Committees on Arms Export ControlsWritten evidence from Andrew Feinstein, with research by Barnaby Pace, [both of Corruption Watch UK]

Summary

1. The UK has a substantial role in the global arms trade and in the corruption that is pervasive within it. This corruption profoundly undermines socio-economic development and the rule of law.

2. The UK should undertake never to promote or participate in a corrupt arms deal and not to award licenses for any deal in which corruption is likely.

3. The UK government should investigate, in a manner open to public scrutiny, allegations of corruption in arms deals in which the government was involved directly or indirectly.

4. The UK government should investigate the possible use of a “publish what you pay” approach on arms deals.

5. The UK government should require the declaration of any agents, middlemen or intermediaries used in arms deals, and should consider banning the use of offsets as selection or evaluation criteria in any arms transactions with which it is involved.

6. The UK government should act impartially as a regulator of the arms trade, a position undermined by the Government’s role in promoting arms exports. Failing this, the government should consider establishing a fully independent regulator for arms transactions.

Introduction

7. Andrew Feinstein is the author of “The Shadow World: Inside the Global Arms Trade”, “the most complete account [of the arms trade] ever written” according to the Washington Post. Andrew is a former South African ANC MP, who as ranking ANC member of the Public Accounts Committee attempted to investigate the South African Arms Deal, an investigation that was neutered, leading to his resignation as an MP. Andrew is a founding director of Corruption Watch UK. A recipient of the Open Society’s International Fellowship, he is also the author of “After the Party: Corruption, the ANC and South Africa’s Uncertain Future” and the chapter on arms trade corruption in the “Oxford Handbook of Organised Crime” (2012). Barnaby Pace is a researcher and writer on issues of the arms trade, corruption and militarism. He was a principal researcher on “The Shadow World” and has worked for several NGOs and media organisations including as a consultant on the Open Society sponsored “Budapest Principles” on National Security and the right to information. Barnaby and Andrew, along with their colleague Paul Holden, authored the lead chapter of the SIPRI Yearbook 2011, “Corruption and the arms trade: Sins of commission”.

8. In the course of our work on the “Shadow World” we conducted in-depth research on the arms trade and corruption globally, particularly focussing on the period after the end of the cold war. We interviewed a wide range of figures involved in the trade including government and military officials, politicians, intelligence agents, journalists, civil society activists, whistle-blowers from within government, the military and defence companies, and a number of arms dealers. Through this research, and our on-going investigations, we have developed an in-depth knowledge of the arms trade and the systemic corruption that characterises it.

9. This submission will locate the UK’s arms exports in a global context and identify the UK’s role in a number of the systemic risk issues that characterise the trade. We will quantify corruption in the global arms trade and identify the reasons for its prevalence. We will address the roles of brokers, middlemen and other intermediaries, the effect of the revolving door between government and the arms industry, the issues surrounding offsets and other economic incentives and the apparent inability of the legal process globally to tackle these problems in a meaningful manner. We shall make reference to several case studies of both arms deals and the records of known arms dealers we have encountered in our work.

Systemic issues

10. The global trade in arms accounts for 40% of corruption in all global trade according to an authoritative study undertaken by Joe Roeber for Transparency International.1 Nearly all studies concur that the arms trade is disproportionately given to corrupt practices compared to its relatively modest financial value—sales of, on average, $60 billion per annum.

11. There are a number of systemic issues within the structure and methods of the global arms trade that create such fertile ground for corruption and other illicit practices. These are built into the very nature of the arms trade.

12. These features are (a) the secrecy related to national security and commercial confidentiality; (b) the intimacy of buyers, suppliers and their brokers; (c) the significant economic and personnel linkages between the licit and illicit trades in weapons; (d) the sophistication, fragmentation and in many cases opacity of global production, transportation and financial networks and instruments; (e) the technical specificity of the product; (f) procurement pressures; and (g) the high financial rewards coupled with a lack of consequences.

13. The four most frequent corrupt practices and means to acquire undue influence are (a) bribery, (b) the failure to declare a conflict of interest, (c) the promise of post-employment and (d) the offer of preferential business access.

