Dangerous Fakes

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The harvesting of microchips in China occurs in open-air stalls David Butow

Some of the U.S. military craft that use microchips found to be counterfeited (top to bottom) Bettmann/Corbis; George Hall/Corbis; U.S. Navy, MC2 David Didier/AP Photo; U.S. Embassy Manila/Handout/EPA/Corbis

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Name-brand manufacturers and well-established distributors, some of which acquire the rights to make obsolete chips, say they mark up prices 10% to 30%. Smaller brokers settle for far less generous margins. The number of small brokers increased sharply after 1994, when Congress stopped requiring government contractors to certify that they were either original manufacturers or authorized distributors. The brokers have to obtain a contractor code but receive little or no oversight. Hundreds are now operating, some out of suburban basements and second bedrooms. A BusinessWeek analysis of a contracting database identified at least 24 active brokers that list residential homes as their place of business. Several have won chip contracts for "critical applications," which the Pentagon defines as "essential to weapon system performance...or the operating personnel." In many cases these entrepreneurs comb Web sites such as brokerforum.net and netcomponents.com, which connect them with traders in Shenzhen and Guiyu. The brokers sell either directly to Pentagon depots or via suppliers to defense contractors such as BAE.

ON A QUIET STREET

Mariya Hakimuddin owns IT Enterprise, a company she runs with her mother out of a modest one-story house in Bakersfield, Calif. Rosebushes line the street, and a basketball hoop hangs in the driveway. Hakimuddin, who is in her 40s, says she has no college education. She began brokering military chips four years ago, after friends told her about the expanding trade. Since 2004 she has won Pentagon contracts worth a total of $2.7 million, records show. The military has acquired microchips and other parts from IT Enterprise for use in radar on the aircraft carrier USS Ronald Reagan and the antisubmarine combat system of Spruance-class destroyers.

Hakimuddin says she knows little about the parts she has bought and sold. She started her business by signing up on the Internet for a government supplier code. After the Defense Dept. approved her application, with no inspection, she began scanning online military procurement requests. She plugged part codes into Google (GOOG) and found Web sites offering low prices. Then she ordered parts and had them shipped directly to military depots. "I wouldn't know what [the parts] were before I'd order them," she says, standing near her front door. "I didn't even know what the parts were for."

The Navy's Ernst became concerned about IT Enterprise in March 2007. His team found a suspicious transistor—a basic type of microchip—supplied by the firm for use in the AV-8B Harrier, a Marine Corps fighter jet. The transistor, which turned up during an inspection of a military depot in Cherry Point, N.C., was supposed to contain lead in its solder joints, but didn't. That defect could cause solders to crack and the flight control system to fail, Ernst explains. When a member of the team telephoned IT Enterprise in Bakersfield, he heard children chattering in the background, Ernst recalls. "It was the 'Aha!' moment for me on counterfeit parts," he says.

Unknown to Ernst, a separate Defense inquiry later found that at least five shipments from IT Enterprise since 2004 had contained counterfeit microcircuits, including those intended for the USS Ronald Reagan, according to Pentagon records. During her interview with BusinessWeek, Hakimuddin denied any wrongdoing and blamed her suppliers, but she wouldn't name them. In January the Defense Dept. banned IT Enterprise, Hakimuddin, and her mother, Lubaina Nooruddin, from supplying the military for three years.

The Hakimuddins weren't deterred. A month after Mariya was barred, her husband, Mukerram, received his own supplier code, using the same home address with a new company name, Mil Enterprise. This time the Pentagon caught on more quickly, banning Mukerram for three years as well. He couldn't be reached for comment. People familiar with the matter say the Defense Criminal Investigative Service is looking into IT Enterprise.

In written responses to questions about kitchen-table brokers, officials at the Defense Supply Center in Columbus, Ohio—a major Pentagon electronic-parts buyer—said they don't inspect brokers or conduct background checks. "The law does not prohibit" work-at-home brokers or using the Internet to find parts, the officials said. "Is there risk? Yes, there is risk," Brigadier General Patricia E. McQuistion, the center's commander, says in an interview. She estimates that "less than one-quarter of 1% of what we buy is compromised."

RULE CHANGE

Nevertheless, after BusinessWeek's inquiries, the center in August issued new contracting rules for microchips. Suppliers now must document the "conformance" and "traceability" of chips when they place bids. Previously such records didn't have to be filed at the bidding stage and were sometimes missing or faked, industry and government officials say.