Disgraceful and a totally inappropriate small penalty

United Technologies sent military copter tech to China

By Mark Hosenball and Andrea Shalal-Esa

WASHINGTON (Reuters) - United Technologies Corp on Thursday admitted selling China software that helped Beijing develop its first modern military attack helicopter, one of hundreds of export control violations over nearly two decades.

At a federal court hearing in Bridgeport, Connecticut, United Technologies and its two subsidiaries, Pratt & Whitney Canada and Hamilton Sundstrand Corp, agreed to pay more than $75 million to the U.S. government to settle criminal and administrative charges related to the violations.

As part of the settlement, Pratt & Whitney Canada pleaded guilty to two federal criminal charges - violating a U.S. export control law and making false statements.

Federal prosecutors said the company knew that its export of modified software to China would allow Beijing to test and develop its new military helicopter, called the Z-10, using 10 engines that had been legally exported as commercial items.

They said the company harmed national security while trying to gain access to China's lucrative civilian helicopter market.

"P&WC exported controlled U.S. technology to China, knowing it would be used in the development of a military attack helicopter in violation of the U.S. arms embargo with China," said U.S. Attorney David Fein of Connecticut.

"P&WC took what it described internally as a ‘calculated risk,' because it wanted to become the exclusive supplier for a civil helicopter market in China with projected revenues of up to $2 billion," Fein said.

The case comes amid growing U.S. concerns about China's military expansion and escalating electronic espionage.

Federal authorities have brought five major cases since last February, involving everything from drone technology to radiation-hardened computers used in satellite communications.

SLAP ON THE WRIST?

United Technologies said it accepted full responsibility for the violations and deeply regretted that they had occurred. It said it had spent $30 million and hired more than 1,000 full and part-time employees to beef up its internal export oversight.

"These violations revealed important opportunities to strengthen our export compliance program," United Technologies Chief Executive Louis Chenevert said in a statement, adding that both the Justice and State departments had recognized the company's "significant remedial actions."

Fein said the penalties were substantial, but analysts said they amounted to a slap on the wrist for a major global industrial conglomerate with annual revenues of $58.1 billion.

"The fine is substantial ... but it's fairly modest measured against the company's overall revenues," said Loren Thompson, analyst with the Virginia-based Lexington Institute. "It will not have a material impact on the company's financial results."

Hamilton Sundstrand and Pratt & Whitney Canada also admitted that they had failed to make timely disclosures, required by regulations, to the U.S. State Department about the exports.

The government said the $75 million settlement included $20.7 million in criminal fines, forfeitures and other penalties to be paid to the Justice Department, and $55 million in payments to the State Department as part of a consent agreement resolving 576 administrative export control violations.

About $20 million of the State Department fines may be used by the company for improving its export control procedures and hiring an independent monitor, United Technologies said.

The export control violations ranged from problems with classification, inadequate monitoring of existing export agreements, and even controls imposed on foreign visitors.

One case centered on the export to Venezuela of a test stand for an F100 engine used for F-16 fighter planes that was falsely classified as commercial because it used only commercial items. The individual responsible is still being hunted by U.S. law enforcement officials.

"The Justice Department will spare no effort to hold accountable those who compromise U.S. national security for the sake of profits and then lie about it to the government," said Assistant Attorney General Lisa Monaco.

As part of the agreement, the U.S. State Department also will impose curbs on new export licenses for Pratt & Whitney Canada, although the company can request licenses on a case-by-case basis. The debarment does not affect the parent company or Hamilton Sundstrand.

The company's shares closed $1.56 lower on the New York Stock Exchange on Thursday, a drop of 2.1 percent. It said it had put money in reserve to cover the payments.

A CAPABLE, MODERN HELICOPTER

Western experts said the Z-10, first delivered to China's People's Liberation Army in 2009, is developing into one of the world's most modern and capable combat helicopters.

Full production of the Z-10 would give China's military unprecedented levels of "aerial artillery" to support an amphibious invasion and subsequent operations against Taiwan, which Beijing claims as its own, said Richard Fisher, an expert on China's military use of so-called dual-use technologies.

U.S. authorities said China had been trying to develop a specialized modern military attack helicopter since the 1980s.

The U.S. government has prohibited the export to China of U.S. defense equipment and technology since Beijing's 1989 crackdown on the pro-democracy movement, but Washington does allow the export of certain so-called dual-use items that may have a military use but are not weapons in and of themselves.

The U.S. case against United Technologies said P&WC knew as early as 2000 that China's effort to develop a new helicopter would lead off with a military variant, but repeatedly made false statements about its knowledge. It also failed to notify its U.S. parent and the U.S. subsidiary Hamilton Sundstrand.

U.S. authorities said that Pratt & Whitney Canada's initial involvement in the program was to deliver 10 engines to China from Canada in 2001 and 2002. The company believed the engines did not constitute defense equipment subject to the U.S. military embargo on China because the engines were identical to those it was supplying China for commercial helicopters.

The problem arose when Connecticut-based Hamilton Sundstrand delivered certain modifications to the engine control software, which allowed China to test and develop the Pratt & Whitney Canada engines as it was developing the new military helicopter.

U.S. authorities say the software modifications were specifically for use on the military program, making them subject to the U.S. military embargo on China.

PRATT CANADA FORESAW PROBLEMS

According to court documents, in one 2001 internal e-mail, a Pratt & Whitney Canada manager said: "We must be very careful that the helicopter programs we are doing with the Chinese are not presented or viewed as military programs ... If the first flight will be a gunship, then we could have problems with the U.S. government."

In the United States, U.S. investigators say, Hamilton Sundstrand believed it was providing its software to Pratt & Whitney Canada for use in a civilian Chinese helicopter, although it learned in 2004 about a possible export law problem and stopped working on the Z-10 program. But authorities say Pratt & Whitney Canada then modified software on its own and continued to export it to China through June 2005.

A law enforcement source said the companies did not even launch an internal inquiry until a non-governmental organization involved in examining "socially responsible" investments in February 2006 asked United Technologies whether Pratt & Whitney Canada's involvement in the Z-10's development might violate U.S. export laws. The group threatened to recommend that investors sell their holdings in UTC.

That investigation led to an initial disclosure, in July 2006, to U.S. authorities about the Z-10 issue, but that filing was based on an incomplete investigation and contained false statements, according to company officials and the filings.

Analysts said the settlement was a setback for United Technologies, which is transforming itself into an aerospace giant. But the penalties are unlikely to affect its sales in China, which accounted for almost $10 billion of its 2011 sales.

"It's certainly a black eye," said analyst Jeff Sprague of Vertical Research Partners.

United Tech expects to close in coming weeks on its $16.5 billion acquisition of aircraft components maker Goodrich Corp. It has put three units up for sale, including the industrial arm of the Hamilton Sundstrand division.

Jay DeFrank, a spokesman for Pratt & Whitney, said the company continued to do business in China, but it had now launched major efforts to educate all 70,000 employees in United Technologies' aerospace units about export controls.

"China is and remains an important market for UTC and we will continue to do business there in full compliance with the law," he said. Company officials said they were being particularly cautious about possible sales of Pratt engines for another Chinese helicopter, the commercial Z-15 aircraft.

The Obama administration has lent high-level backing to United Technologies' work in China.

Then-Commerce Secretary Gary Locke, now the U.S. ambassador to China, visited a Pratt & Whitney joint venture in Shanghai in May 2010, according to the company's website.

(Additional reporting by Jim Wolf in Washington, Edith Honan in Bridgeport, Connecticut, and Nick Zieminski in New York; Editing by Warren Strobel, Bill Trott, Dan Grebler and Michael Perry)