South Africa

14. The South African Arms Deal is a useful indicative case study and one in which we have a unique level of insight because of Andrew Feinstein’s central role in investigating it, not just in South Africa but also with investigators in the UK, Sweden, Switzerland, France and Germany. The deal, one of the most controversial acts of government since the fall of Apartheid, was officially signed in 1999. It will eventually cost approximately 70 billion rand (approximately £5 billion)2 and comprised 26 Saab/BAE Gripen jet fighters, 24 BAE Hawk jet trainer aircraft, 30 Agusta A109M light helicopters, four AK200 MEKO corvettes made by the German Frigate Consortium led by ThyssenKrupp with Thales and Africa Defence Systems and three 209-type submarines from the German Submarine Consortium headed by Ferrostaal.

15. South Africa embarked on the deal despite a post-Apartheid commitment to reduce military spending in favour of socio-economic development and a public Defence Review which found that the greatest security threat to South Africa was poverty and unemployment. Around the time of the deal President Thabo Mbeki stated that the country did not have the fiscal resources to fund anti-retroviral medication for the five million South Africans living with HIV/Aids. According to a study conducted by Harvard University’s School of Public Health more than 365,000 South Africans died over the next five and a half years because they were unable to access life-prolonging anti-retroviral therapies through the public health system.3

16. The procurement process for the equipment was tainted by corruption with over $300 million allegedly paid in bribes.4 We will focus on the procurement of the Hawk and Gripen jets, which were sourced from British and Swedish companies on the basis of extensive promotional activities by their governments.

17. The deal was also covered by the UK’s Export Credit Guarantee Department (ECGD), which was aware of the scale of commissions paid on the deal. After initially objecting to a higher figure, the ECGD described the commissions as “acceptable”.5 These payments, later estimated at £115 million by the Serious Fraud Office (SFO), were paid by BAE Systems through a convoluted arrangement of offshore shell companies to individuals connected with the arms deal,6 including the Defence Minister’s political advisor, Fana Hlongwane. Defence Minister Modise himself acquired shares in a company called Conlog in 1997 through a complex series of transactions that resulted in him paying nothing for the shares. Conlog was identified by BAE during the bidding process as a potential recipient of offset contracts. Modise’s shares greatly increased in value during the selection process as it became clear BAE was to be awarded the contract. This meant that Modise had a substantial incentive for ensuring BAE’s selection.7

18. The South African Air Force (SAAF) had wished to purchase a single aircraft that could undertake both fighter training and combat missions. In mid-1996, both the Gripen and the Hawk failed to reach the final shortlist, the Gripen for being “unaffordable” and the Hawk for its “high cost” and for not satisfying the “SAAF operational requirements”.

19. However the procurement requirements that had excluded the Gripen and the Hawk were altered on the instructions of Minister Modise. These changes were much criticised for significantly increasing the cost, whilst doing little to improve performance. Even once the criteria were changed the Gripen was placed last on the shortlist. In fact, its eventual success was due to BAE and Saab being given the opportunity to resubmit their offer on financing, something their competitors did not do, and there is no evidence that they were asked to do so.

20. The Hawk jet was in 1998 placed third on a short list of four competitors. The Italian Aermacchi MB339FD, roughly half the price of the Hawk, was listed as the best option with a maximum index score of 100 compared to the Hawk’s 44.2. On 30 April 1998, Modise instructed the selection committee to take a “visionary approach” that excluded cost as a criteria. Soon after, in protest at this irresponsible move, the Secretary of Defence, General Pierre Steyn, resigned saying “I was going to have to account for the costs to Parliament, which I couldn’t do”.8 Even excluding cost the Hawk jet did not outperform the Italian competitor. BAE instead offered an offset proposal approximately ten times the size of any competitor. In fact, after later review by the South African Department of Trade and Industry the offset proposals were found to be “grossly inflated” from around $245 million to $1.6 billion. Indeed, when the two main projects in the proposal were evaluated, they were found to be unfeasible, and without them “BAE had virtually no [offsets] package”.9 General Steyn later remarked that the selection of the Hawk “had been clear from the start”; while the chief of the SAAF said they would only accept the Hawk and Gripen option “if politically obliged to do so”.10

