National Security

Missile Creep

Was giving Patriots to Turkey a step toward war in Syria?

In 1913, General Otto Liman von Sanders became the head of the German military mission to the Ottoman Empire, part of a long line of Prussian advisers to Ottoman forces. Almost exactly a century on, up to 400 of Sanders's successors will be making the same trip, this time accompanied by a Patriot missile defense system. It will be the third Patriot deployment to that country since the end of the Cold War.

The deployment is being heralded as a major development in the conflict within Syria, even being compared on Al Jazeera, quite absurdly, to the Cuban Missile Crisis. Rumors -- some seemingly encouraged by Turkish officials, others by Russians -- have declared that this is the first step to the establishment of a no-fly zone. Others have suggested that the Patriots are the prelude to an Israeli strike on Iran. The truth, however, is much more prosaic.

As the Syrian civil war has intensified, to the point where the CIA estimates Assad has only a couple of months left, Turkey has grown increasingly anxious at the spillover and frustrated at its failure to make the case for overt military intervention.

Syria has one of the most formidable arrays of ballistic missiles in the region, built around the ubiquitous Scud. Syria's arsenal is mostly comprised of short-range missiles, each with limited numbers of launchers. There are no reliable public estimates for the size of Syria's inventory, but Turkey's foreign minister has put the number at 700.

But the road-mobile and liquid-fueled Scud-D has a range of 700 kilometers, capable of striking nearly all Turkish territory, including the capital Ankara, if fired from northern launching points. Northern Syria will likely slip out of Assad's hands in short course. Nonetheless, Ankara and other cities remain within range of western launch-points in the coastal areas, where the regime might find a stronger political base. Syria is also believed to possess an array of chemical weapons, some of which are alleged to have been prepared for use over the last week. There are conflicting assessments as to which of Syria's missiles are chemical-capable, but various U.S. government estimates suggest at least a portion of Syria's Scud force is equipped for the task.

Turkey's concerns are threefold. First, desperate regimes can make desperate choices. In 1991, Saddam Hussein fired 88 Scuds at Israel and coalition forces during the First Gulf War. Last year, Colonel Gaddafi fired a Scud-B at rebels in eastern Libya, just one week before his regime was deposed. Turkey, having hosted and helped arm the Syrian opposition on its soil, is a prime target. Second, Ankara may be concerned that Syrian missiles aimed at rebel-held positions near the northern border could overfly their targets and strike Turkish territory. Third, Turkey -- despite its threats of unilateral action -- has made it a priority to pull NATO into the conflict. Yet Turkey's allies are largely unaffected by issues such as Kurdish empowerment in Syria or mass refugee flows. Patriot deployment is a relatively simple means for NATO to demonstrate alliance solidarity and protect against remote but serious ballistic missile threats -- while minimizing its exposure to the civil war itself.

This is where the specific features of the Patriot become important. The Turkish Foreign Ministry is rumored to have leaked news that the Patriots were part of a broader plan to enforce a no-fly zone, a prospect that worried German legislators debating the deployment. Turkish officials appear to have made that leak partly to deter Syrian military action near the border area by generating further ambiguity over the status of airspace and the risk of escalation -- and to force NATO's hand by creating a diplomatic fait accompli.

In truth, the Patriot has a tightly circumscribed military role and is ill-suited for the expansive military intervention for which Turkey has been clamoring. The system is comprised of a ground-based radar and three generations of interceptor missiles, two of which -- the PAC-2/GEM and more advanced PAC-3 -- are employed for missile defense purposes.

Typically, a Patriot battery includes both missiles. Turkey is reported to have requested 15 batteries so as to ensure complete territorial coverage. NATO officials deemed that excessive and appear to have committed to sending up to six batteries. Germany and the Netherlands are reportedly sending two batteries each, and the United States an additional two. Each battery is likely to hold 16 interceptors. The actual battery is only manned by three people, but the support staff will likely include up to 100 soldiers per deployment.

