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entitled 'Defense Trade: Lessons to Be Learned from the Country Export 
Exemption' which was released on March 29, 2002. 

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United States General Accounting Office: 
GAO: 

Report to the Subcommittee on Readiness and Management Support, 
Committee on Armed Services, U.S. Senate: 

March 2002: 

Defense Trade: 

Lessons to Be Learned from the Country Export Exemption: 

GAO-02-63: 

Contents: 

Letter: 

Results in Brief: 

Background: 

Exporters Are Implementing the Exemption Inconsistently: 

Ensuring Export Compliance Is Difficult: 

Experience with the Canadian Exemption Could Assist in Ongoing 
Negotiations: 

Conclusions: 

Recommendations for Executive Actions: 

Agency Comments and Our Evaluation: 

Scope and Methodology: 

Appendix I: Chronology of Selected Defense Cooperation Agreements 
between the United States and Canada: 

Appendix II: Summary of Enforcement Cases That Supported the Need for 
Change in the Canadian Exemption: 

Appendix III Comparison of Recent Changes to the Canadian Exemption-
1994, 1999, 2001: 

Appendix IV: Comments from the U.S. Department of State: 

Appendix V: Comments from the U.S. Customs Service: 

Appendix VI: GAO Contact and Staff Acknowledgments: 

GAO Products on Defense Trade and Export Controls: 

Tables: 

Table 1: Chronology of Selected Defense Cooperation Agreements between 
the United States and Canada: 

Table 2: Comparison of Recent Changes to the Canadian Exemption-1994, 
1999, and 2001: 

[End of section] 

United States General Accounting Office: 
Washington, DC 20548: 

March 29, 2002: 

The Honorable Daniel Akaka: 
Chairman: 
The Honorable James M. Inhofe: 
Ranking Minority Member: 
Subcommittee on Readiness and Management Support: 
Committee on Armed Services: 
United States Senate: 

To control the export of defense items, the U.S. government generally 
requires exporters to obtain a license from the State Department.
[Footnote 1] However, a license is not required for the export of many 
defense items to Canada.[Footnote 2] Currently, the Canadian exemption 
is the only country-specific exemption to the licensing requirement. 
The exemption was temporarily scaled back when unauthorized re-exports 
and diversions to nations of concern occurred. It was renegotiated and 
changes were made in an attempt to address security concerns. In May 
2000, the U.S. government announced the Defense Trade Security 
Initiative,[Footnote 3] which included a proposal to grant Canadian-
like export licensing exemptions to other qualified countries. Since 
the initiative was announced, the State Department has been 
negotiating such exemptions with the United Kingdom and Australia. 
Because the exemption for Canada may serve as the model for these and 
other countries, you asked that we review how the exemption has been 
implemented and enforced and whether the experience offers any lessons 
learned. 

Results in Brief: 

Exporters in some instances have been implementing the Canadian 
exemption inconsistently. For example, some items, such as smokeless 
ammunition powder and technical data, are being exported using the 
exemption by some exporters while others are applying for licenses. 
Moreover, some exporters are interpreting reporting requirements about 
the use of the exemption differently. While the State Department has 
issued some guidance to assist exporters in interpreting and complying 
with the regulations, it has in some cases given inconsistent answers 
to exporters and U.S. Customs Service officials when questions were 
raised about particular situations. 

The U.S. government has some mechanisms in place to help reduce the 
risk of defense items being inappropriately exported, but there are 
limitations associated with them. The State Department encourages 
exporters to voluntarily disclose violations and develop compliance 
programs, but primarily relies on U.S. Customs as the chief enforcer. 
U.S. Customs examines export documentation, performs physical 
inspections of items being exported, and investigates potential export 
violations. However, export documentation is not always complete or 
submitted, inspections of shipments are limited, and investigations of 
potential violations are time-consuming and difficult to prosecute. 
U.S. Customs officials attributed these and other enforcement 
weaknesses largely to a lack of information and resources, including 
inspectors to staff ports. In addition, there are competing demands on 
the agency, which include the prevention of terrorism, and the 
interdiction of illicit drugs, illegal currency, and stolen vehicles. 

The experience with the Canadian exemption shows that three areas need 
to be addressed when negotiating and executing license exemptions with 
other countries. First, there needs to be upfront agreement on such 
issues as what items are to be controlled, who can have access to 
controlled items, and how to control these items through each 
country's respective export laws and regulations. Second, the U.S. 
government needs to monitor agreements to assess their effectiveness 
and ensure that unanticipated problems have not arisen. Third, 
enforcement mechanisms need to be in place to monitor exporters' 
compliance with the exemption and enable prosecution of violators. 

We are making recommendations to the State Department to review its 
guidance for exporters and develop lessons learned from the Canadian 
exemption and to U.S. Customs to assess whether additional actions can 
be taken to strengthen export enforcement activities. In commenting on 
a draft of this report, the State Department generally concurred with 
assessment that under the exemption the compliance and enforcement 
process primarily relies on the exporters' actions. State said it 
would continue to review its guidance and training programs and work 
closely with U.S. law enforcement agencies to assess lessons learned 
from the exemption. Customs concurred with the recommendations and 
will take appropriate actions by December 31, 2002. 

Background: 

Under the authority of the Arms Export Control Act, State requires 
exporters to obtain licenses for defense exports unless an exemption 
applies. State has long exempted the export of many unclassified 
defense items to Canada without prior department approval. While these 
items are exempt from licensing requirements, they are still subject 
to the provisions of the Arms Export Control Act Exporters who use the 
exemption and violate any provisions of the Act are subject to fines, 
penalties, or imprisonment, if convicted. State requires exporters to 
register with its Office of Defense Trade Controls; determine whether 
the articles or services they are exporting are covered by the 
exemption; in most cases, obtain written documentation stating that 
exports are to be used for a permitted purpose; and inform the 
recipient that items are not to be reexported without prior 
authorization from State. 

The Canadian exemption, first codified in 1954,[Footnote 4] grew out 
of the unique geographic relationship and strong economic trading 
partnership between the United States and Canada and their mutual 
interest in the defense of North America. The two countries share the 
world's longest unfortified border. They are also each other's largest 
trading partner. The countries are committed to maintaining a strong 
integrated North American defense industrial base to help fulfill 
their defense and security responsibilities to the North Atlantic 
Treaty Organization and the North American Aerospace Defense 
Agreement, as well as for common defense of national territories. 
Appendix I provides a chronology of selected defense and economic 
agreements between the United States and Canada since 1940. 

The Canadian exemption has evolved since inception in terms of scope. 
For example, earlier versions allowed the export and import of arms, 
ammunition, and implements of war, and the export of unclassified 
technical data without a license. Later versions changed the coverage 
to include defense services and increased the types of items requiring 
a license. 

Enforcement Concerns Led to Negotiations about the Exemption: 

In April 1999, State revised its regulations to clarify when the 
exemption could be used and limited the defense items that could be 
exported under the exemption.[Footnote 5] State took this action based 
on its analysis that exports were being re-exported from Canada to 
countries of concern without U.S. government approval and that 
controls over arms and ammunition transfers needed strengthening. 
[Footnote 6] Nineteen criminal investigations and seizure cases 
related to the Canadian exemption were identified, including 3 
diversions to China, Iran, and Pakistan and 16 attempted diversions to 
these and other nations of concern or technical regulatory violations. 
For example, a major U.S. defense company exported U.S.-controlled 
communication equipment to its Canadian facility under the exemption 
and then re-exported the equipment to Pakistan without U.S. government 
approval. In another case, an Iranian intelligence group established a 
company in Canada and was accused of attempting to use the exemption 
to acquire U. S.-controlled components for the Hawk missile system. 
Appendix II summarizes these and other cases. 

In addition, State received 23 voluntary disclosures[Footnote 7] from 
exporters who inappropriately used the Canadian exemption. For 
example, in a few instances, exporters admitted providing technical 
manuals and software engineering support without obtaining State 
approval. State consulted with the Department of Defense about these 
cases and indicated that had these exporters submitted the appropriate 
license applications, they would have likely been denied. In another 
instance, an exporter submitted a voluntary disclosure after being 
contacted by law enforcement officials. In this case, the U.S. 
exporter was ineligible to export because the firm was debarred and 
under criminal investigation for diversions of military equipment to 
Iran and other locations. 

In response to export concerns identified by State, the U.S. and 
Canadian governments negotiated changes to their respective export 
control systems. The Canadian government changed its export control 
laws and regulations to cover all items currently controlled on the 
U.S. Munitions List,[Footnote 8] established a registration system in 
April 2001 for persons and entities in Canada eligible to receive U.S.-
controlled items under the exemption, and required U.S. government 
approval for re-export of U.S. controlled items from Canada or 
transfer of these items within Canada. In turn, State again revised 
the Canadian exemption effective May 30, 2001. This revision in 
general broadened the exemption to cover temporary imports of 
unclassified defense items, some defense services, and some additional 
items, but continued to exclude other items such as Missile Technology 
Control Regime[Footnote 9] items. Since the conclusion of the 
negotiations, the U.S. and Canadian governments have met and continue 
to exchange information on enforcement and border security issues not 
fully addressed during the negotiations. 

