Industrial Security: DOD Cannot Ensure Its Oversight of 	 
Contractors under Foreign Influence Is Sufficient (15-JUL-05,	 
GAO-05-681).							 
                                                                 
The Department of Defense (DOD) is responsible for ensuring that 
U.S. contractors safeguard classified information in their	 
possession. DOD delegates this responsibility to its Defense	 
Security Service (DSS), which oversees more than 11,000 	 
contractor facilities that are cleared to access classified	 
information. Some U.S. contractors have foreign connections that 
may require measures to be put into place to reduce the risk of  
foreign interests gaining unauthorized access to classified	 
information. In response to a Senate report accompanying the	 
National Defense Authorization Act for Fiscal Year 2004, GAO	 
assessed the extent to which DSS has assurance that its approach 
provides sufficient oversight of contractors under foreign	 
ownership, control, or influence (FOCI).			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-681 					        
    ACCNO:   A30099						        
  TITLE:     Industrial Security: DOD Cannot Ensure Its Oversight of  
Contractors under Foreign Influence Is Sufficient		 
     DATE:   07/15/2005 
  SUBJECT:   Classified defense information			 
	     Contract oversight 				 
	     Department of Defense contractors			 
	     Information disclosure				 
	     Information resources management			 
	     Performance measures				 
	     Unauthorized access				 
	     Policy evaluation					 
	     Foreign corporations				 
	     Information security				 
	     Information security management			 
	     Information security regulations			 
	     National Industrial Security Program		 

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GAO-05-681

United States Government Accountability Office

GAO

Report to the Committee on Armed

                             Services, U.S. Senate

July 2005

INDUSTRIAL SECURITY

DOD Cannot Ensure Its Oversight of Contractors under Foreign Influence Is
                                   Sufficient

GAO-05-681

[IMG]

July 2005

INDUSTRIAL SECURITY

DOD Cannot Ensure Its Oversight of Contractors under Foreign Influence Is
Sufficient

  What GAO Found

DSS's oversight of contractors under FOCI depends on contractors
self-reporting foreign business transactions such as foreign acquisitions.
As part of its oversight responsibilities, DSS verifies the extent of the
foreign relationship, works with the contractor to establish protective
measures to insulate foreign interests, and monitors contractor compliance
with these measures. In summary, GAO found that DSS cannot ensure that its
approach to overseeing contractors under FOCI is sufficient to reduce the
risk of foreign interests gaining unauthorized access to U.S. classified
information.

First, DSS does not systematically ask for, collect, or analyze
information on foreign business transactions in a manner that helps it
properly oversee contractors entrusted with U.S. classified information.
In addition, DSS does not collect and track the extent to which classified
information is left in the hands of a contractor under FOCI before
measures are taken to reduce the risk of unauthorized foreign access.
During our review, we found instances in which contractors did not report
foreign business transactions to DSS for several months. We also found a
contractor under foreign ownership that appeared to operate for at least 6
months with access to U.S. classified information before a protective
measure was implemented to mitigate foreign ownership.

Second, DSS does not centrally collect and analyze information to assess
its effectiveness and determine what corrective actions are needed to
improve oversight of contractors under FOCI. For example, DSS does not
know the universe of all contractors operating under protective measures,
the degree to which contractors are complying overall with measures, or
how its oversight could be strengthened by using information such as
counterintelligence data to bolster its measures.

Third, DSS field staff face a number of challenges that significantly
limit their ability to sufficiently oversee contractors under FOCI. Field
staff told us they lack research tools and training to fully understand
the significance of corporate structures, legal ownership, and complex
financial relationships when foreign entities are involved. Staff turnover
and inconsistencies over how guidance is to be implemented also detract
from field staff's ability to effectively carry out FOCI responsibilities.

                 United States Government Accountability Office

Contents

     Letter                                                                 1 
                                    Results in Brief                        3 
                                       Background                           4 
                          DSS's Approach to Overseeing FOCI Contractors Is  8 
                                                              Insufficient 
                                       Conclusions                         15 
                          Recommendations for Executive Action             16 
                                     Agency Comments                       17 
Appendix I                     Scope and Methodology                    
Appendix II           Comments from the Department of Defense           

  Table

                     Table 1: Types of Protective Measures

  Figures

Figure 1: Overview of DSS's FOCI Process 6 Figure 2: Knowledge Gaps in
DSS's FOCI Process 9

Abbreviations

DOD Department of Defense
DSS Defense Security Service
FOCI foreign ownership, control, or influence

This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
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separately.

United States Government Accountability Office Washington, DC 20548

July 15, 2005

The Honorable John W. Warner
Chairman
Committee on Armed Services
United States Senate

The Honorable Carl Levin
Ranking Minority Member
Committee on Armed Services
United States Senate

The Department of Defense (DOD) depends on numerous U.S. contractor
facilities to develop and produce military technologies, such as those
used
in tactical aircraft and military satellites, that require access to
classified
information. DOD's Defense Security Service (DSS) on behalf of DOD and
23 other federal departments administers the National Industrial Security
Program, which was established to ensure that contractors appropriately
safeguard classified information in their possession while performing
work for the U.S. government. DSS is responsible for providing oversight
and assistance to U.S. contractors that are cleared for access to
classified
information. Among these contractors are those under foreign ownership,
control, or influence (FOCI)-that is, a situation in which a foreign
interest has the power to decide matters affecting a contractor's
operations and that could result in unauthorized access to U.S. classified
information or adversely affect the performance of classified contracts.1
The policy of the U.S. government is to allow foreign interests to invest
in
U.S. contractors as long as those investments do not pose a threat to U.S.
national security interests.

