New York Times
Published: June 12, 1987 

The following article is based on reporting by David E. Sanger, Clyde Haberman and Steve Lohr and was written by Mr. Sanger.

  Early in 1983 a team of Japanese engineers from the Toshiba Machine Company arrived in Leningrad, the center of Russian shipbuilding since Peter the Great, and was whisked through the back gate of the heavily guarded Baltic Shipyard. There they painstakingly assembled more than $17 million worth of computer-controlled machine tools used to make ship propellers.
  Over the next 18 months the engineers returned to the Soviet Union about half a dozen times. Working alongside computer specialists from a state-owned Norwegian company, they fine-tuned the four imposing machines, each of which stands two stories high and weighs half a million pounds. As part of the deal, the Soviet Union even obtained a five-year service agreement.
  To the Japanese and Norwegian customs officials who allowed the equipment to be shipped, this was just another aggressive business deal, and the export licenses appeared in order. Instead, investigators in three countries have now concluded, the sale was one of the most egregious diversions of high-technology products to the Soviet Union in a decade.
  A detailed reconstruction of the sale, based on interviews in the United States, Europe and Japan, shows how readily the export control system broke down. The interviews revealed that the governments involved depended heavily on the truthfulness of companies that were also under pressure to satisfy a major new customer: the Soviet Union. Moreover, the government inspectors appeared to lack the technological sophistication to challenge the companies' claims about the capabilities of equipment being exported.
  The equipment is high on the list of technologies that the Western allies and Japan bar from export to the Soviet bloc, and intelligence officials say the machinery is already making it far easier for the Soviet submarine fleet to elude detection. The Navy says it will cost the United States $1 billion or more to undo the damage.
  "When you strip it all away," said Stephen D. Bryen, the head of the Defense Department's Office of Export Administration, "these people did terrible damage for the sake of making just one more sale."
  Since the diversion became known, the political impact has been widespread.
  American outrage over the incident has caused severe friction among three close military allies - the United States, Norway and Japan. The Pentagon charges that Japan permitted the technology to get away, then dragged its feet for a year when presented with evidence of the diversion. Nor do the Americans fully believe the results of Norway's investigation, which concluded that the country's involvement was limited to the work of one renegade employee.
  Last month two officials of the Japanese company and a British employee of the Norwegian company, Kongsberg Vaapenfabrikk, were arrested, and more arrests in Japan are expected. Meanwhile, the president of Toshiba Machine and two other top company officials have resigned. Norwegian officials, who fear they could lose a major contract with the United States military, have dismantled part of Kongsberg. A Japanese Complaint, Too
  Like the Norwegians, Sugiichiro Watari, chief executive of the Toshiba Corporation, complained in an interview in New York this week that his company has been treated unduly harshly. Mr. Watari said the giant electronics company, which owns 50.8 percent of Toshiba Machine, should not face sanctions now being debated on Capitol Hill - a ban on shipments to the United States and a loss of military contracts - because of the actions of a subsidiary.
  "I was also misled by Toshiba Machine," Mr. Watari said.
  Although many details about the diversion have emerged, questions remain about the handling of the case. For one, despite the fact that the huge machines were shipped directly to the Soviet Union, Western intelligence agencies appear to have missed key clues about what was happening.
  Illegal exports to the Soviet Union or its allies are nothing new. What makes this case so unusual, according to investigators, is not only the size of the deal but also its business-as-usual quality. There is no evidence of large payoffs, and there seems to have been little effort to disguise the equipment's destination by sending it through third countries.
  Even motives appear unusual for a case of this sort: Toshiba and Kongsberg employees apparently wished simply to bolster their ailing companies rather than to profit personally. Trying to Gauge the Damage
  Assessing the actual damage to national security is difficult. Reagan Administration officials assert that it was nearly irreparable because it will cost the Soviet Union far less to produce quiet propellers with the new machines than for the United States to develop advanced sensors to make up for the loss.
  "What's frightening is not how good the Soviets are today," said Norman Polmar, a naval analyst and author, "but how quickly they are improving."
  Other experts counter that the Defense Department is overdramatizing the loss, perhaps to bolster its case in Congress for submarine development projects and improvements in antisubmarine warfare. Mere acquisition of the tools, they point out, does not itself allow the Russians to turn out new propellers. Advanced computer design technology, extensive testing and strict quality controls are all needed to fully exploit the equipment.
  But no one disputes that the loss was a serious breach of Western security, and it was accomplished with remarkable ease. Following is an examination of the diversion, based partly on information provided by investigators that could not be independently verified. In some cases, there are still discrepancies between accounts provided by officials of different countries.

