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THE ACTIVITIES OF AMERICAN MULTINATIONAL
TUESDAY, JULY 29, 1975
HOUSE OF REPRESENTATIVES,
COMMITTEE ON INTERNATIONAL RELATIONS,
The subcommittee met at 3:05 p.m. in room H-236, the Capitol, Hon. Robert N. C. Nix (chairman of the subcommittee) presiding. Mr. Nix. The subcommittee will come to order.
Today we will take up an issue within the direct legislative jurisdiction of this committee, that is the Military Sales Act. Military sales legislation will be considered in September. The specific issue we are considering today is the part played in military sales contracts by foreign sales agents and the fees paid to them which discussion could easily serve as the basis for an amendment when the military sales hearings begin in full committee.
In military sales, the role played by the foreign agent is a political as well as a business role, At a time when European and American arms makers are in a race to move their products in the Middle East in order to obtain a share of the $50 billion a year oil profits resulting from the 400-percent increase in the price of oil, foreign sales agents are employed to use any and all devices to insure sales.
Northrop Aviation has admitted paying two Saudi generals $450,000 through a foreign sales agent. The agent, a Saudi Arabian businessman with holdings of over $400 million and $100 million of that invested in the United States, was recently in the news after he failed to take over a San Jose, Calif., bank by investing $14 million. He failed when shareholders in the bank refused to sell after learning his identity. Obviously, he is a major political as well as business power in the Middle East.
Our previous 3 days of hearings have demonstrated that many Federal agencies, especially the Securities and Exchange Commission, are facing up to a serious situation. The Internal Revenue Service has begun an investigation which will mean auditing the returns of all 111 major companies.
The Civil Aeronautics Board has followed the lead of the SEC in demanding disclosure in the airlines industry while the Overseas Private Investment Corporation and the Antitrust Division of the Department of Justice are prepared to act under their statutes.
The information which has served as a basis of action so far in these Agencies is derived from the efforts of the Watergate Prosecutors Office. That information is almost exhausted now. Those Federal
agencies who have faced up to this problem have an immense task in front of them in investigating such matters without the aid of material developed in a special investigation.
The Defense Department has at its disposal immense amounts of information on this very issue. No interest has been shown by the Department in this issue, in that its mission appears to be the promotion of arms sales.
Information released from a document forwarded to Senator Church revealed that $60 million has been paid out in agents' fees in the past 2 years. This information was released after a news story appeared alleging that a figure of $200 million was realistic.
A copy of the memorandum forwarded to Senator Church and referred to the subcommittee by the Department contains a cover letter in which the material is characterized as "proprietary data within the meaning of 18 U.S.C. 1905." It also has a security designation of "confidential."
Aissue would, then, appear to be joined. If it is legally impossible to release such information now, then should information as to the identity and amounts of agents' fees in military sales contracts be re-leased in a regular report to the Congress for public dissemination under a new statute? It is not a small issue since many domestic enforcement programs are at stake.
At this point, I would like to have introduced into the record, if there is no objection, and I hear none, a memorandum entitled, "Agents Fees in the Middle East," which is an eight page paper described by a United Press release as being approved by the Department of Defense and circulated to American aerospace, electronic, and other industry by the Defense Security Assistance Agency.
[The memorandum follows:]
AGENT'S FEE IN THE MIDDLE EAST
The Middle East, Far East and Latin America are areas of the world where an agent is generally required for the successful completion of a commercial sale. In some areas of the Middle East it is a legal requirement to have a local agent before a proposal is considered. For the most part the Request for Quotations will request among other things, who the local agent is and without this information little or no serious consideration will be given to the contractor's response.
While agents or concessionaries existed since pre-biblical times, it was during the industrial revolution that the prominence of agents became a factor to be considered in manufacturing/commerce as we know it. At that time a local agent was engaged by the purchaser who required a given product or commodity and did not have the talent, facility, or faculty to locate the equipment or product in a complex international market place. The local agent who was well versed in national and international commerce was rewarded for his time and effort in the form of a fee paid by the purchaser. Hence, the term "finders fee" evolved and was based on a negotiated amount, depending entirely upon the supply and demand of the commodity. Since then, the term finders fee has taken on a somewhat different connotation.
As manufacturers or users of equipment became more sophisticated, they began employing their own purchasing agents at a fixed salary to fill the role formerly accomplished by an outside agency on a percentage basis. This was done primarily to eliminate the excessive fees required for alleged scarce material. With this transition, the more aggressive agents turned their efforts from a purchasing function, on behalf of the buyer-to one of selling-on behalf of the supplier, in many cases dealing with the same principals.