DSS depends on the contractor to self-report information about certain
business transactions with foreign entities such as foreign ownership of a
contractor's stock. Once it becomes aware that a contractor has come
under foreign influence through such transactions, DSS is responsible for
verifying the extent of the foreign relationship. DSS and the contractor

1FOCI is defined in the National Industrial Security Program Operating
Manual, which prescribes the requirements, restrictions, and safeguards
that contractors are to follow to prevent the unauthorized disclosure of
classified information.

then work together to decide what appropriate action or measure is to be
taken to protect U.S. classified information from unauthorized disclosure
to foreign interests. DSS relies on a number of protective measures to
reduce the risk of foreign entities having unauthorized access to
classified information, including requiring a foreign owner to transfer
title of company stock to U.S. citizen trustees approved by DOD. DSS is
also responsible for monitoring the contractors' implementation of the
protective measures put in place to mitigate FOCI and relies on
contractors to report instances of noncompliance with its protective
measures.

In a report accompanying the National Defense Authorization Act for Fiscal
Year 2004, the Senate Armed Services Committee directed us to review DSS's
oversight of contractors with foreign business relationships. In response,
we examined the extent to which DSS has assurance that its approach
provides sufficient oversight of contractors under foreign ownership,
control, or influence.2

To assess DSS's oversight of U.S. contractors involved in foreign business
transactions, we interviewed and obtained documentation from DSS
headquarters, DSS field offices, and selected contractors operating under
various protective measures. We reviewed DSS's guidance and procedures for
overseeing contractors that operate under FOCI and for monitoring
contractors' compliance with protective measures. We examined and analyzed
27 case files for contractors that had various types of foreign business
transactions reviewed by DSS, which we discussed with DSS headquarters and
field officials. We performed our work from June 2004 to May 2005 in
accordance with generally accepted government auditing standards. Details
on our scope and methodology can be found in appendix I.

2 As part of its report accompanying the National Defense Authorization
Act for Fiscal Year 2004 (S. Rep. No. 108-46, at 345-346 (2003)), the
Senate Committee on Armed Services also directed us to review DOD's
National Industrial Security Program. In response to that request, we
assessed (1) DSS's oversight of U.S. contractor facilities' implementation
of the National Industrial Security Program and (2) DSS's adherence to
required procedures after a security violation and possible compromise of
classified information. Our assessment was detailed in the following
report: GAO, Industrial Security: DOD Cannot Provide Adequate Assurance
That Its Oversight Ensures the Protection of Classified Information,
GAO-04-332 (Washington, D.C.: Mar. 3, 2004).

  Results in Brief

DSS cannot ensure that its oversight of contractors under FOCI is
sufficient to reduce the risk of foreign interests gaining unauthorized
access to U.S. classified information. First, DSS does not systematically
ask for information that would allow it to know if contractors are
reporting foreign business transactions when they occur. DSS also does not
collect and track the extent to which classified information is accessible
to a contractor under FOCI before measures are taken to reduce the risk of
unauthorized foreign access. Without this information, DSS is limited in
its ability to effectively oversee contractors under FOCI and take actions
when needed to protect classified information from undue foreign access.
During our review, we found instances in which contractors did not report
foreign business transactions to DSS for several months. In addition, we
found a contractor under foreign ownership that appeared to have had
access to U.S. classified information for at least 6 months before a
protective measure was implemented. Second, DSS does not centrally collect
and analyze information to assess its effectiveness and determine what
corrective actions are needed to improve oversight of contractors under
FOCI. For example, DSS does not know the total number of contractors
operating under all protective measures and the degree to which
contractors are complying overall with protective measures. Third, DSS
field staff face a number of challenges in carrying out their
responsibilities in overseeing contractors under FOCI. Field staff told us
they lack research tools and training to fully understand the significance
of corporate structures, legal ownership, and complex financial
relationships when foreign entities are involved. Field staff also
informed us that staff turnover further compounded these challenges. In
addition, we found inconsistencies in how field staff understand and
implement FOCI guidance. These challenges combined significantly limit DSS
field staff's ability to sufficiently oversee contractors under FOCI to
minimize the risk of unauthorized foreign access to U.S. classified
information.

In light of our findings, we are recommending that the Secretary of
Defense take certain actions to (1) improve DDS's knowledge of the timing
of foreign business transactions, (2) assess the overall effectiveness of
DSS's oversight of contractors under FOCI, and (3) develop a human capital
strategy that would provide the appropriate support for industrial
security representatives. DOD did not concur with our recommendations. In
commenting on a draft of our report, DOD indicated that it believes the
FOCI process is adequate to ensure the protection of classified
information. However, DOD did not provide evidence to support this belief.
Given the vulnerabilities we identified in our report, our recommendations
stand.

Background

The National Industrial Security Program was established in 1993 for the
protection of classified information. DSS administers the National
Industrial Security Program on behalf of DOD and 23 other federal
departments and agencies. DSS is responsible for providing oversight,
advice, and assistance to more than 11,000 U.S. contractor facilities that
are cleared for access to classified information. Contractor facilities
can range in size, be located anywhere in the United States, and include
manufacturing plants, laboratories, and universities. About 221 industrial
security representatives work out of 25 DSS field offices across the
United States and serve as the primary points of contact for these
facilities. DSS is responsible for ensuring that these contractors meet
requirements to safeguard classified information under the National
Industrial Security Program. Contractors must have facility security
clearances under this program before they can work on classified
contracts.

To obtain a facility security clearance, contractors are required to
selfreport foreign business transactions on a Certificate Pertaining to
Foreign Interests form. 3 Examples of such transactions include foreign
ownership of a contractor's stock, a contractor's agreements or contracts
with foreign persons, and whether non-U.S. citizens sit on a contractor's
board of directors. DSS's industrial security representatives provide
guidance to contractors on filling out the certificate. If a contractor
declares no foreign business transactions on the certificate, DSS places
the certificate in the contractor's file located in the field. When U.S.
contractors with facility security clearances have changes in foreign
business transactions to report, they are required to complete the
certificate again and resubmit it every 5 years, even if no foreign
transactions take place. Because a U.S. company can own a number of
contractor facilities, the corporate headquarters or another legal entity
within that company is required to complete the certificate.4

3 Throughout our report, we refer to information reported by contractors
on the Certificate Pertaining to Foreign Interests form, or the changes
afterwards, as foreign business transactions.

