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CHURCH COMMITTEE REPORTS

XI. PROPRIETARIES
Proprietaries are business entities, wholly owned by the Central
Intelligence Agency, which either actually do business as private
firms, or appear to do business under commercial guise. They are part
of the "arsenal of tools" the CIA believes it must have to be an effective
intelligence component.1 In recent years, particularly during the
Vietnam War, serious questions were raised about this proprietary
capability.
Much of the accompanying criticism stemmed from a lack of understanding
of the role of proprietaries in both United States foreign
policy and the intelligence operations. Some of the criticism arose from
the suspected entrance of proprietaries into areas where they would be
in competition with legitimate business interests, such as the airline
industry. It has been feared that their profits were used to provide
secret funding for covert operations, thus avoiding scrutiny by the Executive
and the Con~ress through a "back door" funding process.
In addition, there have been allegations that the domestic impact of
these entities has effectively violated the Agency's charter, which generally
proscribes domestic activity of a police or internal security
nature. Concerns have been expressed that favored treatment has been
given these proprietaries by other Government agencies, such as the
Internal Revenue Service and the Civil AeronautIcs Board. The fact
that the size and number of these mechanisms is unknown has caused
concern about potentially pervasive influence on the free enterprise
system. Questions have arisen about whether Agency fJOlicy included
using these entities to engage in illegal activities to make profits which
could be used to fund clandestine operations. Most notably, the latter
charges have involved allegations that the Agency's air proprietaries
were involved in drug trafficking.2
Concern has been expressed about the Agency's financial and management
control over proprietaries and about the treatment of funds
related to such entities.3 It is understandable that there would be misgivings
and suspicion, since much that would have explained the role
of these proprietaries has rema;ned classified. The Committee has,
nonetheless, been able to conduct broad review of these operations.
This review has included examination of documents at the CIA, and
testimony from present and former Agency employees.
In general, these mechanisms have operated with a proper concern
for legality, propriety and ethical standards at the headquarters level.
The deviations that have occurred were in the field and generally in
1 Testimony of Chief of Cover and Commercial Staff (CCS), 1/27/76, p. 20.
, The Committee found no substance to these charges. .
S A careful review has revealed that the CIA's proprietaries are appropriately
limited and controlled with careful considered given to restrict their use within
the spirit and letter of the law by headquarters-level personnel.
(205)
206
the area OT operators, rather than management personnel. Moreover,
the use and past expansion of the proprietaries was a direct
result of demands placed upon the Agency by Presidents, Secretaries
of State and the policy mechanisms of government. This is particularly
true of the large air proprietary complex used to support paramilitary
operations in Southeast Asia. The only exception to this
pattern is the insurance complex, which was partially established on
Agency initiatives to fill a pressing need.
A conceptual problem which continually confronts the intelligence
c~mmunity, applie~ with full force in the propr~etary area. 1\s certain
kmds of covert actIOn were developed to deal WIth the perceIved communist
threat, the use of certain mechanisms had to be limited. In a
totalitarian society for example, governmental and "private" enterprises
are essentially one. The government can and does use these entities
for intelligence and other official purposes. In our society, however,
that which is governmental is generally distinct from that which
is private. Traditionally, problems have developed when the government
has crossed into the private sector. Proprietaries are no exception
to this dilemma. They are, in fact, the embodiment of it.
Thus, the fundamental question presented in this portion of the Committoo's
inquiry is: can a free and open society tolerate such a confluence
of conflicting roles? The Committee concludes that it can, provided
that the Congress plays a role in the supervision of these mechanisms
to ensure that the delicate balance struck in our society between
governmental and private actions is maintained. While there may have
been a temptation to view proprietaries as "abusive" per se, this attitude
was eschewed by the Committee. Although there are potential
problems with proprietaries, the Committee feels that aggressive oversight
can protect the rights of American citizens and instItutions without
the need for a ban on the use of proprietaries which serve a
legitimate intelligence function.
A. OVERVIEW
Acting under broad authority granted them by the National Security
Act of 1947 and Central Intelligence Act of 1949, the various
Directors of Central Intelligence have established proprietaries (Government-
owned business enterprises, foundations and quasi-business
enterprises) to serve a variety of intelligence and covert action purposes.
Chief among those purposes have been:
1. Provision of Om'er for Intelligence Oollection and Action Projects
Commercial firms established in foreign countries provide plausible
reasons for the presence of CIA case officers. Agency-funded foundations
serve as conduits of funds for a variety of purposes, including
clandestine activities and contributions to scholars conducting research
which supports United States foreign policy positions.
2. Extension of Agency Influence and Information Network in Overseas
Business Oommunity
The very act of establishing a proprietary firm requires banking,
insurance, and other services. Acquiring these services entails support,
communications, and intimate business relationships with bona fide
207
commercial entities here and abroad. At a minimum, these relationships
require the clearance of those in top management positions for
access to CIA business. On occasion this relationship includes the
Agency using commercial contacts for information or assistance.
8. Prrn'ision of Su.pportinq Ser'oices for G01'ert OperatioM
In paramilitary operations. airlift and sealift bv Agency-owned
carriers has many advantages: flexibility, security, ability to implant
technical collection devices. etc. CIA agrnts, who engage in hazardous
activities which would ordinariIv make them uninsurable, can
obtain commercial insurance at standard or suhsidized rates via a conglomerate
of CIA-owned insurance companies. In foreign locations
where actual contact with the nearest CIA station is not operationally
discreet, proprietaries provide payroll channels and other administrative
services for Agency personnel. Firms based in locations with permissive
corporate laws and regulations can also engage in many
activities unrelated to their charters. For example, insurance firms can
acquire real estate for operational purposes on a non-attributed basis.
4. Operatwnof Propaganda Mechanism8
In establishing the clandestine radios (Radio Free Europe and
Radio Liberty) in the 1950s, the CIA acquired a means of directly
influencing populations behind the Iron Curtain. These proprietaries
were eventually disposed of and placed under the aegis of the Department
of State.
5. Management of Private Investments
The Agency would deny that private investment is a purpose of
proprietaries. Agency officials state that standing policy prohibits the
investment of CIA operational funds in the private sector without explicit
authorization by the DCI. Actually, the existence of proprietary
enterprises which occasionally returned sizable profits, indicates that
private investment may indeed have been a widespread Agency policy.
Moreover, the Agencv has specifically authorized its insurance complex
to act as an institntional investor for its own funds and those of
other proprietaries. Thus, the extent of private investment by the
Agency is actually a question of definition and shading.
B. STRUCTURE
Proprietaries fall into two broad categories:
(1) Operating companies which actually do business as
private firms; and
(2) Non-operating companies which appear to do business
under commercial guise.
These ent;ties mav be le~ally constituted as corporations. partnerships,
or sole proprietorships; or they may have no such legal standing,
i.e., they may be "notional" entities financed by the Agency. Corporate
proprietaries are incornorated in accordance with the statutory provisions
of the juriSdiction of incorporation, are subject to the same
review as any corporate entity within that jurisdiction, file applicable
state and Federal tax returns, and obtain the necessary licenses to
conduct business.
208
Both operating and non-operating companies serve two purposes:
(1) they provide cover, attribution for funding, and administrative
assistance to agents and clandestine activities; and (2) they provide
services not available through normal commercial facilities. Because
these instrumentalities are established as private organizations, they
must be organized and managed in accordance with normal business
practices and requirements for the types of enterprises they appear
to be.
The Agency has generally employed proprietaries when they have
been the only way, or clearly the best way, to achieve an approved objective.
Under Agency rules proprietaries are established or allowed
to continue only so long as they contribute to accomplishment of the
CIA's mission. and remain the most effective means to achieve
Agency objectives. While current policy does limit the use of operating
proprietary mechanisms, the Agency does retain its capability
to use these mechanisms, although it limits the size of the actual entities
being maintained.
A review of Agency files shows that the number of operating proprietaries
has been consciously pared by about 50 percent since the
mid-1960s. These reductions were the result of both the Katzenbach
guidelines associated with the National Student Association disclosures
in 1967, and a survey conducted by the CIA Inspector General in that
same year. In addition, the need for proprietaries has declined as a
result of: (1) a general shift in emphasis away from covert action;
(2) the transfer of Radio Free Europe and Radio Liberty to the Board
of International Broadcasting with funding through State Department;
(3) the liquidation of the assets of the Air America complex
as requirements for CIA support in Southeast Asia diminished; (4)
the sale of Southern Air Transport and the liquidation of assets of
Intermountain Aviation with their exposure in the press; and (5) a
change in the Agency's approach to contingency requirements.
The evidence received by the committee indicates that the activities
of all agency pronrietaries support the CIA's foreign intelligence
collection or covert action missions. Some proprietaries are located
within the United States for reasons of operational or administrative
necessity, thus there is a domestic infrastructure, but their ultimate
impact is overseas. Some of the questionable domestic uses of these entities
are detailed in the sections of this Report on "MERRIMAC"
and related programs.4 In one area, the insurance complex, serious
questions remain as to the propriety of using such a mechanism to
provide insurance and retirement benefits for agency employees.
1. Operating Proprietaries
Operating proprietaries condnd bllsiness in the commercial sphere.
While they may compete directly with privately-owned corporations
such comnetition is limited by the agency so that private companies
will not be denrived of substantial income. The Agency has been
careful to limit the amount of commercial business engal!ed in by
these proprietaries to that necessarv to support the viability of the
commercial cover. Revenues have been used to partially offset operating
costs, and aggregate profits over the years have boon relatively
, See the Select Committee's detailed feport on CHAOS.
small. Only two propriEtaries have shown significant profits: the Air
America complex, primarily by fulfilling Government contracts in
Southeast Asia; and the insurance company, by handling trust funds
and insurance.
Depending upon the functions they perform, operating proprietaries
vary in terms of capitalization and total assets. Whl}n the commercial
purpose of an operating proprietary is incidental to its CIA mission
(such as an export-import firm which engages in commercial operations
only to the extent necessary to provide cover for a CIA officer
in a foreign country) a minimum capitalization, usually in the neighborhood
of $25,000 or less, is all that is required.
Operating proprietaries whose commercial purposes are in themselves
essential to the CIA mission require much larger capitalization
and investment. They are staffed by Agency personnel and cleared
commercial employees. Among the Agency's operating proprietaries
of this type are a few management companies and non-operating
proprietaries with substantial assets. The Agency's largest operating
proprietaries have been Air America, the insurance complex, and
Intermountain Aviation, Inc.
Air America, the Agency's largest proprietary, provided air support
for CIA operations in Southeast Asia. This support was under
cover of a comm~rcial flying service fulfilling United States Government
contracts. Corporat{\ headquarters were in Washington, D.C.,
with field headquarters in Taipei, Taiwan.
The insurance complex provides a mechanism for both the payment
of annuities and other benefits to sensitive agents, and self-insurance
of risks involved in covert operations. The complex was formed in
19fi2 as a clandestine commercial support mechanism ';0 provide death
and disability benefits to agents or their beneficiaril s when security
considerations precluded payments which might be attributable to
the United States Government. This function wps broadene.d to include
assumption of many risks incurred by operational activities. The
complex has administered agents' escrow accounts and life insurance,
and provided annuity and pension programs for selected agent personnel
employed by the Agency. These programs are solely for the
purpose of meeting the Agency's obligations to personnel who have
rendered services over a substantial period of time, and who are not
eligible for normal United States Government retirement programs.
Individuals who qualify for the CIA Retirement Svstem or the Civil
Service System are not handled through the proprietary system. The
complex has also been used to provide a limited amount of support
to covert operations-specifically, for the acquisition of operational
real estate and as a conduit for the funding of selected covert
activities.
Intermountain Aviation, Inc. provided a varit>ty of nonattributable
air support capabilities which were available for quick deployment
overseas in support of Agency activities. The assets of Intermountain
have been sold, with operations ceasing February 28, 1975, and the
corporation is in the process of being dissolved.
The combined net worth (assets minus liabilities) of the operating
proprietary companies is approximately $57.3 million. Although some
210
are commercially self-supporting, such as those in the insurance complex,
most of these companies usually require budgetary support.
Three of these operating proprietaries will be described in the
following pages to indicate: why they came into existence; what they
did; the management, operations and control environment in which
they operated; and what impact they may have had on the private
sector. In addition, this discussion will supply the necessary factual
rei('l'p))cf', for the Committee's recommendations. These recommendations
reflect the considered judgments of the Committee, which were
formulated after hearing the views of current and former CIA employees,
and those of other knowledgeable individuals.
The Security Froject
In 1958, at the time construction of the new CIA headquarters
building in Langley was initiated, a small counterintelligence operation
was established to maintain surveillance of the site to prevent
hostile penetration and sabotage. It was successful in its objectives
and, upon occupancy of the building in 1962, the Security Project
was established.
From a single office in Virginia the project expanded to four field
offices and grew from a single firm into three separate corporations.
The parent organization operated in the greater Washington area.
This operating proprietary was a commercial corporation which performed
security services on a competitive basis. The firm also conducted
operations for the CIA's Office of Security. This operation was
successful, with customers utilizing the proprietary for document
destruction, consultation, guard work, and security clearance investigations.
This company developed business contracts with agencies of the
Federal Government and commercial firms. Because the provisions
of the "Anti-Pinkerton Act" 5 prohibit a company engaged in investigative
work from contracting with the Federal Government, the
Agency formed a separate company to manage commercial firms as
funding mechanisms for investigative work levied by the Office of
Security. The new company was headquartered in California. As
activity expanded and work increased, a third corporation was organi7ed
ann hellnrlllartered in California.
In early 1966, the original company merged with the third
firm, which remained incorporated in the state of California. The
corporate offirers and the boarn of directors of all three companies
consisted of the same persons. Subsequently, the merged corporation
,vas sold and new legal straw men were introduced as officers, dirpctors
and shareholders. In March 1966, a new home office was established
in Virginia to enhance administrative effiriency, monetary controls,
and cover viability. This "home office," with its investigative charter,
has been llsed to conduct covert investigations.
In addition to conducting investigations, the project was used in
the following activities:
(1) Covert monitoring of construction of CIA headquarters
building;
(2) Monitoring of construction of buildings which were to be
occupied by Agency components;
65 U.S.C. 3108.
211
(3) Covert monitoring of construction of CIA printing services
building;
(4) Surveillance of Department of Defense civilian employees
suspected of being potential defectors to the Soviet Union;
(5) Testing security effectiveness at domestic Directorate of Science
and Technology sites and contractor facilities;
(6) MERRIMAC-monitoring of dissident groups in Washington,
D.C.;6
(7) Hiring and paying contract guards;
(8) Contracting with a civilian firm for the guard force at an
installation;
(9) An operation to recruit, process and train undercover internal
security agents for the Bureau of Narcotics and Dangerous Drugs;
(10) Security support for Directorate of Science and Technology
proieds consisting- mainly of badging and entry controls, background
investigations, and escort of sensitive material-this is the only such
activity currently being serviced by the project;
(11) Physical surveillance of an Agency courier suspected of living
beyond his means including a surreptitious entry into his apartment;
(12) Physical surveillance of an Agency employee "who maintained
contact with people of questionable loyalty" including an audio
penetration of the employee's apartment and a mail cover.
Only one office is currently in operation as part of the project. Over
the past years, its commercial projects have included badging operations
for private companies, i.e., airlines, schools, etc. The company
has never made a true profit. To maintain its image among its competitors,
however, its books reflect a small profit on which Federal and
state taxes are paid. The office presently employs four staff agents,
five contract agents and fourteen proprietary employees. During fiscal
year 1974, the project expended 2.9 percent of the Office of Security
budget.