Exporters Are Implementing the Exemption Inconsistently: 

We found instances where exporters have been implementing the Canadian 
exemption inconsistently. Some items, such as technical data and 
smokeless ammunition powder, are being exported under the exemption by 
some exporters and not by others. These inconsistencies may result in 
the same item being licensed by State in some instances and not 
licensed in others, which may put some exporters at a disadvantage and 
lessen government oversight of exports. 

For example, exporters followed different processes when they exported 
technical data. Before April 1999, some exported technical data under 
the exemption for offshore procurement[Footnote 10] activities, based 
on their interpretation of the regulations.[Footnote 11] However, 
State officials said that exporters were required to obtain approval 
before they could export the data to Canada. In April 1999, State 
revised the regulations to clarify that the export of technical data 
for offshore procurement activity requires a license. After this 
regulatory revision, a number of companies or their subsidiaries 
voluntarily disclosed to State that they had inappropriately exported 
technical data or defense services for offshore procurement and other 
activities using the exemption. Since that time, some exporters said 
they were unclear about when they could export technical data and 
defense services under the May 2001 revised exemption because the 
language in the regulations was subject to interpretation. For 
example, we were told that design data under the new exemption was 
broadly defined, and in some instances has been interpreted as either 
subject to the exemption or requiring a license. Appendix III 
highlights the complexities of the regulatory language and major 
changes made to the Canadian exemption in recent years. 

Some exporters have been interpreting the May 2001 reporting 
requirements differently. This, in turn, can decrease the government's 
visibility over sensitive exports. For example, exporters using the 
Canadian exemption are now required by the International Traffic in 
Arms Regulations to provide State "a semi-annual report of all their 
on-going activities authorized under this section."[Footnote 12] Two 
exporters interpreted the phrase "under this section" to mean that the 
requirement solely pertained to defense services because it fell under 
the paragraph of the regulations entitled "Defense services 
exemption." These exporters, therefore, reported activities 
exclusively involving defense services. Another interpreted the 
language to refer to all activities occurring under the Canadian 
exemption, including those related to defense articles and technical 
data, as well as defense services. When we discussed this matter with 
State officials, they said that the second interpretation was correct 
and that the report should encompass all activities and not just 
defense services. 

Some exporters also said they were unclear about certification 
requirements. The regulations require exporters to obtain written 
certification from Canadian companies that "the technical data and 
defense service being exported" will be used only for a specified 
activity.[Footnote 13] Some exporters said they obtain this 
certification when exporting defense articles in addition to technical 
data and defense services, following preface language in the Federal 
Register notice that changed the regulation in May 2001. One company 
we spoke with said that it only obtains this certification for defense 
services. Another company noted that when it tried to get a Canadian 
company to fill out the certification for a defense article being 
exported to Canada, the Canadian government told the company that only 
the regulations are legally binding, and certifications should be 
provided only for defense services and technical data. State officials 
said that this interpretation was correct, and the certification only 
needed to be obtained for defense services and technical data. It is 
important that exporters correctly interpret these requirements, since 
the certifications enable exporters to document their compliance with 
regulations. 

The effectiveness of the process depends on the exporters making the 
right decisions when interpreting regulations. However, State has an 
important role to play in responding to inquiries about exports. In 
some instances, we found that State provided inconsistent answers in 
situations where exporters or U.S. Customs officials responsible for 
enforcing export regulations raised questions to State about 
particular situations. For example: 

* One exporter who had been shipping smokeless ammunition powder using 
the exemption was stopped by U.S. Customs for inspection on several 
occasions. Each time, U.S. Customs asked State if the exemption could 
be used. The first two times, State said yes, but on a subsequent 
occasion, it determined the powder was a Missile Technology Control 
Regime item and required an export license. This exporter has since 
obtained numerous licenses for this item. Another exporter shipping 
the same type of powder to Canada was also stopped by U.S. Customs for 
inspection. One time, State told U.S. Customs that the powder required 
a license and another time said the item was not a Missile Technology 
Control Regime item and was, therefore, exempt.[Footnote 14] 

* One exporter had planned to temporarily import aerial target 
aircraft for North Atlantic Treaty Organization (NATO) ongoing 
training exercises that were being conducted in the United States and 
informed U.S. Customs in advance that it was going to do this under 
the exemption. Under the changes made to the exemption in May 2001, 
such items are allowed to be imported temporarily. However, in this 
case, State denied the use of the exemption. State officials 
acknowledged this mistake to U.S. Customs, and told us that it 
occurred inadvertently, immediately after the exemption change. 
Nevertheless, at the time, the exporter canceled its plans, which in 
turn, led to the cancellation of the remaining NATO training exercises. 

An exemption places the burden of proper implementation on exporters.
Nevertheless, exporters said they needed guidance from State to assist 
them through the process of deciding what to export and what not to 
export under the exemption, as well as what activities to report. 
State officials said that exporters are to rely on the regulations as 
their guide. However, State has recently provided additional guidance 
through a question-and-answer guide the department prepared with 
industry to answer common questions about the May 2001 revisions to 
the exemption. This guidance answers some questions but does not lay 
out specific, clear criteria for deciding what is allowable under the 
exemption.[Footnote 15] State has also provided outreach in 
conjunction with the Canadian government on changes associated with 
the Canadian exemption and regularly sponsors additional training 
through the Society for International Affairs. [Footnote 16] In March 
2002, State began an in-house training program on export licenses and 
agreements. Further, State issues advisory opinions on specific 
exports when requested by the exporter,[Footnote 17] but such opinions 
are specific to a particular export and are revocable. Clear and 
commonly understood guidance may help State and U.S. Customs officials 
answer questions that surface during inspections. 

Ensuring Export Compliance Is Difficult: 

Although an item may be exempt from State review and approval, it is 
still subject to U.S. export control law. Under an exemption, the 
burden for reviewing the legitimacy of the transaction shifts from 
State to the exporter. Therefore, a large part of the compliance and 
enforcement process under the Canadian exemption relies on the actions 
of exporters. While the U.S. government has some mechanisms in place 
to ensure that exporters are ultimately complying with export law and 
regulations, the government faces limitations in using these 
mechanisms. For example, export documentation is not always submitted 
or complete, border inspections are limited, and violations are 
difficult to prosecute. U.S. Customs officials cite other priorities 
and lack of staff and other resources as reasons for limitations in 
enforcement. Without more effective enforcement, the U.S. government 
is at greater risk of defense items being exported inappropriately. 

U.S. government enforcement mechanisms for defense exports are carried 
out by State and U.S. Customs. State encourages exporters to develop 
their own compliance programs and to voluntarily disclose when they 
have violated the exemption.[Footnote 18] State may direct a company 
to perform an internal control compliance audit or, if warranted, may 
seek civil penalties, administrative actions, sanctions, or referrals 
to the Justice Department. While State oversees these activities, the 
department primarily depends on U.S. Customs for many enforcement 
efforts. U.S. Customs, in turn, has various mechanisms to ensure that 
exporters meet regulatory requirements. For example, U.S. Customs 
examines export documentation, specifically the Shipper's Export 
Declaration.[Footnote 19] U.S. Customs inspectors may perform a 
physical inspection of an export crossing the border, and its agents 
investigate potential export violations. In addition, the Department 
of Justice can prosecute exporters who are suspected of violating 
export control laws. 

Limitations in Compliance and Enforcement: 

We identified a number of limitations for the compliance and 
enforcement process related to the Canadian exemption.[Footnote 20] 
For example, U.S. Customs inspectors are not assured that they are 
receiving all export declarations as required nor are declarations 
always complete or accurate when they are submitted. Inspectors at the 
ports we visited noted that exporters often provide vague descriptions 
of what they are exporting, which makes it difficult to determine 
whether it is a defense item subject to the Canadian exemption. In 
addition, we also found that physical inspections on exports are 
limited. In fact, U.S. Customs officials said that they inspect less 
than 1 percent of exports. 

These limitations are attributed to a lack of information and 
resources and competing demands within U.S. Customs, which include 
interdiction of illicit drugs, illegal currency, and stolen vehicles, 
and since September 11, 2001, terrorism prevention. Of some 7,500 
inspectors, about 400 are assigned to export enforcement activities at 
301 ports. One port we visited had resorted to "borrowing" port staff 
from inbound operations inspections to inspect items being exported. 
Another port had only one person dedicated full time to export 
activities. When that inspector was not on duty, no one at the port 
inspected exports. 

