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China Tech Giant Under Fire

The year-long investigation by the House intelligence committee concluded the firm, Huawei Technologies Inc., and a second firm, ZTE Inc. (0763.HK), pose security risks to the U.S. because their equipment could be used for spying on Americans.

In a report to be released Monday, the committee recommends that the U.S. block acquisitions or mergers involving the two companies through the Committee on Foreign Investments in the U.S. It also recommends that the U.S. government avoid using equipment from the firms, and that U.S. companies seek alternative vendors for telecommunications equipment.

The report is likely to add to tensions with China. American military and intelligence officials have long been warning privately that China poses a cyberespionage threat to U.S. defense systems and companies. Government officials have been reluctant to voice those concerns publicly for fear of angering China. That has begun to change, and the House report represents the most direct statement of concerns about specific Chinese companies.

The report comes as a blow to the two Chinese firms, which have mounted a major lobbying campaign in Washington to allay fears of government influence in their operations. Both companies, which have footholds in the U.S. telecommunications market, have ambitions to expand their share significantly, and both frequently undercut their competitors on price as they seek additional clients in the U.S.

The companies have repeatedly denied they would allow the Chinese government to use their equipment for surveillance, saying it wouldn’t be in their business interests to do so. Both companies also said they cooperated extensively with the committee and have made every effort to respond to requests.

Huawei spokesman William Plummer called national-security concerns “baseless,” saying that “purporting that Huawei is somehow uniquely vulnerable to cyber-mischief ignores technical and commercial realities, recklessly threatens American jobs and innovation, does nothing to protect national security.”

ZTE says that its status as a publicly traded company has ensured that it is transparent about its practices with the public and the intelligence committee. “ZTE has set an unprecedented standard for cooperation by any Chinese company with a congressional investigation,” said David Dai Shu, the company’s director of global public affairs. “ZTE equipment is safe.”

House intelligence committee chairman Mike Rogers (R., Mich.) said of U.S. telecommunications networks: “We simply cannot trust such vital systems to companies with known ties to the Chinese state, a country that is the largest perpetrator of cyberespionage against the U.S.”

The House intelligence committee has no authority to reach conclusions about violations of federal law. But committee officials plan to refer their findings about Huawei to the Justice Department and the Department of Homeland Security, the report says.

In the report, the committee says it based its findings that Huawei and ZTE pose national-security concerns in part on the companies’ failure to provide sufficient information to allay their concerns.

The panel began its probe in November 2011 because of concern that the Chinese government could turn the networks and equipment sold by the two companies into vehicles for spying inside the U.S.

Concerns about Chinese spying have grown in the past year. U.S. intelligence agencies allege China is the most active and persistent perpetrator of economic espionage against U.S. firms. A string of alleged Chinese cyberspying incidents targeting firms ranging from Google to the computer-security firm RSA have contributed to these worries. China has denied engaging in corporate espionage.

“Neither company was willing to provide sufficient evidence to ameliorate the committee’s concerns,” said a draft of the committee’s report. “The risks associated with Huawei’s and ZTE’s provisions of equipment to U.S. critical infrastructure could undermine core U.S. national security interests.”

The 52-page report, which is unclassified, doesn’t include evidence showing either company’s equipment has been used for spying. But it says some companies in the U.S. “have experienced odd or alerting incidents” involving Huawei or ZTE equipment, although it provides no details. The report said a classified annex includes information that adds to concerns.

The committee report says a major concern is that, as Chinese firms, the companies would be required to comply with any Chinese government request for access to their systems.

Huawei is now the world’s second-largest provider of telecommunications equipment, and it does 70% of its business outside China. The Wall Street Journal reported last week that the company, which is closely held, is exploring a public offering. The House report could complicate those plans. Huawei’s U.S. sales last year were $1.3 billion.

ZTE has a smaller U.S. footprint, primarily through sales of devices like smartphones. Its sales in the U.S were $30 million last year. State-owned enterprises own 15.68% of the company.

Huawei officials said the House intelligence committee’s focus on just two companies won’t address the full security problem because many telecommunications providers use equipment made in China that would pose similar national-security risks.

The committee states in its report that it focused on the two companies because their Chinese ownership poses the greatest threat to U.S. national security.

The report’s allegations of potentially illegal practices by Huawei are based in part on interviews with current and former employees, whom the committee didn’t identify. Based on those interviews, the report contends that there have been instances of alleged fraud and bribery by Huawei in seeking U.S.-based contracts. It also points to cases of Huawei employees who were reported to be working full time in the U.S. by using tourist visas, which do not allow for employment in the U.S.

Huawei’s Mr. Plummer said the company “has not seen the committee report so has no familiarity with such allegations.” He said Huawei “has a well-demonstrated track record of responsibly adhering to local laws and regulations in the markets in which it does business.”

The report said that “party committees” within each company provide “a shadow source of power and influence” for the Communist Party within the companies. Huawei didn’t provide details about its party committee for the report. ZTE provided a list of the 19 members of its party committee, which the report says shows crossover with ZTE’s board of directors and other company interests.

At Huawei, Mr. Plummer says the company is independent of the Chinese government and that security of its systems remains a top priority.

In a recent letter to the committee, ZTE said that requiring severe threat assessments only of Chinese companies would be “an obvious unfair trade practice.” It also reiterated that the Chinese government has never requested access to ZTE equipment, and while ZTE doesn’t expect such a request, if it were to occur, the company would be bound by U.S. law.

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