Why Is Counterfeiting Getting Worse?

Earlier this week, the US Department of Justice issued a statement detailing the sentence handed down to a chip counterfeiter. Stephanie McCloskey, 39, will serve 38 months in federal prison for her role in a scheme by VisionTech Components LLC of Clearwater, Florida, to import fake chips from China into the US, some with military markings. The parts were sold to a variety of customers including defense contractors and the military.

McCloskey pled guilty in November 2010 to a federal charge of conspiracy to traffic in counterfeit goods and to commit mail fraud, and cooperated with authorities. She was sentenced by the US District Court for the District of Columbia in the first ever federal prosecution of a case involving the trafficking of counterfeit components.

McCloskey is being held up as an example to other would-be counterfeiters that the feds are watching and if caught will pay a steep price. The Department of Justice's Task Force on Intellectual Property was created last year specifically to prosecute such cases. That's because it will be a national security nightmare if just one counterfeit part ended up, for example, in a naval air defense system and caused a catastrophic failure.

That the government is on the case doesn't mean everyone else can relax. On the contrary, counterfeiting is on the rise and it is getting harder to detect. Counterfeit computer hardware, including chips, was one of the top commodities seized in 2010 by the US Immigration and Customs Enforcement agency (ICE). Seizures in this category were up five-fold over 2009, ICE reported.

The reason for the increase is that there's a lot of money to be made. Many obsolete components are in demand by the military because they need to repair very old equipment, such as 1908s-vintage fighter jets. But the parts are no longer manufactured, and only a few authorized distributors stock the vintage components. In some cases, the only place to buy these chips is from independent distributors or brokers who don't have formal sourcing relationships with the original component manufacturer. They buy them over the Internet from sources they don't know and who can't validate their authenticity.

While the vast majority of independents are legitimate, the system itself has weaknesses that invite abuse. Counterfeiters buy used parts for pennies in the street markets of Shenzhen and other Chinese cities, re-mark them, fix broken leads and buff them up, then ship them to brokers in the West who unknowingly -- and in some cases, like VisionTech, knowingly -- sell them to other brokers or to OEMs for multiples of what they paid.

Getting counterfeits into the US depends in part on how good the paperwork and the fake parts look when they are inspected at the border -- or how well they are hidden. In June, for example, nearly $1 million worth of counterfeit SanDisk Corp. (Nasdaq: SNDK) portable memory chips were discovered and seized by federal agents at the Port of Long Beach/Los Angeles, according to the Los Angeles Times. Agents from US Customs and Border Protection (CBP) found the chips hidden inside 1,932 karaoke machines shipped from China.

Until the good guys start winning and have a system to detect and deter counterfeiters, it's up to the customer to catch the fakes. Many defense contractors have put in place strict regimen for inspecting, testing, and reporting counterfeits. All companies need to be inspecting, testing, and reporting. All companies need to be vigilant.