Vital Technology, From a Catalogue
  The case dates from late 1979 or early 1980. According to intelligence officials, that was not long after the Russians may have been warned by John A. Walker Jr. (who pleaded guilty in 1985 to passing Navy secrets to the K.G.B.) that the positions of Soviet submarines were being given away by propeller noise.

  A Soviet foreign trade organization, Tekmashimport, contacted Wako Koeki, a small Japanese trading firm with offices in Moscow. Japanese police who have reconstructed the dealings say they believe that at least three suspected K.G.B. agents were involved: Igor A. Osipov, who was vice president of Tekmashimport; Anatoly P. Troitskiy of the closely linked Industrial Machine Export-Import Corporation, and Vyacheslav A. Sedov, a vice president of the External Science and Technology Exchange Corporation.

  According to investigators, Mr. Osipov told Wako Koeki that he needed to import large, numerically controlled machine tools, precision instruments that can reduce by months the long process of making a propeller. Mr. Sedov apparently was not directly involved in the negotiations, but an assignment in Tokyo in the 1960's gave him experience in dealing with Japan.

Negotiations in Moscow
  Within months, Wako Koeki approached Toshiba Machine, and soon Ryozo Hayashi, a Toshiba executive, traveled to Moscow to negotiate the deal. Toshiba Machine, in the minds of many experts, was a strange choice because the company is not generally considered a major competitor in that part of the machine tool market. But Toshiba's catalogue contained exactly what the Russians wanted: an MBP-110 propeller milling machine, a $4 million to $5 million model.

  The machine dwarfs its operators, as two giant arms swivel from a crossbar to carve and shape propellers that can be more than 30 feet in diameter, far larger than any current Soviet submarine could need.

  From the Soviet viewpoint, the machine's key attraction was its nine independently controllable axes, meaning that it could be twisted and turned in a number of positions critical to making sophisticated propellers. Under the regulations adopted by Cocom, the coordinating committee of Western allies and Japan that sets export rules, no machine tool with more than three independent axes is to be exported to the Soviet Union or its allies.

Package Approach Avoided
  Toshiba could have provided the entire package wanted by the Soviet Union - the machine tool plus a computer and software to run it. But for reasons that still mystify investigators, Moscow insisted that the computer controllers, the "brains" that operate machines, come from Kongsberg Trade, the marketing arm of Kongsberg Vaapenfabrikk.

  Soon the Russians were negotiating with Bernhard John Green, a 49-year-old British national who was Kongsberg Trade's sales manager. Mr. Green is described by Kongsberg officials as a "competent and hard-working employee" with no previous record of misconduct since joining the company in the mid-1970's. Because of turmoil in Kongsberg at the time, the company officials said, he was without any real supervision.

  Some American officials say they suspect that Mr. Green, who could not be located for comment, may have been a Soviet agent. But Norwegian officials disagree. "His motivation, he says, was to get the sale for a business that was in desperate shape," said Tore Johnsen, who heads the Norwegian investigation. "And we have found nothing to indicate that he is not telling the truth about why he did what he did."

The Dawning Of Deception
  The deal was sealed in Moscow on April 24, 1981, with the signing of two contracts.

  The first, calling for the delivery of four unspecified milling machines, along with service and spare parts for five years, was between Tekmashimport and C. Itoh & Company, Toshiba's standard export broker and one of Japan's largest trading houses.

  "C. Itoh handles pretty routine stuff that doesn't raise any warning flags," one American investigator said, explaining why Wako Koeki, which deals extensively with Vietnam and other Communist nations, was paid a finder's fee and dismissed. "This was the beginning of the concealment effort."