According to Customs inspectors, staffing limitations make it 
extremely difficult for them to examine export declarations that cite 
the Canadian exemption. Inspectors are to perform several time-
consuming tasks to ensure proper use of the exemption. For example, 
inspectors said that they should verify that an exporter is registered 
with State by querying U.S. Customs' Automated Export System.[Footnote 
21] They should check whether a company has a record of prior export 
violations by searching the Treasury Enforcement Communications System 
database. And they should verify that the item cited on the export 
declaration is eligible for exemption by reading the International 
Traffic in Arms Regulations or consulting with the U.S. Customs' 
Exodus Command Center. These tasks may be especially difficult to 
complete at land ports since declarations are presented at the time of 
crossing. 

After the terrorist attacks of September 11, 2001, the U.S. Customs 
Commissioner stated that terrorism prevention had replaced drug 
interdiction as the agency's top priority. U.S. Customs subsequently 
redeployed nearly 100 inspectors to increase security along the U.S.-
Canadian border. On December 10, 2001, a new program called Project 
Shield America was launched, focused on preventing international 
terrorist organizations from obtaining sensitive U.S. technology, 
weapons, and other equipment that could help carry out attacks on 
America. Some inspectors we spoke with said that after the September 
11 terrorist attacks, U.S. Customs increased coverage along the 
northern border by realigning inspectors, temporarily employing 
National Guardsmen, and increasing inspectors' overtime. However, 
these inspectors are primarily focused on passengers entering and 
exiting the country, rather than inspections of defense exports. 

U.S. Customs inspectors do not have updated guidance from Customs 
headquarters that would enable them to conduct inspections 
effectively. U.S. Customs developed and distributed its primary 
guidance to inspectors in 1993. This guidance provides an overview of 
U.S. export laws and regulations, including information on State 
licensing requirements and a synopsis of the Canadian exemption. U.S. 
Customs has also recently prepared and distributed a memorandum 
addressing the May 2001 Canadian exemption requirements. However, the 
1993 guidance and the recent memorandum do not discuss inspection 
techniques for identifying questionable exports. A draft update 
prepared in 1999 provides some inspection guidance, but it has not 
been finalized or distributed to inspectors. Some inspectors said that 
this draft could be useful but had insufficient information when 
inspecting shipments at land ports. 

U.S. Customs headquarters and Justice Department officials told us 
that it is difficult to investigate and prosecute violations of export 
control laws. In particular, prosecution of export violations under 
the exemption are difficult because it is hard to obtain evidence of 
criminal intent-—especially since the government does not always have 
the documents to demonstrate the violation of the exemption, such as 
the Shipper's Export Declaration. Even with the documents, some U.S. 
Customs agents told us that cases involving the Canadian exemption 
normally involved undercover operations to obtain evidence of criminal 
intent, and these cases often took a long time to complete. 

Experience with the Canadian Exemption Could Assist in Ongoing 
Negotiations: 

The United States and Canada have had a long history of exporting 
items under a licensing exemption, and both countries have said the 
exemption is beneficial for facilitating defense trade and advancing 
mutual defense. However, when the U.S. government found that some 
exports under the Canadian exemption were being diverted to countries 
of concern, the United States and Canada had to come to the 
negotiating table and reach agreement, making sure that they could 
balance achieving compatibility of their export control systems with 
maintaining national sovereignty over export control laws and 
regulations. Based on the experience with the Canadian exemption, the 
United States will likely need to address three areas when negotiating 
and executing similar exemptions with other countries.[Footnote 22] 
First, upfront agreement is needed on such issues as what items are to 
be controlled and who can have access to these controlled items. 
Second, the U.S. government needs to monitor agreements to assess 
their effectiveness and ensure that unanticipated problems have not 
arisen. Third, enforcement mechanisms need to be in place to monitor 
exporters' compliance with the exemption and enable prosecution of 
violators. 

First, countries need upfront agreement on a number of key issues. 

* Agreement on what defense items to control. For example, Canada did 
not control the same defense items that the U.S. government 
controlled. This included radiation-hardened microelectronic circuits 
and nuclear weapons design and test equipment, which could be exported 
from Canada without a Canadian license. Countries need to have the 
same starting point for controlling items so that enforcement efforts 
could be concentrated on the same items. 

* Agreement on what types of items, including technical data and 
defense services, could be exported under the exemption. Items 
excluded from the exemption would require licenses. For example, 
during the Canadian exemption negotiations, discussions centered on 
whether Missile Technology Control Regime Items could be exported 
under the exemption or required a license. 

* Agreement on who can have access to controlled articles, technical 
data, and services, and whether items exported under the exemption can 
be sent to dual nationals and temporary workers and still be compliant 
with the laws of both countries. When negotiating the Canadian 
exemption, this discussion centered on whether dual nationals and 
temporary workers could have access to U.S.-controlled items and what 
type of system, such as an exporter registration system, needed to be 
established to identify who has access to controlled items. 

* Resolving conflicts between the export regulations and legal 
requirements of each country. For example, U.S. law requires that U.S. 
government approval is needed before controlled items can be re-
transferred within a country or re-exported to another country. U.S. 
government officials said that unauthorized re-exports were the major 
reason for the negotiations with Canada. 

* The applicability of U.S. export control law to U.S. defense items 
that are incorporated into products that are made in another country. 
In the U.S.Canadian negotiations, discussions centered on how far-
reaching U.S. export control requirements are once U.S. items are 
incorporated in foreign products and then re-exported. 

Second, the Canadian exemption experience shows that once agreements 
have been reached, the U.S. government needs to periodically evaluate 
the exemption to assess the effectiveness of agreed upon measures and 
ensure that unanticipated problems do not arise. The U.S. and Canadian 
governments spent over 2 years negotiating a new exemption and are now 
working on implementation issues. For example, under new provisions, 
the Canadian government established a registration system to reduce 
the risk of transfer to unauthorized individuals and facilitate the 
Canadian defense industry's access to U. S.-controlled items. 
Questions remain, however, about how it will be implemented and who 
needs to be registered. U.S. government officials said that 
verification of the registrant is key for compliance and enforcement 
activities. 

Finally, enforcement mechanisms need to be in place to ensure export 
compliance with the exemption. As discussed earlier, U.S. Customs 
inspectors are not always assured that exporters are submitting 
required export documentation or that the documentation is complete 
and accurate, which limits their enforcement efforts. The Department 
of Justice, in a letter to State, echoed this concern regarding 
negotiations for additional exemptions and also stated that foreign 
law enforcement cooperation is needed to provide evidence for 
successful prosecutions. Resource constraints also create challenges 
for the law enforcement community. In the end, establishing criteria 
and lessons learned from current experiences would assist in 
evaluating whether on-going and future negotiations are successful or 
if additional issues need to be addressed. State officials 
acknowledged that there are lessons to be drawn from the Canadian 
experience. Conclusions The Canadian exemption relies on exporters to 
comply voluntarily with export regulations and to disclose when they 
have not followed those regulations. As such, a system of effective 
checks and balances is needed to maximize the U.S. government's 
assurance that defense items are being appropriately safeguarded. This 
includes making sure that exporters have sufficient guidance to enable 
them to make the right decisions and that exporters, in turn, provide 
required information to the U.S. government for oversight and 
enforcement efforts. It also includes making sure that enforcement 
mechanisms work as effectively as possible. 

Extending exemptions to other countries may aggravate problems if the 
U.S. government does not learn from its experiences. New exemptions 
may increase the risk of exporters misinterpreting the regulations and 
create additional opportunities for exporters to inconsistently apply 
the exemption. In addition, broadening the exemption could further 
exacerbate enforcement efforts for an already overburdened law 
enforcement agency. Accordingly, the U.S. government can benefit from 
the lessons learned from U.S.-Canadian negotiations when extending 
similar exemptions to other countries. 

Recommendations for Executive Actions: 

To enhance the exemption process, we recommend that the secretary of 
state direct the Office of Defense Trade Controls to review guidance 
and licensing officer training to improve clarity and ensure 
consistent application of the exemption. The State Department should 
also direct the Office of Defense Trade Controls to provide this 
guidance to U.S. Customs Service for dissemination to field inspectors 
and agents so that consistent information about the exemption is 
provided to exporters. 

To strengthen enforcement activities, we recommend that the 
commissioner of the U.S. Customs Service assess the threat of illegal 
defense exports at all ports along the northern border and evaluate 
whether reallocation of its inspectors, additional training, or other 
actions are warranted to augment the capability of inspectors to 
enforce export regulations. We also recommend that U.S. Customs 
update, finalize, and disseminate its guidance on defense export 
inspection requirements to all inspectors. 

To facilitate future country exemption negotiations, we recommend that 
the secretary of state work with the Department of Justice and U.S. 
Customs Service to assess lessons learned from experience with the 
Canadian exemption and ensure that these are incorporated in any 
future agreements. 