As noted, this security project has provided the Office of Security
and Agency operators support on sensitive covert operations and
investigative matters, counterintelligence and counterespionage support
for Agency components, custodial support, technical and physical
support in surveillances, and Agency proprietary support. The project
hns also condncted snecial nongovernmental and sensitive inquiries.
Its commercial activities have included; internal security management,
security surveys, counteraudio measures and inspection, management
of security protective equipment and devices. classified material storage,
secure destruction of cla"sified waste, incinerator equipment sales,
personnel investiB:ations, and industrial undercover activities.
A unique example of its Agency security function was a project
which utilized both security "probes" and security "penetrations." A
security probe is a test of the current effectiveneps of a security system
within an Agency installation. A security penetration is an internal
investigation and search which attempts to locate subversive elements
at a facility. Such a penetration seeks to detect those who may be en-
• This particular project and other aspects of the project's dompstic activities
are treated in greater detail in the Committee's Staff Report "On CHAOS.
212
gaged in foreign intelligence or sabotage, and those who, by lack of
security discipline or gross malfeasance, may be weakening the security
structure of the fa~ility. In essence, penetrations are counterintelligence
against ~ domestic installation.
In one instance, an agent was sent under the natural cover of a
union construction man to an Agency contractor to gain employment
as a pipefitter.8 He succeeded in gaining access to the target, and developed
information on the installation and its personnel. Similar
probes were also conducted against other companies contracting with
the Federal Government. The proprietaries which are part of the security
project have helped maintain the security required by sensitive
Agency operations. Their utility, however, as in the case of nearly all
proprietaries is relative to policy demands and "flap" potential. As one
Agency commentator phrased it when New8week revealed the relationship
of two Boston la'wyers with the CIA in setting up proprietaries:
Proprietaries have been and will continue to be an important
tool to achieve selected operational objectives. Their use, however,
has been drastically cut back, more because of changes
in the international scene and in operational priorities, than
as a result of embarrassing exposures.9
As has been the case with nearly all other proprietaries, not
everyone within the Agency has been satisfied with the existing mechanisms
of the security project. There has been constant review, criticism,
and internal restraint due to a fear and suspicion that entities
which are "out there" may not readily respond to the leash. For example,
in June of 1964, the Chief of the Operational Support Division
wrote to the Deputy Director of Security (Investigations and Operational
Support) concerning project pohcy and procedures. In terms
of operational objectives, he noted that they had "created an operational
support entity of dubious capability and with ill-defined objectives
or purpose." He suggested that they "look this ugly duckling
in the face" and see if it could be terminated gracefully or "see if we
can nurture it into a productive and responsible bird of acceptable
countenance." 10
The Chief of the Operations Division wrote that he "received the
definite impression that there may be some grev area with regard to the
internal channels of command and administrative direction." He
noted that there was confusion resulting from lack of a clear-cut distinction
"at just what level policy matters may be decided ...." Management
procedures for the project were such that "under the current
8 He was, in fact, a legitimate tradesman.
• New8week, 5/19/75, pp. 25-28.
10 Memorandum from Chief, Operational Support Division to Deputy Director of
Security, 6/64.
In many cases these concerns dealt with the inability of the entity to provide
adequate cover for itself in order to more adequately fulfill its role. In one instance,
the physical backstopping of this project was inadequate. After this was
rectified, one official noted:
"It is felt that this step has strengthened the [Corporation's] cover, [in two
East coast cities] so that now the company would withstand any inquiries, except
that of an official Government investigation."
213
status everyone may take credit but no one could be blamed." With
regard to operational capability he noted:
Quite candidly, I am somewhat concerned about the operational
capability of [the] Project. It seems, as a result of its
Topsy-like growth, to be oriented toward the military and
the building trades. Quite candidly, it is felt that the base
must be broadened. Further, I am far from convinced that we
have yet developed anywhere near the professional status
necessary to "sell" this Project as one having unique operational
capabilities sufficient to justify its existence. In other
words, I am not impressed with the capability as it now exists
nor am I sure that we can sell this product and then be assured
that it can perform in a satisfactory mannerY
His comments concerning the attitude of Agency personnel were not
unique to this proprietary. They are included here to illustrate the special
problems posed by these entities. His remarks also show the dangers
inherent in some areas of this activity.
It would seem that this Agency, particularly operating components,
are insistent upon pursuing an "ostrich policy" when
it comes to their operational security procedures. I have personally
witnessed almost hysterical reactions to criticisms as
well as total rejections of practical sugrrestions with regard to
operational security procedures. Now it seems to me that we
are going about this in a verv awkward and embarrassing
manner. WE ARE, IN EFFECT, ALLOWING THE
WRITERS OF SENSATIONAL BOOKS SUCH AS
THE "INVISIBLE GOVERNMENT" TO PROVIDE
THE NECESSARY INFORMATION AND PRESSURE
ON TOP AGENCY MANAGEMENT TO CORRECT
GLARING AND STUPID COURSES OF
ACTION BEING PURSUED AT THE WORKING
LEVEL. I have been the object of considerable personal ridicule
due to my stand in opposition to the unrealistic cover and
operational security procedures as they relate to certain
aspects of [CIA Operational Base] for example. IF we had
the authority and capribility to have made an objective probe
of this sensitive activity we may ha,-e been able to have surfaced
these obviously ridiculous procedures in such a manner
that corrective action would have been taken. Now is the time
to present the case in light of the abiding fear of publicity currently
permeating the Agency. I recommend that we go after
the authority to make independent (unilateral) probes and/or
probes requested and known only at the very highest levels of
t~e Agency with the results discreetly channeled where they
wIll do the most good. There necessarilv follows the unpleasant
subject of money. As distasteful as it may be, it is no good
to have the authority without a sufficiently large confidential
1.1 Ibid.
214
fund set aside and earmarked for independently initiated
activities.12 [ Emphasis in the original]
He emphasized that if the Agency did not take the above kind of
action to monitor its "image" at the operational level, it would "continue
to be plagued with the unsolicited and uncontrolled critique
through the newspapers, periodicals and books." He critically concluded:
Further, I challenge anyone to deny that such exposes to date
are largely true and usually the result of our own "ostri~h
policy" and refusal to face the fact that we have operated ill
some relatively amateurish manners over the years.13
Such concerns have extended beyond these operational levels to
general issues of propriety and legality. As noted earlier, the socalled
"Anti-Pinkerton Act" prohibited the Office's continued contractual
relationship with private companies or their employees for
purposes of conducting investigations or providing cover. The General
Counsel responded as follows:
I am aware that in fulfilling the responsibilities placed
upon your office in support of the Agency's mission, many
investigations must be conducted without revealing Government
interest. Absent the relationships you question, you
could not discharge your responsibilities. It is this inability
to accomplish your tasks which causes recourse to the Agency's
rather broad statutory authority to expend funds as
contained in Section 8 of the CIA Act of 1949, as amended.
This authority provides
(a) Notwithstanding any other provision of law, sums
m~de available to the Agency by appropriation or otherWIse
may be expended for purposes necessary to carry out its
functions, including-
(1) personal services, including personal services without
regard to limitations on types of persons to be employed, ...
(b) The sums made available to the Agency may be expended
without regard to the provisions of law and regulations
relating to the expenditure of Government funds'
and for objects of a confidential, extraordinary, or emer~
gency nature, such exnenditures to be accounted for solelv on
the certificate of the Director and every such certificate shall
be deemed a sufficipnt voucher for the amount therein certified.
It.is my opinion that.this authoritv permits the Agency to
contInue the two praf't!ces as Sf't out aboye without fear of
violation of the Anti-Pinkerton Statute.l38
He closed, however, with the following admonitions:
:rhere are, of course, o~her dim.ensions of th~ question you
raI~. As a matter .of polIcy I belIeve the practIces should be
reVIewed at the hIghest levels within the Agency and, peru
Ibid.
,. Ibid.
,.. Memorandum from General Counsel to Director of Security, 6/64.
215
haps, cleared with the Agency's oversight committees. In
addition. if one of these relationships became public, it must
be recognized that there will be allegations that the law has
been violated. On balance, it is my view that these considerations
are not so significant as to warrant a termination of the
hvo practices with the three companies. It is suggested, however,
that any subsequent projected association with a detective
company or private investigative company beyond the
three present companies be reviewed with this Office prior to
its initiation.14
The Insurance Oomplew
This proprietary is a complex of insurance companies, most of
which are located abroad, operated by the Agency to provide the following
services :
(i) Handling of risks ostensibly covered under commercially
issued policies;
(ii) extending term life insurance, annuities, trusts and
workmen's compensation to Agency employees who are not
entitled to United States Government benefits;
(iii) handling escrow accounts for agents; and,
(iv) limited operational support and investment activities.
Is
Origin.-Prompted by the Bay of Pigs losses, the complex was
created in 1962 to provide death and disability benefits to agents and
beneficiaries when security considerations preclude attribution to the
United States Government. Lawrence Houston. retired General Counsel
of the Agency, testified that his office established the insuranceinvestment
complex, because his staff was responsible for all problems
related to the death or disability of employees during the course of
their Agency work. These problems were all handled in what Houston
called a very "sketchy way" which he felt was undesirable from all
points of view. 'When the Agency went into air proprietaries on a large
scale, additional risks arose which simply could not be underwritten
commercially.
So somewhere in the late 1950s or around 1960, I think I was
the one that posed that we might organize our own insurance
entities.I6
A single event served as the catalyst for the establishment of the
complex. Houston recalled in latter testimony that
the event that brought it into focus was the death of four
airmen in the Bay of Pigs. These men were not supposed
to have engaged in the fighting and were training on the
mainland, but when the Cubans were either exhausted or
unable to fly anymore, they pitched in, went over the beach,
and were shot down.
U Ibid.
15 Escrow aecounts are established when an agent cannot receive his full payment
from the CIA without attracting suspicion. The funds not paid to the agent
go into escrow accounts and are invested under the complex.
,. Lawrence Houston testimony, 1/15/76, p. 61.
216
We heard of this for the first time the next morning and
Allen Dulles called me over and said, you'll have to make
some provision for the families of those four fliers . . ..
Through [an ad hoc] mechanism we paid benefits to the
family for a considerable length of time until we were able
to turn it over to the Bureau of Employees Compensation.
This was a very makeshift arrangement, and so based on
that I came to the conclusion that we needed a much more
formal and flexible instrument. And so after long consideration
within the Agency we acquired the first two insurance
entities which had been in being before and then we flushed
them out a little bitY
Thus, the formation of this entity represented the "culmination of
experience" in this support area, according to Houston. Although
the complex originally operated under the Domestic Operations Division,
a special board of directors later assumed control of the proprietaries
and their investments. In July 1973 control of the complex
was transferred to the Commercial and Cover Staff.
The Ourrent Statu8.-All of the clients of the project are Agency
employeesya The complex was originally capitalized in 1962 with $4
million. Most of the assets are held outside the United States and the
companies do not write insurance in the United States. Each of the
United States companies pays little tax and is audited by a proprietary
firm. This method of self-insurance enables the Agency to funnel money
where needed in any of its project categories. Currently, 60 percent of
the investments are in long-term interest bearing securities abroad, 20
percent in off-shore time deposits in United States banks, and the balance
is in common stocks, debentures and commercial paper of various
types. In the past twelve years the sale of stocks has resulted in profits
in excess of $500,000 accruing to the CIA. The combined total assets
of the complex are in excess of $30 million, including its retained net
earnings of approximatBly $9 million.
In 1970 the Inspector General examined the insurance complex. His
report raised questions about briefing congressional oversight subcommittees
which indicate that Congress had never been informed of
the existence or extent of the insurance complex which had grown to
an organization with assets of $30 million without oversight, knowledge,
or approval. While annual audits of the complex were conducted,
there was no annual allotment and no annual operational review
within the CIA, because the insurance activity was no longer a true
project after its removal from the Domestic Operations Division.
17 Houston, 1/27/76, p. 8.
17. The complex itself is only for covert non-staff officers of the CIA. In essence,
it only works for what would broadly be described as "agents". those not en·
titled to participate in the CIA retirement plan or in the Civil Service Retirement
Plan. They are primarily foreigners, and usually work for DDO. In the
case of most agents. the CIA contributes 7 percent and the agent contributes 7
percent, in keeping with CIA practice for regular employees. In cases where
the agent is well along in years and contributions from the Agency and the
agent would not provide enough funds to capitalize an annuity, the Agency pro·
vides thp initial capitalization; however, such an arrangement must be approved
by the DDO.
217
Houston indicated that the complex had been operating "for some
time" before
we told our committees any detail. I think it was mentioned
as a problem that we had to make arrangements to
cope with insurance problems fairly early on. But the fact
that it was a business and a business of this substance was
not done for some time. My recollection is there was not deliberate
avoidance; we just didn't get to it.18
With regard to buying and selling securities, the Committee sought
to discover whether the CIA has any method of preventing personal
profit-taking by Intelligence Directorate analysts who have access of
clandestinely collected economic intelligence. The CIA has indicated
that such an analyst would be in the same conflict of interest position
as a staff member of the Securities and Exchange Commission,
Department of Agriculture, or any other Government agency for misuse
of confide,ntial material. Moreover, financial reporting requirements
are imposed upon CIA employees.
Similarly, the Committee attempted to determine whether financial
transactions \vere made by the complex to influence foreign stock markets
or currencies. The 1970 review by the Inspector General found no
evidence of such influence. Neither did the Committee. All witnesses
and documentary evidence indicated that the complex was never so
used. Indeed, all ag-reed that the amounts involved in the fund were insufficient
to destabilize any currency or market, even if such an effort
hao been made.
The complex was subject to an audit in 1974 which concluded that
it "continued to be administered in an efficient and effective manner,
and in compliance with applicable Agency regulations and directives."
Prior audit reports had commented on the need for a revised
administrative plan. In accordance with earlier reports, the 1974 audit
noted, a "new plan was approved in March 1975." In addition,
"minor administrative and financial problems surfaced during
the audit were discussed with [project] officials and resolved." The
audit noted that total income for that year (from interest, premiums,
gain or loss on sale of securities, dividends, rentals, professional fees,
gain on foreign exchange, gain on sale of property and from miscellaneous
transactions) was in excess of $4 million. The total empenses
for that year (allocation of premium income to reserve for claims,
interest, sal.aries, rent, accounting fees, taxes, loss on property writeoff,
legal and other fees, communications, depreciation and amortization,
travel, equipment rent, real estate expenses, pensions, due and
subscriptions, directors fees, entertainment and mIscellaneous) were
nearly $2.5 million. These combined for a net income in excess of
$1.5 million.19
The current Chief of the Cover and Commercial Staff has focused
on the insurance-investment project in a number of interviews with
both the Rockefeller Commiesion and the Committee. He has suggested
that the real question for the complex is what its role and shape
should be after the termination of many of the Agency's proprie-
18 Houston. 1/15/76. p. 81.
1'01974 Audit of Insurance Complex.
207-932 0 - 76 -15
218
taries. With their liquidation, he believes a reorganization and redefinition
of the insurance-investment complex is needed.
As to the issue of a safeguard against misuse of project funds or
"insider" information by the Agency, the Chief of CCS has told the
Committee that the guarantees against such abuse are (1) compartmentation;
(2) the integrity of the Chief of CCS; and (3) dis:
play of portfolios to appropriate congressional committees.20
Houston agreed with the three safeguards outlined by the CCS
Chief. However, he added a fourth:
''\Then we were investing in stock, I would have the list of
stock, the portfolio, reviewed by our contract people, and if I
found we had any contract relationship with any of the companies
involved, we'd either refuse to-Well, a cou}?}e of times
our investment 'advisor recommended a stock whICh I knew
we had big contrads with, and I told the board no, this involves
a conflict of interest. We won't touch it. And if we had
anything from the Agency contract office that indicated a
relationship, we would either sell the stock or wouldn't buy
it."