  The contract was witnessed by the export manager of Toshiba Machine, according to officials of Toshiba's corporate parent.

  The second contract was with Kongsberg Trade for slightly more than $2 million, enough for a NC-2000 numerical controller, the computer that guides the system, and a service agreement.

  With the signings, Toshiba and Kongsberg began a series of deceptions to obtain export licenses, needed to get the equipment past Japanese and Norwegian customs officials.

  On May 19, in Tokyo, Toshiba applied to the Ministry of International Trade and Industry for a permit to ship a machine called a TDP 70/110. In a detail apparently overlooked by the Japanese authorities, the model appears to be mentioned nowhere in Toshiba's sales brochures over the past several years. Toshiba said the tool was limited to two axes, well within the Cocom rules. A Civilian Purpose Stated

  The machinery, Toshiba said, was going to be used for a civilian purpose - improving the electric power utility in Leningrad.

  None of the trade ministry's 30 export control inspectors, who review 200,000 applications a year, questioned the permit. Apparently customs did not notice that the machine shipped was a different model from the one listed on the export permit.

  A senior Japanese official in the Foreign Ministry explained recently that the Ministry of International Trade and Industry had simply trusted that a company with which it had long and close ties was telling the truth.

  "This is the first case where the trust relationship between industry and government completely collapsed," the Foreign Ministry official said. "Here, we had a case in which the Japanese family-like relationship was abused."

  A year later Mr. Green applied to the Norwegian Trade Ministry to export a numerical controller that Kongsberg specifically manufactures for Soviet-bloc trade because it can be used only in less sophisticated two- and three-axis milling machines. In fact, investigators say, Mr. Green had made an oral agreement with the Soviet Union - an agreement not found in the written contract - to ship a variant of the computer that could control a nine-axis machine. The difference between the two models lies in microscopic circuitry; no customs official would be able to tell the difference. A Navy in Search Of Quieter Subs

  In interviews, Toshiba has maintained that few of Toshiba Machine's employees knew the true power or use of the equipment shipped to the Soviet Union and that officials at the parent company were completely unaware of the transaction. But investigators in the United States say that if Toshiba executives were in the dark it is because they averted their eyes.

  By late 1982, when the first milling machine was shipped, virtually everyone in Japan's shipbuilding and machine tool industry knew two things about the Soviet Navy: It was in search of Western equipment, and it was rapidly making its submarines quieter.

  Japan had just recently been embarrassed by a major technology diversion. In April 1982 Defense Secretary Caspar W. Weinberger handed Japan's Defense Minister a spy satellite photograph of the Soviet aircraft carrier Minsk under repair in an 80,000-ton floating drydock built by Ishikawajima-Harima Heavy Industries. Mr. Weinberger asked his Japanese counterpart, Soichiro Ito, to "consider what this picture means." Attitude on Export Rules

  "The Japanese had no respect at all for the Cocom restrictions," said Mr. Bryen, who has been one of the leading critics of Japan's role in the machine tools episode. "In the drydock case, the Secretary made it clear this stuff has to stop."

  Japanese officials in the United States respond that their country is a strong advocate of export controls, but they maintain that the United States is frequently alarmist about the severity of high-tech diversions.

  At the time of the Toshiba deal, it was also common knowledge that the Soviet Union had embarked on a major initiative to catch up with American "quieting" technology, the key to making any submarine fleet safe from detection.

  "For a long time the Soviets didn't seem to give a damn about the noise radiated by their submarines," said Ira Dyer, an acoustics expert and professor of ocean engineering at the Massachusetts Institute of Technology. But in each generation of Soviet submarines - particularly the new Sierra and Akula classes - the giant power plants that propel Soviet submarines have grown quieter.

  Thus, it was hardly surprising that Soviet engineers turned to other telltale evidence of a submarine's whereabouts: two distinctive sounds generated by propellers. When Blades Churn Water

  The first is cavitation, sounds created as moving propeller blades cause pressure changes in seawater. These sounds are particularly discernible when a submarine is moving fast and near the surface.

  The second distinctive sound consists of blade tonals, caused as the propeller cuts through the wake created by appendages on the submarine's hull, such as the conning tower, the stabilizers and the rudders.