21. As of late 2010, only 11 of the 24 Hawks were operational, and they have only been allocated 2500 flying hours per year due to cost. The lack of flying hours for the Hawk, according to the SAAF, means that pilots lack the flying hours necessary to graduate to the Gripen.11 A strategic plan for 2013 suggests that South Africa can only afford the minimal 250 hours of flight time per year for the Gripens, down from the originally intended 550.12 We estimate that corruption added almost a third to the cost of the arms deal in total. Furthermore, because of the Gripen and Hawk purchase the SAAF has been unable to afford the transport planes required to play a useful peacekeeping role in Africa.13

22. The evidence suggests that the deal violated at least criterion eight of the licensing criteria, threatening sustainable development. The government should have been aware of the likelihood of corruption in the deal, given the ECGD’s awareness of an unjustifiable level of commissions and the changing nature of the tender process. In such cases the UK should not provide an export license, let alone promote the deal. An American-Canadian company withdrew from the tendering process when it became clear it would violate the US’s Foreign Corrupt Practices Act.14

23. The Serious Fraud Office investigated the deal, however the case was dropped as part of the SFO’s settlement with BAE systems which resulted in only one charge being pressed, of false accounting on the smallest deal examined in Tanzania, resulting in a £500,000 fine. As part of the settlement the SFO agreed not to allege corruption against BAE in any third party investigation and not to further investigate the allegations against the company predating February 2010. A key BAE agent in Eastern Europe will go on trial in Austria in December on charges of money laundering and misleading a Parliamentary enquiry. The South African deal is currently the subject of a judicial commission of enquiry in South Africa.

24. No public statement regarding the UK government’s involvement in promoting and underwriting the deal has ever been made. We recommend that the National Audit Office investigate the government’s role in this deal, and the other arms deals where prime facie allegations of corruption have been made.

Other Government-to-Government Deals

25. Allegations of corruption and violations of arms export criteria have been prevalent in other cases of government-to-government transactions, most notably in arms deals between the UK and the Kingdom of Saudi Arabia. We believe that the Al Yamamah arms deal, which still continues, is possibly the most corrupt commercial transaction of all time with over £6 billion in commissions paid, according to police estimates.15 It should be noted that the National Audit Office investigation into the deal is the only report of its kind never to be made public. The Serious Fraud Office’s investigation was shelved in 2006 after political intervention from the Saudi Arabian government and UK government of the time.

26. As your committee has noted in the past, there is credible evidence that the Saudi Arabian government has used British equipment in a way that violates several of the criteria. However, the criteria are not applied in the case of the government-to-government trade. This is indefensible, as UK-made arms continue to be used in human rights violations, the facilitation of repression and/or stoking of tensions, as well as the jeopardising of sustainable development. We believe that the UK government should hold its own arms exports to at least the same standards as it would hold any other export, if not higher.

27. The current SFO investigation into the SANGCOM deal, another government-to-government arms deal to Saudi Arabia, this time involving the EADS subsidiary GPT as the prime contractor, gives an opportunity to prove whether corruption in UK government arms deals is above the law and if the lesson from the Al Yamamah case have been learned. The UK must show that it will live up to its international commitments under the OECD anti-bribery convention that corruption allegations will be investigated regardless of concerns around national interest, as article 5 requires.

28. Public documents relating to the deal suggest that once again the government was aware of illicit commission payments from the inception of the deal and handled corrupt transactions. Furthermore, according to whistle-blowers at least £14.5 million in suspicious payments were made from 2007 and 2010 to two companies based in the Cayman Islands. The companies received 14% of the equipment budget on the contract yet provided no goods or services. Ministry of Defence officials were told about the payments by a whistle-blower in 2008 and while the MoD warned GPT that such payments would not be allowed in the future, they took no action, as the disbursements continued for the next 19 months. We believe that investigations into all government-to-government arms deals, above all those with Saudi Arabia, would be appropriate.

29. In both government-to-government deals and arguably all arms export deals, any use of middlemen, agents or intermediaries should be declared. Our extensive global research shows that this is the primary and often simplest means by which corruption and illegality is facilitated. We believe that this could be consolidated with a register of brokers, which could be checked against sanctions or watch-lists. [We can make available to the committee information about the role of specific individual intermediaries in the deals cited, as well as in many other arms transactions].

