Meet The 'Parlor Maid'

It's not easy for American politicians to get face time with China's reclusive leaders. So in 1998, when Los Angeles Mayor Richard Riordan wanted to persuade Beijing to sign a multimillion-dollar contract to use L.A.'s port, his aides knew who to ask for help: Chinese-American businesswoman Katrina Leung. Flamboyant and relentlessly self-promoting, Leung had close connections with top officials in Beijing. With her help, Riordan met face to face with Chinese President Jiang Zemin.

The meeting was cordial, but the mayor went home empty-handed. Not long after, NEWSWEEK has learned, Leung told a top L.A. official that she could still make the deal happen. "You'll have to put some money in a certain bank in Hong Kong," the official recalls her saying. "Then... the city will get the contract." Stunned, the official ushered her out. In the future, he concluded, "Katrina would never be allowed to be alone with any of us."

If only the FBI had come to the same conclusion. Leung, as the world now knows, was one of the FBI's most trusted informants, who for two decades secretly fed the U.S. government valuable information about Chinese operations. But federal prosecutors now say that trust was badly misplaced. Last month, Leung was arrested on a charge of illegal possession of classified U.S. documents. Federal prosecutors say Leung was a double agent who carried on a secret sexual affair with her FBI "handler." Special agent James Smith, who recruited Leung 20 years ago, was arrested on a felony count of gross negligence. When Smith was with Leung, the Feds say, he would sometimes leave his unlocked briefcase unattended--giving Leung access to the classified documents inside. Federal prosecutors are expected to indict Leung and Smith this week. (In an e-mail to NEWSWEEK, Leung's husband, Kam, said he is confident that her lawyers "will bring the truth to light and my wife will be cleared of all wrongdoings." Smith's lawyer has said he will contest the charges.)

Smith, a respected Los Angeles agent, recruited Leung in 1982. A 28-year-old Chinese emigre with a University of Chicago M.B.A., Leung was fluent in Cantonese and Mandarin and made frequent trips to China in her job as a marketer. Soon the two, both married, began an affair.

There were early signs that Leung might be trouble. According to court documents, in 1991 an FBI agent in San Francisco named William Cleveland called Smith with a warning: bureau wiretaps had caught Leung "providing intelligence" to China. (As it turned out, Cleveland was also having an affair with Leung.) Though the Feds feared she might be a double agent, the bureau let her off with a mere warning from Smith.

Along the way, the woman the FBI code-named "Parlor Maid" became wealthy helping Western companies strike deals in China. In the mid-'90s, Canadian telecom giant Nortel paid her a $1.2 million commission for her services (Leung and her husband controlled 16 foreign bank accounts, the FBI said). She had a million-dollar house in upscale San Marino, threw lavish parties and gave generously to political candidates.

It's not clear how much the FBI knew about Leung's business deals. Smith's lawyer says his client was "generally aware" of her other sources of income, but didn't delve too deeply since she was such a good source. The FBI apparently wasn't concerned that she seemed to use her government-paid trips to China to advance her business. Leung's informant's stipend from the FBI topped out at $3,000 a month. Yet, over the years, she was paid a total of $1.7 million. Most of that money went to reimburse travel expenses. "She was providing us what she thought we wanted, and she was providing [the Chinese] what they wanted," says Van Magers, a former FBI counterintelligence official. "And she was doing it all for the benefit of Katrina Leung."

Law-enforcement sources say it could take years to figure out how much damage Leung might have done. NEWSWEEK has learned that the FBI has ordered a sweeping review of the way the FBI handles informants, and has developed a "matrix" to red-flag signs that a handler may be getting too cozy with a source. In the case of Katrina Leung, those red flags were pretty hard to miss.