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In Depth October 2, 2008, 5:00PM EST

Dangerous Fakes

(page 4 of 5)

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

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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

Even after the likes of IT Enterprise are identified, it can take time to clean up the mess. On Feb. 5, 2008, a manager at Tobyhanna Army Depot, the Pentagon's largest electronics maintenance facility, in Stroud Township, Pa., notified the supply center in Columbus that his unit had discovered counterfeit chips supplied by IT Enterprise for use in global positioning systems on F-15 fighters, according to internal Pentagon e-mails reviewed by BusinessWeek. The e-mails show that, as late as July, the Columbus center was still trying to locate parts purchased from IT Enterprise.

In a July 24 e-mail, an F-15 engineer, whom BusinessWeek agreed not to identify, wrote: "Suppose that a part like that makes it onto a flight-critical piece of hardware or mission-essential piece of hardware. The[re] is a very good chance that the part may work...but what happens at 40[,000] ft and -50 degrees? Hardware failure. Not good."

Ernst says the Hakimuddin episode helped him realize how blind the military has been: "We don't know how big the counterfeit problem is, and, to me, that is irresponsible." Now he's trying to get others in the bureaucracy to confront what he considers to be a crisis: "The risk of counterfeiting is so high, and the cost to our weapon systems is so great, that we need to take action." Glenn Benninger, a senior civilian engineer at the Naval Surface Warfare Center in Crane, Ind., concurs: "Counterfeiting has literally exploded over the last few years, but not a lot of people have been paying attention."

The pending investigations could force the Defense Dept. to heed such warnings. In addition to the Justice Dept.'s probe of BAE, there is the Pentagon's in-house criminal inquiry. "The DoD takes this threat very seriously," John J. Young Jr., Defense Under Secretary for Acquisition, Technology, and Logistics, said in a statement. "This security threat will require great vigilance by DoD to defeat, but we will do everything within our power to do so."

Policies aimed at promoting "disadvantaged" businesses have apparently encouraged dealings with brokers that otherwise might seem questionable. Federal affirmative-action goals require the Pentagon to seek to make 22% of its purchases from small contractors—as measured by staff and revenue—including those run by women, military veterans, or members of certain ethnic minority groups. A contracting database refers to IT Enterprise as a "Subcontinent Asian American Owned Business." Hakimuddin wouldn't discuss her ethnicity but says she was born in the U.S.

Daniel Spencer designated his wife, Brenda, as the legal owner of his brokering business, BDS Supply. "I thought we'd get some kind of benefit [from being woman-owned]," says Spencer, 54, who acknowledges that he runs the company with his wife. Working from home in Great Falls, Mont., he says, he buys from legitimate suppliers and has parts shipped to him before sending them on to the Pentagon. But he admits that, despite a background in computers, he doesn't have the expertise to identify fake chips. Promod Dubey, who runs Phoenix Systems Engineering, a broker in Lake Mary, Fla., complains that military procurement offices "want the cheapest possible s--t they can get." Dubey, who lists Phoenix as a "small disadvantaged" business on Pentagon documents, says he acquires parts from China only as a "last resort" because "sometimes the quality is questionable." Neither he nor Spencer has been accused of impropriety in their military work.

Contractor reports to the GIDEP counterfeits database show a total of 115 incidents over the past six years. But "everybody believes the [GIDEP] reports are just the tip of the iceberg," says Brian Hughitt, manager of quality assurance for NASA. Hughitt says that, during testing, NASA inspectors have identified two shipments of counterfeit chips in the past 18 months. One lot was installed in flight hardware. "That's something that is going to be launched into space," Hughitt says, declining to elaborate. "It could have been real bad." NASA, which helps launch military satellites and missiles, is investigating the shipments.

TRACKING THE CONNECTION

To understand the counterfeiting phenomenon, BusinessWeek independently traced four incidents of phony parts that BAE Systems reported to GIDEP. The circuitous trails all led back to China, as did those of at least six other BAE incidents that BusinessWeek did not investigate in detail.

In April 2007 BAE reported receiving fake military-grade chips purportedly made by Philips Semiconductor for undisclosed weapon systems. A production date stamped on the supposedly military-grade chips identified them as having been made in 1998. But NXP Semiconductors, a unit spun off from the Dutch company Philips two years ago, confirms that it stopped making military-grade chips in 1997.

BAE bought the chips from Port Electronics, a Salem (N.H.) distributor. Robert W. Wentworth, a vice-president at Port, says in an interview that BAE asked his firm to find a series of older microchips to avoid a redesign of weapon systems "that would have cost [BAE] millions." He declines to specify the weapons but adds: "These people [at BAE] were desperate to find the parts."

BAE said in a statement that, after discovering the counterfeits in 2007, it "immediately ceased" using all independent chip brokers, including Port. Following a careful review, BAE added, it again began buying certain products from Port, which it described as a "small disadvantaged and disabled veteran-owned business." Without commenting directly on Wentworth's account, BAE said that redesigning older weapon technology is expensive and that it sometimes makes more economic sense to seek "small quantities of the original parts."

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