  "These seem like small things, but they make a huge difference," Professor Dyer said. "One watt of acoustical energy coming out of the propeller of a submarine in the Strait of Gibraltar can be heard off the coast of Virginia."

  The United States Navy has spent tens of millions of dollars to reduce cavitation and blade tonals, chiefly through highly classified propeller designs. Most involve an odd number of overlapping blades, turned into a rather convoluted shape. Although the specific designs are classified, many of the underlying principles are contained in public literature.

No Chance For Sightseeing
  For years the Navy has produced propellers at the Philadelphia Naval Shipyard with numerically controlled machine tools that eliminate many quality control problems. It was exactly those kinds of machines that Toshiba began shipping to Leningrad, in pieces, starting in December 1982.

  By the summer of 1983 all the machines were in place, though there is now a dispute about their exact whereabouts. American intelligence officials insist that all four are at the Baltic Shipyard, on the edge of the Gulf of Finland. (That facility has primarily produced surface ships, but submarines are constructed at a neighboring shipyard.) Japanese and Norwegian officials say that only two of the machines are in Leningrad and that they do not know the location of the other two. Some naval experts suggest that Moscow sent them to shipyards on the opposite coast, perhaps at Vladivostock on the Sea of Japan.

  In either event, the engineers who installed the equipment over a period of months in Leningrad say security was tight during the operation. 'Constantly Being Watched'

  "We were constantly being watched by the K.G.B.," a Toshiba Machine technician told police investigators a few weeks ago, in an account in the Japanese press. Each day, he recounted, the group was driven through the rear gate of the shipyard and, later, directly back to a Leningrad hotel.

  "We didn't have time even for sightseeing," he complained.

  Toshiba's engineers were not alone. Two Kongsberg employees also made four trips from Norway to Leningrad during the fall of 1983 and spring of 1984, apparently to install the control system and software for the Toshiba machinery. In June 1984 the Norwegian company made a last visit to improve the software and reduce the time it took to mill a propeller.

  Investigators disagree about whether top officials of Kongsberg knew, or should have known, about the deal. More than half a dozen Kongsberg employees were interviewed, including technicians who traveled to Moscow. But last week the Norwegian police let the statute of limitations on the diversion expire without pressing further charges. Comments by Norwegians

  "Green is the only one who went through the whole deal," said Mr. Johnsen, Norway's chief investigator in the case. Added Jens C. Width, senior vice president of marketing for Kongsberg, "This is very different from Toshiba's involvement, where top management was aware of what's happening."

  American officials, noting that Kongsberg is essentially run by Norway's Defense Ministry, say it is inconceivable that the company's leadership was unaware of any sensitive shipment to the Soviet Union. On Capitol Hill and at the Pentagon there have been calls for more arrests and dismissals.

  Norwegian officials respond that most of Kongsberg's top officers at the time were dismissed last year because of the company's troubled financial condition.

  "It doesn't make sense to punish people who were not responsible," said Arve Thorvik, the economic counselor for the Norwegian Embassy in Washington. Inside Leningrad While Spies Slept Despite the fact that the true use of the milling equipment was only faintly disguised, the equipment shipments, the falsified export licenses and the many visits to Leningrad apparently all went undetected by Western intelligence agencies until last year. Now investigators cannot even agree about how the scheme was finally uncovered.

  According to the Japanese, the break came in December 1985, when Kazuo Kumagai, the Moscow office manager of the Wako Koeki trading firm, told officials of Wako and Toshiba Machine that he would disclose the story of the illegal exports unless he was paid to remain silent.

  When he got nowhere, he carried out his threat by writing a letter to Cocom in Paris. That information was sent to the United States and eventually relayed to Japan.

  At Toshiba, Mr. Watari said the Toshiba Corporation had never received a threat from Mr. Kumagai, but he said he could not speak for Toshiba Machine, the subsidiary. American Version Differs

  Pentagon officials tell a very different story. They say there was no letter to Cocom that they are aware of; instead, a series of clues, which they will not describe, led them to discover the deception and inform the Japanese. "It was more a case of putting together a Chinese puzzle," Mr. Bryen said.

