the Chinese government. UTE asserts that by recognizing ZTE’s right to assert the “state secrets privilege,” the 2017 settlement agreement is a “clear confession” that ZTE is “part of the Chinese security services, military or government.”

A 2012 congressional report by the House Intelligence Committee raised the same issues, detailing ZTE’s close relationship to Chinese intelligence services, and outlined ongoing concerns that the Chinese government would use features or vulnerabilities in ZTE’s products to engage in espionage or cyber warfare. Congress also condemned ZTE’s refusal to address press reports, including a bombshell Reuters exclusive, alleging that ZTE sold surveillance products to Iran that the regime used to spy on dissidents and human rights advocates.

In this context, the report recommended that the U.S. government and contractors exclude equipment and products made by Chinese companies from their systems. This year, federal agencies and Congress are finally poised to implement this step to protect U.S. national security.

At the beginning of May, the Pentagon ordered military bases to stop selling ZTE phones. ZTE equipment has also been the target of proposed FCC rule changes barring the use of federal funds to purchase equipment from companies that pose a risk to U.S. national security. Most significantly, the House and Senate versions of the 2019 National Defense Authorization Act expressly prohibit the entire U.S. government and the Department of Defense, respectively, from contracting with any company that uses technologies from ZTE and another Chinese telecom company: Huawei.

In addition to undermining U.S. national security, ZTE threatens American businesses because the company does not respect intellectual property rights or and normal business practices. In the UTE vs. ZTE case, the U.S. company alleges that after signing a nondisclosure agreement as part of standard procedure when exploring business relationships, ZTE used confidential information to compete with UTE and bribed officials in Liberia to try to steal a contract from UTE.

In 2015, the U.S. company Vringo and ZTE reached a $21.5 million settlementafter Vringo accused ZTE of allowing the dissemination of proprietary information and using patented technology without paying licensing fees. According to an Office of the U.S. Trade Representative report, stealing intellectual property and engaging in technology transfers to the detriment of U.S. companies is common practice for China.

Finally, the settlement with ZTE also has implications for the Trump administration’s new strategy on Iran. Last month, Secretary of State Mike Pompeo announced that following its withdrawal from the 2015 nuclear agreement, Washington would impose “the strongest sanctions in history” on Tehran to persuade the regime to curtail its regional aggression and other malign activities. Similarly, in a June 5 speech, the U.S. Treasury Department’s sanctions chief, Sigal Mandelker, pledged that America “will hold those doing prohibited business in Iran to account.” But while U.S. sanctions bar Iranian entities from U.S. markets, their real power comes when foreign companies excommunicate sanctioned parties rather than risk penalties for violating U.S. sanctions.

In fact, U.S. sanctions are effective because foreign companies understand that doing business with designated persons carries a significant risk of fines or worse. Reducing ZTE’s punishment after the company repeatedly violated sanctions and its settlement agreement sends a message that Washington is not serious about sanctions enforcement. Consequently, the decision not only undermines U.S. strategy toward Iran, but also risks weakening Washington’s ability to use sanctions as an instrument of national economic power to confront the full range of its foreign policy challenges.

Annie Fixler is a policy analyst at FDD’s Center on Sanctions and Illicit Finance, where Trevor Logan is a cyber research associate. Follow them on Twitter @afixler and @TrevorLoganFDD.

FDD is a Washington-based, nonpartisan research institute focusing on national security and foreign policy. Follow FDD on Twitter @FDD.

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