Agency Comments and Our Evaluation: 

In written comments on a draft of this report, State generally 
concurred with our assessment that a large part of the compliance and 
enforcement process under the Canadian exemption relies on the actions 
of the exporters. In response to our recommendation on guidance and 
training, State said it will continue its on-going update of its 
exporter guidance and its training programs. State provided a number 
of examples of the types of guidance and training it plans to continue 
to provide exporters on the Canadian exemption. As part of its efforts 
to update, we believe State should still assess whether its guidance 
and training are clear and commonly understood by those who need to 
use them. In concurring with our recommendation on assessing lessons 
learned, State said it will continue to work closely with U.S. law 
enforcement agencies to assess lessons from the Canadian exemption to 
facilitate future country exemption negotiations. However, State did 
not identify the specific steps it would take to ensure that lessons 
are actually shared and that knowledge gained will be acted upon in 
the future. As we stated in our report, enforcement and compliance 
problems could be exacerbated without full consideration of lessons 
learned under the Canadian exemption when extending similar exemptions 
to other countries. State comments are reprinted in appendix IV, along 
with our evaluation of them. 

In its written comments, Customs concurred with our recommendations to 
(1) assess the threat of illegal exports along the northern border and 
evaluate whether reallocation of resources and other actions are 
warranted and (2) update, finalize, and disseminate guidance on 
defense export inspection requirements. Customs said it will complete 
these actions no later than December 31, 2002. Customs stated that it 
conducts yearly threat assessments for the entire country and provides 
training on various issues, but such activities require a commitment 
of funds. In addition, Customs stated that we did not address the 
Automated Export System, which it said has assisted the agency in 
enforcement efforts. Finally, Customs indicated that lack of manpower 
and funding for enforcement is problematic for enforcing the Canadian 
exemption or other defense exports. Customs added that new exemptions 
for other countries will be increasingly difficult to enforce 
effectively. We did not include a detailed discussion of the Automated 
Export System because regulations requiring mandatory filing of export 
declarations through this system had not been finalized. At the time 
of our review, most inspectors we contacted were not using the 
automated system for the majority of enforcement functions related to 
the Canadian exemption. Customs' comments are reprinted in appendix V. 

Scope and Methodology: 

We collected and reviewed selected defense cooperation agreements 
establishing the special defense relationship between the United 
States and Canada, developed a regulatory history of the Canadian 
exemption, and prepared a comparative analysis of the various changes 
to the Canadian exemption since inception. We also discussed the 
history and objectives of the exemption with officials at State, the 
Department of Defense, U.S. and Canadian industry associations, and 
the Canadian government. 

To ascertain how exporters use the exemption, we reviewed the Arms 
Export Control Act and International Traffic in Arms Regulations to 
understand the rules governing the U.S.-Canadian exemption process. 
Because there is no centralized database identifying exporters that 
use the Canadian exemption, we analyzed State's licensing and 
registration data for Canada and obtained recommendations from agency 
officials, industry associations, and others to develop a list of 
companies that export to Canada. We then selected 12 companies that 
used the exemption and conducted structured interviews regarding their 
process and the criteria for exporting under the exemption. These 
companies represented various small, medium, and large exporters and 
freight forwarders. We also corroborated information with other U.S. 
companies and two Canadian industry associations that hosted 
roundtable discussions for us with 10 Canadian companies. 

To determine how U.S. government mechanisms for ensuring compliance 
with export law and regulations operate, we interviewed State and U.S. 
Customs officials to obtain explanations about their mechanisms. We 
reviewed State regulations and briefing materials related to the 
Canadian exemption and U.S. Customs' draft handbook, standard 
operating procedures, and training materials. We visited four U.S. 
Customs ports to observe the inspection process and reviewed seizure 
case files to determine the nature of noncompliance with the 
exemption, and another U.S. Customs' port to discuss enforcement 
issues with officials in the Office of Special Agents in Charge of 
Investigations. We also interviewed officials at U.S. Customs 
headquarters in the Office of Field Operations and Special 
Investigations' Exodus Command Center. We analyzed U.S. Customs' 
enforcement cases to determine the nature of the noncompliance that 
led to the change in the April 1999 version of the exemption, along 
with disclosures of noncompliance with the exemption that were 
submitted to State by exporters. We also discussed enforcement 
challenges surrounding the exemption with Justice Department officials. 

To develop observations about future exemption proposals for other 
countries, we reviewed issues covered in the Canadian exemption 
negotiation, prior GAO reports on defense trade and export controls, 
and other documents related to efforts to obtain similar exemptions 
with other countries. We also asked senior State officials about 
lessons learned in the Canadian negotiations that may be pertinent for 
on-going or future negotiations of similar Canadian-like exemptions 
with other countries. 

We requested information and documentation from State related to a 
number of areas, including the history of the exemption, changes in 
its scope and reasons for such changes, and issues covered during 
negotiations that resulted in the May 2001 Canadian exemption. As 
discussed with your staff, we experienced significant delays in 
obtaining documents from State. For example, the department took 
approximately 6 months to provide us with an initial set of 37 
documents and an additional 2 months to provide the remaining 
information that we requested. These delays caused numerous follow-ups 
with State officials, needlessly occupying time for both State 
officials and us. More than 90 telephone contacts or E-mails alone 
pertained to the status of our document request. The delays and lack 
of State cooperation extended the amount of time needed to respond to 
this request. We plan to address these issues in a follow-up letter to 
the secretary of state. 

We performed our work between October 2000 and February 2002 in 
accordance with generally accepted government auditing standards. 

We will send copies of this report to the chairmen and ranking 
minority members of the Senate Committee on Foreign Relations, the 
House Committee on International Relations, and the House Committee on 
Armed Services. We will also send copies to the secretaries of state, 
defense, treasury, and justice; the commissioner, U.S. Customs 
Service; and the director, Office of Management and Budget. This 
report will also be made available on GAO's home page [hyperlink, 
http://www.gao.gov]. 

If you or your staff have questions concerning this report, please 
contact me at (202) 512-4841. Others making key contributions to this 
report are listed in appendix VI. 

Signed by: 

Katherine V. Schinasi: 
Director, Acquisition and Sourcing Management: 

[End of section] 

Appendix I: Chronology of Selected Defense Cooperation Agreements 
between the United States and Canada: 

The United States and Canada have demonstrated their mutual 
cooperation by entering into more than 2,500 agreements and 
arrangements over the years. The following are selected defense and 
economic agreements since 1940. 

Table 1: Chronology of Selected Defense Cooperation Agreements between 
the United States and Canada: 

Year Established: August 18, 1940; 
Agreement: Ogdensburg Declaration; 
Synopsis of Agreement: This declaration formed the basis for defense 
cooperation between the United States and Canada. The Permanent Joint 
Board on Defense was founded to conduct studies relating to sea, land, 
and air problems, covering personnel and material, and to consider the 
defense of the northern half of the Western Hemisphere. 

Year Established: April 20, 1941; 
Agreement: Hyde Park Declaration; 
Synopsis of Agreement: A joint statement between the U.S. president 
and Canada's prime minister agreeing that each country should provide 
the other with the defense articles it is best able to produce during 
war mobilization and that each country should coordinate its 
production programs. 

Year Established: February 12, 1947; 
Agreement: U.S./Canada Joint Statement on Defense Cooperation; 
Synopsis of Agreement: A joint statement by both countries' leadership 
reiterating that the wartime cooperation between the armed forces of 
the two countries should continue to the extent authorized by law 
through the postwar period in the interest of efficiency and economy 
for joint security. 

Year Established: April 12, 1949; 
Agreement: Exchange of Notes on the Joint Industrial Mobilization 
Committee; 
Synopsis of Agreement: The notes established the Joint Industrial 
Mobilization Committee to coordinate each country's Industrial 
Mobilization Plans that would effectively use the production 
facilities of both countries. 

Year Established: September 20, 1950; 
Agreement: Statement of Principles for Economic Cooperation; 
Synopsis of Agreement: An agreement by the United States and Canada to 
coordinate the production and resources of both countries to achieve a 
common defense. Among other things, it required a coordinated program 
of requirements, production, and procurement between the two countries 
and instituted coordinated controls over the distribution of scarce 
raw materials and supplies. 

Year Established: October 1, 1956; 
Agreement: Defense Production Sharing Agreement; 
Synopsis of Agreement: The agreement was established to achieve 
greater integration of both countries' military development and 
production capabilities while maintaining greater standardization of 
military equipment, wider dispersal of production facilities, and 
establishing a supply of supplemental sources. Also, this agreement 
established that Canadian defense vendors would receive equal and 
immediate consideration on Department of Defense procurements, just 
like U.S. vendors, with certain exceptions. 

Year Established: May 12, 1958; 
Agreement: North American Aerospace Defense Command Agreement; 
Synopsis of Agreement: This agreement established an integrated 
command in Colorado Springs, Colorado, that centralized operational 
control of shared air defenses, integrated operational exercises, and 
maintained individual and collective capacity to resist air attack. 

