Background Memo: Senate Armed Services Committee Hearing on Counterfeit Electronic Parts in the DOD Supply Chain

Monday, November 7, 2011

In March 2011, Chairman Carl Levin and Ranking Member John McCain announced a Senate Armed Services Committee investigation into counterfeit electronic parts in the Department of Defense’s supply chain.  Counterfeit electronic parts pose a risk to our national security, the reliability of our defense systems, and the safety of our military men and women.  The proliferation of counterfeit goods also damages our economy and costs American jobs.  

On November 8, 2011, the Committee will hold a hearing on the investigation.  The hearing will explore sources of counterfeit electronic parts and how they are made, cases where counterfeit electronic parts have penetrated the defense supply chain, and the cost and potential impact of counterfeit electronic parts on defense systems.   

Background on Investigation

1.    Source of Counterfeits

In January 2010, the Department of Commerce’s Bureau of Industry and Security published the report, “Defense Industrial Base Assessment: Counterfeit Electronics,” which included the results of a survey of 387 companies and organizations in the defense supply chain, including electronic parts manufacturers, distributors, assemblers, defense contractors, and the Department of Defense (DOD).  The report highlighted “an increasing number of counterfeit incidents being detected, rising from 3,868 incidents in 2005 to 9,356 incidents in 2008.”  The Commerce Department asked respondents to identify particular countries suspected or confirmed to be sources of counterfeits.  China was identified nearly five times more frequently than any other country.  The Commerce Department’s report raised concerns about the threat that counterfeit electronic parts pose to DOD’s supply chain.    

Over the course of the ongoing investigation, staff has reviewed in excess of 100,000 pages of documents from the Department of Defense and more than 70 private companies, including defense contractors and subcontractors, manufacturers and distributors of electronic parts, and independent testing laboratories that conduct testing to determine the authenticity of electronic parts.  The investigation uncovered approximately 1,800 cases of suspect counterfeit electronic parts being identified by some companies in the defense supply chain, with the total number of suspect parts exceeding 1 million.  Of those approximately 1,800 cases, staff tracked well over 100 backwards through the supply chain.  In more than 70 percent of those cases, the trail led to China.  Nearly 20 percent of the remaining cases were tracked to the UK and Canada – known resale points for counterfeit electronic parts from China.  

2.    How Counterfeits are Made and Sold

Much of the raw material of counterfeit electronic parts is salvaged electronic waste (e-waste) shipped from the U.S. and the rest of the world to Hong Kong.  From Hong Kong, waste is trucked to cities in mainland China, such as the counterfeiting district of Shantou in Guangdong Province, where electronic parts may be burned off of old circuit boards, washed in the river, and dried on city sidewalks.  Once washed and sorted, parts may be sanded down to remove the existing part number, date code (which tells you when a part was made), and other identifying marks.  In a process known as “black topping,” the tops of the parts may be recoated to hide those sanding marks.  State of the art printing equipment may then be used to put false markings on the parts.  When the process is complete the parts can look brand new.

Once they have been through the counterfeiting process, parts are shipped to Shenzhen or other cities to be sold openly in the markets or on the internet.  In its April 2011 report of “notorious markets,” the United States Trade Representative said Shenzhen and another city in Guangdong Province were “home to dozens of markets offering counterfeit or pirated goods,” including electronic components.    

Counterfeiters are not limited to doing business in physical markets.  The internet has provided them access to a global marketplace and a large number of China-based distributors are active on internet-based web sites that specialize in the electronic parts trade.

3.    Why DOD is Vulnerable to Counterfeits

The defense industry is particularly vulnerable to counterfeit electronic parts, as many defense systems rely on military and commercial-grade “obsolete parts,” i.e., electronic parts that are no longer produced by the original manufacturer (e.g., Intel, Micron, Xilinx) or sold by their authorized distributors.1   That reliance is based, in part, on the long life cycles of defense systems.  An electronic part may be manufactured for two years, while a defense system it is used on may be in service for more than two decades.  Compounding the problem, from a manufacturer’s perspective, is that DOD demand for parts is often not strong enough to warrant a part’s continued production.  The director of the DOD’s Microelectronics Activity Unit put it this way:  “The defense community is critically reliant on a technology that obsoletes itself every 18 months, is made in unsecure locations and over which we have absolutely no market share influence.”  

As a result, to sustain defense systems, DOD and defense contractors are often forced to purchase parts from independent distributors or brokers.  Independent distributors often specialize in the trade of electronic parts that are no longer in production.  There is a significant risk to purchasing parts in the independent market.  There are many independent distributors who operate legitimate businesses, stock inventory, and invest in state-of-the art testing to detect and screen-out counterfeit parts.  Others, however, may consist of nothing more than a website, be based in China or elsewhere, and be set up for the sole purpose of selling counterfeit parts.  Some agencies and contractors understand that and take steps to reduce risk by imposing strict requirements on their suppliers and by aggressively testing electronic parts not purchased from the manufacturer or a manufacturer-authorized distributor.