WHY USE AN AGENT
The use of sales agents in some foreign countries by U.S. companies has developed over the years on the basis that locals must deal with locals because of an inherent mistrust of foreigners. Foreign marketeers generally have a reputation for aggressiveness (not appreciated in some areas of the world), have little or no local language competence, insist on doing business in their language and on their terms, and are unfamiliar with customs, procedures and regulations of the purchasing country. Generally, the local purchaser is much more at ease in dealing with a local representative or agent because of long standing friendships or business arrangements. In addition, the local agent relieves the purchaser of the arduous task of communicating with the foreign supplier in a strange language. In essence, the agent again becomes a middleman between buyer and seller, serving a useful purpose to both parties.
The question as to whether agents are necessary, has arisen many times. There is the classic example of a new Vice President of a U.S. firm who, after reviewing company agent's fees, decided that a local Middle East agent's contract could be cancelled. All that the company had in the country at that time was a continuous but lucrative servicing contract that had been negotiated many years ago. Within 48 hours after the agent had been cancelled, all local work permits of the company's employees were withdrawn. Needless to say, the agent was reinstated immediately.
Another case involved competition by two U.S. firms in a North African country. As the competition became keener, one of the contractors found it almost impossible to obtain a visa for its sales personnel, which would have enabled their marketing people to make a sales presentation. This action was attributable to the influence of one of the competitive agents.
In the past, the volume of sales to the Middle East have been rather limited with the result that the agent's commission has been nominal and, in general, in proportion to the effort expanded by the agent. Recently, however, the countries in the Middle East have embarked on huge defense modernization programs involving hundreds of millions of dollars. Obviously the agent's fee, since it is based on a percentage of sales, is inordinately large and in no way can be equated directly with the amount of effort expended by the agent or representative.
With the increasing expenditures in the Middle East for defense modernization, the Gulf countries are becoming increasingly aware of additional cost for which there is little in the way of value received. More importantly, they are concerned with the influence on the equipment selection process which is being applied by local agents. This influence, if not countered, can result in the acquisition of equipment unsuited or marginal to the defensive posture of the procuring country. A classic example of influence by a local agent on procurement resulted in the purchase by one country of used aircraft. These aircraft have been plagued with maintenance problems since arrival in country with the resulting capability of having not more than three aircraft fully operational at any one time. This same agent was influential in promoting European wheeled vehicles with complete disregard of local desert conditions and temperatures. The result-complete immobility due to engine overheating during the hot summer months.
The term "influence" is used here rather loosely. To be more specific, it can range from normal friendships or family ties between local agent and procuring officer to the payment of substantial sums of money to individuals in high government positions with somewhat lesser amounts paid to lower echelon government officials. One local agent had admitted to the writer that he has three members of the National Assembly (Parliament) of the country on retainer fees for the purpose of obtaining inner circle intelligence and to promote the sales potential of his principal's product.
Since most major defense contractors (both U.S. and foreign) have local agents for the express purpose of influencing a sale, it is no wonder that the decision-making process is complicated by conflicting points of view as to the proper equipment to acquire. Obviously the agent with the greatest margin of profit or percentage has a distinct advantage over those with a lesser fee in that greater "influence" can be applied to all personnel in the governmental decision-making chain.
Influence is not always related directly to a cash gratuity. It can include the rent-free use of a villa in France or a flat in London along with car and servants. Sometimes the government official is a silent partner in the agency or other business completely divorced from his normal activities from which he receives a financial benefit.
THE AGENT'S FEE
The "points" or percentage of a sale received by an agent vary depending upon the size, reputation, and effectiveness of the agent. U.S. contractors selling major systems usually limit their standard fee to an agent of between four and six percent. On less expensive equipment the percentage can exceed 25% of the selling price. There are known cases, however, where the agent has insisted upon an additional four to five percentage points to insure the successful completion of the sale because of some "unusual" added expenses. The French and British industries are masters in dealing through agents and generally have no compunction to agreeing to excessive fees, if, in the final analysis, the sale is consummated. In an on-going negotiation in the Middle East, one European aircraft contractor had a tidy 21 points for the local agent. On the basis of this $200 million contract, the agent had millions to use for influence and still retain a respectable profit for his effort. Intensive negotiation of this contract by the country over an eight-month period finally resulted in a reduction of 16 percentage points and ultimately to a complete elimination of any agent's fee in the price of the aircraft.