30. Furthermore payments to governments, foreign officials, political parties, trade unions, agents, middlemen and intermediaries should be declared in our opinion. The declaration of such payments should in no way violate national security and commercial confidentiality is unlikely to be meaningfully damaged, whereas the public good in transparency around these high corruption risk areas would be enormous.

Offsets

31. The use of economic, industrial or trade offsets, as well as counter-trade, also pose a severe corruption risk in the arms trade. Offsets are where the company supplying the weapons undertake to invest a certain amount of money in the buying country’s economy. However, offsets rarely materialise to the extent promised, job creation estimates tend to be inflated and the penalties for non-fulfilment are often built into the contract price.16

32. The World Trade Organisation bans the use of offsets as a selection/evaluation criteria in public tenders, with the exception of the arms trade.17 We believe this exception is a mistake, both due to the inflated promises deceiving decision makers and/or the public into thinking that military expenditure is an economic good with limited opportunity costs and because of the corruption risk intrinsic to offsets.

33. Furthermore, the decisions around the entities receiving investment and oversight of offsets tend to be opaque, secretive and largely at the discretion of the selling arms company. It is, therefore, all too easy for a company to offer preferential business access to officials or to provide shares or cash through offset arrangements. We have evidence that this was a key mechanism through which BAE Systems made secret payments for many years.

34. A recent case has further highlighted the UK’s role in the use of offsets as a means of making illicit overseas payments. Ferrostaal, the German- based arms company was recently fined €149 million by German authorities in settlement of a corruption investigation into its submarine deal with Greece.18

35. In 2003 Ferrostaal and HDW (a subsidiary of ThyssenKrupp) created a joint venture called MarineForce International (MFI) based in London. This business had a public website advertising itself as offset consultants until October 2012. They have very recently changed their name to ThyssenKrupp Marine Systems LLP and taken down their website.

36. As part of an internal investigation into corruption allegations, Ferrostaal hired a US law firm to investigate the company’s payments between 1999 and 2010. The report compiled by Debevoise and Plimpton has found its way into the public domain in a partial form. It identifies a total of €336 million in “questionable payments”. Moreover the report traces the creation of MFI in London and its purpose.19

37. According to the report, MFI was created so that the parent companies could “insulate themselves from potential tax and prosecutorial investigations in Germany”, and was designed for “outsourcing commission payments”. The report also found numerous “red flags” regarding the company’s agents and questionable payments for arms deals in South Korea, Greece, Turkey, Italy, Egypt, Croatia and Indonesia, often as part of offset programmes. One MFI agent in Indonesia asked MFI for more money telling the company “I will be putting ‘grease’ into my buddies pockets”. MFI made no attempt to question the use of the money and paid the agent what he had asked. Other worrying findings included an MFI payment of €42.9 million to their agent in South Korea, who had prior convictions for bribery. The company avoided asking questions in writing regarding his use of the money in a submarine deal that is alleged to have involved corruption.

38. In the report, the companies’ lawyers explicitly analysed the UK’s “treatment of bribes… by tax authorities and prosecutors” comparing it to what they saw as Germany’s “overzealous” and “unwelcome” investigations.

39. We are concerned that a business such as MFI appears to have been located in the UK to avoid German law, based on the view that UK authorities are not as zealous in allowing “questionable payments” to be made around the world. We believe that the operations of such companies in the UK should be investigated by the appropriate authorities and that Parliament should investigate the UK’s involvement in the facilitation of offset arrangements in the global arms trade with the objective of introducing regulations of the sector as befitting its identification as a high corruption risk. Furthermore, we suggest that claims around offsets should be more carefully examined wherever they are used to justify a major arms deal, whether the UK is the purchaser or supplier.

Arms Trade Treaty

40. With respect to the proposed international arms trade treaty (ATT) being negotiated at the United Nations, we are concerned to note that little mention is made of anti-corruption criteria, measures and their enforcement in the draft circulated at the conclusion of the July negotiating session. We believe that such a provision is essential to any meaningful treaty, and wish to encourage the UK government to push for it.