Year Established: September 14, 1960; 
Agreement: Defense Development Sharing Agreement; 
Synopsis of Agreement: This agreement was established to allow 
Canadian firms to perform research and development work for the U.S. 
military services. 

Year Established: November 21, 1963; 
Agreement: Cooperative Development Between the United States 
Department of Defense and the Canadian Department of Defense 
Production Memorandum of Understanding; 
Synopsis of Agreement: This memorandum established a cooperative 
program in defense research and development between the U.S. 
Department of Defense and the Canadian Department of Defence 
Production. The agreement complements the Defense Production Sharing 
Program and, among other things, allows Canadian firms to perform 
research and development work to meet requirements of the U.S. 
military services and permits the standardization and 
interchangeability of additional equipment needed for the defense of 
both countries. 

Year Established: February 1, 1979; 
Agreement: Coordination of Cooperative Research and Development 
Memorandum of Understanding; 
Synopsis of Agreement: This memorandum identified the means and 
opportunities to use the scientific and technical resources to achieve 
common naval defense interests and made possible the standardization 
and interoperability of systems and equipment used for the naval 
defense of the two countries. 

Year Established: March 18, 1985; 
Agreement: The Quebec Summit Declaration; 
Synopsis of Agreement: A declaration between the prime minister of 
Canada and the president of the United States regarding international 
security. Both countries pledged to reduce barriers in defense trade 
and to establish a freer exchange of technical knowledge and skill in 
defense production. As a result of this agreement, the North American 
Defense Industrial Base Organization was created March 23, 1987. 

Year Established: March 23, 1987; 
Agreement: Charter for the North American Defense Industrial Base 
Organization and Letter of Guidance to the Executive Committee; 
Synopsis of Agreement: The charter formalized cooperation among 
Industrial Preparedness Planning activities within the United States 
and Canada. The organization is designed to ensure that Industrial 
Preparedness Planning remains a visible and vital element to 
strengthening the North American defense industrial base. 

[End of table] 

[End of section] 

Appendix II: Summary of Enforcement Cases That Supported the Need for 
Change in the Canadian Exemption: 

In April 1999, State revised its regulations to limit the scope of the 
Canadian exemption after concluding that some exporters misunderstood 
the exemption and that items were being improperly exported to Canada 
and re-exported from Canada to unauthorized destinations. State's 
concerns were supported by a summary of nineteen criminal 
investigations and seizure cases it identified as related to the 
Canadian exemption. These cases are summarized below: 

1. A major U.S. defense company established a manufacturing facility 
in Canada and exported defense components, technical data, and 
technical manuals to this facility under the Canadian exemption. The 
facility assembled components and prepared complete communication 
systems for export to Pakistan and provided training for the Pakistani 
army, without obtaining State-required approval for the exports. State 
had previously denied the export of such systems to Pakistan because 
of Congressional prohibitions on such transfers. 

2. A Canadian company attempted to sell 35 OH-58 U.S.-origin 
helicopters to undercover agents posing as brokers for the Iraqi 
government. These helicopters were to be equipped for air-dispensing 
chemical weapons. They were seized before being exported from Canada. 

3. Fifty-eight M-113 armored vehicles originally sold to the Canadian 
armed forces were exported without State approval, transferred to 
Europe, and then to Iran. 

4. An Iranian intelligence group established a company in Canada and 
attempted to acquire U.S. Munitions List controlled klystron tubes, 
which are specifically used for Hawk missile systems. The U.S. 
government sought extradition, but was denied. The case was eventually 
dismissed. 

5. A Chinese national established a Canadian company and used the 
Canadian exemption to acquire a focal plane array-long-range infrared 
camera. The camera was shipped to China from Canada without State 
approval. The same individual subsequently ordered an additional 400 
cameras. As in the first instance, the Chinese national specified that 
the Canadian exemption could be used. 

6. Another Chinese-owned company established in Canada ordered 400 
U.S. Munitions List controlled infrared cameras from a U.S. company 
and stated that the Canadian exemption should be used, although this 
would have been an inappropriate use of the exemption. 

7. A U.S. company received an order for infrared equipment from a 
Chinese entity. The U.S. company informed the Chinese buyer that such 
equipment was controlled on the U.S. Munitions List and restricted 
from export to China. Upon learning this, the Chinese buyer suggested 
that the export could take place through a Canadian company under the 
Canadian exemption and then be re-exported to China. 

8. A shipment of 356 U.S. Munitions List controlled turbine engine 
vanes to be used for military aircraft was seized prior to export. The 
shipment was destined for an Iranian national, located in Canada, who 
planned to divert the vanes to Iran. 

9. A Canadian company ordered U.S. military fiber optic gyroscopes, 
stating that the items were to be used in Canada. A government 
investigation established that the company's owner was a Chinese 
national, and the gyroscopes, to be obtained using the Canadian 
exemption, were actually destined for China. Arrests were made and the 
defendants were eventually convicted. 

10. U.S. Munitions List controlled F-18 parts were seized in the 
United States while in transit from Canada to New Zealand. State had 
not authorized the re-export. 

11. U.S. Munitions List controlled electronic countermeasure equipment 
was intercepted in the United States when a Canadian company attempted 
to export this equipment to Malaysia without U.S. export approval. 

12. A 3-year investigation uncovered an attempt to ship U.S.-origin 
items to a subsidiary in Canada and then divert these items to Libya. 
The items were seized, and an indictment led to a plea agreement. 

13. Three U.S. rocket warheads were seized while being shipped from 
Belgium to Canada. The exporter claimed the Canadian exemption on the 
export documents, but the exemption did not apply because the shipment 
was in transit. 

14. A Canadian company shipped military vehicles to an Army facility 
in the United States to test a new classified communications system. 
After testing, the vehicles were to return to Canada. A Canadian 
company, rather than the Canadian government, was handling the 
temporary import of the vehicles. The Canadian company did not seek or 
obtain a U.S. export license for moving the vehicles back and forth 
across the border. It was also learned that this Canadian company had 
shipped communications equipment, which was eventually intercepted and 
then seized. 

15. U.S. Munitions List controlled gas grenades, projectile guns, and 
projectiles were seized at the border during an attempt to ship them 
to Canada while claiming the exemption, rather than under a State-
approved license. 

16. A shipment of U.S. Munitions List controlled computers and related 
items were intercepted before being exported to the Sudan. The 
shipment originated in Canada and was seized when transiting through 
the United States. 

17. U.S.-origin armored vehicle spare parts were intercepted when they 
were shipped from Canada to the Middle East. The shipment was seized 
when transiting through the United States without appropriate U.S. 
export authority. 

18. U.S. components for a mobile radar system had originally been 
exported to Canada under the exemption. The radar was then to be 
exported to Taiwan under a Canadian license. Since the radar was of 
U.S. origin, State needed to approve the export to Taiwan. However, 
State approval was not obtained. 

19. A U.S.-origin gas turbine engine had been exported to Sweden and 
returned to the United States for repair. The engine was then sent to 
Canada under the Canadian exemption for the actual repair work, 
although the use of the exemption was inappropriate in this case. The 
engine was seized on its return to Sweden through the United States. 

[End of section] 

Appendix III: Comparison of Recent Changes to the Canadian Exemption-
1994 1999, 2001: 

The Canadian regulatory exemption is complex and has changed 
substantially in recent years. The following table highlights changes 
regarding what is or is not covered under the exemption and reporting 
or record keeping requirements associated with the exemption. 

Table 2: Comparison of Recent Changes to the Canadian Exemption--1994, 
1999, and 2001: 

Export Provisions: 

June 10, 1994: 
This version of the exemption allowed the export or temporary import 
of unclassified equipment or technical data without a license under 
certain circumstances. Exported items had to be used in Canada by 
Canadian citizens or returned to the United States. For items imported 
from Canada, the regulation stated that the exemption applied to a 
"temporary import" that was "...for end-use in the United States or 
return to Canada to a Canadian citizen..."[A] 

April 12, 1999: 
Language is mostly unchanged from the 1994 version regarding permanent 
and temporary exports.[B] 

May 30, 2001: 
Language changed to allow all temporary imports from Canada of 
unclassified defense articles to the United States without a license 
for temporary use in the United States and return to Canada. Exported 
items must be used in Canada by Canadian government officials acting 
in official capacity or by a Canadian registered person or returned to 
the United States.[C] 

Exceptions to the Exemption (or Items Requiring Licenses from State): 

June 10, 1994: 
Some defense items were not covered by the exemption, requiring a 
license export to Canada. These items included: 
* Fully automatic firearms and components and parts in Category I (a), 
which are not for end use by the Canadian federal, provincial, or 
municipal government; 
* Nuclear weapons, strategic delivery systems, and all components, 
parts, accessories, and attachments specifically designed for such 
systems and associated equipment; 
* Nuclear weapon design and test equipment (Category XVI); 
* Naval nuclear propulsion equipment (Category VI (e)); 
* Aircraft, which includes helicopters and drones (Category VIII (a)); 
* Submersible vessels and oceanographic and related equipment, such as 
swimmer delivery vehicles, designed or modified for military purposes 
(Category XX (a) through (d)); 
* Defense articles, defense services, or related technical data for 
use by a foreign national other than a Canadian; 
* Defense services provided under agreements such as manufacturing 
license agreements and technical assistance agreements found in Part 
124 of the International Traffic and Arms Regulations.[D] 