  Outside intelligence experts say the first clue may have come from Navy listening posts, where operators detected fainter sounds emitted from new Soviet propellers.

  The Pentagon makes no effort to dispel that conjecture. Other experts contend that it is too soon for many of those propellers to have been installed on operating submarines.

  In any event, the Japanese investigation barely moved forward throughout 1986. A Japanese Foreign Ministry official explained that Toshiba Machine was widely believed when it told MITI it had merely shipped two-axis machines.

  "We really couldn't believe that a reputable company like Toshiba could do such a thing," the official said. Another Japanese official added that "the Americans did not apply much pressure" until Mr. Bryen and Fred C. Ikle, the Under Secretary of Defense for Policy, went to Tokyo last December and described the deception in detail. Japan asked for more documentation, and it was not until Mr. Weinberger complained directly to Japan's Defense Minister that a full investigation began. Explanations Fall Apart

  Under further questioning, explanations offered by Toshiba Machine executives began to crumble. "Initially Toshiba Machine maintained that this was a two-axis machine that could not be converted into anything more complex," Mr. Watari said, but "later they said it was possible" to convert the machine to nine axes.

  Early last month, soon after Prime Minister Yasuhiro Nakasone was briefed about the incident before a visit to Washington, Japanese police raided Toshiba Machine's offices and carried away heaps of paperwork. On May 15 Toshiba Machine's president, Kazuo Iimura, resigned, a move Mr. Watari says he demanded.

  After days of interrogation, Mr. Hayashi and another Toshiba Machine executive were arrested. Half a dozen more arrests are expected.

  Last Friday two more Toshiba Machine executives - Yasuhiro Matsuzaki, the head of oversea operations in 1982, and Goro Yasuda, head of the machine tool divison at that time -also resigned. Tokyo's Tough Sanctions

  Meanwhile, Japan has imposed relatively tough sanctions. Toshiba Machine has been ordered to suspend all exports to 14 Communist countries for a year. The company said last week that as a result, it expected losses of $100 million in its present fiscal year. C. Itoh, the trading firm, was banned from machine tool exports to Communist nations for three months.

  "Short of driving Toshiba into bankruptcy, I think they were the toughest sanctions we could take," a Foreign Ministry official said.

  In the United States, the parent Toshiba company is trying to block a growing movement on Capitol Hill to ban the import of its products for a year or more. Meanwhile, the Pentagon has delayed awarding contracts to Toshiba and Kongsberg, including a $100 million order Toshiba is seeking to provide the Air Force with portable computers.

  Pentagon officials say neither company should expect to sign contracts until responsibility for the loss is sorted out. "This time," one Pentagon investigator declared, "we are going to hang these people in public."

The Trail of the Propellers
* 1. In early 1980 Soviet officials contact the Moscow office of a small Japanese trading firm in search of automated propeller manufacturing equipment. Soon executives of Toshiba Machine Company, C. Itoh & Co. and Norway's state-owned armaments manufacturer, travel to the Soviet Union and sign contracts on April 24, 1981. Though the order does not specify model numbers, it is for four giant milling machines that are illegal to export to the Soviet bloc.

* 2. In Tokyo and Oslo, company officials file export license applications with false model numbers and claim that the Japanese machinery and Norwegian computers are legal to export. No one challenges the claims. In December 1981, Toshiba begins shipping the machines; at least two go directly to the Baltic Shipyard in Leningrad. In 1982 Kongsberg ships software - not covered by restrictions in place at the time - directly to Leningrad. It sends the "numerical controllers" for the milling machines to Toshiba in Japan, perhaps to hide their ultimate destination.

* 3. Technicians from Toshiba Machine and Kongsberg travel back and forth from Japan and Norway to Leningrad about half a dozen times to install the equipment, with the last trip in June 1984 to upgrade the software. In December 1985, by the Japanese account, a disaffected Japanese employee writes to Cocom, the organization of Western allies and Japan that governs export controls, revealing the shipment's true nature. The data are dismissed in Japan. It takes more than a year before a full investigation is begun at the insistence of the United States, which says it uncovered the scheme.