4 Each business structure has its own set of legal requirements. Within
the National Industrial Security Program, the most common type of business
structure is the corporation. A corporation may be organized as a single
corporate entity, a multiple facility organization with divisions, or a
parent-subsidiary relationship. Under a multiple facility organization,
the home office is the legal entity, while the divisions are extensions of
the legal entity. In a parent-subsidiary relationship, the parent and the
subsidiary are separate legal entities.

When contractors declare foreign transactions on their certificates and
notify DSS, industrial security representatives are responsible for
ensuring that contractors properly identify all relevant foreign business
transactions. They are also required to collect, analyze, and verify
pertinent information about these transactions. For example, by examining
various corporate documents, the industrial security representatives can
determine corporate structures and ownership and identify key management
officials. The representatives may consult with DSS counterintelligence
officials, who can provide information about threats to U.S. classified
information. If contractors' answers on the certificates indicate that
foreign transactions meet certain DSS criteria or exceed thresholds, such
as the percentage of company stock owned by foreign persons, the
representatives forward these FOCI cases to DSS headquarters. DSS
headquarters works with contractors to determine what, if any, protective
measures are needed to reduce the risk of foreign interests gaining
unauthorized access to U.S. classified information. DSS field staff are
then responsible for monitoring contractor compliance with these measures.
Figure 1 shows highlights of the FOCI process.

Figure 1: Overview of DSS's FOCI Process

Source: DSS (data); GAO (analysis and presentation).

On a case-by-case basis, DSS headquarters can approve the use by
contractors of one of six types of protective measures: voting trust
agreements, proxy agreements, special security agreements, security
control agreements, board resolutions, and limited facility clearances.
These protective measures are intended to insulate contractor facilities
from undue foreign control and influence and to reduce the risk of
unauthorized foreign access to classified information. Protective measures
vary in the degree to which foreign entities are insulated from classified
information and are not intended to deny foreign owners the opportunity

to pursue business relationships with their U.S.-based contractor
facilities working on classified contracts. Table 1 provides a general
description of each of these protective measures. In addition to these
measures, DSS can also require contractors to take certain actions to
mitigate specific FOCI situations such as termination of loan agreements
or elimination of debt owed to a foreign entity.

                     Table 1: Types of Protective Measures

Protective measure General description

Voting trust agreement  o  	Foreign owners transfer legal title to the
stock of the foreign-owned U.S. company to U.S. citizen trustees that are
approved by DOD

Proxy agreement  o  	Similar to a voting trust, except foreign owners
retain legal title to the stock and transfer voting rights of stock to
U.S. citizen proxy holders that are approved by DOD

Special security agreement  o  	Allows representatives of the foreign
owner to be on the U.S. contractor's board of directors but requires U.S.
citizen outside directors that are approved by DOD

o  	Contractors under a special security agreement are denied access to
classified information such as Top Secret, special access, and other
sensitive information unless DOD determines it is in the U.S. national
interest and grants an exception

Security control agreement  o  	Similar to a special security agreement
and used when contractor is not effectively owned or controlled by foreign
person(s)

o  	Unlike contractors under a special security agreement, contractors
under a security control agreement are not denied access to classified
information such as Top Secret, special access, and other sensitive
information

Board resolution  o  	Resolution by contractor's board of directors
certifying that foreign shareholder(s) shall not have access to classified
information or be permitted to hold positions that enable them to
influence the performance of classified contracts

Limited facility clearance  o  	Requires industrial security agreement
with the foreign government of the country from which foreign ownership is
derived

o  	Access to classified information is restricted to performance on a
specific contract as defined by the government customer, but there is no
restriction on foreign management control and influence

Source: DSS (data); GAO (analysis and presentation).

For contractors operating under voting trust, proxy, special security, or
security control agreements, industrial security representatives are
supposed to conduct annual FOCI meetings with contractor staff who are
responsible for ensuring compliance with these protective measures. In
preparation for these annual meetings, contractors are required to produce
and submit to DSS annual FOCI compliance reports that can describe
specific acts of noncompliance with protective measures, changes in
organizational structure or changes in security procedures at the
contractor, and other issues that have occurred over the course of a year.
Industrial security representatives should then review the reports to
determine how contractors are fulfilling their obligations under the

protective measures. In addition, DSS generally conducts security reviews
annually for facilities that store classified information or every 18
months for facilities that do not have classified information on site.
However, for contractors operating under voting trust, proxy, special
security, or security control agreements, industrial security
representatives are required to conduct a security review every 12 months
whether the contractor has classified information on site or not. These
reviews are designed to determine security vulnerabilities and contractor
compliance with National Industrial Security Program requirements and to
evaluate the overall quality of the facility's security program, including
compliance with protective measures to mitigate FOCI.

DSS will not grant a new facility security clearance to a contractor until
all relevant FOCI have been mitigated. In addition, DSS shall suspend an
existing clearance if FOCI at a contractor facility has not been
mitigated. A contractor with a suspended facility clearance can continue
to work on an existing classified contract unless the government
contracting office denies access to the existing contract. In addition,
the contractor cannot be awarded a new classified contract until the
clearance is restored.