April 12, 1999: 
The number of items requiring a license expanded from the 1994 
version. Specifically, the following items were added to the list of 
exceptions to the exemption: 
* All Category I – Firearms. This was broadened from the prior version 
to include all firearms in Category I; 
* Ammunition in Category III for the firearms covered in Category I; 
* Launch vehicles, guided missiles, ballistic missiles, and rockets 
(Category IV);[E] 
* Military information security systems, cryptographic devices, 
software and componenets and stealth (Categories XIII (b) and XIII 
(j)); 
* Toxicological, chemical, and biological agents and related equipment 
and radiological equipment (Category XIV (a) through (d)); 
* Spacecraft, remote sensing satellites, and military communications 
satellites, which includes global positioning systems receiving 
equipment designed or configured for military use (Category XV (a), 
(b), and (c)); 
* All classified articles, technical data, and defense services 
defined in Category XVII, which includes classified articles, 
technical data, and defense services as defined in 120.21 
(manufacturing licensing agreements) and 120.8 (defense services)[F]; 
* All U.S. Munitions list items and related technical data on the 
Missile Technology Control Regime Annex. 

May 30, 2001: 
The following items were added to the for 1999 list of exceptions to 
the exemption: 
* All technical data and defense services for gas turbine engine hot 
sections covered under Category VI (f) and aircraft and military 
aircraft engines covered under Category VIII (b); 
* Developmental aircraft, engines, and components (Category VIII (f)); 
* All Category XII (c) items such as infrared focal plane array 
detectors and image intensification and other night-sighting equipment 
or systems designed, modified, or configured for components, and 
stealth (Categories XIII military use. This, however, excludes any 
first and second generation image intensification tube and first and 
second generation image intensification night-sighting equipment; 
* Some radiation hardened microelectronic circuits (Category XV d)); 
* Certain systems, components, parts, and accessories for space 
systems and associated equipment (Category XV (e)); 
* Miscellaneous articles, which includes any article that has military 
applicability not specifically enumerated in other categories of the 
U.S. Munitions List (Category XXI). 

Defense Items No Longer Requiring a License: 

May 30, 2001: 
These items are now permitted under the exemption: 
* Launch vehicles, guided and ballistic missiles, and rockets (except 
when Missile Technology Control Regime items) (Category IV)); 
* Chemical and biological agent detection, identification, and 
defensive equipment (Certain parts of Category XIV (c)); 
* Commercial Communications Satellites in Category XV (a); 
* GPS-receiving equipment end-items only for export to Canada for use 
by the Canadian federal government directly or indirectly through a 
Canadian-registered person (certain parts of Category XV (c)); 
* Military information security systems, and encryption devices 
(except classified defense articles) (Category XIII (b) and (e)); 
* Limited defense services, including exports of technical data and 
performance of defense services meeting certain criteria. 

Reporting and Record Keeping Requirements: 

June 10, 1994: 
The following were the reporting requirements in the 1994 version of 
the exemption. 
* Exporter was required to comply with the requirements under section 
123.22 regarding the Shipper's Export Declaration. Specifically, with 
the exception of unclassified technical data, an exporter was required 
to file the declaration with U.S. Customs or the postmaster when using 
an exemption; 
* Defense articles and defense services requiring congressional 
notification, as stated in parts 123.15 and 124.11 of the 
International Traffic in Arms Regulations. 

April 12, 1999: 
Although elsewhere required in the regulations, the following 
requirements were explicitly added to the Canadian exemption: 
* The exporter must be registered as an exporter or manufacturer of 
defense articles with State and meet certain eligibility requirements, 
which includes requiring the exporter to be a U.S. person; 
* The exporter must obtain written documentation that (i) the defense 
article is for end use in Canada by a Canadian citizen, and (ii) prior 
U.S. government approval will be obtained when the article is used by 
non-Canadians, in Canada, or exported from Canada to another foreign 
destination; 
* For all defense articles identified as significant military 
equipment on the U.S. Munitions List, the exporter must obtain a non-
transfer and use certificate; 
* Records related to these exports are to be maintained for five years; 
* A note to the exemption covered the exporter's responsibilities for 
obtaining in writing that the Canadian end user and end use are 
legitimate. It stated that if such written documentation is not 
available, the exemption may not be used. 

May 30, 2001: 
The 2001 version of the exemption contains the same requirements as 
previous versions, with the following changes. 
* Re-export/retransfer of U.S. Munitions List items to another user in 
Canada or from Canada to another country requires prior approval from 
State. This section also discusses who is responsible for obtaining 
such approval;[G] 
* A note discusses a requirement to obtain a license when the exporter 
knows the defense article is not being exported to a qualified 
Canadian registered person and provides additional exemptions that are 
also applicable to Canada. 

[A] The reference to end use of a temporary import in the United 
States was confusing. Apparently, the regulations should have 
permitted the end-use in the United States and return to Canada. 

[B] This version of the regulations continued to confusingly refer to 
temporary imports for end-use in the United States. 

[C] For the purpose of the Canadian exemption, a Canadian registered 
person is any Canadian national (including Canadian business entities 
organized under the laws of Canada), dual national, and permanent 
resident registered in Canada in accordance with the Canadian Defense 
Production Act, and such other Canadian Crown Corporations as may be 
identified by State. 

[D] A manufacturing license agreement is an agreement in which a U.S. 
person grants a foreign person an authorization to manufacture defense 
articles abroad and involves or contemplates use and/or export of 
technical data. A technical assistance agreement is for performance of 
defense services or for the disclosure of technical data, as opposed 
to an agreement granting a right or license to manufacture defense 
articles. 

[E] Certain items like bombs, grenades, torpedoes, depth charges, and 
land and naval mines were excluded from this license requirement. 

[F] We noted that section 120.8 of the regulations refers to major 
defense equipment. Defense services are covered in section 120.9 of 
the regulations. 

[G] Although elsewhere required in the regulations, this requirement 
was explicitly added to the Canadian exemption. 

[End of table] 

Appendix IV: Comments from the U.S. Department of State: 

Note: GAO comments supplementing those in the report text appear at 
the end of this appendix. 

United States Department of State: 
Washington, D.C. 20520: 

March 20, 2002: 

Dear Ms. Westin: 

We appreciate the opportunity to review your draft report, "Defense 
Trade: Lessons to Be Learned from the Country Export Exemption," GAO-
02-63, GAO Job Code 120046. 

The enclosed Department of State comments are provided for 
incorporation with this letter as an appendix to the final report. 

If you have any questions concerning this response, please contact 
Peter Berry, Chief, Arms Licensing Division, Bureau of Political-
Military Affairs, at (202) 663-2806. 

Sincerely, 

Signed by: 

James L. Millette: 
Acting Assistant Secretary and Chief Financial Officer: 

Enclosure: As stated. 

cc: GAO/ASM - Ms. Katherine V. Schinasi: 
State/OIG - Mr. Berman: 
State/PM - Mr. Maggi: 
Ms. Susan S. Westin, Managing Director,International Affairs and 
Trade, U.S. General Accounting Office: 

[End of letter] 

Department of State Comments on GAO Draft Report: 

Defense Trade: Lessons to Be Learned from the Country Export Exemption: 
(GAO-02-63, GAO Code 120046): 

State Department comments on this draft report are set forth below in 
detail. As always, Department officers are prepared to discuss and 
elaborate on these comments in person at any time. 

General Comments: 

The Department generally agrees with GAO's observation that: 

"Although an item may be exempt, from State [licensing] review and 
approval, it is still subject to U.S. export control law. Under an 
exemption, the burden for reviewing the legitimacy of, the transaction 
shifts from State to the exporter. Therefore, a large part of the 
compliance and enforcement process under the Canadian exemption relies 
on the actions of exporters." 

Exports under such exemptions receive little government scrutiny prior 
to the export. It is the nature of export license exemptions that 
greater responsibility resides in the hands of the exporter. The 
allowances and limitations of the Canadian ITAR exemption are 
delineated in detail in section 126.5 of the regulations, and the U.S. 
Government reasonably expects U.S. exporters that utilize the 
exemption to adhere to the provisions of that regulation. 

Exporters that seek to transfer defense articles to Canada retain the 
option to apply for a license in the usual manner, though most, if 
their export is eligible for the licensing exemption, will export 
license-free. If exporters are uncertain as to whether their proposed 
export is eligible for the licensing exemption, they may seek an 
advisory opinion from DTC in accordance with established procedures. 

