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UPDATE 1-US lawmakers seek to block China Huawei, ZTE US inroads

* Report targets China's Huawei, ZTE for security concerns

* Cites odd behavior from companies' equipment

* Says U.S. companies should look for other vendors

* Huawei, ZTE aggressively denies allegations

(Adds comments from press conference)

By Jim Wolf

WASHINGTON, Oct 8 (Reuters) - U.S. telecommunicationsoperators should not do business with China's top networkequipment makers because potential Chinese state influence onthe companies poses a security threat, the U.S. House ofRepresentatives Intelligence Committee said in a report onMonday.

The report follows an 11-month investigation by thecommittee into Huawei Technologies Co Ltd and itssmaller rival, ZTE Corp .

The companies have been fighting an uphill battle toovercome U.S. lawmakers' suspicions and expand in the UnitedStates after becoming key players in the worldwide market.

The House Intelligence Committee's bipartisan concerns arebound to set back the companies' U.S. prospects and may alsolead to new strains in trade ties between the United States andChina, the world's two biggest economies.

Committee Chairman Mike Rogers, at a press conference torelease the report, said companies that had used Huaweiequipment had reported "numerous allegations" of unexpectedbehavior, including routers supposedly sending large data packsto China late at night.

The panel cited what it called long-term security riskssupposedly linked with the companies' equipment and services. Itdid not provide any hard evidence to back up its concerns, atleast not in the unclassified version of the report.

Rogers, a Michigan Republican who is a former FBI agent,said lawmakers' concerns had been heightened by what he and thepanel's top Democrat, C.A. Ruppersberger of Maryland, describedas the companies' lack of full cooperation with theinvestigation.

If the committee's warnings about doing business with Huaweiand ZTE prompt the Chinese government to get out of the businessof cyberespionage, a growing U.S. concern, "then that's great,"he added.<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

GRAPHIC: Huawei by the numbers GRAPHIC: ZTE at a glance Ren pits Huawei against the world ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

The committee recommended that the Committee on ForeignInvestment in the United States, an inter-agency group thatevaluates the national security risks of foreign investments,should block any deals involving Huawei or ZTE.

Government contractors and private-sector companies shouldseek other vendors for their network equipment, the panel said.

Rogers, responding to a question at the press conference,stopped short of urging a U.S. boycott of mobile phones andother handheld devices made by Huawei and ZTE.

The panel's warning pertains only to devices that involveprocessing of data on a large scale, he said, not Huawei- andZTE-made mobile phones.

Employee-owned Huawei is the world's second-biggest maker ofrouters, switches and other telecommunications equipment afterSweden's Ericsson . ZTE ranks fifth.

The panel said it had received credible allegationssuggesting Huawei may be guilty of bribery and corruption,discriminatory behavior and copyright infringement.

Such allegations will be referred to the Justice Departmentand Department of Homeland Security for investigation, the panelsaid. A spokesman for the Justice Department, Dean Boyd,declined to comment.

'RUMORS AND SPECULATIONS'

The committee's warning comes as Huawei weighs a possibleinitial public offering, sources said, as part of an effort toovercome suspicions that have all but blocked its U.S. efforts,including business tie-ins.

Huawei denounced the findings, which it said "employs manyrumors and speculations to prove non-existent accusations."

"We have to suspect that the only purpose of such a reportis to impede competition and obstruct Chinese (telecom)companies from entering the U.S. market," Huawei said.

ZTE, in a newly released copy of a letter to the committee,said it "profoundly disagrees" with allegations that it isdirected or controlled by the Chinese government.

"ZTE should not be a focus of this investigation to theexclusion of the much larger Western vendors," it said.

Zeus Kerravala, a networking equipment analyst at ZKresearch, said the effect of the congressional probe was to handthe market to Ericsson and Altactel-Lucent because he does notsee any U.S. firm able to compete, for instance, with wirelesstechnology.

ZTE's Hong Kong-listed shares fell as much as 3.4 percentearly on Monday.

Huawei's U.S. sales totaled $1.3 billion last year, a smallfraction of its worldwide sales of $32.4 billion. Handhelddevices accounted for about three-fourths of Huawei sales in theUnited States last year, including via T-Mobile, AT&T andSprint.

ZTE's U.S. telecom infrastructure equipment sales last yearwere less than $30 million. In contrast, two of the largerWestern vendors alone had combined U.S. sales that topped $14billion, ZTE has said, alluding to Espoo, Finland-based NokiaSiemens Networks and Paris-based Alcatel Lucent.

GLOBAL PLAYERS

Huawei and ZTE, which are both based in Shenzhen, China, arerapidly becoming "dominant global players" in thetelecommunications market, the report said. It noted thattelecoms are intertwined with computerized controls for electricpower grids; banking and finance systems; gas, oil and watersystems; and rail and shipping.

The National Counterintelligence Executive, a U.S.intelligence arm, said in a landmark public report a year agothat "Chinese actors are the world's most active and persistentperpetrators of economic espionage."

China has also been a frequent target on the campaign trail,with President Barack Obama and Republican challenger MittRomney both saying the United States needs to get tougher onChina for alleged abusive trade practices.

The committee's report criticized Huawei and ZTE for failingto answer questions or provide documentation regarding theirbusiness activities in Iran. In the case of ZTE, the report saidthe company "consistently declined to comment on recent mediareports that ZTE had sold export-controlled items to Iran."

Reuters reported in March and April that ZTE had sold bannedU.S. computer equipment to Iran's largest telecom firm. ZTE alsoagreed last year to ship millions of dollars worth of additionalU.S. tech products to a unit of the consortium that controls thetelecom firm. The Reuters stories have sparked investigations bythe Commerce Department and the Federal Bureau of Investigation.

In the wake of those allegations, Cisco Systems has ended alongstanding sales partnership with ZTE Corp.

"MEANS, OPPORTUNITY, MOTIVE"

Huawei and ZTE may not be the only companies that present arisk to U.S. infrastructure, the committee's report said, butthey are the two largest Chinese-founded, Chinese-ownedcompanies seeking to market critical network equipment in theUnited States.

Beijing has the "means, opportunity and motive" to use themto its own ends, it added.

The report underscores how little return Huawei inparticular has gotten from its significant investment inlobbying in Washington after suffering a number of high-profilesetbacks.

In 2008, Huawei and private equity firm Bain Capital wereforced to give up their bid for 3Com Corp after a U.S. panelrejected the deal because of national security concerns. Then in2011, the company was forced to relinquish plans to buy someassets from U.S. server technology firm 3Leaf after theCommittee on Foreign Investment mandated that Huawei divestcertain parts of the deal.

The company has brought on seven firms registered to lobbyU.S. lawmakers, including APCO, Doyce Boesch andFleishman-Hillard, according to forms filed under the lobbyingdisclosure act. That is up from four firms in 2011, two in 2010and one in 2009.

(Additional reporting by Chyen Yee Lee, Diane Bartz, SteveStecklow and Aruna Viswanatha; Editing by John Wallace andLeslie Adler)

((jim.wolf@thomsonreuters.com)(+1 202 898 8402))

Keywords: USA CHINA/HUAWEI ZTE