Houston believes that the complex should continue in some form
and that the current method, while not perfect, is the best that can
be devised. The problem is that the generation of funds for these
companies must be demonstrably legitimate and nongovernmental if
beneficiaries are to be protected; i.e., the absence of investment by an
insurance corporation could well indicate to outsiders that its funding
is actually coming from the Federal Government.
Beyond "Doing ,BUlJiness": Peak Non-Government Seml/rity
Investments by Proprietaries Active as of Dec. 31, 1974.-The insurance
and pension complex has sizable investments in both domestic
and foreign securities markets. Its portfolio runs the gamut of notes,
bonds, debentures, etc. But other proprietaries have also used this
investment route as a method of increasing capital and insuring adequate
cover.
For example, a domestic corporation purchases general merchandise
in a manner which cannot be traced to the United States Government.
It provides covert procurement for the CIA Office of Logistics.
mile this corporation has no outsirle commercial business and only
five employees, as of December 31, 1974, it had invested over $100,000
in time deposits. A second domestic corporation purchases arms, ammunition,
and police-related equipment for the Office of Logistics. This
company has no employees and is managed by Headquarters officials
under alias. As of December 31, 1974, this corporation had invested
more than $30,000 in a certificate of deposit.
A trayel service proprietary was recently sold to an Agency employee.
at the time of his retirement. This employee had ostensibly
owned the firm, but had in fact managed it for the Agency. As of
20 Chief, CCS, 1/27/76, pp. 15-16.
... Houston, 1/15/76, p. 80.
The current chartpr for the insurance complex and the administrative plan
forbid further acquisition of U.S. stocks and require the divesture of American
equity investments in the immediate future.
219
December 31, 1974, this corporation had invested more than $30,000
in a certificate of deposit,23 An investment proJ;>rietary, which was later
dissolved, had investBd about $100,000 in MexIco as of March 31, 1973.
A Delaware corporation, which has provided secure air support for
Agency employ~ and classified pouches between Headquarters and
other Agency facilities in the United States, has nearly $150,000 in,-
ested in a certificate of deposit.
A former youth activity proprietary, in which the Agency no
longer retains an interest, had approximately $50,000 invested in time
deposits as of March 31, 1972. Another proprietary is part of a complex
managed by the Cover and Commercial Staff which provides
operational support, for foreign operations. It is a Delaware corporation
used wcollect proceeds from the sale of Agency proprietary
entities and to refund such proceeds to tl'e Agency. Its total assets
were nearly three-quarters of a million donars and its total stockholders
equity was in excess of $15,000 as of DecembH 31, 1973. It
has no employees. As of December 31, 1974, it had invested almost
hali a million dollars in a convertible sllbordinated debenture from
the sale of a company and almost $50,000 in notes receivable.
Another company in this complex ie a foreign company which has
been used as an investment vehicle for funds earmarked for new commercial
operations requiring A~ency investments. This investment
project has been terminated and all funds were returne,d to the Agency.
The company has no employees. As of December 31, 1973, it had invested
nearly a quarter of a million dollars in a Security Note of a
private domestic corporation.
A proprietary 'which was part of the air support complex had invested
over $200,000 in a certificate of deposit as of December 31, 1974.
This entity was later sold. Another is part of the management and
accounting complex. As of December 31, 1974, it had nearly half a
million dollars invested in time deposits.
The Air Proprietaries
History.-Lawrence R. Houston. fomrer CIA General Counsel,
was involved in the establishment of the first set of Agency proprietaries,
and has concluded that they should be a mechanism of last
resort. Houswn maintains that the Agency learned this "the hard
way and almost an of the lessons involved probably came out one way
or the other in connection with a major aviation proprietary in the
Far East. Others had their own special problems, but I think the Air
America complex had pretty near everything." 24
The Agency acquired Air America in ]949 ostensihly to deny the
assets of this company to the Communist Chi1"e"e. The CIA first arranged
cash advances to the company in 1949. These advances were
eventually credited to tJ'e Agency's purchase of the corporation. At
that time, Houston dl."scribed the airline as follows:
This norma] aviation organization, this wonld have no meaning
at an, was completely at an, it would have no standing
23 The Agenc.v today uses this firm for the purchase of airline tickets for travel
in support of sensitive projects. It is estimated by the Agency that CIA business
represents about 30 percent of the gross airline ticket sales of the entity on an
annual basis. .
2< Bouston, 1/15/76, p. 5.
220
in international law, aviation rights, or any of that. But it
worked for what they wanted, which was to take supplies upcountry
into inland China and then to bring back whatever
cargo they could get commercially: tallow, hides, bristles, all
that sort of trade, and then they traded that off for their own
account. And for awhile the operation was fairly successful,
the C-47's and C-46'S.25
To finance this activity the lawyer for the airline organized a company,
Civil Air Transport, which was funded by a Panamanian corporation.
The two owners of Air America approached the Agency in
connection with a foreign operation in the spring of 1959, and indicated
that unless they received financial assistance, the airline would
go out of business.
A series of meetings were held subsequently in which it was determined
that the Agency needed to contract for air transport in some of
its operations, particularly those involving arms and ammunition.
And so we entered into an arrangement, I think in about September
of 1949 whereby we would advance them, the figure of
$750,000 sticks in my mind, against which we could draw for
actual use of the planes at an agreed on rate.... And we did
draw down, I think; all the flying time and expended the
$750,000 between September and about January, at which
time we suspended any further payments or draw-downs.
I think the money was exhausted.26
The owners came to Washington in early 1950 for a series of discussions
with the CIA. As a result of these negotiations, the Agency agreed
to advance more funds, and received an option to purchase the assets
of Civil Air Transport. Any unused portion of the advances was to
be credited toward the purchase price. Air America, operated under
this arrangement until the owners "came in in the summer of 1950
and said again they were in desperate straits for funds." 27 Another
series of meetings was held at the Agency in which it was concluded
that the operations in the Far East would ha,ve a continuing
need for secure airlift. There was also a general estimate that the loss
of this airlift to the Chinese Communists would substantially assist
them. Thus "the Agency then made the decision that they would exercise
the option given there was no objection otherwise." 28
The Agency felt that it was necessary to obtain approval from the
Department of State, so the head of the 'CIA's Office of Policy Coordination
(who was responsible for conduct of covert actions) and Mr.
Houston visited the Assistant Secretary of State for the Far East:
He and I went to see [the Assistant SecretaryJ and explained
the situation. And [heJ reminded us that it was basic U.S.
policy not to get the government in competition with U.S.
private industry. But under the particular circumstances, in
particular as there was really no U.S. private industry in-
26 Ibid., p. 6.
m Ibid., pp. 7-8.
27 Ibid., p. 8.
.. Ibid., p. 9.
221
yolved in the area. and they agreed it ,,'as important to deny
the assets to the Red Chinese. State wOllld go along on the
understanding that ,,'e wOllld divest ourselves of the private
enterprise as soon as such a divestment ,,'as feasible, and
all of the circumstances that might obtain.29
The divestiture of these air proprietaries was not initiated until
1975, and some of the entities haye not yet been fully diYested. Mr.
Houston noted, howeYer, that:
'Ve did not disregard that guidance because after very considerable
use of this asset during the early '50's, there was a
question of whether to continue it, and the matter was taken
up in the National Security Counci1. And Allen Dulles, as
Director, proposed that we continue the ownership and control
of the assets of Air America, as it then was known including
the subsidy as needed. And there was a subsidy at that
time.... It was about $1,200,000 per year.30
The National Security Council considered whether this asset should
be retained in 1956 and, on Dulles' recommendation, decided to continu~
the subsidy to Air America.
The air proprietary's business consisted almost entirely of Agency
cargo carnage under contracts carrying military designations. The
company was not organized, according t.o Houston, to fly common
carriage and had no status in the international air business. The evidence
indicates that during the early 1950s, there were two i~ternal
struggles: one was where control should lie in the Agency, and the
other was what policies should apply to the operation of the company
itself :
The struggle within the Agency ranged all the way from
sort of quiet management disc\l.ssions as to what was good
management, to som6times rather vociferous arguments of
who's in charge here. And the operators always said, "Well,
we need to call the shots because it's our operation. . . . And
this is what we were running into all the time, of red hot
operators opposed to what we would consider good management.
3 !
The air proprietary was managed by elements of the Office of Policy
Coordination. From the very outset there were problems in this management
structure. One such example is the acqnisition of Air America
in AUP'ust HlilO. Honston was participating in the negotiations at
the invitation of the Head of the Office of Policy Coordination.
OPC was a curious organization, determined as being
attached to the Agency for quarters and rationing with policy
.. Ibid., pp. 9-10.
30 Ibid.. p. 10.
Houston indicated that there had hel'n a subsidy running to the entities since
1949. "$1.2 million represented about the maximum subsidy given until, I believe,
about 1958 was the turning point, and from ]958 on, there was no subsidy as such
that went into it." The reason for that, of course, was that the air complex had
become "money-making."
31 Ibid., pp. 12-13.
222
guidance from State, which was an impossible situation.
Very nice fellows were doing the negotiating with
[OPC] ... quite unknown to me, when they made the agreement
to purchase carrying out the option, they gave the
vendors the right to repurchase at any time within two years.
And I thought this was really inconsistent with our whole
position. And during the next two years they negotiated
out that repurchase agreement and in its place substituted
an agreement to give them a first refusal, if we were to dispose
of the airline. That first refusal plagued uS for years. They
used to make all sorts of extraordinary claims under it and it
was never exercised and eventually it was sort of forgotten
when [the owners] died. It ran to them personally, whether
it ran to them and two others personally, and they all are dead
now. But this shows a part of the learning curve, which was
the thing we were going through.32
In the summer of 1954. Houston and a consultant traveled to the Far
East to observe the operation. The consultant went "specifically to
look at the organization of the airline." At the time of the airline's
purchase, the Agency had formed a Delaware corporation to buy it.
The corporate counsel and the consultant were both very concerned
about the technical organization, or lack of it, in the operation. According
to Houston, they demonstrated:
to my satisfaction that it was an absolute situation and that
no one out there had the slightest understanding of the
problem or what they were UP against, or wanted to do anything
about it [in terms of airline management].33
Following this review, a new organization, designed to be more
resnonsive to the Operations Directorate, was created.
Pacific Corporation held title to 40 percent of the equity in Air
America, while the remainder was ostensibly owned by Chinese, who
gave deeds of trust to the Agency for their shares. For purposes of
international law this overt arrangement demonstrated that the company
was majority-owned and controlled by Chinese.
Air America originally had several DC-4's and began modest operations
between Hong Kong, Taipei and Tokyo. The corporation soon
acquired DC-6's, and it was at this time that the question of competition
with private corporations first arose. Northwest Orient Airlines
was then flying to Tokyo, Seoul, and Manila. A Northwest executive
had noted the Agency's interest in this area when he was Chairman of
the Civil Aeronautics Board in the late 1.9405 and early 1950s. Houston
told the Committee:
He became head of Northwest, a very tight manager, a very
capable fellow, and he used to compl!ain that we were interferring,
we were taking passengers off his airline, and we
would go to him and say, we have to keep the airline in this
business because the Chinese say they need an international
airline. They're not ready to sbart their own yet. And it is
., IMd., pp 13-14.
lIS Ibid., p. 17.
223
necessary to its overall cover status as a going commercial
COnCklITl.34
By 1959 the executive had decided to ask the Civil Aeronautics
Board for a decision. A meeting was held with the entire Board, where
the executive maintained "that he was a private industry, he should
not be interferred with by government competition." 35 The Agency
explained its situation, the need for cover, and their efforts to restrict
carriage to the minimum necessary to retain their cover.
And it ended up by one of the members of the Board turning
to [the executive] and saying, "You ought to be glad that
you don't have 'a really good, reliable competitor in there."
He said, "If you were being competed with by private business,
you'd have real headaches. You ought to be real glad
that it's not worse than it is." 36
In these proceedings, Houston conceded that some passengers were
traveling on CIA aircraft rather than Northwest planes, but maintained
that the impact was minimal and unavoidable. The CAB participated
in discussions with both the Agency and Northwest. After
hearing both sides, the CAB "came down on the side of the Agency
after making a reasoned judgment." 37
By 1960 the airline's international commercial business was not making
money. Maintenance work in Taiwan, however, was "normally a
money-maker, and this was [contracted] primarily, although not
exclusively, with the U.S. Air Force." 38
There were management problems in the maintenance operation,
which originally stemmed from the fact that field personnel were not
particularly astute in setting costs for their contracts. Houston cited
one instance when the Af!:ency consultant replaced a corporation comptroller
who was very able, but "had his own ideas of bookkeeping and
controls." The consultant insisted that the corporation implement
bookkeeping practices and controls consistent with CAB and FAA
regulations. The military maintenance contra0ts were constantly
audited by on-site teams.39
In the early 1960s, the CIA received an exemption from the Contract
Renegotiation Board on the grounds that renegotiation personnel
might recognize that Air America waS not a commercial operation
and discover that the CIA was involved. The Agency went to the head
of the Contract Renegotiation Board with a letter from the Department
of Defense requesting an exemption on what it considered "perfectly
legitimate grounds." 40 There was indeed a basis for exemption
under the Renegotiation Act as the business was conducted entirely
overseas, and the exemption was granted. The Agency was concerned
that it had made a type of profit (over 40 percent on the Air Force
maintenance contracts), which may well have been the subject of rene-
" Ibid. p. 21.
35 Ibid., p. 22.
.. Ibid. pp. 22-23.
'" Ibid., p. 24.
38 Ibid., p. 25.
31l Ibid., p. 26.
'" Ibid.
224
gotiation, had it not been subject to the exemption. "So the question
was what to do about it. And finally, we made a voluntary repayment
against part of the profit on that contract to the Air Force." 41
As noted previously, the commercial airline aS1)ect of the operation
operated mostly at a loss. While there were periods when Air America
cargo carriers were very busy on CIA contracts, the Korean War,
Diem Bien Phu, and other paramilitary operations; there were also
periods between these activities when there was nothing for the airlines
to do. During these periods of inactivity, the airline was still
saddled with expenses such as crews' salaries and the maintenance of
grounded aircraft. To alleviate this problem,
... we finally organized the stand-by contract, which was an
apparent military entity on Okinawa. It was our entity, but
it had a military designation. I can't remember the name for
it. And that entity contracted with Air America for so many
hours of cargo stand-by to be available any time on call, and
that they would pay so much for that capability being maintained
... so that'is how we kept the subsidy going to maintain
them during periods when there was not profitable
flying. 42
Another area of concern was the proprietary's relationship with the
Internal Revenue Service. From the outset, the company's management
was informed that they would be required to pay appropriate
taxes, While there were the usual arguments about whether certain
items were appropriate for taxation and whether certain deductions
should have been granted, the relationship maintained with the IRS
was basically a normal one.