While describing in the present tense what it terms as inconsistent 
implementation of the Canadian ITAR exemption by exporters, GAO seems 
to be recounting exporter behavior in the 1999 timeframe. While it is 
possible that inconsistencies in implementation may still occur from 
time to time, it is the Department's understanding that the examples 
cited by GAO occurred in 1999 and 2000. The chronology is important 
because the exemption was subsequently revised to address areas, such 
as technical data, where the current Canadian ITAR exemption requires 
an export license for technical data when part of an offshore 
procurement. [See comment 1] 

Inconsistent implementation: One of the opening lines in the GAO 
report is that "exporters are implementing the Canadian exemption 
inconsistently." This is not surprising. Exporters are not required to 
use the Canadian export exemption when eligible. As GAO states, 
certain commodities "are being exported using the exemption by some 
exporters while others are applying for licenses." DTC does not 
consider such inconsistency a negative development as long as the 
export utilizing the exemption meets the requirements of the ITAR. 

If some exporters for their own business operations or internal 
compliance reasons wish to apply for a license even when technically 
qualified to use the exemption, we believe they ought not be 
discouraged. This situation should be distinguished from other 
situations where exporters might use the licensing exemption 
inappropriately (knowingly or not) or where experience with the 
exemption will lead to more regular use in the future. [See comment 2] 

Ensuring compliance is difficult: While compliance with the ITAR is 
left in the hands of the exporter during the implementation of a 
licensing exemption, the U.S. Customs Service has jurisdiction in the 
case of criminal violations of the AECA and ITAR and also has 
exclusive jurisdiction generally at U.S. ports of exit. Since the 
government does not review use of the license exemption until the 
exporter delivers the out-bound shipment to the port, it is very 
important that the exporter provide the required paperwork to Customs 
at, or prior to the time of export. 

In the case of exports under the authority of a licensing exemption, 
Customs is the first and last government agency to review the 
prospective export. It is therefore imperative that Customs demand 
that for each export, all required documentation, such as the Shipper's 
Export Declaration, be provided with enough detail to adequately 
describe the export articles. The Canadian exemption does not make the 
export to Canada exempt from documentation requirements, and Customs 
should deny exit of any shipment that is not properly documented. 

GAO noted that State has an important role to play assisting Customs 
by responding to inquires on the applicability of the ITAR exemption 
for particular exports, but said that "at times, we found that State 
provided inconsistent answers" when responding to inquires. 

At the request of USCS, responses to these referrals need to be swift 
because they usually involve the detention of a shipment of goods at 
the port, potentially resulting in storage, shipping, and contract 
costs for the exporter while the goods remain in detention. In such 
cases, and particularly those in which incomplete information is 
provided, the advice tendered by DTC officers does not represent a 
formal determination as to USML coverage, but the best advice 
immediately available based on the information submitted. (In this 
regard, DTC receives about 1,500 referrals from USCS each year for 
immediate attention.) [See comment 3] 

Exporters who may believe the commodity has been mischaracterized or 
not fully understood in the USCS referral process are free, and 
encouraged when appropriate, to pursue formal determinations through 
the commodity jurisdiction procedure. [See comment 4] Implementation 
of the Automated Export Service (AES) should provide a future basis 
upon which computer tracking of precedent cases by Exodus will reduce 
the prospects for inconsistent determinations, a problem whose 
dimensions appear to be modest in any case. [See comment 5] 

Recommendation: State should review and clarify exporter guidance and 
licensing officer training. State should also provide this guidance to 
Customs for dissemination to field inspectors and agents. 

State will continue its ongoing update of its exporter guidance and 
its training programs. 

When the Canadian exemption was added as an amendment to the ITAR, DTC 
conducted training seminars throughout Canada so that Canadian trade 
firms would know how the new exemption would operate. [See comment 6] 
DTC continues to provide information and guidance to the exporting 
public on the Canadian ITAR exemption through information on the DTC 
Internet website, periodic exporter outreach programs held at DTC, and 
regular DTC participation in seminars organized by export industry 
groups. Customs Service officers receive ITAR training from DTC 
personnel during periodic training held across the country. DTC also 
holds weekly training sessions for its licensing officers on various 
export control topics, and recently the session was devoted to the 
Canadian ITAR exemption. The specific Qs and As appearing on DTC's web 
site on use of the Canadian exemption were fashioned through an 
extensive outreach program involving the U.S. defense industry and led 
by the Department's private sector federal advisory committee, the 
Defense Trade Advisory Group. 

Recommendation: State should work with Justice and Customs to assess 
lessons learned from the Canadian exemption to facilitate future 
country exemption negotiations. 

State will continue to work closely with U.S. law enforcement agencies 
with this objective in mind. 

The following are GAO's comments on the Department of State's letter 
dated March 20, 2002. 

GAO Comments: 

1. We clarified text to identify when inconsistencies occurred for the 
export of technical data under the exemption for offshore procurement 
activities. We added an example to our report showing that some 
exporters are unclear about when to export technical data and defense 
services under the May 2001 revision to the Canadian exemption. 

2. State indicated that it did not discourage exporters from applying 
for licenses when the exemption can be used. Such a practice results 
in State's already scarce resources having to process additional 
licenses. In addition, some exporters may be at a competitive 
disadvantage because they are applying for a license when others may 
be using the exemption when exporting the same item. 

3. State said that the advice it provides to Customs through the 
referral process does not represent a formal State determination. 
According to Customs guidance and a Customs headquarters official, 
Customs considers State's input as a formal determination and not 
advice. A decision from State is critical because it may result in a 
seizure of the export. 

4. As State noted, responses to referrals need to be made quickly when 
items are detained at the port. State further indicated that exporters 
who believe the commodity has been mischaracterized or not fully 
understood are encouraged to pursue formal determination through the 
commodity jurisdiction process. However, the commodity jurisdiction 
process is time-consuming. Therefore, determinations made through the 
commodity jurisdiction process would not resolve the need to make 
quick determinations through the referral process. 

5. We did not include a detailed discussion on the Automated Export 
System because regulations requiring mandatory filing of export 
declarations through this system had not been finalized at the time of 
our review. 

6. Based on discussions with State officials, we added information to 
the report on State's training and outreach efforts. 

[End of section] 

Appendix V: Comments from the U.S. Customs Service: 

U.S. Customs Service: 
Memorandum: 

Date: March 14, 2002: 
File: AUD-1-OP SM: 

Memorandum For Katherine V. Schinasi, General Accounting Office: 

From: Director, Office of Planning: 

Subject: Draft Audit Report on Canadian Export Exemption: 

Thank you for providing us with a copy of your draft report entitled 
"Defense Trade: Lessons to Be Learned from the Country Export 
Exemption" and the opportunity to discuss the issues in this report. 
We believe that most of our concerns have been addressed through 
discussions with the audit team. 

U.S. Customs currently conducts a yearly threat assessment for the 
entire country for various threats, including the threat of illegal 
defense exports. Additionally, U.S. Customs provides training on 
Exodus, seaport and land border Outbound issues. To improve 
enforcement and reduce the threat of illegal defense exports to either 
Canada or anywhere else in the world requires a commitment of funds to 
the U.S. Customs Service dedicated to Outbound enforcement. 

The report did not address any aspect of the Automated Export System 
or how it is impacting the enforcement of the Canadian exemption. The 
Automated Export System becomes a major component when regulations are 
finalized for the mandatory electronic filing of Shipper's Export 
Declarations data for U.S. Munitions List (USML) and Commerce Control 
List (CCL) commodities. There is no mention that this electronic 
system was designed for statistical data collection for the Bureau of 
the Census. U.S. Customs has been able to adapt the system to assist 
in enforcement efforts. However, it is not currently capable of 
performing all the enforcement functions required for the efficient 
and effective enforcement of the ITAR. Additionally, there is no 
funding available to make the necessary programming changes for 
currently identified improvements. 

Based on the lack of manpower and funding for improved enforcement in 
the automated environment, overall enforcement of the new Canadian 
ITAR exemption or any other ITAR license or exemption becomes 
problematic at best. New exemptions for Australia, United Kingdom, and 
other countries will prove to be increasingly difficult to effectively 
enforce except on a spot basis. U.S. Munitions List commodities will 
be exported in violation of the International Traffic in Arms 
Regulations both willfully and by oversight on the part of U.S. 
exporters. 

We concur with the recommendations stated in the report and will 
complete the actions cited below not later than December 31, 2002. 

Recommendation 1: The Commissioner of the U.S. Customs Service assess 
the threat of illegal defense exports at all ports along the northern 
border and evaluate whether reallocation of its inspectors, additional 
training or other actions are warranted to augment the capability of 
the inspectors to enforce export regulations. 

Management Comments: We will review current threat assessment to 
determine the need for reallocation of inspectional resources. 

Recommendation 2: The U.S. Customs Service should update, finalize, 
and disseminate its guidance on defense export inspections 
requirements to all inspectors. 