DSS does not systematically ask for, collect, or analyze foreign business
transactions in a manner that helps it properly oversee contractors
entrusted with U.S. classified information, nor does DSS aggregate and
analyze information to determine the overall effectiveness of its
oversight of FOCI contractors. Notably, DSS does not know if contractors
are reporting foreign business transactions as they occur and lacks
knowledge about how much time a contractor facility with unmitigated FOCI
has access to classified information.5 Figure 2 shows a general
description of gaps in DSS knowledge about the FOCI process. Furthermore,
DSS field staff said they lack research tools and sufficient training
regarding the subject of foreign transactions and have indicated
challenges with regard to staff turnover.

  DSS's Approach to Overseeing FOCI Contractors Is Insufficient

5 "Unmitigated FOCI" refers to situations in which contractors with
facility security clearances are under FOCI and protective measures are
needed but not yet implemented.

Figure 2: Knowledge Gaps in DSS's FOCI Process

                      Potential period of unmitigated FOCI

FOCI business transaction occurs

                Contractor self-reports FOCI transaction to DSS

If protective measure is required, DSS and contractor decide which type of
                              measure to implement

Contractor implements protective measure

 DSS does not analyze whether contractors self-report transactions DSS does not
 know how much time passes before contractor implements the protective measure

              Source: DSS (data); GAO (analysis and presentation).

Note: Per the National Industrial Security Program Operating Manual,
DSSshall suspend the facility clearance of a contractor with unmitigated
FOCI.

    DSS Cannot Ensure Timely Reporting from FOCI Contractors or Determine the
    Extent to Which FOCI Is Unmitigated

DSS does not systematically ask for information that would allow it to
know if contractors are reporting certain foreign business transactions
when they occur, which begins the process for reducing FOCI-related
security risks. DSS industrial security representatives are responsible
for advising contractors that timely notification of foreign business
transactions is essential. The National Industrial Security Program
Operating Manual requires contractors with security clearances to report
any material changes of foreign business transactions previously notified
to DSS but does not specify a time frame for doing so. DSS is dependent on
contractors to self-report transactions by filling out the Certificate
Pertaining to Foreign Interests form, but this form does not ask
contractors to provide specific dates for when foreign transactions took
place. In addition, DSS does not compile or analyze how much time passes
before DSS becomes aware of foreign business transactions. DSS field staff
told us that some contractors report foreign business transactions as they
occur, while others report transactions months later, if at all. During
our review, we found a few instances in which contractors were not
reporting foreign business transactions when they occurred. One contractor
did not report FOCI until 21 months after awarding a subcontract to a
foreign entity. Another contractor hired a foreign national as its
corporate president but did not report this transaction to DSS, and DSS
did not know about the FOCI change until 9 months later, when the
industrial security representative came across the information on the

contractor's Web site. In another example, DSS was not aware that a
foreign national sat on a contractor's board of directors for 15 months
until we discovered it in the process of conducting our audit work.
Without timely notification from contractors, DSS cannot track when
specific foreign business transactions took place and therefore is not in
a position to take immediate action so that FOCI is mitigated, if
necessary.

In addition, DSS does not determine the time elapsed from reporting of
foreign business transactions by contractors with facility clearances to
the implementation of protective measures or when suspensions of facility
clearances occur. Without protective measures in place, unmitigated FOCI
at a cleared contractor increases the risk that foreign interests can gain
unauthorized access to U.S. classified information. During our review, we
found two cases in which contractors appeared to have operated with
unmitigated FOCI before protective measures were implemented. For example,
officials at one contractor stated they reported to DSS that their company
had been acquired by a foreign entity. However, the contractor continued
operating with unmitigated FOCI for at least 6 months. In the other
example, a foreign-purchased contractor continued operating for 2 months
with unmitigated FOCI. Contractor officials in both examples told us that
their facility clearances were not suspended. According to the National
Industrial Security Program Operating Manual, DSS shall suspend the
facility clearance of a contractor with unmitigated FOCI. DSS relies on
field office staff to make this determination. Because information on
suspended contractors with unmitigated FOCI is maintained in the field,
DSS headquarters does not determine at an aggregate level the extent to
which and under what conditions it suspends contractors' facility
clearances due to unmitigated FOCI.

    DSS Does Not Maintain Aggregate Information to Assess Overall Effectiveness
    of the FOCI Process

DSS does not centrally collect and analyze information to determine the
magnitude of contractors under FOCI and assess the effectiveness of its
oversight of those contractors. For example, DSS does not know how many
contractors under FOCI are operating under all types of protective
measures and, therefore, does not know the extent of potential FOCIrelated
security risks. Although DSS tracks information on contractors operating
under some types of protective measures, it does not centrally compile
data on contractors operating under all types of protective measures.6
Specifically, DSS headquarters maintains a central repository

6 There may be multiple contractor locations under a particular protective
measure, but the legal parent signs the measure that covers its divisions.

of data on contractors under voting trust agreements, proxy agreements,
and special security agreements-protective measures intended to mitigate
majority foreign ownership. However, information on contractors under
three other protective measures-security control agreements, limited
facility clearances, and board resolutions-are maintained in paper files
in the field offices.7 DSS does not aggregate data on contractors for all
six types of protective measures and does not track and analyze overall
numbers. In addition, DSS does not conduct overall analysis of foreign
business transactions reported by contractors on their Certificate
Pertaining to Foreign Interests forms or maintain aggregate information
for contractors' responses. Consequently, DSS does not know the universe
of FOCI contractors operating under protective measures, and DSS cannot
determine the extent to which contractors under FOCI are increasing or if
particular types of foreign business transactions are becoming more
prevalent. This information would help DSS target areas for improved
oversight. According to DSS officials, centralizing and tracking
information on contractors under all types of measures would require more
resources because information is dispersed in paper files in DSS field
offices around the country.