Houston recalled that in the mid-1950s Air America received notice
of an upcoming- audit by the IRS. Company officials came to the
AQ"ency and indicated that this might pose a security problem. The
CIA went to the Commissioner of the Internal Revenue Service and
indicated that they wished to have the audit conducted by an IRS
team on an unwitting basis to see what they could learn. "We thought
it would be a good test of the security of our arrangements." 43 Later,
the IRS personnel would be notified'that they had begun to audit an
Agency proprietary, and the audit would be discontinued:
They put a very bright young fellow on and he went into
it. Thev came up with discrepancies and things that would
be settled in the normal tax argument, corporate-IRS argument,
and all of these were worked eventually, and then we
went to this fellow and said, "Now, thiR was owned and
backed bv the CIA, the U.S. Government. What was your
guess as to what was happening?"
And he said, "Well, I knew there was something- there. and
I thought, what a wonderful asset it would be for the Russians
to have. bnt I came to the conclusion that it was Rockefeller
money." 44
41 Ihid., p. 27.
.. Ibid., p. 29.
-Ibid., p. 30.
.. Ibid.
As the operations of Air America developed, problems arose involving
large cargo carriers. In the early days of its operation the
airline used C-54's, which had an extremely limited range, but were
able to perform under demanding circumstances. Discussions proceeded
during that period about modernizing the equipment and the
Agency, through Air America, bought DC-6AB's. These aircraft were
a conversion of the DC-6 with large cargo doors installed. Air
America did not maintain any jet equipment at that point.
In the early 1950's Air America became deeply involved in a military
Air Transport System. This system was originally known as
MATS, and later as MAC.
They got MATS contracts, and Air America got these, and
these were very good to keep a constant utilization at a good
rate, the MATS rates were usually good, because the policy
was not to do competitive bidding for the lowest bidder because
then you got the poorest service, but give good rates to
the carriers, and then require the carrier belong to the Civil
Reserve Air Fleet.45
In 1956 MATS changed its policy and required that bidders on their
contracts be certified. Becailse Air America could not become certificated,
the Agency decided to purchase Southern Air Transport.
While this corporation was technically a separate entity, not involved
with Air America, it was actually an integral part of the complex
from a management perspective. All management decisions for Southern
Air Transport were made by the same CIA consultant and advisory
team that established Air America policy.
Eventually, MAC decided to require that bidders not only be certificated,
but that they also have equipment qualified for the Civil
Reserve Air Fleet, i.e., jet aircraft. As a result, the Agency acquired
Boein.-r 727's and convinced Boeing to modify the 727 by enlarging the
ventral exit, enhancing its airdrop capability.
So the theory was that the 727's would be used on MAC contracts
to be available on an overridin~ basis if needed for
major national security operation. The" were l1"ed, u"ually
when they had spare time. To my recollection, they were
only called off once, off the actual contract time, and this was
for a possible use which didn't frO through. But the White
House asked if we had the capability to move something from
here to there, I think from the Philippines to somewhere
in Southeast Asia. I don't recalL and so they sent word to
mana~ementthat they wanted a nlane available at the earliest
onnortunitv at Clark Field. Thev nulled one of them off the
MAC contract and had it available. I think readv to go, in
twelve hours. an set for the operation. And the' operation
was never called. But it showed "hat the canabilitv was. And
what thev had to do was get substitute service for the MAC
contract.46
During the late lll60s several (;hinese airlines bpP'1ln operations on
a limited scale. With the establishment of these indigenous airlines
"lhM.• 3R.
.. Ibid., p. 89.
226
flying Far East routes, the CIA considered reducing its international
carriage work. The Agency decided to retain the MAC contracts because
they did not compete with the native enterprises, but plans to
reduce Air America's international common carriage were initiated.
Another CIA proprietary, Civil Air Transport Company, Ltd.,
which had been organized in 1954, had been the first Agency entity
to engage in common carriage. Later, Air America did the American
contracting, followed by Southern Air Transport which also performed
MAC and MATS contracts with planes leased from Air
America.47
Houston noted that in the late 1960s an internal decision was made
that:
... we probably couldn't justify this major airlift. with the
big jets, and so we started getting- rid of them. See, they had
no utilization to speak of down in Southeast Asia. A couple
of supply flights went into [another area] and I think we used
prop planes for that, to my recollection.47a
So the Agency began to phase out the 727s, which contributed to the
decision to divest itself of Southern Air Transport and Air America.
Internal management was streamlined in 1963 by the establishment
of an executive committee consisting of the boards of directors of the
Pacific Company, Air America and Air Asia. The overt board of
directors in New York City passed a resolution organizing an overt
executive committee, which consisted of the CIA consultant and
two other directors. Covertly, the Agency added its own representatives
to this committee, which allowed representatives of management,
Agency and the operators to meet, consider policies. and gIve
guidance to the company. Houston indicated that this mechanism
was extremely effective in controlling the company:
So I think for the last, oh, fifteen, eighteen years, the proprietary
management system was on the whole pretty effective
from the Agency point of view. I think we knew what
was going on. I think we were able to get things up for decisions,
and if we couldn't resolve them at the staff level,
we would take them up to the Director for decisions; quite
different from the early days in the early 50's that I described,
and the operators at least made the claim that they
had the right to call the tune.48
Dming this period of time Operations Directorate personnel
were getting themselves involved in the acquisition of aircraft
and which were getting awfully damned expensive at
this time, and separate projects were going after some of this
expensive equipment without consideration of what might
be available elsewhere to the Agency by contract or old aircraft.
And so the Director of Ceritrai Intelligence set up
EXCOMAIR, of which I was Chairman, and had representation
from both the operation and management and fi-
<7 SAT actually owned one 727 and leased two from Air America.
<.. Ibid., p. 42.
"Ibid., pp. 46-47.
nance out of the Agency, to try and coordinate the overall
control and acquisition and disposition of aircraft.49
A February 5, 1963 memorandum entitled "Establishment of Executive
Committee for Air Proprietary Operations," noted that the committee
was "to provide general policy guidance for the management of
air proprietary projects, and review and final recommendations for
approval of air proprietary proiect actions." Houston indicated that
this committee, dubbed EXCOMAIR, "was ... an amorphous
group" which worked on a very informal basis. He indicated that
EXCOMAIR was an effective method of achieving overall coordination;
it was responsible for conducting a thoroug-h inventory of all the
equipment that the Agency had in the aviation field and was generally
able to keep track of who needed what.50
According to Houston, a general shift in thinking at the Agency
occurred between 1968 and 1972 as to the desirability of maintaining
a substantial airlift capability. The records appear to indicate that
Houston convinced the Director in the early 19708 that such a capacity.
was no lonQ.'er necessary to retain. Houston commented on this assessment
as follows:
Through what knowledge I had of the ntilization of the various
assets, it seemed to me that utilization, particularly
of large assets, that is, heavy flight equipment, was going
down to the point where there was very little of it. Consequently,
we couldn't forecast a specific requirement. Such
requirements as you could forecast were highly contingent.
But I also remember a couple of times putting the caveat into
the Director that with a changing world and with the complications
in the aviation field, once you liquidate it, you could
not rebuild, and so you ought to think very, very carefully
before getting rid of an asset that did have a contingent
capability.51
Allegation of Drug Traffickinq.-Persistent questions have been
raised whether Agency policy has included using proprietaries to
engage in illegal activities or to make profits which could be used to
fund operations. Most notahly, these charges included allegations that
the CIA used air proprietaries to engage in drug trafficking. The
Committee investigated this area to determine whether there is any
evidence to substantiate these charges. On the basis of its examination,
the Committ~ has concluded that the CIA air proprietaries did not
participate in illicit drug trafficking.
As allegations of illegal drug trafficking by Air America personnel
grew in the spring and summer of 1972, the CIA launched a fullscale
inquiry. The Inspector General interviewed a score of officers at
CIA headquarters who had served in Asia and were familiar with the
problems related to drug trafficking. After this initial step, the Office
of the Inspector General dispatched investigators to the field. From
August 24 to September 10, 1972, this group travelled the Far East
.. Ibid., p. 51.
OG Ibid., p. 52.
til Ibid., p. 57.
228
in search of the facts. They first visited Hong Kong, then eleven
Agency facilities in Southeast Asia. During this period they interviewed
more than 100 representatives of the CIA, the Department of
State, the Agency for International Development, the Bureau of Narcotics
and Dangerous Drugs, the U.S. Customs Service, the Army, Air
America, and a cooperating air transport company. .
This inspection culminated in an Inspector General's report in September
1972, which concluded that there was
no evidence that the Agency, or any senior officer of the
Agency, has ever sanctioned or supported drug trafficking
as a matter of policy. Also, we found not the slightest suspicion,
much less evidence, that any Agency officer, staff or
contract, has ever been involved in the drug business. With
respect to Air America, we found that it has always
forbidden, as a matter of policy, the transportation of contraband
goods aboard its aircraft. We believe that its Security
Inspection Service, which is used by the cooperating air
transport company as well, is now serving as an added deterrent
to drug traffickers.52
But there were aspects of the situation in Southeast Asia which were
cause for concern:
The one area of our activities in Southeast Asia that gives
us some concern has to do with the agents and local officials
with whom we are in contact who have been or may be still
involved in one way or another in the drug business. We are
not referring here to those agents who are run as penetrations
of the narcotics industry for collection of intelligence on the
industry but, rather, to those with whom we are in touch in
our other operations. What to do about these people is a particularly
troublesome problem, in view of its implications
for some of our operations, particularly in Laos.53
The Inspector General noted that there was a need for better intelligence
not only to support American efforts to suppress drug traffic in
Southeast Asia, but also to provide continuing assurance that Agency
personnel and facilities were not involved in the drug business.
His report began by placing the allegations against the CIA in .historical
perspective. It allowed that when the United States arrIved
in Southeast Asia "opium was as much a part of the agricultural infrastructure
of this area as was rice, one suitable for the hills, the other
for the vallevs." 54
The record before the Inspector General clearly established that official
United States policy deplored the use of opium as a narcotic in
Southeast Asia, but regarded it as a problem for local goverr~men~s.
It was equally clear that Agency personnel in the area reco~lllzed Its
dangers to U.S. paramilitary operations and "took steps to dIscourage
.2 CIA Inspector General's Report, "Investigation of the Drug Situation in
Sontheast Asia." 9/72, p. 2.
M Ibid., pp. 2-3.
50 Ibid., p: 5.
229
its use by indigenous paramilitary troops." 55 For example, Meo troops
were ejected from various camps when they were caught using the
drug. But, the 1. G. noted:
We did not, however, attempt to prevent its use among the
ci vilian population in those areas where ,ve exercised military
control, believing that such intervention would have been resisted
by the tribals with whom we were working and might
have even resulted in their refusal to cooperate.56
Nor did the Agency interfere with the movement of the opium from
the hillEl to market in the cities farther south. In this regard, the LG.
remarked candidly:
The war has clearly been our overriding priority in Southeast
Asia and all other issues have taken second place in the scheme
of things. It would be foolish to deny this, and we see no
reason to do SO.57
Although it maintained this posture, the CIA was reporting information
on opium trafficking lOllg before any formal requrements
were levied upon it. As far back as the mid-i960s, when CIA case
officers began to get a picture of the opium traffic out of Burma as a
by-product of cross-border operations, they chronicled this information
in their operational reporting. As more information came to light
in Laos and Thailand, this information began to appear in intelligence
reporting. Indeed, the Agency "had substantial ascets [in two Southeast
Asian countries, which] could 'be specifically direcled against this
target when it assumed top priority in 1971." 58
Air America
As early as 1957, Air America's regulations contained an injunction
against smuggling. This regulation later came to include opium. The
Report indicated that the airline's effort at this time was concentrated
on preventing the smuggling of opium out of Laos on its aircraft.
Although still not a crime in Laos, shipment of opium on
international flights was clearly illegal and was grounds for dismissal
of any pilot or crew member involved. The Inspector General stated
that:
Air America has had a few cases of this kind (all of which
are documented in the files in the Agency) and has, in each
case, taken prompt and decisive action upon their discovery:·
Air America was less able to control drug traffic involving its aircraft
within Laos. Although it had a rule that opium could not be carried
aboard its planes, the only thing that could be done if the rule was
violated was to put the opium and its owner off at the nearest airstrip.
.. Ibid., p. 6.
56 Ibid.
57 Ibid.
The report related a sta'tement of a case officer which typified the CIA position
in the matter during the period 1966-1968. The officer said that he "was under
orders not to get too deeply involved in opium matters since his primary mission
was to get on with <the war and not risk sonring relations with his indigenous
military counterparts by investigation of opium matters."
58 Ibid, p. 7.
liB Ibid-.
230
Moreover, as a charter carrier, Air America did not have full control
over its traffic. It hauled what its customers put on the aircraft. Air
operations officers, in the case of Agency traffic, ",ere responsible for
authenticatin~ the passen~ers and cargo they wished to put on the
plane. In some locations, the air operations officers had to rely on
indigenous assistants for much of the actual details of preparing manifests,
checkin~ car~o, and supervising the loading of the aircraft. In
areas where active military operations were in progress, this process
could become cursory if not actually chaotic. In such circumstances, the
Inspector General concluded that:
it was hardly fair to blame Air America if opium happened
to ~et aboard its aircraft. There is no question that it did on
occasion.60
With the realization that drug abuse amon~ American troops in
Vietnam was growing and that Southeast Asian heroin was finding
its way to U.S. markets, the CIA's early attitude toward the opium
problem be~an to chan~e. The Agency joined the effort that be~an in
1971 to halt the flow of opium and heroin from Burma, Laos, and
Thailand, and pursued a vigorous intelligence program against these
targets.
In tenus of staff and contract personnel, the Inspector General was
impressed that "to a man, our officers overseas find the drug business
as distasteful as those at headquarters." 61 Indeed, many of the CIA's
officers were restive about having to deal with Laotian officials who
were involved in the drug business:
One young officer even let his zeal get the better of his judgment
and destroyed a refinery in northwest Laos in 19'71 before
the anti-narcotics law was passed, thus risking being
charged with destruction of private property.62
But, the I.G. reported, CIA officers generally tolerated the opium
problem, regarding it as just another of the frustrations one encounters
in the area.
From what the Inspector General contingent was able to observe in
the field, "the pilots in the employ of Air America and the cooperating
air transport company merit a clean bill of health." 63 While it was
true that narcotics had been found aboard some of their aircraft, in
almost every case the small quantity involved could only have been
for the personal use of the possessor. The Inspector General felt that
Given the strict anti-contraband regulations under which
these two airlines have been operating for years, it is highly
unlikely that any pildt would knowingly have permitted narcotics
or any other contraband aboard his aircraft.64
Although they noted, "if it is a truism to say that they're in the
business for the money," the investigators concluded that these pilots
"Ibid, p. 8.
01 Ibid. p. 11.
albid.
• Ibid. p. 12.
"Ibid.
231
were deeply committed to their job, and that the subject of drugs was
as much an anathema to them as it is ''to any decent, respectable citizen
in the United States." 65
The Inspector General indicated how one pilot felt about the subject.
He stated:
You get me a contract to defoliate the poppy fields in Burma,
and I'll take off right now and destroy them. I have a friend
whose son is hooked on drugs, and I too have teenage children.