Both types of interceptors are capable of engaging and destroying not just missiles, but also aircraft and, depending on their placement, low-flying helicopters. Patriot operators could theoretically track and destroy a large proportion of Syrian aircraft approaching parts of the border. The PAC-3, which has a forward-facing fuze and a warhead designed to intercept faster and higher-flying ballistic missiles, is sufficiently maneuverable to intercept relatively slow-flying jets. But the older, less expensive PAC-2s are better suited to an anti-aircraft role.

Both missiles provide some protection for Turkish population centers in range of Syrian missiles. Depending on where you put the radar and interceptor sites, they are also capable of protecting a zone roughly 50-100 kilometers into Syrian territory. This could bring key battlegrounds in the civil war, such as the city of Aleppo, within range.

However, there is reason to accept the NATO secretary general's pledge that "any deployment would be defensive only" and "would in no way support a no-fly zone or any offensive operation." The enforcement of a no-fly zone requires the establishment of robust and capable command-and-control arrangements and the careful deconfliction of airspace. As such, these zones have historically been handled with aircraft. The Turkish air force participated in the NATO effort in Bosnia and also hosted American aircraft that enforced the no-fly zone over Iraqi Kurdistan during the 1990s. But neither NATO nor Turkey has released any information suggesting that they are putting in place the prerequisites for an aircraft-enforced no-fly zone.

While the Patriot system can provide some anti-aircraft coverage, it would be incomplete and extremely expensive. A single PAC-3 missile costs $3-4 million. Moreover, configuring Patriots to engage lower and slower-flying targets -- like aircraft -- presents other dangers. During the 2003 Iraq War, an American Patriot battery downed a British Tornado jet, killing its crew; a U.S. Navy F/A-18 was also shot down; and a U.S. F-16 was forced to destroy a ground-based radar that had "painted" the jet.

Even against missiles, the Patriot cannot be treated as a panacea. For a start, it doesn't cover short-range rockets or artillery shells -- the only projectiles that have actually crossed the border thus far. Moreover, the system has well-documented flaws that could limit its effectiveness against a Syrian Scud attack. During the first Gulf War, the Iraqi Scuds' irregular ballistic trajectories confused the first-generation PAC-2, to the point where its hit-rate may have been startlingly low -- near zero percent, according to three independent studies.

Although low hit-rates are undesirable under ordinary circumstances, they are especially worrying in the context of WMD warheads. If the conditions are favorable, the delivery of sarin by a short-range rocket outfitted with small cluster munitions -- which the Patriot is not designed to intercept anyway -- could, according to Jonathan Tucker's War of Nerves, "generate a lethal concentration of the nerve agent over a 500 meter area, not including downwind spread." However, the actual number of casualties would depend on other environmental factors and Turkish preparedness, thus it would be very difficult to assess with any accuracy. Nevertheless, a very small number of successful strikes could have a disproportionate strategic effect.

While improvements have been made since, the PAC-3 has yet to be tested against Scuds in battlefield conditions. Critically, if Syrian Scuds break up while in flight -- a common occurrence when Iraq used similar missiles during the first Gulf War -- the interceptor could be confused and miss its target.

The upshot of all this is that the Patriot deployment serves two purposes. First, it serves as a defensive move, aimed at protecting Turkish territory against a narrow range of threats. Second, it acts as a tangible political signal, with NATO personnel operating in Turkey. Not quite a trip wire, but better than reassuring words. In short, both Turkey and NATO are eager to maintain flexibility. Turkey has been unwilling to make the political decision to engage Syrian targets on Syrian territory other than in sporadic time- and space-limited retaliatory salvos. The deployment of Patriot missiles is not a step to intervention, but a compromise that keeps NATO at arms-length.



Clash of the Balance Sheets

The most important showdown between China and the United States isn't happening in the Pacific. It's happening at the SEC.

China and the United States are on a collision course -- over accounting. Last week, the U.S. Securities and Exchange Commission (SEC) charged the Chinese affiliates of the world's top five accounting firms with violating securities laws for refusing to hand over information on suspect Chinese companies to investigators. The move is the latest, most dramatic step in an escalating standoff that could easily lead to a financial version of Armageddon: the forcible (and unprecedented) delisting of all Chinese shares currently traded on U.S. exchanges, including big-name stocks like Baidu, Sinopec, and China Mobile -- causing losses of billions of dollars and damaging the perception that the United States is friendly to Chinese businesses.