DSS does not systematically compile and analyze trends from its oversight
functions to identify overall compliance trends or concerns with
implementation of protective measures by contractors. DSS industrial
security representatives are responsible for ensuring compliance of FOCI
contractors under certain protective measures through annual FOCI meetings
where they discuss contractors' compliance reports.8 Industrial security
representatives notify headquarters of the results of the meetings and
place compliance reports and their own assessments in paper files located
in field offices. However, DSS headquarters does not use annual compliance
reports to assess trends to evaluate overall effectiveness of the FOCI
process.

7 The field office files are the official record for documenting
information on contractor facilities' security programs and industrial
security representatives' interactions with those contractors, including
those under FOCI. The paper folders contain such information as the
identity of the facility owner, contractor-submitted Certificate
Pertaining to Foreign Interests forms, and the results of the contractor's
last two security reviews. In addition to the file folders, DSS has a
facilities database that contains information on facilities' security
programs. DSS officials acknowledged that the database is prone to data
integrity and data loss problems that need to be addressed.

8 The protective measures include voting trust, proxy, special security,
and security control agreements.

Finally, the use of protective measures at FOCI contractor facilities was
designed in part to counter attempts to gather classified information
through unauthorized means. DSS does not assess trends from its own
counterintelligence data or information gathered by other intelligence
agencies to evaluate whether protective measures are effectively
mitigating FOCI risk across the board. For example, a 2004 DSS
counterintelligence report states that foreign information targeting
through e-mail and Internet communication and collection methods is on the
rise. However, according to DSS officials, not all protective measures at
FOCI contractors include provisions to monitor e-mail or other Internet
traffic. By assessing counterintelligence trends to analyze the
effectiveness of protective measures in countering foreign information
collection attempts, DSS could identify weaknesses in its protective
measures and adjust them accordingly.

    DSS Industrial Security Representatives Face Challenges in Carrying Out FOCI
    Responsibilities

DSS's field staff face numerous challenges: complexities in verifying FOCI
cases, limited tools to research FOCI transactions, insufficient FOCI
training, staff turnover, and inconsistencies in implementing guidance on
FOCI cases.

For industrial security representatives, verifying if a contractor is
under FOCI is complex. Industrial security representatives cited various
difficulties verifying FOCI information. To verify if a contractor is
under FOCI, industrial security representatives are required to understand
the corporate structure of the legal entity completing the Certificate
Pertaining to Foreign Interests form and evaluate the types of foreign
control or influence that exist for each entity within a corporate family.
DSS officials informed us that tracing strategic company relationships,
country of ownership, and foreign affiliations and suppliers, or reviewing
corporate documentation-such as loan agreements, financial reports, or
Securities and Exchange Commission filings-is complicated. For example,
representatives are required to verify information on stock ownership by
determining the distribution of the stock among the stockholders and the
influence or control the stockholders may have within the corporation.
This entails identifying the type of stock and the number of shares owned
by the foreign person(s) to determine their authority and management
prerogatives, which DSS guidance indicates may be difficult to ascertain
in certain cases. According to DSS field officials, verifying information
is especially difficult when industrial security representatives have
limited exposure to FOCI cases. In some field offices we visited,
industrial security representatives had few or no

FOCI cases and, therefore, had limited knowledge about how to verify
foreign business transactions.

Some industrial security representatives in one field office told us they
do not always have the tools needed to verify if contractors are under
FOCI. As part of their review process, industrial security representatives
are responsible for verifying what a contractor reports on its Certificate
Pertaining to Foreign Interests form and determining the extent of foreign
interests in the company. Industrial security representatives conduct
independent research using the Internet or return to the contractor for
more information to evaluate the FOCI relationships and hold discussions
with management officials, such as the chief financial officer, treasurer,
and legal counsel. DSS headquarters officials told us additional
information sources, such as the Dun and Bradstreet database of millions
of private and public companies are currently not available in the field.
However, some industrial security representatives stated that such
additional resource tools would be beneficial for verifying complex FOCI
information.

In addition, industrial security representatives stated they lacked the
training and knowledge needed to better verify and oversee contractors
under FOCI. For example, DSS does not require its representatives to have
financial or legal training. While some FOCI training is provided,
representatives largely depend on DSS guidance and on-the-job training to
oversee a FOCI contractor. In so doing, representatives work with more
experienced staff or seek guidance, when needed, from DSS headquarters. In
a 1999 review, DSS recognized that recurring training was necessary to
ensure industrial security representatives remain current on complex FOCI
issues and other aspects of the FOCI process. DSS headquarters officials
said that they have held regionwide meetings where they discussed FOCI
case scenarios and responded to questions about the FOCI process. However,
we found that the training needs on complex FOCI issues are still a
concern to representatives. In fact, many said they needed more training
to help with their responsibility of verifying FOCI information, including
how to review corporate documents, strategic company relationships, and
financial reports. DSS field officials said the DSS training institute
currently offers a brief training unit on FOCI

covering basic information.9 DSS established a working group of DSS field
and headquarters staff to look at ways to improve the training program,
including more specific FOCI training. The group submitted recommendations
in March 2005 to field managers for their review.10 DSS is also planning
to work with its training institute to develop additional FOCI courses to
better meet the needs of the industrial security representatives.

According to field staff, industrial security representatives operate in
an environment of staff turnover, which can affect their in-depth
knowledge of FOCI contractors. Officials from one-third of the field
offices we reviewed noted staff retention problems. DSS officials at two
of these field offices said that in particular they have problems
retaining more experienced industrial security representatives. Field
officials said that when an industrial security representative retires or
leaves, the staff member's entire workload is divided among the remaining
representatives, who already have a substantial workload. In addition, DSS
guidance advises field office officials to rotate contractor facilities
among industrial security representative every 3 years, if possible, as a
means of retaining DSS independence from the contractors. DSS officials
told us the rotation can actually occur more frequently because of staff
turnover. DSS headquarters officials said they are formulating a working
group to help improve staff retention in the field.