It scares the hell out of me as much as it does you and
the rest of the people in the States.611
The report also established that the pilots were well paid, averaging
close to $45,000 a year. Almost half of their salary was tax-free. In
this context the LG. concluded that
Althoug'h the temptation for big money offered by drugs cannot
be dismissed out of hand, it helps to know that the pilots
'are making good money. Further, an American living in
Vientiane can bank a substantial part of his salary without
much difficulty, and a common topic of conversation among
pilots is how and where to invest their fairly substantial
savings.67
The milieu in which these pilots found themselves did serve to evoke
images of them as mercenaries or soldiers of fortune. The Inspector
General indicated that a "number of them do like their wine and
'Women, but on the job they are all business and very much like the
average American." 68
The investigators, however, could not be as sanguine about the
behavior of the numerous other individuals who worked for Air
America and the cooperating air transport company as mechanics or
baggage handlers. The nature of their work allowed these employees
easy access to the airplanes, and created real opportunities for concealing
packages of narcotics in the airframes. The records indicated
that there were several instances where employees had been fired because
they were suspected of handling drugs. The Inspector General
advisd that:
Despite the introduction of tighter security measures, it
would be foolish to assume that there will not be any further
attempts by mechanics and baggage handlers to conceal narcotics
on airplanes.69
In a startling revelation concerning indigenous officials in Southeast
Asia, the LG. bitterly reported that
In recent testimony to Agency officers in Vientiane, Laotian
officials who had been involved in the dnlg' business stated
that there was no need for drug traffickers to use Air America
facilities because they had their own. We certainly found
'"' Ibid.
.. Ibid. p. 13.
ffl Ibid.
.. Ibid. p. 14.
III Ibid.
232
this to be true. In addition to the Royal Lao Air Force
(RLAF), there are several commercial airlines in Laos, including
Royal Air Lines, Lao Air Development, Air Laos,
and perhaps others, all of which evidently have ties with
high Laotian government officials. It is highly problematical
whether these airlines have a full platter of legitimate business.
70
Another factor which had the effect of making Air America a less
desirable target for the drug trafficker was that there were virtually
no regular, pre-arranged flight schedules for the pilots. Ordinarily,
the pilot did not know until he reported for duty which airplane he
would be flying or what his flight schedule would be for the day.
Air America's Security Inspection Service, which was established
early in 1972, also had five inspection units in Laos. Similar units
were eventually established elsewhere in Southeast Asia. Each unit
consisted of an American chief and three or four indigenous personel.
The baggage of the pilot and all passengers traveling in CIA-owned
aircraft was inspected in the presence of an American official before
anyone was permitted to board. All cargo was inspected unless it had
been exempted under established procedures. The very existence of
the system was consirlered a deterrent to drug smuggling on Air
America a,ircraft and did result in several discoveries of drugs among
the baggage of passengers, although only one or two of these involved
quantities of sufficient size to be as commercial.
Agent8 and A88et8
This is one area where the CIA is particularly vulnerable to criticism.
Relationships with indigenous assets and contacts are always
broad. In Laos, clandestine relationships were maintained in every
aspect of the Agency's operational program-whether paramilitary,
political action, or intelligence collection. These relationships included
people who either were known to be, or were suspected of being, involved
in narcotics trafficking. Although these individuals were of considerable
importance to the Agency, it had doubts in some instances.
For example, the investigators were troubled by a foreign official who
was alleged to have been involved in one instance of transporting
opium. He was evidently considered "worth the damage that his exposure
as an Agency asset would bring, although the Station insists
(a) that he is of value to the Station as an agent of influence [deletedl
and (b) that his complicity in the [deleted] incident has never been
proved." 71
Among lia,ison contacts, which in the military arena included virtually
every high-ranking Laotian officer, the Inspector General
warned that the Agency was "in a particular dilemma."
The past involvement of many of these officers in drugs is
well-known, and the continued participation of many is suspected:
yet their goodwill. if not actual cooperation, considerably
facilitates the military activities of the Agencysupported
irregulars. 72
'lO Ibid.
'll Ibid.
,. Ibid, p. 18.
233
The Inspector General concluded, that
The fact remains ... that om continued support to these people
can be construed by them, and by others who might become
aware of the association, as evidence that the Agency is not as
concerned about the drug problem as other elements of the
U.S. mission in Laos. The Station has recently submitted, at
headquarters' request, an assessment of the possible adverse
repercussions for the Agency, if its relationship to certain assets
were exposed. vVe think that. on the whole, that assessment
was unduly sanguine. We believe the Station should
take a new look at this problem, using somewhat more stringent
criteria in assessing the cost-benefit ratio of these relationships.
'Ve realize that it is impossible to lay down any but
the most general kind of rules in judging whether to continue,
or to initiate, a clandestine relationship with Laotians.
Each case has to be decided on its own merits, but within a
framework that attaches appropriate importance to its possible
effect on the U.S. Government's anti-narcotics efforts in
Laos. It is possible that the Station will need additional
guidance from headquarters as to current priorities among
our objectives in Laos.73
12. Nonoperating Proprietaries
Nonoperating proprietaries vary in complexity according to their
Agency task. They are generally corporate shells which facilitate foreign
operations and clearly pose no competitive threat to legitimate
businesses. The most elaborate are legally licensed and established to
conduct bona fide business.
All nonoperating proprietaries do have nominee stockholders,
directors, and officers and are generally directed by one of the Agency's
proprietary management companies. The company address may be a
Post Office box, a legitimate address provided by a cleared and witting
company official or private individual or the address of a proprietary
management company. The nonoperating proprietaries maintain bank
accounts, generate business correspondence, keep book~ of account
which can withstand commercial and tax audit, file Stnh and Federal
tax returns, and perform normal business l'rporting to I" gulntory
authorities. They are moderately capitalized, grnerally at around
$5,000, and their net worth at anyone time ntrips accord;n~: to the
Agency task they are performing. As of December 31, 1973, more '-hall
60 percent of the combined net worth of these proprietarir-s WllS operat·
ing capital for companies which provide cover to agency personneL
Legally incorporated companies require less elaborate commercial
Hoministration due to the nature of the tasks they perform for tIll'
CIA. This kind of proprietary is directly managed by headquartrI":
specialists operating in alias. No commercial book or accounts are kept,
and in the event of a tax audit the Agency has to brier the auditing authority.
Depending on use, administration may be as simple as maintaining
bank accounts and filing annual franchise taxes, or as extensive
.,. Ibid, p. 19.
207-932 0 - 76 -16
234
as that required to obtain Employee Identification numbers, to pay
personnel taxes, and to file tax returns.
There are also 8ole-proprietorships, which are proprietaries in the
sense of being Agency-owned and administered. The Agency establishes
and registers these sole-proprietorships. Arrangements are made
to provide an address for these entities. Like the proprietary corporations
administered by Agency Headquarters specialists, these companies
provide cover, salaries, and tax attribution for Agency
personnel.
Another type of entity used by the Agency is a proprietary only
in the sense of being Agency-owned and administered. These are
the notional companies which are not legally registered, but have
names and bank accounts controlled by the Agency. The Agency
arranges domiciliary addresses and any queries are referred to the
Agency specialists concerned. These notional entities are used to provide
status and operational cover for Agency personnel involved in
all types of high-risk intelligence operations.
C. OPER..<\TION OF PROPRIETARIES
1. Statutory Authority
The Agency's statutory authority to spend money for proprietary
corporations in support of Agency operations is derived from Section
8(b) of the CIA Act of 1949. This act states:
The sums made available to the Agency may be expended
without regard to the provisions of lawand regulations relating
to the expenditure of Government funds; and for objects
of a confidential, extraordinary, or emergency nature, such
expenditures to be accounted for solely on the certificate of
the Director and every such certificate shall be deemed a sufficient
voucher for the amount therein certified.74
The language contained in Section 8(b) is adequate authority to
exclude the operation of these proprietary corporation~fromthe law
governing Government corporations in 31 U.S.C. 841 et seq. However,
the CIA General Counsel ruled in 1958 that the CIA should
comply with the principles in that act to the extent possible, and this
has been done. A classified Memorandum of Law by the CIA General
Counsel on the Agency's authority to acquire and dispose of a
proprietary without regard to provisions of the Federal Property
and Administrative Services Act, outlines the CIA's position. This
position was upheld by the U.S. District Court in the Southern
District of Florida in dismissing the suit Farmer v. Southern Air
Transport on July 17, 1974.75 That result was not appealed and
remains the law.
'2. Specific Oontrols
The formation and activities of proprietaries are controlled through
various mechanisms to assure their proper use. These include internal
7< 50 usc 403(b) .
... See p. 246.
235
Agency regulations whic~l establish. the adm~ni~trat.iveprocedu:es to
be followed in the formatIOn, operatIOn, and lIqUIdatIOn of proprIetaries.
An Administrative Plan (specifying the operational p~rp~se, ~dministrative
and management procedures, and cost) and a LIqUIdatIOn
Plan (specifying details of liquidation and disposition of fnnds when
liquidation is contemplated) must be coordinated among the effected
CIA components and approve~ at a~propriate manageJ1.lent levels.
This regulatory control along WIth polIcy memoranda are mtended to
assure proper conduct by proprietaries. Each Agency component involved
in the operation of a proprietary enterprise is responsibl~ for
compliance. The Chief of the Cover and Co~mercial ~taff, the DIre~tor
of Finance, and the Comptroller are assIgned partIcular responSIbilities.
The controls and procedures applicable to each operating proprietary
specify that a proiect outline and an administrative plan must
be approved at the Deputy Director level. Routine control and administration
is executed by a project officer at Headquarters. The Agency
conducts semi-annual reviews to determine whether operational needs
still exist, and performs regular audits to assure proper management
and financial accountability. Proprietaries are liquidated as their usefulness
ends and new ones are formed as needed.
3. Treatment of Profit8
The CIA General Counsel ruled in January 1958 that "income of
proprietaries, including profits, need not be considered miscellaneous
receipts to be covered into the Treasury but may be used for proper
corporate or company purposes." 76 This subject was reviewed and the
opinion reaffirmed by the General Counsel in July 1965. The policy of
retaining profits has continued, although onlv a very few Agency proprietaries
have ever been profitable. The CIA's legafbasis for retaining
profits for the use of the operating eorporate entities is discussed below.
Section 104 of the Government Corporations Control Act provides
that Congress shall enact legislation necessary to make funds or other
financial resources available for expenditure and limit the use thereof
as the Congress may determine. It is further provided that "this section
shall not be construed as preventing the Government corporations
from carrying out and financing their activities as authorized by
existing law ..." 77 The legislative history explaining this section
of the act states tl>at "in cases where no other law required a congressional
authorization of expenditures, tl>e corporation, if it had means
of ~nancing other than anll1~al appropriations, could continue to operate
m the absence of any actIOn by Congress on its budget program." 78
The ~tatutecreating a particul~r Government corporation may provide
speCIfically how that corporatIOn may use its profits in the conduct of
its business.
The Government Corporations Control Act clearly did not contem~
late Government corporations of the type that the CIA has establIshed.
Furthermore, it is not feasible for Agency proprietaries to be
created by act of Congress or overseen precisely as provided for normal
: CIA Genpral Counsel Memorandum of Law, 1/6/58.
31 U.S.C. 8'19.
'IS Senate Banking and Currency Committee Report 694,11/2/45.
236
Government corporations in the Act. Nevertheless, the Agency has
felt that the appropriate and reasonable policy would be to treat and
control proprietaries in accordance with the tenus of the law. The
Agency maintains that there is no need to have more restrictive rules
applied to its corporations in the use of funds, including profits, than
are applied to government corporations under existing statute. Thus,
the Agency considers the use by a proprietary of its earnings to carry
on its corporate affairs without an offset against Agency appropriations
to be a legitimate practice which does not constitute an illegal
augmentation of appropriations.
With rare exception, operating proprietaries have not been selfsustaining
from real income. Income, including profits, is retained b;r
the proprietaries consistent with the usual operating practices of bUSIness
enterprises.
The use of proprietaries' profits is controlled by annual CIA reviews
and audits of the total capital, investment and profits situations in the
context of operational objectives and cover needs of the corporations.
The CIA maintains that, 'in effect, the annual project review is based
upon an audit as searching as that required for statutory government
corporations. While this may be technically true, such audits do not
raise broad questions of pro~ram duration and effectiveness.
There is no broad management audit in program terms, but rather only
a financial audit to determine essential security and integrity. Moreover,
there have been no outside audits of any kind, especially those to
determine performance and eflectiveness. One former CIA employee
intimately involved with this process suggested strongly that these
provisions were inadequate. This needs to be rectified, and the Committee
recommends that such audits be reported to the new legislative oversight
committee.79
4. Disposition of Funds
Any proprietary with funds in excess of its current or foreseeable
needs is required to return such funds to the Agency. Funds generated
by the liquidation or termination of a proprietary are returned to the
Agency, except in a limited number of situations when they are transferred
to another proprietary for "similar use." On the basis of a CIA
General Counsel opinion of February 3, 1975, the Agency has revised
its policy on the treatment of all returns of funds from proprietaries.
All such returns are to be remitted to the United States Treasury as
"Miscellaneous Receipts." Prior to this change in policy, returns were
treated as refunds of the previously recorded expenses, up to the
amount of such expense for a particular proprietary with any excess
amounts returned to the Treasury as "Miscellaneous Receipts." 80
D. THE DISPOSAL OF PROPRIETARIES
1. 01)erview
The Agency has emphasized the degree to which the extensive proprietary
system it has maintained in the past has been disposed of in
recent years. According to the current Chief of the Cover and Com-
,. See Recommendation 50.
80 See Recommendation 52.
237
mercial Staff, at least as far as large proprietaries are concern.ed,
"because of multitudinous reasons they will be viewed as the solutIOn
of last resort.81 Size was a problem and made it "inevitable t.hat cover
would not last." Moreover, there simply is not a need, accordl.ng t? the
Agency, for the kind of capabilities supplied by an Air AmerIca mther
now or in the foreseeable future. In thIS regard, th~ Agency has also
indicated that no "real proprietaries" are m plannmg because there
are no such operational requirements before the Cover and Commercial
Staff.
The Committee has learned from its study that the Agency retains
the capability "in being" to create large prop~ietaries.82 Moreover,
numerous "shelf" corporations are kept avaIla~le to p~ovlde
cover. These entities are generally of the notIOnal vanety whIch do
not compete with legitimate enterprises. Nonetheless, the Agency has
emphasized the need to maintain this general vehicle for at least one
purpose: to retain assets. Notionals are a very effective cover mechanism
when they are small, and can be very effedive in securely providing
various support items. In addition, the Chief of the Cover and
Commercial Staff told the Committee that, in order to carry out operational
functions, the CIA needs a variety of tools:
We need a variety of mechanisms. We need a variety of
cooperating personnel and organizations in the private
sector.
Proprietaries, in the largest sense as we have used it
throughout these investigations, are part of this arsenal of
tools that the Agency must have in order to fulfill its job.
I said earlier on this morning that on the basis of our experience
with proprietaries we have come to the conclusion
that wherever possible we try to use other means of providing
cover and hiding the CIA hand than proprietaries.
But where there is no other way, or where it is the best way
in order to achieve the operational objective, we have used
proprietaries in the past and we propose to continue to use
proprietaries. So we are not getting out of the proprietary
81 Chief, CCS, 1/27/76, np. 15-16.
The Deputy Director of Operations noted recently in testimony:
"I think by and large that the day of the big proprietary is over. We have
attempted over the past few years to try to squeeze down on those kinds of proprietaries
and I think we have really gone now to a fairly small number, and
a fairly tightly controlled gTOUp of proprietaries who are doing legitimate operational
jobs, particularly in the media field.
"Our experience with proprietaries in the past has been if left by themselves,
they tend to absorb larger and'larger amounts of government money and are not
particularly for a business. They are not very viable in the business sense and
qUic~ly ?ecome suspect as not having any commercial validity. And we have,
I thmk III the past ten years, we have in this past ten years gottE'n rid of an
enormous number of proprietaries in this field. I don't foresee us getting in the
immediate future into any expansion of that proprietary record. I think we are
ahout right in terms of where we are now."