4.    Risks Associated with Counterfeit Electronic Parts

The manufacturing of electronic components is done in a highly controlled environment.  Manufacturers invest billions of dollars in state-of-the-art facilities and take extreme precautions to prevent particles of dust, moisture, or other elements from damaging their products.  Compare that process to the one used by counterfeiters, where chips may be burned off boards, washed in dirty rivers, dried on the ground, and remarked with newer or different part numbers.  

The use of an electronic part that has been subject to the counterfeiting process can undermine the performance and reliability of defense systems.  The risk to national security that arises from using these parts can include reduced reliability and availability of defense systems.  Even when counterfeit parts pass acceptance testing, that risk remains.  

5.    Counterfeits Identified in Military Systems

In the course of its investigation, the Committee has uncovered dozens of instances of suspect counterfeit electronic parts in defense systems.  Counterfeit or suspect counterfeit electronic parts have been installed or delivered to the military for use on thermal weapons sights, on THAAD missile mission computers, and on military aircraft, including the C-17, C-130J, C-27J, P-8A Poseidon, AH-64, SH-60B, and CH-46.  The Committee’s hearing will explore three cases where suspect counterfeit electronic parts from China were installed on military systems and subsystems that were manufactured by Raytheon, L-3, and Boeing, respectively.    

a.    U.S. Navy SH-60B Helicopter – FLIR Manufactured by Raytheon

The SH-60B is a Navy helicopter that conducts anti-submarine and anti-surface warfare, surveillance, and targeting support.  The SH-60B deploys on Navy cruisers, destroyers, and frigates and has a Forward Looking InfraRed or “FLIR” system which provides night vision capability.  The FLIR also contains a laser used for targeting the SH-60B’s Hellfire missiles.  Raytheon Company is the prime contractor to the Navy for the FLIR system.  

On September 8, 2011, the Raytheon Company notified the U.S. Naval Supply Systems Command that suspect counterfeit transistors had been integrated in three Electromagnetic Interference Filters (EIF) on FLIR units delivered to the Navy.  While there is no “safety of flight” issue associated with the suspect counterfeit parts, according to the Navy, the failure of an EIF could cause the FLIR to fail.  Without a functioning FLIR, the Navy advises, an SH-60B could not conduct surface warfare missions involving Hellfire missiles.  A FLIR failure would also compromise the pilot’s ability to avoid hazards and identify targets at night, affecting the ability of SH-60Bs pilots to conduct night operations.  Raytheon became aware of the suspect counterfeit parts after being alerted to it by the Committee’s investigation.

The Committee traced the suspect counterfeit transistors back to Huajie Electronics Ltd. in Shenzhen, China.  Huajie Electronics Ltd. sold the parts to Pivotal Electronics in the UK, which sold the parts to E-Warehouse in California, which sold them for commercial use to Thomson Broadcasting in Massachusetts, which sent them as “E-scrap” to Technology Conservation Group (TCG).  TCG is both an electronics recycling company and an electronics distributor.  According to TCG, the parts arrived in what appeared to be the original packaging so TCG sold the transistors to Texas Spectrum Electronics, a defense subcontractor, as “new” and unused parts.  Texas Spectrum used the transistors to manufacture the EIFs that it sold to Raytheon.

b.    U.S. Air Force C-27J – Manufactured by L-3 Communications

The C-27J is military aircraft used for tactical transport and to support combat operations.  The U.S. Air Force has ordered 38 C-27Js from L-3 Communications, 11 of which have been delivered.  Two C-27Js are currently deployed in Afghanistan.  The C-27J is equipped with display units which provide the pilot with information on the health of the airplane, including engine status, fuel usage, location, and warning messages. The display units are manufactured by L-3 Communications Display Systems and are sold to Alenia Aeronautica, a subcontractor for L-3 Communications Integrated Systems who is the prime contractor to the Air Force on the C-27J.  On September 19, 2011, L-3 Integrated Systems notified the Air Force that 38 suspect counterfeit parts had been installed on display units in eight C-27Js.  The suspect counterfeit part at issue is a commercial-grade video memory chip.  Failure of the memory chip could cause a display unit to show a degraded image, lose data, or even go blank altogether.

The Committee traced the counterfeit chips to Hong Dark Electronic Trade in Shenzhen, China.  Hong Dark sold the parts to Global IC Trading Group, an independent distributor, which, in turn, sold them to L-3 Displays for use in display units.  More than 500 display units containing suspect parts were sold to the Air Force, the Navy, and to defense contractors, intended for installation on the C-27J, C-130J, and C-17 aircraft, as well as on the CH-46, a helicopter used by the Marine Corps for assault support.  