Compounding these challenges are inconsistencies among field offices in
how industrial security representatives said they understood and
implemented DSS guidance for reviewing contractors under FOCI. For
example, per DSS guidance, security reviews and FOCI meetings should be
performed every 12 months for contractors operating under special security
agreements, security control agreements, voting trust agreements, and
proxy agreements. However, we found that some industrial security
representatives were inconsistent in implementing the guidance. For
example, one representative said a contractor under a special security

9 DSS officials told us that new industrial security representatives
participate in a 12-week mentoring program prior to attending a 4-week
course at the DSS training institute. The mentoring program consists of
separate units that contain activities that must be completed before an
industrial security representative is approved to attend the 4-week
course. In either the program or the course, only one unit or section of
training pertains to general FOCI information.

10 According to DSS, the overall goal for this working group was to
connect professional development to the individual employee, the budget,
and DSS's mission.

agreement was subject to a security review every 18 months because the
contractor did not store classified information on-site.11 In addition,
two industrial security representatives told us they did not conduct
annual FOCI meetings for contractors that were operating under a proxy
agreement and security control agreement, respectively. We also found that
industrial security representatives varied in their understanding or
application of DSS guidance for when they should suspend a contractor's
facility clearance when FOCI is unmitigated. The guidance indicates that
when a contractor with a facility clearance is determined to be under FOCI
that requires mitigation by DSS headquarters, the facility security
clearance shall be suspended until a protective measure is implemented.
However, we were told by officials in some field offices that they rarely
suspend clearances when a contractor has unmitigated FOCI as long as the
contractor is demonstrating good faith in an effort to provide
documentation to DSS to identify the extent of FOCI and submits a FOCI
mitigation plan to DSS. Officials in other field offices said they would
suspend a contractor's facility clearance once they learned the contractor
had unmitigated FOCI.

                                  Conclusions

The protection of classified information has become increasingly important
in light of the internationalization of multibillion-dollar cooperative
development programs, such as a new-generation fighter aircraft, and a
growing number of complex cross-border industrial arrangements. Although
such developments offer various economic and technological benefits, there
can be national security risks when foreign companies control or influence
U.S. contractors with access to classified information. Given the growing
number of DOD contractors with connections to foreign countries, it is
critical for DSS to ensure that classified information is protected from
unauthorized foreign access. In carrying out its responsibilities, DSS is
dependent on self-reported information from the contractors about their
foreign activities, creating vulnerabilities outside of DSS's control.
Within this environment, unless DSS improves the collection and analysis
of key information and provides its field staff with the training and
tools they need to perform FOCI responsibilities, DSS will continue to
operate without knowing how

11 DSS reported in a 1999 review of its FOCI process that the oversight by
industrial security representatives was not always consistent, and at that
time DSS recommended that FOCI companies should be assessed annually
rather than on an 18-month schedule.

  Recommendations for Executive Action

effective its oversight is at reducing the risk of foreign interests
gaining unauthorized access to U.S. classified information.

To improve knowledge of the timing of foreign business transactions and
reduce the risk of unauthorized foreign access to classified information,
we recommend that the Secretary of Defense direct the director of DSS to
take the following three actions:

o  	clarify when contractors need to report foreign business transactions
to DSS,

o  	determine how contractors should report and communicate dates of
specific foreign business transactions to DSS, and

o  	collect and analyze when foreign business transactions occurred at
contractor facilities and when protective measures were implemented to
mitigate FOCI.

To assess overall effectiveness of DSS oversight of contractors under
FOCI, we recommend that the Secretary of Defense direct the director of
DSS to take the following three actions:

o  	collect and analyze data on contractors operating under all protective
measures as well as changes in types and prevalence of foreign business
transactions reported by contractors;

o  	collect, aggregate, and analyze the results of annual FOCI meetings,
contractors' compliance reports, and data from the counterintelligence
community; and

o  	develop a plan to systematically review and evaluate the effectiveness
of the FOCI process.

To better support industrial security representatives in overseeing
contractors under FOCI, we recommend the Secretary of Defense direct the
director of DSS to formulate a human capital strategy and plan that would
encompass the following two actions:

o  	evaluate the needs of representatives in carrying out their FOCI
responsibilities and

  Agency Comments
  and Our Evaluation

o  	determine and implement changes needed to job requirements, guidance,
and training to meet FOCI responsibilities and explore options for
improving resource tools and knowledge-sharing efforts among
representatives.

In commenting on a draft of our report, DOD disagreed with our conclusions
that improvements are needed to ensure sufficient oversight of contractors
under FOCI, and it also disagreed with our recommendations to improve
oversight. Overall, DOD's comments indicate that it believes that the
actions DSS takes when it learns of FOCI at contractors is sufficient.
However, DOD has not provided evidence necessary to support its
assertions. In fact, we found two cases in which contractors appeared to
have operated with unmitigated FOCI before protective measures were put
into place. Unmitigated FOCI at contractors increases the risk that
foreign interests can gain unauthorized access to U.S. classified
information. Further, DOD states that we did not establish a link between
collecting and analyzing FOCI data and the effectiveness of DSS's
oversight or the protection of classified information. We found that DSS
lacks fundamental FOCI information-including information on the universe
of FOCI contractors and trends in overall contractor compliance with
protective measures-that is needed to determine the effectiveness of the
FOCI process and the sufficiency of oversight. Ultimately, without making
this determination, DSS cannot adequately ensure it is taking necessary
steps to reduce the risk of foreign interests gaining unauthorized access
to classified information. Unless our recommendations are implemented, we
are concerned that DSS will continue to operate on blind faith that its
FOCI process is effective and its oversight is sufficient.

