DoD Personnel: Weaknesses in Security Investigation Program Are Being Addressed, Statement of Carol R. Schuster, Associate Director, National Security Preparedness Issues, National Security and International Affairs Division, Testimony before the Committee on Armed Services, U.S. Senate [open pdf - 511KB]
"The Department of Defense uses a two-part process to determine whether an individual should be granted a security clearance. The first phase is the personnel security investigation, in which Defense Security Service investigators corroborate information provided by the applicant, interview character references, and review federal and local records for financial vulnerabilities and criminal activity. The second phase is the adjudication, which is conducted by eight DOD components. Adjudicators weigh favorable and unfavorable information with regard to a number of factors (such as the nature, extent, and seriousness of any conduct). If, on balance, the evidence suggests the individual is a good security risk, the clearance can be granted."
Government Accountability Office: http://www.gao.gov