L-3 Displays first learned that it had a suspect counterfeit video memory chip on its display units in November 2010.  That was at least the second time that Hong Dark had provided L-3 with counterfeit parts as Hong Dark was the source of another counterfeit part that L-3 discovered in October 2009.    

In November 2010, Global IC notified L-3 that Global IC Trading Group had supplied it with a third shipment of parts from Hong Dark.  Parts from that shipment, which were installed on display units intended for the EA-6B military aircraft, were tested by L-3 a few weeks ago, after Committee staff asked L-3 whether they had been tested.  That testing identified the parts as “suspect counterfeit.”   

In total, the Committee identified nearly 30 shipments, totaling more than 28,000 electronic parts from Hong Dark to Global IC Trading Group that were subsequently sold to L-3.  At least 14,000 of those parts have been identified as suspect counterfeit.  Neither the Committee nor L-3 knows the status of the remaining 14,000 parts.  L-3 has not yet identified what military systems they might be in.  

c.    U.S. Navy P-8A Poseidon – Manufactured by Boeing

The P-8A Poseidon is a Boeing 737 airplane modified to incorporate antisubmarine and anti-surface warfare capabilities.  Three P-8A flight test aircraft currently are in test at the Naval Air Station at Patuxent River, Maryland and the Navy intends to purchase 108 of the aircraft from Boeing.  On August 17, 2011 Boeing sent a message marked “Priority:  Critical” to the P-8 program office.  The message said that an ice detection module installed on one of the P-8 test aircraft contained a “reworked part that should not have been put on the airplane originally and should be replaced immediately.”  Although the part at issue does not impact “safety of flight,” it is critical to the functioning of the P-8’s ice detection module.

Boeing first identified a problem in December 2009 when an ice detection module failed on the company’s flight line.  In that case, the part had fallen out of its socket and was found rattling around inside the module on the airplane.  

BAE Systems, who manufactures the ice detection module for Boeing, investigated the failure and found that the failed part, as well as many others from the same lot as the one installed in the P-8, were not new parts at all.  Rather, they appeared to have been sanded down and remarked to make them look new.  The leads on many parts were bent and markings on the parts were inconsistent.  Parts that should have been virtually identical to one another were actually found to be of different sizes.  In January 2010 BAE notified Boeing of their findings, calling the counterfeit parts “unacceptable for use” and recommending they be replaced.  BAE engineers believed their use created a long-term reliability risk.    

The Committee traced the part in the ice detection systems to A Access Electronics Japan, an affiliate of A Access Electronics in Shenzhen, China.  A company called Abacus Technologies in the U.S. wired payment for the parts to A Access’s account at the Chartered Bank Shenzhen.  Abacus, in turn, sold the parts to Tandex Test Labs.  BAE Systems had hired Tandex to source the parts and screen them for signs of counterfeiting.  Tandex, however, only screened the first 50.  The company sent the remainder – around 250 parts – to BAE without inspecting them at all.  BAE Systems installed the parts in the ice detection system and sold the system to Boeing for installation in the P-8A and commercial 737 aircraft.

6.    Timely Notification to the Government

As described above, the Committee has identified numerous instances in which defense contractors have installed counterfeit or suspect counterfeit parts on systems or subsystems manufactured for the U.S. military.  The Committee has also identified instances in which those contractors have not provided timely notification to the government.  

L-3 Communications Integrated Systems is the prime contractor to the Air Force on the C-27J.   Despite being a division of the same company that identified the counterfeit part in November 2010, L-3 Integrated Systems says it only learned of the counterfeit part in the C-27J as a result of the Committee’s investigation.  As a result, L-3 Integrated Systems did not notify the Air Force that the C-27Js were affected until September 19, 2011, nearly a year after it had been discovered.

In January 2010, BAE notified Boeing that the part in the P-8A and other aircraft were “unacceptable for use” and recommended they be replaced.  Boeing did not notify the Navy until August 17, 2011; more than a year and a half later and only after the Committee asked Boeing whether they had notified the government.  On October 31, 2011 the Navy wrote Boeing that “the Government’s position is that any ‘counterfeit’ material received … is nonconforming material and shall be immediately reported.”

1 In some industries, the term “counterfeit” suggests a complete fabrication of an original product.  For electronic parts, however, the definition of counterfeit endorsed by the Department of Defense and widely accepted by defense contractors, includes previously used parts that are made to look new, and are sold as new.  

In the defense industry, the term “suspect counterfeit” is used in one of two ways.  First, it is common to use the terms “suspect counterfeit” and “counterfeit” interchangeably.  In the absence of explicit confirmation from the original manufacturer of the chip about the authenticity of the part, defense contractors have expressed a preference to use the term suspect counterfeit over counterfeit.  Second, where a sample of parts from a delivery (called a “lot”) display signs of counterfeiting, the entire lot is considered to be suspect counterfeit.