Accounting audit practices may seem like a topic more likely to lull nations (and magazine readers) to sleep. But as anyone who lost money investing in Enron or with Bernie Madoff knows, playing fast and loose with accounting rules can have huge consequences. Accounting is the language of business, and lying about revenues or liabilities is fraud. Washington created the SEC in the wake of the Wall Street Crash of 1929 to ensure that companies that offer their shares to the public are what they claim to be.

To meet that objective, the SEC requires that all companies selling securities to the public to submit annual financial statements audited by a qualified third party. If a company doesn't file reports that have an auditor's stamp of approval, its stocks and bonds cannot be traded on a public exchange. After the scandal following the 2001 collapse of energy giant Enron, in which the company's auditor, Arthur Andersen, faced criminal charges for covering up dodgy accounting practices, Congress passed the Sarbanes-Oxley Act to tighten up regulation of auditors and the audit process. The new law created the Public Company Accounting Oversight Board (PCAOB), a quasi-public entity that reports to the SEC and is responsible for policing the auditors. Now, in order to perform qualified audits, an audit firm must register with the board and submit to rigorous and regular inspections by its staff.

Over the past decade, roughly 400 Chinese companies have listed their shares on U.S. stock exchanges. A few are multi-billion dollar state-owned enterprises, such as China Life, China Telecom, and PetroChina. More than 100 were so-called backdoor-listed companies that circumvented the cost and scrutiny associated with an initial public offering by buying and merging into a U.S. firm whose stock was already listed. As U.S.-listed stocks, all of them have chosen to submit themselves to SEC regulation in order to tap U.S. and global investors for funds via U.S. markets.

Because the bulk of their operations are in China, these companies must rely on auditors licensed in China -- in many cases the Chinese subsidiaries of the top global audit firms -- to audit them. For the SEC to accept their audits, these China-based auditors must register and maintain good standing with the board.

The problem is that the Chinese regulator, the China Securities Regulatory Commission (CSRC), refuses to allow the board to inspect the U.S.-registered, China-based auditors, as required by Sarbanes-Oxley. It sees the idea of a U.S. regulator overseeing a Chinese auditor as a violation of China's national sovereignty. For some time now, the board has been negotiating with the CSRC, trying to get them to accept some form of cooperative inspections, or even allow it to observe Chinese inspections. So far, these talks have gone nowhere.

It's not unusual for the United States to get pushback from foreign countries or foreign companies on new regulations. When Sarbanes-Oxley first passed, several U.S.-listed European firms (as well as many U.S. companies) objected to a provision requiring listed firms to perform an annual audit of internal controls, in addition to the traditional audit of financial statements. They argued that this extra requirement was so costly and burdensome, they might no longer bother to maintain their stock listings in the United States, seriously undermining the position of the U.S. capital markets on the world stage. In response, the SEC temporarily suspended the rule for foreign companies, and eventually scaled down the requirement for all companies to a less onerous "top-down review."

Recent events, however, have made it a lot harder for the SEC to show similar flexibility toward China. Since 2010, a number of short-sellers researching in China have leveled high-profile accusations of fraud against Chinese firms listed on U.S. markets. Five companies targeted by Muddy Waters, the best-known of those short-sellers, lost almost $5 billion in market value through June 2011. Several others have seen their shares rendered nearly worthless or been forced to declare bankruptcy. These firms allegedly engaged in malfeasance ranging from questionable accounting practices to inflate revenues and profits, making up numbers out of thin air (and hoping no one has the resources to prove otherwise), embezzling funds, and even being total shams.

The SEC has also raised concerns about a popular holding structure, called the Variable Interest Entity, that many U.S.-listed "China stocks" use to operate in certain industries in China, such as media and education, where foreign ownership is prohibited. The U.S.-listed company exercises operational and financial "control" via contracts, allowing it to claim the China business as its own. Virtually all Chinese Internet start-ups listed in the United States are structured this way. The SEC worries that Chinese authorities could someday invalidate the contracts as illegal, leaving U.S. investors holding completely worthless shares.