DOD did not concur with seven of our recommendations and only partially
concurred with the eighth. Regarding our first three recommendations,
which aim to improve DSS's knowledge of the timing of foreign business
transactions and reduce the risk of unauthorized foreign access to
classified information, DOD argues that having such information will not
help protect classified information. However, as we noted in our report,
without this information, DSS is not in a position to know when FOCI
transactions occur so that timely protective measures can be implemented
to mitigate FOCI as needed-the purpose of the FOCI process.

Regarding our next three recommendations, which aim to enable DSS to
assess the overall effectiveness of its oversight of contractors under
FOCI, DOD argues that it does not need to collect and analyze information
on the

universe of contractors under FOCI and trends in foreign business
transactions, or aggregate compliance and counterintelligence information.
However, without this information, DSS limits its ability to identify
vulnerabilities in the FOCI process and to target areas for improving
oversight of contractors, including potential changes to protective
measures. DOD also argues that it has three mechanisms to systematically
evaluate DSS's processes: DSS's Inspector General, a management review
process for industrial security field office oversight, and a standards
and quality program. However, DOD has not provided evidence in its
comments that these mechanisms are focused on systematically reviewing and
evaluating the effectiveness of the FOCI process.

Regarding our last two recommendations-to formulate a human capital
strategy and plan that would better support industrial security
representatives in overseeing FOCI contractors-DOD does not believe that
its industrial security representatives need additional support. DOD
supports this belief with two points. First, DOD states that because less
than 3 percent of the approximately 12,000 cleared companies overseen by
DSS have any FOCI mitigation, most DSS industrial security representatives
do not oversee such contractors. Yet it is unclear how DOD arrived at
these figures because DSS does not collect and analyze information on all
contactors operating under protective measures. Regardless of the number
of these contractors, industrial security representatives must have
adequate support-including training and guidance-to verify if contractors
are under FOCI and to ensure contractors comply with any protective
measures put in place. In the course of our review, we found that
industrial security representatives are not sufficiently equipped to
fulfill their FOCI responsibilities. Second, DOD noted that DSS is under
new leadership and is exploring operational improvements as well as
implementing a new industrial security information management system.
While it is too early to assess the effect of these proposals, it is also
unclear how these efforts will bring about any needed changes to
industrial security representatives' job requirements, guidance, tools,
and training.

As we concluded in our report, DSS's dependence on self-reported
information from contractors about their foreign activities creates
vulnerabilities outside of DSS's control. Given these vulnerabilities, it
is imperative that DSS improve the collection and analysis of key
information on the FOCI process and provide its industrial security
representatives with the training and tools they need to perform their
FOCI responsibilities. If DSS continues to operate without knowing how

effective its oversight is and does not support the representatives in
carrying out their FOCI responsibilities, then the value of DSS's
management and the FOCI process should be open for further examination.
Therefore, we did not modify our recommendations.

DOD also provided technical comments, which we addressed. DOD's letter is
reprinted in appendix II, along with our evaluation of its comments.

We are sending copies of this report to interested congressional
committees; the Secretary of Defense; the Director, Defense Security
Service; the Assistant to the President for National Security Affairs; and
the Director, Office of Management and Budget. We will make copies
available to others upon request. In addition, this report will be
available
at no charge on the GAO Web site at http://www.gao.gov.

If you have any questions about this report, please contact me at (202)
512-4841. Major contributors to this report are Anne-Marie Lasowski,
Maria Durant, Ian A. Ferguson, Suzanne Sterling, Kenneth E. Patton, Lily
J.
Chin, and Karen Sloan.

Ann Calvaresi-Barr
Director
Acquisition and Sourcing Management

                       Appendix I: Scope and Methodology

To assess the Defense Security Service's (DSS) process for determining and
overseeing contractors under foreign ownership, control, or influence
(FOCI), we reviewed Department of Defense (DOD) regulations and guidance
on FOCI protective measures included in the National Industrial Security
Program Operating Manual, and the Industrial Security Operating Manual, as
well as DSS policies, procedures, and guidance for verifying contractors
under FOCI and for overseeing them. We discussed with DSS officials at
headquarters and field locations how they use DSS guidance to oversee FOCI
contractors. We also discussed DSS roles and responsibilities for
headquarters and field staff and challenges in overseeing contractors that
report FOCI and the use of FOCI information to evaluate effectiveness of
the process. We reviewed DSS training materials to learn about the type of
training DSS offers industrial security representatives in meeting their
FOCI responsibilities. We also examined FOCI studies conducted by DSS to
determine the results of earlier DSS reviews of the FOCI process.

We visited nine field offices that varied in how many FOCI contractors
they monitored and in their geographic location. Through discussions with
DSS officials at headquarters in Alexandria, Virginia, and from nine field
offices, we identified FOCI contractors operating under various protective
measures and examined DSS actions to verify FOCI and oversee the
implementation of protective measures at contractor facilities. We
collected information on a nonrepresentative sample of 27 contractor
facility case files reviewed by DSS for FOCI. In addition, we visited 8 of
the 27 contractor facilities and spoke with security officials, corporate
officers, and board members to obtain additional clarification on the
types of protective measures and the FOCI process.

We spoke with DSS headquarters and field staff regarding actions taken to
implement protective measures and reviewed supporting documentation
maintained by DSS and contractor facilities. During our visits to nine
field offices, we discussed the contents of selected contractor facility
file folders to understand how DSS oversees contractors' implementation of
protective measures, determines unmitigated FOCI, and assesses the
effectiveness of the FOCI process. Because we did not take a statistical
sample of case files, the results of our analyses cannot be generalized.
However, we confirmed that the data used to select the files that we
reviewed were consistent with the information in the facility files that
we reviewed.

Appendix II: Comments from the Department of Defense

GAO's comments supplementing those in the report text appear at the end of
this appendix.