"'The DDO clOf~Pd hi~ rerE'nt testimony with a raveat:
"I can visualize. howevE'r, depending on what hapPE'ns to the AlrE'ncy in the
f~turE'. t~e possibility that :VI' ~ight want. to use more proprietarIes. particularly
III the field of cover If thIS lrets terrIbly tight or terribly difficult. But
the avera.goe operational 1n~rflose. except for some of these medin operations, an
we need IS cover and I thmk that most of the proprietaries that we have fall
into that category."
238
business as such. But it is true that the proprietaries that
we are using at the present time and what I can foresee for
the immediate future is going to be of a smallish variety.83
The former General Counsel of the CIA, Lawrence R. Houston, concurred
in this judgment. It should, he said, be used only as a "last
resort." 84 The Chief of CCS noted that these operations are run for
specific purposes unrelated to profit and that, "I am not in the business
to make money." 85
Only two proprietaries, the insurance complex and Air America,
returned continuing profits or did large volumes of business. For
this reason, the Committee sought to discover if the CIA would ever
again seek to establish a large proprietary conglomerate such as the
Air America complex. The Chief, CCS responded in this manner:
These kind of facilities, any kind of facilities of this
kind get established and are used because they are needed in
the pursuit of an existing operational requirement.
If such an operational requirement should again arise, I
would assume that the Agency would consider setting up a
large-scale air proprietary with one proviso-that we have a
chance at keeping it secret that it is CIA."
Mr. Houston noted that he did not believe it was possible to keep such
an activity secret:
I'll answer to that. I don't believe it's possible. The aviation
industry, everybody knows what everybody is doing and
something new coming along is immediately the focus of
thousands of eyes and prying questions, and that combined
with the intricacies of a corporate administration these days,
and the checks and balances, I think make a large aviation
proprietary probably impossible .... I don't think you can do
a real cover operation, is my personal assessment.8T
The Committee reviewed those proprietaries which had been sold
or otherwise disposed of during the period from 1965 to 1975. It sou~ht
to discover which of those proprietaries disposed of in the last ten
years maintained a significant relationship with the Agency by contract
or informal understanding. More specifically, the Committee
sought answers to the following questions:
(1) How have proprietaries been disposed of by the
Agency~
(2) Have proprietaries or their assets been sold to persons
who had previously served as directors, officers or employees
of the proprietaries ~
(3) How often were proprietaries sold pursuant to an
agreement or understanding that the purchased proprietary
would provide the Agency with goods, services or other
assistance ~
sa Chief. CCS, 1/27/76, pp. 19-20.
Il6 Houston, 1/15/76. p. 5.
.. Chief, CCS. 1/27/76, p. 80.
.. Ibid.• p. 21.
mHouston, 1/27/76, p. 21.
239
Our study revealed that during the indicated period, a large number
of proprietaries were dissolved, sold, or otherwise disrosed of,
thus substantiating the Agency's claim that it had moved declsi vely to
extricate itself from this area of activity. In a very real sense, it is
nearly impossible to evaluate whether a "link" still exists between the
Agency and a former asset related to a proprietary. In some cases,
even though formal and informal Agency ties are discontinued, social
and interpersonal relationships remain. The impaCit of such liaisons is
difficult to assess.
At its peak, Air America, the Agency's largest proprietary, had
total assets of some $50 million and directly employed more than 5,600
individuals (the total number of employees for the Air America complex
was in excess of 8,000). The company is in the process of being
liquidated because it is no longer required. The Air America complex
included a number of other companies with the Pacific Corporation
as the holding company. The general plan for liquidation of Air
America is for the Pacific Corporation to sell off Air America, Inc.,
and its affiliates. A private New York firm was engaged to estimate
a fair market value for the complex. Although the Agency conducted
an intensive search for competitive bidders, it was able to
find buyers for only one- of the affiliated companies. The sale of this
company was closed on January 31, 1975. The remaining parts of
Air America are being liquidated by sale of individual assets upon
completion of existing contracts. Funds realized from the sales could be
as much as $25 million and will be returned to the Treasury.
Agency financial support for Radio Liberty and Radio Free
Europe, both sizeable proprietaries, was terminated in FY 1971 and
responsibility for their funding and operation vms assumed by the
Department of State.
Southern Air Transport was sold on December 31, 1973 because
its contingency capability was no longer needed. The Agency realized
$6,470,000 from this sale, of which $3,345,000 was in cash (including
a $1.2 million award in arbitration of a dispute over the proceeds of
the sale of an aircraft by Southern Air Transport after the sale of
the company by the Agency). The purchaser paid the balance to Air
America to retire a debt owed by Southern Air Transport. A group
of employees of Southern Air Transport filed a civil action dif'puting
the propriety of the sale of the company by the Agency, but the case
was dismissed with prejudice on July 17, 1974 by a Federal court.
Most of the entities of which the Agency has divested itself were
either sold or given to witting individuals (former officers, employees,
managers, contractors, etc.). A handful were sold or given
to witting individuals who had no formal relationship with the proprietary.
In several cases, transfer of the entity was conditioned as an
agre~ment that the proprietary woul~ continue to provide goods or
serVIces to the CIA. Other methods wlllch have occaSIOnally been used
to dispose of entities include: merger with another Agency proprietary;
transfer or sale of a proprietary to another Government
department; and liquidation, with the remaining assets of the proprietary
being given to previously uncompensated participants in the
venture, or to other Agency proprietaries.
240
2. The Sale of Southern Air Transport, 1rw.
Southern Air Transport Incorporated (SAT) is an American air
carrier, incorporated in the State of Florida on October 31, 1949.
From its inception until its purchase in 1960 by the Central Intelligence
Agency, it was privately owned. It was purchased by the CIA
on August 5, 1960, and owned by the CIA through December 31,
1973 when the Agency sold the firm back to one of its original owners.
The decision to acquire Southern Air Transport was triggered by
a change in the regulations governing the award of Military Air
Transport Service (MATS) contracts. On April 1, 1960, Air America
had begun flying a seven month MATS contract operating out of
Tachikawa Air Force Base in Japan, to other Pacific locations. In
June of 1960, the Department of Defense and the Civil Aeronautics
Board changed the regulations governing the awarding of MATS
contracts to require that bidders hold at least a Supplemental Certificate
of Convenience and Necessity for an air carrier and that they
participate in the Civil Reserve Air Fleet Program. Air America
did not meet either of these new criteria and could not obtain appropriate
waivers.
The Air America heavy airlift capability represented an American
asset for use in future operational contingencies throughout the Far
East area. Loss of the MATS contract would result in underutilization
of aircraft and air crews, and the revenues were needed to
sustain these assets. Therefore, the CIA proposed that either Air
America s~lOuld obtain the necessary certification, or that the Agency
should buy another commercial firm that already held these certifications.
The October 1, 1960 contract date, the need for public hearings,
and lengthy proceedings militated against Air America applying
for the certificate. In order to avoid lengthy public hearings,
which would be time-consuming and generate public exposure, it was
decided that the ownership of the company to be acquired must be
kept completely separate from Air America. This solution was concurred
in by the CAB, DOD, the CIA, and Air America management.
It was anticipated that if the new comprmy were awarded an ongoing
MATS contract, it would actually perform the flying service
but would use equipment under conditional sale from Air America
and would employ personnel transferred from Air America. Under
ipter-company agreements Air America would provide all maintenance
work, ground handling, and other services for which it would
be reimbursed by the new company. In this wav, Air America would
share in the revenues generated by the MATS contracts. The proposal
to purchase a supplemental carrier and operate it under the
ahove arrangement was approved by Direotor of Central Intelligence
Allen Dulles on .Tuly 15, 1960. Funds from the Clandm:tine Services
budget for FY 1962 were made available for the purchase.
After World War II there had been over 200 supplemental carriers
in existence. By 1960 only 18 were still operating. Air America management
made a survev of the 18 and determined that Southern Air
Transnort in Miami, Florida, was the most attractive as a purchase
possibility. It operated two C-46s-one owned, one leased-between
241
Miami and points in the Caribbean and South America. Its associated
company owned the four acre property on which SAT was located.
Moreover, it operated at a modest profit and had no long term debts.
Negotiations for the purchase of SAT were successful and on August
5, 1960, the CIA exchanged $307,506.10 for all outstanding shares
of capital stock of SAT and its real property owning affiliate. The
Agency owned these shares in the name of a former board member of
Air America.
Under CIA management Southern Air Transport operated with
two semi-autonomous sections: the Pacific and Atlantic Divisions. The
Pacific Division performed the MATS contract and supported Agency
"heavylift" requirements in East Asia. The Atlantic Division continued
to operate in the Caribbean and South America; doing the
same sort of flying SAT had done prior to Agency acquisition. The
Atlantic Division was also able to furnish support for certain sensitive
operations. At the peak of its activities, the SAT fleet, comprised of
both owned and leased aircraft, included Douglas DC-6, Boeing 727,
and Lockheed L-100 Hercules aircraft.
The Sale
In 1972 it became apparent that the Agency's air capabilities exceeded
its needs, and that political realities and future operational requirements
in the post-war era of Southeast Asia would not require
large air proprietary assets. On April 21, 1972, the Director of Central
Intelligence authorized the divestiture of CIA ownership and control
of the Air America complex and Southern Air Transport. He approved
recommendations calling for: Air America to be retained until the
end of the war in Southeast Asia; the immediate elimination of the
Pacific Division of SAT; the sale of two 727 aircraft leased to SAT
by Air America; and subsequent divestiture of Agency ownership
and control of the remainder of SAT.88 Specific note was made that
conflict of interest should be avoided and that no employee should
receive a windfall benefit as a result of these transactions.89
In May 1972, two Agency officials met with the Chairman of the
Civil Aeronautics Board and his Administrative Assistant to seek
informal advice as to the best way to disengage from SAT. Three
alternatives were discussed: (1) dissolve the company and sell the
assets; (2) sell the assets to the current operators of thl' company;
(3) ~ell SAT to, or merge SAT into, one of the other supplemental
carrIers.
The CAB chairman discouraged option (3) because it would involve
public hearings and would be subject to criticism by the other
supplementals : Option (1), although least troublesome from the legal
88 The Director determinpd that "we no longer should retain air proprietaries
purely for contingpnt requirements and that on the record, therefore, the Agency
should divest itself of the Southern Air Transport complex entirply." He stated
that the desirable course of action would be dissolution, although }:Ie realized
that the prohlpms were many and complex. AI'o. he did not rule out other solutions
which might achieve the end and yet better satisfy the interests of all concerned.
.. A condition imposed by the DCI was that "in the disposition of any of the
assets involved nothing inure to the benefit of Agency employees or former employees
or persons whose relationship with the Agency has been or is of such
a nature as might raise a question of conflict of interest."
242
and security standpoints, \vould further reduce the shrinking number
of U.S. supplementals (by 1972, there were only eleven supplemental
carriers left) and would be unfair to SAT employees. The CAB
officials had no objections to option (2).
On May 5, 1972 the DCI was presented with the results of the meeting
with the CAB chairman. He approved the recommendation to explore
the sale of the equity in SAT to the current management. It
was noted that SAT had been operating as a supplemental carrier for
25 years, that none of the employees of SAT had ever been an employee
of the Agency, and that both the Department of Defense and
the chairman of the CAB considered it in their best interests to keep
SAT as a viable carrier. The rationale behind selling SAT intact to
its management was:
(1) Liquidation would deprive the United States of a useful air
carrier and would be unfair to the employees.
(2) Sale of SAT on the open market would generate an unacceptable
level of public interest and scrutiny. A publicly advertised disposition
would run contrary to the Director's statutory mandate to protect
intelligence sources and methods.
(3) Although a potential for conflict of interest and windfall profit
existed, the sale of SAT to its management would best satisfy the
requirements of everyone involved.
The DCI was, apparently, allowed this flexibility in method of disposal
by statute. 40 U.S.C. § 474(17) provides that nothing in the
regulations relating to disposal of surplus government property shall
affect any authority of the CIA. In addition, 50 U.S.C. § 403 (d) (5)
provides that the Director of Central Intelligence is responsible for
protecting intelligence sources and methods from unauthorized disclosure.
It was determined that sale of SAT stock to one of its former
owners in a confidential manner would prevent damage which could
result from disclosure of CIA ownership.
Agency officials began exploring ways in which SAT could be sold to
its management, without permitting a windfall to accrue to the buyer,
and in a way that could not be construed as a conflict of interest. To
establish a reasonable selling price, the Agency asked a Certified
Public Accounting firm to perform a valuation study. The accounting
firm in turn engaged an aviation consultant firm to conduct an evaluation
of the aircraft. The following values were established:
Millions
(1) Book value of SAT $3.900
(2) Estimated total value of SAT capital stock on open market- 2.645
(3) ]Disposal as going concern______________________________ 2.100
(4) Liquidation value______________________________________ 1.250
(5) Agency investment 1.500
Based on these figures, the Executive Director-Comptroller on August
17,1972, approved an asking price of $2.7 million. Sale at this "price to
the management would require simultaneous payment in full of the
$3.2 million note payable to Air America through an associated land
holding company, and would not include any equity in the lease purchase
agreement between 'SAT and Air America for a Lockheed L
100-30 Hercules aircraft. AlthouR,'h this $2.7 million price was less
than the $3.9 million book value, it did exceed the ,fair market value
of the company as calculated by professional appraisers. The appraisals
were based not on depreciated purchase prices for assets, as
243
reflected in book values, but on the earning power of the assets adjusted
to "present value" and the current resale value for all assets.
On August 23, 1972, the former owner was advised that the asking
price for SAT was $5.9 million; $2.7 million for the acquisition of
stock and $3.2 million for payment of debt to Air America. A deadline
date of October 1, 1972 was established; otherwise the firm would be
dissolved and the assets liquidated. Although the former owner contended
the asking price should be reduced because the outstanding loan
to Air America had been reduced since the date of the study, he stated
that he would attempt to work out financing within the deadline date
of October 1, 1972. This deadline was extended by the Agency to
December 4,1972.
On December 5, 1972, the former owner submitted an offer to buy
SAT for $5 million: $1.875 million for the acquisition of SAT and
$3.125 million to payoff the debt to Ail' America. On December 26,
1972, the Executive Director-Comptroller approved the recommendation
that the offer be rejected and that if the former owner was unable
to raise by January 20, 1973, the additional funds required for the
original purchase price of $5.9 million, including the Air America
debt, that the Agency proceed with liquidation plans and the dismissal
of SAT employees not later than February 1, 1973.
On January 11, 1973, a new proposal ,vas submitted to purchase
SAT for a total price of $5,605,000. The former owner cited a tentative
commitment for a loan of $4.0 million and his offer was contingent
upon an additional loan. The offer called for a total payment
of $5,605,000 broken down as follows:
In millions
Acquisition of SAT stock $2.145
Payment of debt to Air America______________________________ 3. 125
Credit for payments to Air America since 10 June 1972 in liquidation
of long term debL____________________________________ .335
Total payrnent 5.605
Prior to accepting the offer, CIA officers again discussed the sale
of SAT with a CAB representative, who indicated that the board
would be interested in seeing SAT continued. The CAB representative
stated that it would not be necessary to surface the Agency's name
as the true owner of SAT in the CAB proceedings, and that he did not
anticipate any problems with other supplemental carriers as a result
of the sale.
On January 19, 1973, the DCI appro,-ed the sale of SAT. It was
noted that the offer was within 5 percent of the original asking price,
was above the independent evaluation for sale as a going concern, and
was at a figure which would not seem to give the buyer windfall profit.