In response, the SEC has launched fraud investigations into several U.S.-listed Chinese companies and their executives, ordering their China-based auditors to hand over confidential documents to examine for potential evidence of wrongdoing. In the most visible case, the SEC in May 2011 handed lawyers for Deloitte China a federal court subpoena to turn over its audit work papers for Longtop Financial Technologies, a Hong Kong-based maker of financial software that short-seller Citron Research had accused of fraudulent accounting (prompting Deloitte to resign the account, citing "recently identified falsity" in Longtop's financial statements).

Deloitte China fired its lawyer for accepting the subpoena, and refused to comply. In a court filing explaining why, Deloitte claimed that Chinese regulators had issued an extraordinary threat, telling auditors that handing over audit work papers would violate China's (vague and draconian) State Secrets law, allowing China to "dissolve the firm entirely and to seek prison sentences up to life in prison for any [Deloitte] partners and employees who participated in the violation."

The refusals come at a time when Chinese local authorities, embarrassed by the allegations, have been cracking down on short-sellers' researchers, shutting off access to company disclosure filings and sometimes harassing and even jailing research teams conducting due diligence within China. The SEC, for its part, asked the judge in the Deloitte case for a stay until this coming January, to see if it could work out some kind of solution with its counterparts at the CSRC.

Last week's decision to file charges against all five top global audit firms in China appears to signal an end to the SEC's patience. In its court filing, the SEC expressed frustration, noting that since 2009, the CSRC had refused to provide any meaningful assistance on 21 information requests arising from 16 securities investigations into U.S.-listed Chinese firms. The Chinese, it has concluded, are simply stonewalling.

While the details may seem arcane, the ramifications can hardly be overstated. Chinese auditors could face financial penalties, but they could also be disqualified from conducting SEC audits. If Chinese auditors get de-registered, U.S.-listed Chinese companies won't be able to find anyone to sign off on their audits, leading all of these firms to have their shares forcibly delisted, en masse, from U.S. markets. Shareholders would still own their shares, but those shares would be much harder to buy and sell, making them worth considerably less.

Some domestic players think China has outgrown its need to rely on U.S. capital markets. State-owned China Development Bank has put together a $1 billion war chest to help buy out U.S.-listed Chinese companies and take them private. Rather than caving in, their defenders argue, Chinese companies should come home and relist on domestic or Hong Kong stock exchanges, where they might command even higher valuations. Given that China's Shanghai Index is down two-thirds from its peak five years ago, and with Hong Kong regulators raising similar concerns about fraud, this path may not be as easy or as promising as it sounds.

Chinese companies won't be the only ones affected if SEC-qualified Chinese auditors go the way of the dodo. Plenty of multinationals listed on U.S. markets, many of them headquartered in the United States, have substantial parts of their business in China. Yum Brands takes in 44 percent of its revenues from the KFC and Pizza Hut outlets it has in China. Car sales in China account for 34 percent of General Motors' profits. These numbers matter to their global bottom lines, and to sign off on their SEC filings, their lead auditors in the United States need a PBAOC-registered Chinese auditor to vouch for them. If no such auditors exist, these companies have a problem. (There may be clever workarounds, such as dividing up the work among so many auditors that none of them is vouching for a "substantial" part of the business, but it's a costly and cumbersome solution. Nor is it clear if easy loopholes can be created for multinationals with substantial China operations without tearing a big hole in the fabric of U.S. securities regulation).

The SEC, though, may feel it has no other option. China's constraints effectively place Chinese companies completely beyond the reach of U.S. securities laws. If this were just a theoretical concern, there might be room to maneuver. But with dozens of Chinese stocks traded on U.S. exchanges dragged down by fraud allegations, costing investors billions of dollars in losses, the SEC has to act. And each action it takes brings the United States and China one step closer to an ugly financial divorce.