Management Comments: Customs will update and finalize the Exodus 
Handbook. 

Once again, thank you for the opportunity to comment on the draft 
report. If you have any questions, please have a member of your staff 
contact Ms. Sandy Manuel at (202) 927-2096. 

Signed by: 

William F. Riley: 

[End of section] 

Appendix VI: GAO Contact and Staff Acknowledgments: 

GAO Contact: 
Anne-Marie Lasowski, (202) 512-4146. 

Acknowledgments: 

Marion Gatling, Lillian Slodkowski, Delores Cohen, Ian Ferguson, Bob 
Swierczek, and John Van Schalk also made significant contributions to 
this report. 

[End of section] 

GAO Products on Defense Trade and Export Controls: 

Export Controls: Reengineering Business Processes Can Improve 
Efficiency of State Department License Reviews. [hyperlink, 
http://www.gao.gov/products/GAO-02-203]. Washington, D.C.: December 
31, 2001. 

Export Controls: Clarification of Jurisdiction for Missile Technology 
Items Needed. [hyperlink, http://www.gao.gov/products/GAO-02-120]. 
Washington, D.C.: October 9, 2001. 

Defense Trade: Information on U.S. Weapons Deliveries to the Middle 
East [hyperlink, http://www.gao.gov/products/GAO-01-1078]. Washington, 
D.C.: September 21, 2001. 

Export Controls: State and Commerce Department License Review Times 
are Similar. [hyperlink, http://www.gao.gov/products/GAO-01-528]. 
Washington, D.C.: June 1, 2001. 

Export Controls: Regulatory Change Needed to Comply with Missile 
Technology Licensing Requirements. [hyperlink, 
http://www.gao.gov/products/GAO-01-530]. Washington, D.C.: May 31, 
2001. 

Foreign Military Sales: Changes Needed to Correct Weaknesses in End-
Use Monitoring Program. [hyperlink, 
http://www.gao.gov/products/GAO/NSIAD-00-208]. Washington, D.C.: 
August 24, 2000. 

Defense Trade: Status of the Department of Defense's Initiatives on 
Defense Cooperation. [hyperlink, 
http://www.gao.gov/products/GAO/NSIAD-00-190R]. Washington, D.C.: July 
19, 2000. 

Defense Trade: Analysis of Support for Recent Initiatives. [hyperlink, 
http://www.gao.gov/products/GAO/NSIAD-00-191]. Washington, D.C.: 
August 31, 2000. 

Defense Trade: Identifying Foreign Acquisitions Affecting National 
Security Can Be Improved. [hyperlink, 
http://www.gao.gov/products/GAO/NSIAD-00-144]. Washington, D.C.: June 
29, 2000. 

Foreign Military Sales: Efforts to Improve Administration Hampered by 
Insufficient Information. [hyperlink, 
http://www.gao.gov/products/GAO/NSIAD-00-37]. Washington, D.C.: 
November 22, 1999. 

Foreign Military Sales: Review Process for Controlled Missile 
Technology Needs Improvement. [hyperlink, 
http://www.gao.gov/products/GAO/NSIAD-99-231]. Washington, D.C.: 
September 29, 1999. 

Defense Trade: Department of Defense Savings From Export Sales Are 
Difficult to Capture. [hyperlink, 
http://www.gao.gov/products/GAO/NSIAD-99-191]. Washington, D.C.: 
September 17, 1999. 

Defense Trade: Weaknesses Exist in DOD Foreign Subcontract Data. 
[hyperlink, http://www.gao.gov/products/GAO/NSIAD-99-8]. Washington, 
D.C.: November 13, 1998. 

Defense Trade: Status of the Defense Export Loan Guarantee Program. 
[hyperlink, http://www.gao.gov/products/GAO/NSIAD-99-30]. Washington, 
D.C.: December 21, 1998. 

Defense Trade: Observations on Issues Concerning Offsets. [hyperlink, 
http://www.gao.gov/products/GAO-O1-278T]. Washington, D.C.: December 
15, 2000. 

Defense Trade: Data Collection and Coordination on Offsets. 
[hyperlink, http://www.gao.gov/products/GAO-01-83R]. Washington, D.C.: 
October 26, 2000. 

Defense Trade: U.S. Contractors Employ Diverse Activities to Meet 
Offset Obligations. [hyperlink, 
http://www.gao.gov/products/GAO/NSIAD-99-35]. Washington, D.C.: 
December 18, 1998. 

Defense Trade: Contractors Engage in Varied International Alliances. 
[hyperlink, http://www.gao.gov/products/GAO/NSIAD-00-213]. Washington, 
D.C.: September 7, 2000. 

[End of section] 

Footnotes: 

[1] Under the authority of the Arms Export Control Act (22 U.S.C. 
secs. 2751 et seq), the State Department administers the International 
Traffic in Arms Regulations that govern the export and temporary 
import of defense articles and services. The regulations identify the 
defense articles and services that are controlled on the U.S. 
Munitions List (22 C.F.R., secs. 120-130). 

[2] The State Department is authorized to regulate commercial defense 
trade under the Arms Export Control Act, including exemptions to 
licensing requirements. State's regulations allow many unclassified 
defense articles, such as artillery projectors and military vehicles, 
and some defense services, to be exported to Canada without a license. 
While these items are exempt from licensing requirements, they are 
still subject to the act. 

[3] For more information on the Defense Trade Security Initiative, see 
U.S. General Accounting Office, Defense Trade: Analysis of Support for 
Recent Initiatives, [hyperlink, 
http://www.gao.gov/products/GAO/NSIAD-00-191] (Washington, D.C.: Aug. 
31, 2000). 

[4] 22 CFR sec. 75.36, effective January 1,1954. This was the first 
time that chapter 1 of Title 22, "Foreign Relations" stated that 
shipments to Canada were exempt from licensing requirements. 

[5] As a result of the April 1999 changes, numerous items—such as 
spacecraft and missiles—previously exported under the exemption 
required an export license. 

[6] At the 1998 Summit of the Americas, the United States, Canada, and 
other countries agreed to strengthen controls over arms and ammunition 
transfers to better protect the hemisphere's common security. As part 
of this effort, State reviewed its regulations to ensure that firearms 
and ammunition were subject to licensing requirements. 

[7] Most of these voluntary disclosures were reported to State after 
the April 1999 revision to the Canadian exemption. 

[8] The U.S. Munitions List identifies the defense articles, services, 
and related technical data controlled by State. 

[9] The Missile Technology Control Regime was established to limit the 
proliferation of rocket and unmanned air vehicle systems capable of 
delivering nuclear, biological, and chemical weapons of mass 
destruction and their associated equipment and technology. 

[10] An offshore procurement occurs when a U.S. company transfers 
unclassified technical data to a foreign company that has indigenous 
capability to produce the defense item outside the United States. 
After the foreign company produces the defense item, it is returned to 
the United States. 

[11] 22 CFR sec. 124.13 (e). 

[12] 22 CFR sec. 126.5 (c)(5). 

[13] 22 CFR sec. 126.5 (c)(3). 

[14] Questions regarding smokeless powder represented about 5 percent 
of Customs' referrals to State involving exports to Canada between 
April 12,1999, and December 31, 2000. 

[15] State previously prepared guidelines to help exporters determine 
licensing requirements for Canada, in conjunction with the 
regulations, but these guidelines do not reflect the May 2001 revision. 

[16] The Society for International Affairs training covers various 
topics on export licensing and compliance processes. 

[17] 22 CFR sec. 126.9. 

[18] 22 CFR sec. 127.12. 

[19] Exporters are required to submit a Shipper's Export Declaration 
to U.S. Customs upon exiting a U.S. port and provide copies to State. 
Sometimes the submission to U.S. Customs is done in advance, since 
exporters make advance arrangements to ship their goods via sea or 
air. The U.S. government uses this form to collect export information 
and compile U.S. trade statistics, as well as to assess export 
compliance. State has not systematically collected or analyzed 
information on the declarations to determine compliance. 

[20] Some of these limitations also apply to the enforcement process 
for licensed defense items. 

[21] The export declaration currently does not require the exporter to 
provide its registration number, which forces an inspector to take 
more time to search the database for the name of the company. However, 
State officials informed us that they are working with U.S. Customs to 
require the exporter's registration number on the export declaration. 

[22] On May 24, 2000, the U.S. government unveiled 17 proposals known 
as the Defense Trade Security Initiative, which included a proposal to 
extend Canadian-like exemptions to qualified countries to facilitate 
defense cooperation and trade. The U.S. government has since begun 
negotiations with the United Kingdom and Australia. Further, the 
Security Assistance Act of 2000 (Pub.L. 106-280, Oct. 6, 2000) 
requires that exemptions with countries other than Canada be based on 
legally binding agreements that meet specified requirements and 
facilitate law enforcement efforts. 

[End of section] 

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