In another ME country an agent for a French firm was reported to have netted $40 million on a contract valued at $200-300 million.
THE CURRENT TREND
A trend has now developed throughout the Middle East to purchase defense material on a government-to-government basis. The principal reason for this development is to eliminate the influence factor in equipment selection as well as to restrict the payment of exorbitant fees to a local agent on major procurements. While the development of this trend to go government-to-government on defense procurement is being dictated by the very highest government officials (Heads of State, Ministers of Defense, etc.), it must be kept in mind that the second echelon and lower governmental officials who are normally the benefactors of gratuities, still continue to become involved in exerting influence for a fee. A distinction must also be made between what top governmental officials say publicly and what they really mean. In one ME country the Defense Minister has repeatedly stated in public that no "third party" will be used for the procurement of equipment for their defense modernization program. Yet the Defense Council, of which he is a member, has approved the use of local agents for the procurement of defense material.
The Armed Service Procurement Regulation (ASPR) permits payment of reasonable agents' fees as part of "cost of sales" on Foreign Military Sales (FMS) and contains general guidelines on how "reasonableness" is to be determined. There are exceptions, however, such as in the case of Iran. The Iranian Government has categorically stated that under no circumstances will they permit a fee for an agent in the price of any US equipment purchased under FMS. This has resulted in the issuance of Defense Procurement Circular #117 dated 23 November 1973, and dictated the inclusion of the following paragraph on all USG Letters of Offer to Iran.
"Notwithstanding any other provision of this contract, any direct or indirect costs of agent's fees/commissions for contractor sales agents involved in FMS to the Government of Iran shall be considered as an unallowable item of cost under this contract."
While this is only one example of a country that has already taken concrete steps to remove the agent's fee from defense procurement activities, it is fully expected that other countries in the Middle East will soon follow suit. Therefore, US contractors who are already doing business thru agents in these areas, or those that are contemplating making agency arrangements should be aware of this trend in the Middle East and be guided accordingly.
As stated in the onset of this paper, the more aggressive agents earlier switched from a purchasing function to one of a selling function. It will be most interesting to see how and in what form they adapt to this latest trend. One thing for sure, this lucrative function, developed over the past two thousand years will not evaporate easily.
Mr. Nix. Now, ladies and gentlemen, we are pleased to welcome General Fish and his associates. You may proceed, General, to introduce. your associates.
STATEMENT OF LT. GEN. HOWARD M. FISH, DIRECTOR, DEFENSE SECURITY ASSISTANCE AGENCY
General FISH. I would like to introduce Mr. Douglas Smith, who is my special assistant; Mr. Glenn Rudd, who is the Assistant Director of Operations, Defense Security Assistance Agency; and Mr. Benjamin Forman, who is the Assistant General Counsel for International Affairs in the Department of Defense.
Mr. Nix. Welcome, gentlemen.
General FISH. Mr. Chairman, and members of the committee: I am pleased to respond to your request to testify on the posture of the Department of Defense regarding recent news accounts as to payment of consultants and agents fees in connection with sales by American firms of military items to foreign governments.
The statements, which follow, address seriatim the questions asked by you, in your letter of June 9, 1975, to the Secretary of Defense.1 Before addressing those questions, however, I think it appropriate to note briefly, for the record, the scope of my responsibilities in the Department of Defense.
The Defense Security Assistance Agency, of which I am the Director, is charged by the Secretary of Defense with functions of directing, administering, and supervising approved security assistance plans and programs.
Security assistance encompasses foreign military sales and the grant military assistance program. The function of placing and administering contracts with American industry to procure defense articles and services for the foreign military sales and military assistance programs is delegated to the military departments.
Within the military departments, these contract responsibilities are, in turn, delegated to the procurement activities and the major materiel commands.
The third paragraph of your letter refers to a news account in the New York Times of May 18, 1975, reporting that a judgment has been entered in a class action lawsuit which directs the Northrop Corp. to request the Department of Defense to examine "present rules applying to the use of foreign agents to insure Northrop practices are consistent with the law," and asks what action, if any, the Department of Defense has taken.
This news account did not fully report the text of that provision of the judgment. It provides for Northrop to make such a request of the Department of Defense "in conjunction with the consideration of the executive committee's final report to the board."
1 See appendix 12, p. 267.