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

Dangerous Fakes

(page 5 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

Port obtained the fake Philips chips from another distributor, Aapex International, in Salem, Mass. Aapex had purchased the components from Hong Kong Fair International Electronics in Shenzhen, according to BAE documents. A brochure provided by Hong Kong Fair at its office on the 15th floor of a well-kept commercial building says it enjoys "a good relationship and faithful partnership" with Aapex. Jiang Hongyan, 43, Hong Kong Fair's export manager, says in an interview that her company never tests the microchips it supplies and rarely knows anything about the companies from which it buys. "We are a trading company," says Jiang, who wears red-rimmed glasses and uses the English name "Snow." She adds: "We buy goods with one hand and sell them with the other hand. We do not have any capability to do research, production, or modifications."

SUPPLIER WARNINGS

The owner of Aapex, Marie Gauthier, says her company purchased chips from Hong Kong Fair only once. She says she doesn't know anything about the brochure in which Hong Kong Fair boasts of its "faithful partnership" with Aapex. She says she made chip sales worth $2 million to Port Electronics between 1999 and 2007. "Ninety-nine percent of it was for BAE," she says. BAE engineers regularly contacted Aapex in their search for older, hard-to-find chips, Gauthier says. She told the defense contractor she was buying parts from China. "We notified BAE that this was high-risk," says Gauthier. "They begged us because they said they needed the product." E-mail exchanges, reviewed by BusinessWeek, confirm that Aapex repeatedly warned Port and BAE about parts from China.

Gauthier says BAE and Port no longer buy from Aapex. "I got thrown under the bus by BAE," she says. "They did not want to take responsibility, so they pointed at us." BAE declined to comment on her assertion or on the e-mail exchanges.

Hong Kong Fair bought the fake Philips chips from the Guiyu Electronics Market, according to the BAE documents. No specific vendor is listed in BAE's GIDEP report. At Jinlong Electronics Trade Center in Guiyu, proprietor Lu Weilong says he could easily supply many types of military-grade chips, including those acquired for BAE. As he speaks, he turns to a PC in the back of his cluttered store and types military part numbers into Google to see from which kinds of circuit boards they can be extracted. "I have the circuit boards at home," he says confidently.

Some Chinese parts providers appear to have set up front companies in the U.S. and sell to brokers that supply the U.S. defense industry. JFBK of Fullerton, Calif., seems to be one such Chinese affiliate. The company is identified in GIDEP documents from this past June as having provided chips to North Shore Components, a distributor in Bellport, N.Y. The chips, typically used in the FA-18 fighter and E-2C Hawkeye surveillance plane, were supposed to have been made by National Semiconductor (NSM) in Santa Clara, Calif., but they turned out to be counterfeits of only commercial grade, according to North Shore's report to GIDEP. North Shore Vice-President Joseph Ruggiero says in an interview that his company found JFBK on the chip-trading Web site NetComponents.

JFBK's office in a strip mall in Fullerton is a single small room that also houses two other companies: MeiXin Technologies and New World Tech, both chip brokers. JFBK's Web site describes a "knowledgeable and friendly staff" with "years of collective experience and professional support." One afternoon in mid-July, four women and a man, who all appeared to be in their 20s, sat at desks with small signs tacked above them bearing the names of the three companies. The employees answered the phone on each desk with the name of the company designated on the card. Asked about microchip sales, one young woman, who declined to give her name, said: "We're not allowed to talk about what we do."

According to the California Department of Corporations, JFBK and New World have been "dissolved" as legal entities since 2000. MeiXin is still listed as active. Public records identify a woman named JianJu Cho as the agent for JFBK. Reached by phone while on vacation in Florida, Cho said neither she nor her staff knows much about microchips. "I don't have any knowledge about electronic components," said Cho. "All the things just depend on what our supplier tells us." Cho says the owners of JFBK and MeiXin are "a couple from China and a man from Taiwan. MeiXin and JFBK [are from] China; New World is from Taiwan."

A company called Tongda MeiXin Electronics operates on the 15th floor of an office building in Shenzhen. Under the MeiXin nameplate is another sign that states, in Chinese, "JFBK Shenzhen office." Asked about the relationship between JFBK and Tongda MeiXin, Wang Tong, general manager of MeiXin, says: "We are their supplier." Wang, 27, says JFBK probably didn't appreciate that the purportedly military-grade chips supplied to North Shore were counterfeit because neither MeiXin nor JFBK knows where the product came from. "They don't understand the technology," says Tong. "They only do trade. None of us understand the technology."

Wayne Chao, secretary general of the China Electronics Purchasing Assn., based in Shenzhen, admits that microchip counterfeiting is rife in China: "It's widespread, and we acknowledge that." Asked why Chinese officials don't shut down the blatant counterfeiting, he says: "Everyone wants to blame China. But it's difficult to differentiate between a legitimate product and a fake."

U.S. chipmakers say it is not their job to police a disorderly global marketplace, although some companies are at least trying to assess the challenge. John Sullivan, vice-president for worldwide security at Dallas-based Texas Instruments (TXN), has traveled to chip markets in Shenzhen to photograph allegedly counterfeit stockpiles and label-printing machines.

U.S. Customs & Border Protection officials at American ports have seized eight shipments of fake military-grade chips purportedly made by Texas Instruments in the past three years, according to GIDEP records. Sullivan says Pentagon representatives have met with TI and other chipmakers. "They're not seeing it as just an economic problem; they're seeing it as a problem that could affect national security and health and safety," he says.

Major chipmakers blame the Pentagon and its practice of buying from small brokers for the spread of counterfeit military-grade chips. "We've been telling people [at Defense] for 10 years to buy only from us or our authorized distributor," says Chuck Mulloy, a spokesman for Intel (INTC). "The military is slavishly following the low-cost paradigm but not following the idea of checking the quality as well."

Hong Kong Fair's Jiang, the alleged supplier of counterfeit chips to BAE, argues that if the U.S. military wants guaranteed high-quality chips, it should purchase them directly from the original manufacturers or their official franchisees. "Why do you come to China to buy it? You know that these things in China are cheap," Jiang says. "Why are they cheap? They have problems with quality."

For a video tour of a microchip bazaar in China where counterfeits are sold, go to www.businessweek.com/go/tv/counterfeit

Business Exchange related topics:
Defense Industry
High Tech Electronics
China Labor
China Manufacturing

Grow is a correspondent in BusinessWeek's Atlanta bureau. Tschang is a correspondent in BusinessWeek's Beijing bureau. Edwards is a correspondent in BusinessWeek's Silicon Valley bureau. Burnsed is an editorial assistant for BusinessWeek based in Atlanta.

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