41. Furthermore, we are concerned that that there is limited possibility of the UK’s arms export behaviour changing fundamentally in the event of an ATT being agreed. A frequent argument in favour of a strong ATT is that arms deals such as those currently occurring between Russia, a major arms producer, and Syria, a state currently engaged in repression, human rights abuses and possibly war crimes, would be prevented. However, we struggle to see how any treaty could enforce such prohibition when the UK continues to arm a state such as Saudi Arabia, which most international human rights organisations describe as being engaged in repression, human rights abuses and arguably war crimes using British equipment.20

42. As Amnesty International summarised: “Planned protests inspired by events elsewhere in the region were ruthlessly suppressed and hundreds of people who protested or dared to call for reform were arrested; some were prosecuted on security-related and political charges. Thousands of people suspected of security-related offences remained in prison. The justice system and information about detainees, including prisoners of conscience, remained shrouded in secrecy, although it was clear that torture and grossly unfair trials continued. Cruel, inhuman and degrading punishments, particularly flogging, continued to be imposed and carried out. Women and girls faced severe discrimination in law and practice, as well as violence; increased campaigning for women’s rights resulted in arrests as well as some small improvements. Foreign migrant workers continued to be exploited and abused by their employers, generally with impunity. At least 82 prisoners were executed, a sharp rise over the previous two years.”21 Given this independent assessment, it is hard to see how Saudi Arabia could be considered a reasonable state to supply with arms, let alone a priority arms market to be lobbied by the Prime Minister and government departments.22

43. A strong, enforceable ATT would have to be impartial and applied consistently across the world. Therefore, we urge Parliament to encourage the UK government to take the lead in ensuring its own arms export legislation and practices are consistent and strictly implemented.

UK Revolving Door

44. We are concerned, if not surprised, to learn of the recent revelations in the Sunday Times and Guardian newspapers. The first, using a sting operation, found that recently retired senior officials and military officers offered to influence government arms procurement policy in favour of a fictitious arms company. We believe this investigation reveals a potentially very dangerous practice of improper and inappropriate influencing of government arms policy in favour of specific private interests.23

45. This concern is intensified by the research conducted by the Guardian showing that senior officials at the Ministry of Defence and in the military had been offered 3,500 jobs at arms companies over the past sixteen years.24 This illustrates a significant corruption risk, in relation to these officials’ conduct in office being skewed in anticipation of post-employment benefits. Given the secretive nature of military and arms trade affairs and the obscure nature of decision-making, we are concerned that there is no effective oversight to ensure that there are no conflicts of interest, including with regards to arms exports.

Legal Process

46. Our investigations suggest that the UK’s track record in dealing with criminality in the arms trade is very poor, like that of most other countries. For example, a research group at the University of British Columbia identified 502 violations of UN arms embargoes. Only two of these violations resulted in legal action and only one in a conviction.25 Furthermore, the disappointing end to the SFO’s investigations into BAE System’s activities, which involved the apparent collusion of the British Government, is deeply troubling. We hope that current cases, such as the SFO’s investigation into the SANGCOM deal, exhibit less political interference and a greater willingness to punish allegedly illegal activities.

47. In addition, we strongly urge that public inquiries be set up into the role of the UK state in corruption in the arms trade, both as a facilitator and a participant. Such inquiries should include both investigation of past and present cases as well as examining the current anti-corruption policies and regulations and their implementation. A full inquiry would cover the activities of the Ministry of Defence, UK Export Finance/ECGD, DESO/UKTI, Foreign and Commonwealth Office and intelligence services, their knowledge or promotion of, and sometimes active part in, corrupt arms deals.

48. UK legislation, notably on bribery, has advanced since some of the events cited in the earlier case studies. However, the UK government has had direct involvement in these important cases, none of which has been satisfactorily resolved. The systemic issues identified remain of real concern in relation to the UK’s arms exports and the Government’s approach to promoting and regulating them. Until these underlying issues are resolved and illicit activities in relation to the trade have been entirely halted there can be little confidence in the propriety of the UK’s involvement in the global arms trade.

6 November 2012