China makes spying a company policy; by purchasing high-tech firms in the United States, China gains access to advanced weapons technology which then is duplicated on Chinese production lines

Insight on the News, Nov 12, 2002 by Scott L. Wheeler

A U.S. high-tech firm bought in 1995 with Clinton-administration approval by a consortium that included two Chinese companies is proving to be a threat to U.S. national security, according to senior government analysts. The Anderson, Ind., based Magnequench Inc. was bought by the San Huan New Materials and Hi-Tech Co. of the People's Republic of China (PRC), which was started and still is partially owned by the Chinese Academy of Sciences in Beijing. It teamed in this venture with a Hong Kong investment house and a U.S. firm to form Magnequench International, which since has bought out at least one U.S. national laboratory spin-off company and has been project partner with another lab.

"The company is little more than a front for the PRC," a senior government analyst tells INSIGHT. The official insists that the PRC owners of Magnequench are using its status as a U.S. company to obtain "state-of-the-art and emerging technology and transfer it to the PRC.... It's just another form of espionage."

Magnequench itself is a General Motors (GM) spin-off company that produces rare-earth permanent magnets that have practical uses in electric motors. But these magnets also are used in advanced military equipment such as magnetic bearings in high-performance gas-turbine engines and in permanent-magnet submarine-propulsion systems, and are a key component in missile-guidance systems. The concerns expressed by the senior government analyst are that the technology and equipment used to produce the permanent magnets here in the United States would not be allowed for export to the PRC. But, because Magnequench supposedly is a U.S. company owned partly by a Chinese company, there is no control over how the technology is used. And the source indicates the technology is being used to enhance the PRC's production capabilities. "They have already duplicated the existing manufacturing line in China," the source tells INSIGHT.

The chairman of Magnequench is Hong Zhang, who also is chairman of San Huan. The company's president and chief executive officer, Archibald Cox Jr., tells INSIGHT that he did not believe his Chinese partners posed a threat. "There is no story about China stealing technology," he says. Cox points out that since a recent realignment of the corporate structure, "San Huan's stake is only 20 percent now." He also acknowledges, though, that there was no wall of security protecting U.S.-developed technology from Magnequench's Chinese partners.

The senior government official says that the activities of Magnequench since the 1995 buyout by the Chinese companies point to an aggressive pursuit of U.S. high-technology in rare-earth permanent magnets. In 1998 Magnequench acquired a small company formed by the Idaho National Engineering and Environmental Laboratory (INEEL), a U.S. national laboratory. This company, GA Powders, was put together by two scientists who had developed an atomization process to aid in the production of high-tech neodymium-iron-boron permanent magnets while they worked at INEEL.

The U.S. national labs have been identified by U.S. counterintelligence as targets of PRC espionage attempts--especially the Los Alamos National Laboratory where the government says the theft of the nuclear W-88 warhead design occurred through a series of espionage efforts by the PRC.

The senior government analyst who is monitoring Magnequench says that by acquiring GA Powders the company has gained new technology developed at one of the nation's most important labs. "The Idaho lab is where some of the most exotic work is done on new materials, including ordnance and other materials used in advanced manufacturing.... It is a tremendous security issue." Indeed, in an internal newsletter the Sandia National Laboratory also has reported working on a joint project with Magnequench involving rare-earth magnets. The newsletter quotes a Sandia scientist involved in the project as saying, "Enabling aspects include advanced electrical controls [and] new magnet technology." The senior government analyst calls the project "a disturbing partnership."

In March 2000, Magnequench International announced that it would open "Magnequench Tianjin Co. Ltd., a new neodymium-powder plant, in Tianjin, China. This plant opening will locate the production of neodymium-iron-boron permanent magnetic powder close to the source of raw materials." The senior government analyst says this fits a pattern for the PRC: "They seem to be cloning whatever they do at Magnequench USA in China."

When the consortium composed of two PRC companies and one U.S. company teamed up to buy Magnequench in 1995, the deal had to be approved by the Committee on Foreign Investment in the United States (CFIUS). Chaired by the secretary of the Treasury, CFIUS is an interagency committee responsible for conducting thorough reviews of foreign companies attempting to purchase stakes in U.S. companies. Once notified of a foreign interest in a U.S. company, CFIUS determines whether the foreign interest would pose a threat to national security. The 1988 Exon-Florio provision to the Defense Production Act gives the president the authority to restrict a foreign company from investing in a U.S. company if it poses a national-security risk.