The sale would constitute a clean break-away of SAT from the
Agency with the exception of a one year extensIon on the lease/purchase
agreement with Air America for an L 100-30 aircraft. This
agreement for sale between the former owner and the Agency included
a provision that any profit derived from the sale of assets
within one year would constitute a windfall and would be adrled to
the total sale price.
On Fe.bruary 28. 1973, tIlE' Board of Directors of SAT executed
corporate action on the Agn'ement for Sale of SAT to the former
owner. Closing date was established at not later than 30 days after
C~\B approval. On March 1, 1973 application for approval of acquisition
of control of SAT by the former owner was filed with the CAB
under Docket K0.252-64. It ,ms anticipated that CAB approval would
be forthcoming within 60 days.
Subsequent to the agreement for sale and application to CAB, several
supplemental carriers generated a great deal of pressure to pre-
vent SAT from being sold to the former owner and to prevent SAT
from operating as a supplemental carrier. This pressure was applied
through Congressional representatives, the General Accounting Office,
and the General Services Administration. The various supplemental
carriers objected to the sale of SAT for a variety of reasons. Basically
each supplemental objected to the portions of SAT's operating authority
which would allow SAT to compete with it. Specifically, representatives
of one competitor indicated that it would not oppose the
sale if the new owner would voluntarily renounce his rights to TransPacific
routes.
Two other companies objected to SAT operating any aircraft as
large or larger than a 727 in the Far East. Another objected to SAT
bidding on any domestic MAC contracts. Restricting SAT to satisfy
all potential competitors could make SAT sufficiently unattractive as
a profitable investment that financing would be unobtainable. With
this in mind the Agency took the position that agreement for sale of
SAT had been executed, subject to CAB approval. If the CAB ruled
against the sale and ownership reverted to the Agency, the Agency
would cease any bids or service under MAC contracts and dissolve
SAT.
Two supplementals expressed interest in buying SAT. One did not
make a cash offer, but on .June 29, 1973, the other made a cash offer
of about $2 million in excess of what the former owner had offered.
According to the Agency, there were compelling reasons not to pursue
these offers. Agency officers had reason to believe that the supplementals
were not interested in actually buying SAT as they were
attempting to secure a commitment from the Agency which could be
used to compromise the CIA's position in future CAB hearings. Three
reasons for not accepting either offer were:
(1) Any merger with another supplemental carrier would
necessitate a very difficult series of CAB hearings during
which all other major supplementals would certainly voice
loud and strenuous objections.
(2) To sell the firm on a sole source basis to either outside
buyer without soliciting public bids would be contrary to
sound business practice, and would attract even more adverse
publicity.
(3) Both offers were made directly to officials of the CIA
and not to the stockholders of record. Although the relationship
between the CIA and SAT was the subject of much
public speculation, the relationship was still classified and an
acceptance of either offer would be a violation of security
and cover.
Dissolution of the firm, or sale to the former owner, continued as the
most acceptable method of divestiture, subject to CAB approval.
In view of the objections by other supplemental carriers to the sale
of SAT to its former owner, and the award by the Air Force of a
Logistics Air contract to SAT, the DCI directed on July 31, 1973,
245
that SAT be dissolved, that it withdraw from the LOGAIR contract
and \"ithdra\" its application for renewal of supplemental certificate.
The former owner was advised of this decision and made a counter
offer to purchase the company under his previous offer. He also proposed
that SAT return its supplemental certificate, withdraw application
for acquisition for sale from CAB, and operate as a commercial
carrier under Federal Aviation Regulation Part 121 authority. Such
action would remove SAT from direct competition with the supplementals,
but retain a worthwhile market in which to operate. Additionally,
no CAB hearing would be necessary to obtain this type of
operating authority. On October 1, 1973, the DCI ,agreed to entertain
the proposal to continue the sale of SAT as a Part 121 operator, on
the condition that the former owner obtain prompt financing. Otherwise,
the firm would be dissolved.
On October 5, 1973, the SAT Board of Directors approved and
executed a new agreement for sale including the following provisions.
(1) The former owner to acquire stock of SAT and Actus
for $2,145,000.
(2) The former owner to payoff $3,125,000 o\ved to Air
America.
(3) Agreement subject to the former owner obtaining
$4 million loan.
(4) Agreement to be subject to SAT withdrawing application
for renewal of its Certificate of Necessity and Convenience
for an Air Carrier (Supplemental Certificate).
(5) Lease/purchase ,agreement for L-lOO between AAM
and SAT to be extended one year.
(6) Anti-windfall proviSIOn to be effective for one year
from date of sale.
On November 29, 1973, the former owner received a commitment
from The First National Bank of Chicago for a 101m of $4.5 million
thereby making the October 5, 1973 agreement operative. On November
30, 1973, the DCI approved the sale of SAT in accordance with
the October 5 agreement for sale. On the same day, the application to
the CAB for acquisition of SAT under Docket No. 252-64 was withdrawn
and petition for cancellation of certificate and termination of
exemption authority was filed with an effective date of December 30,
1973. On December 31, 197:3 the sale was closed, the note to Air
America was paid off, and the former owner became the sole owner
of SAT.
In early January 1974, CIA officials learned from Air America
management that SAT had exercised the purchase option of the lease/
purchase agreement between SAT and Air America for the Lockheed
L 100-30 Hercules aircraft. The option sale price from Air America
was $3,150,000. SAT immediately resold the aircraft to Saturn Airways
for $4,350,000, for a profit of $1.2 million. The Agency interpreted
this sale as a violation of the anti-windfall provisions of its
agreement with the owner. On January 25,1974, Air America executed
an Escrow and Arbitration Agreement on behalf of the CIA with
SAT on the disputed $1.2 million profit. The agreement called for
$750,000 to be placed in escrow with the American Security and
Trnst Company of ",Vashington, D.C. The escrow funds were to be
held as a Certificate of Deposit purchased at the prevailing market
246
rate. It was further agreed that SAT would also place in escrow a
Promissory Note to Air America for the remaining $450,000 of the
disputed amount. The note was to bear interest at the same rate currently
being earned on the Certificate of Deposit in escrow. It was
arranged that the escrow deposits plus accrued interest would be paid
to the party deemed in favor by an arbitrator with each party to pay
one-half of the costs of arbitration. On September 5, 1974 the arbitrator
ruled in favor of Air America. This decision caused an additional
$1,304,243 to accrue to the Agency from the SAT sale. This
was the sum of the $1.2 million under arbitration plus accrued interest,
less the Agency's share of arbitration costs.
3. Decla8sification of Relationship With CIA
In March 1974 the employees of SAT retained an attorney and
brought a class action suit in U.S. District Court for Southern Florida
against Southern Air Transport, Inc. and the Central Intelligence
Agency. The employees as plaintiffs sued for injunctive relief and
damages. In this suit the employees alleged:
(1) That the CIA sold the stock of SAT to the former
owner illegally,
(2) That SAT had embarked on a program to sell off its
assets, depriving the plaintiffs of employment,
(3) That the plaintiffs were entitled to the benefits of the
CIA Retirement and Disability System, and
(4) That their civiI rights had been violated.
In view of the publicity arising from the allegations made by the
other supplemental carriers during the CAB proceedings and the
publicity arising from this suit, it was determined that no useful
purpose would be served by continuing to deny the true ownership
relationship of SAT by CIA. The operational activities performed
by SAT on behalf of CIA were and remain classified. As a part of the
Agency's defense in this suit, an affidavit of the Deputy Director for
Management and Services of the CIA was presented in court.
In the affidavit he delineated the relationship between the CIA and
SAT and the authorities for purchasing and later selling the capital
stock of SAT. He also defined the employment status of the plaintiffs
as not being government employees and not being CIA employees,
and therefore not being eligible for participation in the CIA Retirement
and Disability System.
In the Order Granting Motion for Summary Judgment, the court
found that the sale of SAT capital stock was not in violation of law;
that the plaintiffs' claim to be U.S. Government employees and entitled
to CIA retirement benefits was invalid ; and that the SAT employees
were not deprived of any civil right under any state law.
As a result, the action was dismissed with prejudice as to the plaintiff.
Although this suit did cause the relationship between the Agency and
SAT to be officially disclosed, it did establish, in a court of law, two
points favoralile tothe Agency:
a. The sale of SAT violated no laws and was within the
authority of the DCI ; and
b. The directly hired employees of CIA owned proprietary
firms such as SAT do not necessarily enjoy the status of Federal
Government employees.
247
4. Possible Conflict of Interest
In the SAT divestiture, the Agency took precautions to avoid confiict
of interest. A retired staff agent who had been the M:anaging
Director of Air America, Inc., made several offers to acquire SAT.
In early 1972 he and some other members of Air America management
made an informal offer to buy SAT. On August 7, 1972, the retired
staff agent told the Agency official responsible for the management
of SAT and Air America, that he, in association with two supplementals,
wanted to offer "book value" for SAT. He stated that they
were not interested in SAT's certificate, but rather in the equipment
and that if allowed to make an offer, it would be one that would not
require CAB hearings. In both cases, the CIA General Counsel determined
that due to the offeror's dose association with the Agency, the
offer was unacceptable. In later discussions, the retire'd staff agent
asked to be allowed to bid on SATin open bidding. The General
Counsel's position on this request was that open bids would not solve
the conflict of interest problems. In any transaction this complex,
selecting the bid is only a preliminary to the negotiated final sale.
Another potential conflict of interest involved another supplemental
air carrier. From the time the Agency first decided to divest until the
sale was consummated, this company expressed continuing interest in
merging with SAT. Their representative was a former Director of
Central Intelligence, who made literally dozens of phone calls to
Agency officials and arranged many meetings i all for the purpose of
pressing this company's case to purchase SAT. The company also
proposed to arrange "shadow financing" for the former owner of SAT
if he would agree to merge 'at some later time. These offers were all
rejected because merger with another supplemental was not an acceptable
solution and the apparent conflict of interest was too great.
The sale of SAT to its former owner was another area of possible
conflict of interest. 'While the former owner was not an employee of the
Federal Government during any period of association with SAT or
CIA, he had been the owner prior to CIA acquisition, and had been
nominal president of SAT during Agency ownership. This potential
area of conflict had been recognized at the outset of sale proceedings,
and the Agency obtained third party professional evaluation and
restricted windfall profits to prevent such conflicts. The underlying
philosophy for sale back to the former owner was to restore the statU8
quo ante, i.e. return of the corporation to its previous ownership once
the need for a Government-controlled entity had terminated.
E. FINANCIAL ASPECTS
1. Relations with Other U.s. Government Agencies
Management and control of proprietaries often requires "cooperative
interface" with outside agencies to gain beneficial working relationships
and appropriate authorizations. These relationships are described
briefly below.
For those proprietaries which maintain commercial books and other
financial records, commercial managers prepare United States and
State tax returns annually, based on the corporation's financial records.
For other entities where only internal Agency records are maintained,
Agency specialists prepare tax returns which reflect normal
operations of a legitimate commercial business. The Agency maintains
close coordination with the Int~rnal Revenue Service, which is a,vare
of the CIA's use of proprietary commercial entities but not of specific
proprietaries' identities. In the event the IRS singles out an Agency
proprietary for an audit, the Office of General Counsel notifies IRS
of CIA ownership. The IRS then cancels the audit to conserve
manpower.
Operation of the air proprietaries has resulted in contact with the
Civil Aeronautics Board, the Federal Aviation Agency and the National
Transportation Safety Board. Specific problems have been discussed,
usually between the Office of General Counsel of the agency
conc~rned and the CIA General Counsel.
The air proprietaries have dealt with State Department and the
Agency for International Development, generally on a contractor/
customer basis, although senior personnel of those agencies have
been advised by the Agency of its ownership of the companies.
Those proprietaries engaged in the shipment of weapons or other
items on the Munitions Control list have required CIA assistance in
obtaining the necessary export licenses. The ownership of the companies
has been discussed with the State Department Office of Munitions
Control, and the Bureau of Alcohol, Tobacco and Firearms.
While the radio proprietaries were funded by the CIA, they received
policy guidance from the Department of State to ensure that their
broadcasts conformed to United States foreign policy. The Agency
has intervened with the Department of Labor on behalf of survivors
of employees of the proprietaries in order to assist them in receiving
the available benefits under the applicaple Workmen's Compensation
Acts. The Agency has also interceded with the Defense Department
to have proprietaries' contracts exempted from the Renegotiation
Board.
The CIA has requested that the Air Force consider the interests
of the Agency in awarding commercial contracts to proprietaries.
Initially this was done in the mid-1950s on the basis of a policy decision
by the Operations Coordination Board that Air America was an
instrument of value to national security. Air America was then operating
at a deficit, and the Agency was able to maintain a standby capability
without budget subsidies if it could obtain enough business to
support large commercial aircraft. Finally, the United States Forest
Service was advised of the ownership of a pro11rietary and asked to
award contracts to the proprietary to assist the development of a
commercial posture.
2. Magnitude of United States Financial Stakes
Most proprietaries are small-scale operations. In many cases (the
notionals), the overseas proprietary actually conducts no business at
all; it simply has a commercial charter, staff, and cover arrangements
for Agency collection and action projects.
Proprietary income consists of a mixture of CIA subsidy and income.
In some cases, the outside income is from sources outside the
United States Government income, e.g., Air America received income
249
for aircraft maintenance of foreign airlines in Southeast Asia. For
the most part, proprietary income is in the form of "cross-orders" from
CIA and other Government agencies. For example, a CIA paramilitary
project placed orders for aIrcraft engines and pilot services with
the Agency proprietary, Intermountain Aviation, Inc., and AID
contracted with Air America to carry rice shipments in Laos. In this
sense, many proprietaries are analogous to what are traditionally
termed "intragovernmental funds" or "industrial funds" in United
States Government budget and accounting manuals.
Compared with earlier years, the current size of proprietary expenditures
has markedly declined. The potential for future expansion
is nevertheless present. Indeed, new proprietaries have been formed
within the last several years.
In terms of United States budgetary impact, proprietaries do not
add significant new capital to CIA available resources, i.e., while
they have a very large expenditure level and momentum over the
years, most of these expenditures originated in the CIA and other
United States Government appropriations, and the net profits generated
by outside business and investment have been relatively small.
Another way of interpreting the figures is to observe that nearly half
the $1.6 billion gross income of CIA proprietaries has been supplied
by sources outside the CIA.
The Committee reviewed the pattern of income, expense, and net
United States investment for the twenty largest proprietaries now
active. including their financial experience in the tvi-elve months preceding
June 30,1975. The two largest proprietaries, Air America and
the insurance complex, dwarf the rest. While Air America will be
phased out by June 30,1976, ending the CIA-owned airlift capability
and returning an estimated $20 million to the United States Treasury,
the insurance complex will continue.
In programmatic terms, the contrast between the current low levels
of proprietary activity and the high levels of five years ago reflects
the decline of paramilitary operations in Southeast Asia. Large volumes
of outside orders by Defense and AID, along with sizable levies
by CIA components, and maintenance and passenger income from
commercial operations, were generated by a covert war.
Looking toward the future, will new air proprietaries be established?
The CIA thinks not, but the matter is not resolved. The ultimate
question is whether there will be future United States involvement
in covert wars-and if so, can some substitute for CIA-owned
air support meet the operational requirements of secure, well-maintained
local aircraft? The Chief of ess suggested that third-country
assets could be used instead. Another possibility is the use of United
States military aircraft, overtly or "sanitized."