See comment 1.

See comment 2.

See comment 3.

Appendix II: Comments from the Department of Defense

Appendix II: Comments from the Department of Defense

                                 See comment 4.

                                 See comment 5.

Appendix II: Comments from the Department of Defense

                                 See comment 6.

                         See comment 7. See comment 8.

Appendix II: Comments from the Department of Defense

                                 See comment 9.

                                See comment 10.

                                 See comment 4.

                                See comment 11.

Appendix II: Comments from the Department of Defense

                                See comment 12.

                                See comment 13.

                                See comment 11.

Appendix II: Comments from the Department of Defense

                                See comment 14.

              Appendix II: Comments from the Department of Defense

  GAO's Comments

The following are GAO's comments on the Department of Defense's letter
dated June 29, 2005.

1. 	It is unclear how DOD came to the conclusion that our report lacks an
understanding of the national policy governing contractors' access to
classified information, given that our description of the policy and
process in the background of our report is taken directly from
documentation provided by DSS. Further, DOD did not provide in its
technical comments any suggested amendments to remove perceived
misunderstandings from our report.

2. 	Cleared U.S. citizens need not break the law for foreign interests to
gain unauthorized access to classified information or adversely affect
performance of classified contracts. Classified information can be at risk
when foreign nationals at a cleared FOCI contractor facility are not
identified and timely protective measures are not established to mitigate
their influence.

3. 	DOD's position that there is little in our report that would enable
DSS to improve the FOCI process or justify the cost of implementing our
recommendations underscores the department's failure to grasp the gravity
of our findings. DOD has neither systematically evaluated the
effectiveness of its FOCI process nor identified opportunities to
strengthen its oversight for contractors under FOCI. Our recommendations
specifically target correcting these weaknesses. Further, raising concerns
about cost without evaluating the effectiveness of its FOCI process is
shortsighted.

4. 	According to the National Industrial Security Program Operating
Manual, contractors are required to report material changes to FOCI
information previously reported and every 5 years, even if no change
occurs. We added a footnote to further clarify the definition of foreign
business transactions used in our report.

5. 	DOD's response concerning self-reporting underscores the department's
complacency regarding its responsibility to take actions needed to prevent
foreign interests from gaining unauthorized access to U.S. classified
information. While we recognize that DSS is dependent on self-reporting
and that some vulnerabilities are outside of DSS's control, there are
numerous steps DOD could take to mitigate these vulnerabilities. For
example, if DSS implemented our recommendation to clarify when reporting
should occur and require reporting dates when specific foreign business
transactions took place,

Appendix II: Comments from the Department of Defense

then DSS could monitor whether contractors are reporting foreign
transactions on time and put mitigation measures in place, as appropriate.

6. 	While DOD maintains that contractors are to report material changes
concerning FOCI information as they occur, we found that the National
Industrial Security Program Operating Manual does not state this. As we
reported, DSS field staff told us that while some contractors report
transactions as they occur, some do not report transactions until months
later, if at all. Specifying a time frame for contractors could result in
more timely reporting of these transactions.

7. 	As we reported, the FOCI process begins when a contractor reports FOCI
information. Having information on when foreign transactions occur would
enable DSS to take timely action to impose safeguards or restrictions
authorized by the National Industrial Security Program Operating Manual.

8. 	Unmitigated FOCI at a cleared contractor increases the risk that
foreign interests can gain unauthorized access to U.S. classified
information. During our review, we found two cases in which contractors
appeared to have operated with unmitigated FOCI before protective measures
were put in place. Therefore, it is important to know the length of time
between when a foreign transaction occurs and when protective measures are
put in place to mitigate FOCI.

9. 	According to the National Industrial Security Program Operating
Manual, a contractor under FOCI with an existing facility clearance shall
have its clearance suspended or revoked unless protective measures are
established to remove the possibility of unauthorized access to classified
information or adversely affect performance on classified contracts. DOD's
characterization of DSS having the option to suspend the clearance of
contractors with unmitigated FOCI seems to differ from what is stated in
the manual.

10. It is unclear why DOD does not see the value in collecting information
on contractors operating under all six protective measures, when DSS
already centrally collects information on contractors operating under
three measures. DSS cannot assess the overall effectiveness of its FOCI
process unless it has a complete and accurate account of contractors
operating under all types of protective measures.

11. It is unclear how DOD determined that less than 3 percent of its
cleared contractors are operating under all six protective measures
because DSS does not centrally collect and analyze this information

Appendix II: Comments from the Department of Defense

for all six measures. In addition, the most recent information provided to
us by DSS indicated that there are about 11,000 contractor facilities
participating in the National Industrial Security Program, rather than the
12,000 cited in DOD's comments. Further, DOD did not provide technical
comments to revise the number of contractor facilities stated in our
report.

12. Industrial security representatives may use the results of annual
meetings, compliance reports, and counterintelligence data to assess an
individual contractor's security posture. However, as stated in our
report, DSS does not systematically compile and analyze trends from these
oversight activities. Aggregating overall compliance and
counterintelligence trends is valuable because it would allow DSS to
identify actual or potential weaknesses, evaluate effectiveness, and take
actions as needed to improve its FOCI process.

13. Citing how long the program has been in existence misses the point,
and DOD does not provide evidence that the needs of representatives are
well known. As we reported, industrial security representatives face
numerous challenges in carrying out their FOCI responsibilities, which
formulates the basis of our recommendation to evaluate the needs of the
representatives. Assessing their needs is particularly important given the
increasingly complex environment-characterized by international
cooperative defense programs and a growing number of cross-border defense
industrial relationships-in which industrial security representatives
work.

14. As stated in our report, industrial security representatives told us
they lacked the training and knowledge they needed to verify complex FOCI
cases and oversee contractors under FOCI.

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