One thing is clear: CIA sees itself as entering a different era of
proprietaries. It has rejected the long-held doctrine of "standby" capability,
i.e., the notion that it is worth investing considerable capital
and operating resources in airlift, sealift, and other assets primarily
targeted toward contingency requirements. Agency representatives
maintain that the CIA is keeping proprietaries focused on (JU/rrent
operational tasks. The test of retention is the utility oT a proprietary
in executing assigned tasks instrumental to approved Agency projects.
207-9320- 76 -17
250
Generally, the nationals have increased by about 30 percent since
1967. This reflects a policy of increasing the number of cutout arrangements
to increase security, i.e., to reduce one likelihood of outside
discovery of agents or case officers working under cover of the endpoint
notional by introducing intermediate notionals for payments or
identity backstops.
What are the basic distinctions of one type of proprietary from
another? First, external registration divides the total in half. Those
which have some form of legal standing with domestic and foreign
corporate regulatory and tax authorities are subject to external governmental
scrutiny. This occasions additional expenses and manpower
to assure that in all respects this group of proprietaries operates in
accordance with local law and commercial expectations. The second
group, the nationals, exist only as names on doors, in phone directories,
and on stationary. Backstopping for identification of these proprietaries
is provided by Agency switchboards, mailstops, and check
Issuance.
The next level of distinction is within the class of legally registered
proprietaries: those which carryon a commercial income-producing
operation as contrasted to those which are simply cover arrangements.
'Within the class of commercial proprietaries which produce income,
there is a distinction between those which are wholly dependent upon
CIA for income (in the form of orders placed and subsidies) and
those which have mixed outside and inside income. Even for those
with mixed income, it is possible to distinguish those which have outside
income wholly within the United States Government (i.e., a mix
of CIA-derived income and income from other Government agencies)
from those which have both Uniteel States Government income and
income from private contracts.
3. Visibility in the Budget
Budgetary accountability to the President and Congress depends
upon the extent to which the Federal agencies' budget requests provide
information to facilitate evaluation. Circular A-Il, issued by the
Office of Management and Budget, prescribes the financial schedules
and explanatory data which all Federal agencies must provide in their
budget submissions. These provisions are consistent with the Budget
and Accounting Acts of 1920 and 1950. The Central Intelligence
Agency regards itself as subject to these prescriptions. The Agency
limits the application of this principle to providinj:!; only the A-Il
materials which OMB and the Congress specifically request. This
policy has resulted in near invisibility of proprietaries in the CIA
budget submission.
Circular A-ll requires agencies to provide schedules and narratives
for each public enterprise or intragovernmental fund. This data is
to include all sources of funding purposes and levels of expenditure,
and approximate indications of performance through comparisons of
past and proposed funding by activity. Under these regulations, it
appears that the CIA should have been providing a complete set of
schedules for the proprietaries which Mtually do business, i.e., exclud·
ing notionals.
The question of the programmatic impact of proprietaries should
also be considered. While proprietaries have been heavily involved
251
in CIA intelligence collection and covert action, these activities have
not been reflected in the CIA budget submission. A policy review
of the budget requires programmatic judgments of the necessity and
appropriate use of proprietaries in overseas areas. The Contingency
Reserve Fund is an example of why such clear budgetary information
is necessary. Recent debate concerning U.S. involvement in Angola
has brought into sharp focus the role of this fund. All United States
aid to forces in Angola came from the Contingency Reserve.
The only place in the budgets of the CIA where proprietaries have
assumed even a limited visibility is in the years when supplemental
financing was needed to establish or strengthen a proprietary. When
such financing is necessary, the budget shows, tersely, that Contingency
Reserve drawdowns have been made. For example, one past
budget showed a certain amount to subsidize Radio Free Europe, but
provided no justifying materials. This practice reflects the unwritten,
post hoc nature of the Contingency Reserve financing process. In effect,
these practices allow executive branch "supplementals" in which
Congress is informed after the OMB has acted.
The budget does not normally indicate Agency intentions to create
a proprietary in the budget year ahead. For any other Federal agency,
establishing a new publIcly owned enterprise without advance notice
to the Appropriations and substantive committees of Congress would
be proscribed. Proprietaries which require only small subsidies to get
under way are funded by the CIA without supplemental financing,
i.e., within its regular budget. Therefore, these proprietaries are completely
invisible in the Agency budget submission.
F. SOME GENERAL CONSIDERATIONS
1. The Relationship of Utility to Size
The Committee's review revealed a dilemma taced by CIA planners.
Proprietaries can sometimes be most effective in operations when they
are large; indeed, as in Laos, they may be impelled toward enormity
by the very nature of the operation. Yet large size conflicts with deniability.
In areas of the world where there are few operating firms,
and in types of activity which have only limited commercial appeal,
where would large-scale enterprises get financing but from the United
States Government? Operations in Laos simply could not be concealeq
in the end. This experience suggests that proprietaries may have only
l.imited utility in future paramilitary operations.
9Z. The Factor of OompetitWn with Private Enterpri8es
Do CIA proprietaries which produce income compete unfairly with
private United States businesses? Is their utility to the Government of
such magnitude that CIA proprietaries should be retained regardless
of their competitive impact? Generally, the Agency believes that operating
proprietaries do not compete with United States private enterprise
because they tend to do things which private companies are not
equipped, motivated, or staffed to perform.
For example, CIA proprietaries purchase weapons, foreign armaments,
and technical devices; conduct security investigations; purchase
real estate; insure uninsurable risks; train foreign police forces; and
252
run airlines in remote areas or on commercially unattractive routes.
Would private enterprise do any or all of these things? It is true that
private contracts with the Government include highly sensitive contracts
with the CIA for technical intelligence collection, research, and
development. Would the abandonment of CIA proprietaries and the
cooperation of private firms be more desirable in terms of policy,
economy or flexibility?
3. Relative Scarcity of Oorrvrnercial and Offidal Oover
The continuing CIA desire for more notionals reflects the scarcity
of United States Government official cover in many areas of the world,
and the developing desire of some United States companies not to
cooperate with the Agency.
4. Profits
Some questions concerning profits have been raised. Does proprietary
profit constitute a significant addition to the resources available
to CIA? How is such profit treated in the budget? How is it controlled?
How can the Congress (or the President, for that matter) be sure that
proprietary profits are not diverted to projects not included in the
regular CIA budget?
First, profits (defined as net income to a proprietary after deduction
of operating expenses) are relatively small. Even in the days
when the most profitable air proprietaries were operating at peak
capacity, the most that any single firm netted was less than $4 million.
Over the entire period 1947-1975, total profits have been $50 million,
an average of about $1.6 million annually, for the 16 biggest CIA
proprietaries. And in these years, a net loss was sustained three times$
2.5 million in 1971; $0.5 million in 1973; and $0.3 million in 1975.
Looking to the future, after liquidation of the air proprietaries has
been completed, there is forecast to be only one profitable proprietary:
the complex of insurance companies which derives most of its profit
from investment portfolios. This entity's net income in 1974 was less
than $2 million and a profit of this general magnitude is expected in
the foreseeable future. These profits are to be used only for the insurance,
escrow, annuity and related complex functions. Neither the
complex, nor profits accruing to it, are used for operational support of
any other projects or activities. Nevertheless profits from all proprietaries
may be reprogrammed into CIA operations due to a "change in
policy" reflected in the General Counsel's decision of February 3,
1975.90 Thus proprietaries do not presently provide a mechanism for
"back door" funding of covert operations; nor are they currently intended
to do SO.91
The current Chief of CCS noted that:
It may be the questions that have been raised by the staffs
of this Committee and of the House Committee, have kind of
energized certain action as far as our Comptroller is concerned,
as far as the Office of Management and Budget is
concerned, and a methodology is being developed at the present
time that the balance sheets of the salient information of
DO Chief, CCS, 1/27/76, pp. 80--81.
01 Ibid., p. 79.
the operation of proprietaries, particularly those that are
having earnings, are annexed to the budgetary presentation
process and review process, so that this information is available
to the Office of Management and Budget, and I assume
to Congress, so that this can be taken into consideration.
And you would then have, it seems to me, a degree of safeguard
that money cannot be taken out of there and used as
an add-on to appropriated funds.92
According to the testimony, from 1973 to 1975, before the opinion
was rendered by the General Counsel of the CIA concerning profits
and their treatment, the Appropriations Committees were advised
that such profits existed, and "it was taken into consideration at the
time of appropriations."
In the future, I would think that any oversight committee
could very promptly bring to the attention of the DCI their
interest in this question of profit, and ask for an accounting,
and certainly could be assured that there was no use of funds
derived from a proprietary for an operational purpose unrelated
to such activity.
I would think . . . the DCI would be under the same
prohibition using funds that were appropriated for the intdligence
directorate for operational purposes or any other
comparable redesignation of funds. 93
When asked whether funds built up in a complex such as the insurance
proprietary should be used for purposes beyond those included
in an annual authorization, an Agency representative replied:
I would view them as segregated funds to the extent that
there was a profit, unnecessary for the purposes of the proprietary,
that the profit would have to be turned over to the
Treasury and it could not be used for other Agency
programs.94
As for the treatment in the budget, there are both policy and procedural
aspects. The policy of CIA was changed by the February 1975
General Counsel ruling that profits of proprietaries and proceeds of
liquidation must be returned to the Treasury as miscellaneous receipts,
and cannot be used to augment the Contingency Reserve or otherwise
be applied to operations. This ruling overturned the practice of the
past which on occasion included the transfer of proprietaries' net
proceeds to the Contingency Reserve for later release to operations.
The budgetary presentation and review procedures only partially
focus upon proprietary profits. The insurance complex's profits are
invisible in the Agency budget; they are taken into account and subject
to scrutiny only within CIA. Operationally, the Directorate of Operation's
annual review' has the most detailed grasp of these monies at the
Agency review levels. A standard set of public enterprise fund schedules,
as prescribed by OMB Circular A-ll, would be appropriate for
making this complex visible in the Agency budget. Other commercial
proprietaries should show these schedules as well. The Agency has in-
.2 Ibid. pp. 82-83.
93 Ibid. p. 84.
.. Ibid. pp. 84-85.
dicated that the Comptroller is working with the Directorates of Operations
and Administration to develop more comprehensive budgetary
presentation and review procedures for CIA proprietaries.
To what extent can these new procedures prevent abuses of proprietary
profits? To what extent do they predude the need for legislation
in this area? What form of Congressional oversight is needed
here; at what point should Congress exert control.
Improvement of visibility in the budget of proprietary resources
and provision for review of the major proprietaries as a regular part
of budget review by CIA1OMB, and Congressional Committees would
seem to preclude most of the dangers of abuse. On the other hand1there
is one type of abuse for which additional Congressional scrutiny and
safeguards may be needed: the possibility of a small-scale1high-risk
covert project directed by the President or DCI which is not covered
by the regular appropriation but financed by proprietary profits.
'While no foolproof preventives can be designed by law or regulation,
the possibility of such abuse, or the avoidance of congressional review,
can be minimized by requiring that all CIA proprietaries report operational
activities to the congressional oversight committee.95
5. Private Investment by 01A
Two types of general issues are raised by investments made by the
Agency:
(1) Should the CIA engage in investments which could accumulate
funds outside the budget process and thus be available for operations
that have no public scrutiny outside CIA?
(2) Is CIA investment policy too restrictive in regard to bank deposits?
SpecificallY1 should the CIA place large amounts of money in
comntercial banks without drawing interest?
A sizable percentage of the Agency1s annual appropriated and
advanced funds are deposited here and abroad in commercial accounts
on an incremental basis to fund operational needs. If accounts are
maintained at levels above the minimum balance necessary for offset
costs to the bank1 the banks selected earn an interest or 'investment
bonus. The selection of these institutions is non-competitive, rooted in
historic circumstance1 albeit in institutions that have shown themselves
flexible and responsive in providing the Agency services, Further
investigation of this area is needed1 and we encourage the new
oversight committee to study this issue in greater detail than we have
been able. This is one area where the exclusion of the General Accounting
Office from CIA audits has had an unfortunate effect: there
is no outside reviewer of a complex set of financial records and1 consequently,
confidence in the Agency's role in this area may have been
eroded.
6. What UJ the Future for Proprietaries '!
No new proprietaries are in formation or planned. This past fiscal
year, 19751one new proprietary was created which rented office space
for an East Coast CIA base and provided C0ver for Agency employees.
The main provision for new growth is the plan of some years standing
for establishment in the insurance complex of several corporate
.. See Recommendation 50.
"shells" i.e., legally constituted and registered companies that do
very little commercial business but which can be adapted to various
new CIA missions. To adapt to these new missions, as noted, would
require CIA to amend the insurance complex Administrative Plan.
But this could be done quickly; the existence of the shells avoids the
leadtime of creating new corporate entities, with all the complications
of local laws and risk of exposure.
While CIA proprietaries are now smaller than previously, they are
so largely for administrative reasons, i.e., response to executive branch
directions. Although the CIA may never find proprietary expansion
to be operationally desirable, there is currently no statutory constraint
on such expansion. Congress should be a partner in the process of
reviewing any such expansion by providing for changes in the charter
process. Another approach is establishing substantive guidelines for
proprietary operation. This approach is typified by the post-Katzenbach
guidelines that prohibit CIA operation of tax-exempt foundations.
Lawrence R. Houston, the former General Counsel of the Agency,
was intimately involved with all of the proprietaries for his entire
tenure with CIA. Consequently, his views have been invaluable to
the Committee in reviewing 'and evaluating the history and the role
of these mechanisms. In the course of far-ranging testimony with the
Committee on several occasions Houston concluded that proprietaries
"should be the last resort for use to backstop Agency activities." He
grounded his opinion on the fact that:
they are cumbersome. To be properly run they take many,
many man-hours of many, many different parts of the
Agency, so they are expensive in man-hours. There are builtin
difficulties in running what appears to be a normal business
for operational purposes. There's really a built-in dichotomy
there that leads to a continual conflict with policies. And
due to the number of people invoh·ed. there is a security problem
on the old grounds that security doesn't go by the mathematical
incr-ease in the number of people. It goes geometrically
as to rthe number of people, the security risk.96
This assessment appears to be correct based on the evidence reviewed
by the committee.
The current Director of Central Intelligence has insisted on streamlining
such opemtions and is keenly a ware of the potential for abuse.
It is, for example, the current written policy of the Agency that "to
the degree that domestic proprietary or cover companies are required,
p, clear justification will be developed as to the relationship of their
support of our overseas operations." 97
In the one area of continuing large-scale activity, the investment
complex, the Agency has moved to insure propriety even in an area
where there is no evidence that any illegal conduct has occurred. The
current policy, established as of June 1975 is:
[The project.] will be operated in conformance with appropriate
legal restrictions. Arrangements are being made for the
.,. Houston, 1/15/76. p, 4,
In ~Iemora[ldllmof the DeI, 6/75,
briefing of the -appropriate Congressional committees. P.articu}
ar attention will be given to avoiding any possible conflict
of interest situations with firms with which the Agency
has contraots. Particular concern will also be exhibited over
possible improper influence on the stock market or stock dealings
through the investments involved in [the project].98
The Committee is mindful of the potential danger inherent in such
operations. Therefore, it recommends that the review of this and other
simi}ar projects by the -appropriate oversight Committees be most
stringent.
The disposal of proprietaries has also generally proceeded along
legal and ethical lines with more than due concern for conflicts of
interegt. Most notable in this spectrum of actions was the degree to
which the Agency avoided conflicts of interest in the sale of Southern
Air Transport. Such internal vigilance no doubt should and will continue.
Moreover, with the establishment of -a permanent oversight committee,
the CIA's reporting will be made easier because it will -be able
to report on its dealings on a regular basis to informed Members of
Congress.
.. Ibid.

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