Editor:Please provide our readers with background on the Exon-Florio law passed in 1988, which gives the President authority under the Committee on Foreign Investment in the United States (CFIUS) to rule on foreign investment in U.S companies that might constitute a national security risk. Who are the members of CFIUS?
Smith: We at Willkie have a deep understanding of the context of the Exon-Florio law, since some of our attorneys who today help clients clear transactions in the CFIUS process helped to draft the law as staff members in the U.S. Congress. Prior to 1988, there was national security screening authority for foreign investments in the United States. At that time foreign investors acquired a number of iconic American enterprises, and there began to be considerable concern, that, as one congressman put it, "we are selling our family jewels for a night on the town."
After much debate over the merits of open investment policies, the existing authority was amended to establish a confidential interagency review process for exercising the President's authority. Parties to a covered transaction that is "cleared" by CFIUS essentially receive a "safe harbor." Notifying CFIUS of a pending transaction is voluntary. But if the parties choose not to do so, CFIUS can review a transaction on its own initiative and the President could require a divestiture after a transaction has closed. Under the Exon-Florio law the President may only exercise the authority to reject or ask for conditions on a transaction if other laws are inadequate to address national security concerns about that transaction.
CFIUS is headed by the Treasury Department. The other permanent member agencies are the Commerce, Defense, State, Energy, and Homeland Security Departments, the Office of Management and Budget, the Council of Economic Advisers, the U.S. Trade Representative, the National Economic Council, the National Security Council, and the White House Office of Science and Technology Policy. Other federal agencies can be part of the CFIUS process if appropriate to a particular transaction.
Editor:Has the provision that final decisions under this law are not subject to appeal ever been challenged? What measures may a foreign investor take whose initial application to CFIUS is turned down?
Smith: So far as I am aware there has never been a judicial challenge of the non-reviewability of Exon-Florio determinations. Bear in mind that actual rejection of a transaction is extremely rare. If it appears that CFIUS is not going to clear a transaction, the parties are likely to withdraw their notification and abandon or restructure the transaction. If a CFIUS notification is well organized and if the parties to a transaction establish a cooperative relationship with CFIUS, the odds are overwhelmingly favorable that the transaction will be cleared, even if CFIUS identifies national security concerns that need to be addressed. These concerns may require a mitigation agreement, or even a restructuring of the transaction with different ownership or control provisions or isolation of operations that CFIUS deems to be highly sensitive.
Editor:How has the term "foreign-controlled transaction" been interpreted by CFIUS? What definition is used by CFIUS in determining "control"?
Smith: The CFIUS regulations take an expansive, but well-understood approach to defining what will constitute acquisition of "control" by a foreign person over a U.S. business. If a foreign person can direct "important matters affecting an entity," through majority or "dominant minority" voting control, or any one of a comprehensive list of other mechanisms (board membership, special share, proxy rights, contract terms, "formal or informal arrangements to act in concert,"), or "other means" it is deemed to be in control. The regulations go on to provide an illustrative list of such matters: sale of assets, reorganization, merger, dissolution, major business or operations changes, major financial actions, new business lines, major contract actions, confidentiality policies, appointment of senior management or national security-sensitive employees, or amendment of organizational documents in regard to one of these matters. The regulations also provide illustrations as to what is not considered to be control: veto rights over asset sales or bankruptcy, and traditional minority shareholder protections against possible majority abuses.
Editor:How does counsel advise a client regarding whether a transaction is of a nature that application must be made to CFIUS?
Smith: At Willkie we work with the parties to a transaction to review carefully the U.S. operations of the target company. As a threshold issue, we look at whether the target is involved in sectors that CFIUS has identified as having national security significance. Since we have handled a very substantial number of CFIUS notifications, and reviewed even more bids, offerings, and proposed transactions, we know that these sectors currently include information technology, financial services, energy, environmental services, telecommunications, aviation and space technology, ground transportation, and defense-related activities.
We then ask about the target's U.S. government contracts, particularly those involving classified information, U.S. manufacturing operations, any unique or highly sensitive technology that the target may possess (even if it does no U.S. government business), and whether the target exports any goods or services that are subject to U.S. export controls.
Once we complete this discussion, we can usually make a recommendation to the parties about filing a voluntary notification with CFIUS. In some cases we may have to look more carefully at the ownership structure of the acquirer, since we have had situations in which the acquirer has foreign investors but is in fact controlled by U.S. persons, and in which the acquirer is a U.S. person but under foreign control. Occasionally we will determine that a U.S. entity is not an operating business since it has no employees or physical assets in the United States.
Editor:Why is it incumbent on both parties, the foreign acquirer and the U.S. acquiree, to engage in a pre-filing consultation with CFIUS?
Smith: CFIUS strongly prefers that the parties provide a "heads-up" about a coming notification. "Surprise" notifications are frowned upon. Prefiling consultation allows the Treasury Department team administering the law to advise those CFIUS member agencies that might want to take a lead role in the review. Since the statutory deadlines for review are so short, it also gives CFIUS agencies time to prepare for the formal filing. Just as importantly, it allows an informal exchange between CFIUS and the parties where CFIUS can highlight issues or ask that specific information be included in the notification. So, prefiling consultations can smooth the process for everyone involved.
Editor:Is there any rule of thumb that pertains to what constitutes "critical infrastructure" of the U.S.?
Smith: CFIUS looks at whether the destruction or crippling of a system or asset that is being acquired would have a "debilitating impact on" U.S. national security. If so, CFIUS will then look at how foreign control will affect that system or asset. Clearly this covers utilities, telecommunications, and transportation, but other sectors are often implicated as well.
Editor:Please describe the steps in the process of reaching CFIUS approval.Smith: After preliminary consultations, the parties prepare and file a notification. Once CFIUS formally accepts the notification, it initiates a review of the transaction. The review must be completed within 30 days, and during that period CFIUS often asks the parties questions or requests additional information. U.S. intelligence agencies (National Security Agency, CIA, FBI) conduct an internal review of the parties during this phase. If CFIUS determines that there are no national security concerns, then it will provide a clearance letter.
If there are concerns, if there is a need for further information, or if CFIUS determines that the acquirer is controlled by a foreign government, then the process moves to the investigation phase, which must be completed within an additional 45 days. During this phase CFIUS will either clear the transaction with no conditions or request that the parties take steps to address or mitigate any national security concerns. In the latter case the parties negotiate a mitigation agreement with CFIUS that generally provides for some continuing government oversight of sensitive U.S. operations.
If the issues cannot be resolved within the 45-day period, the transaction goes to the President with a report from CFIUS, and the President has 15 days to decide how to proceed. Again this is extremely rare.
Editor:One of the most conspicuous cases illustrating the frustrating of a foreign investment in a U.S. entity was the Dubai Ports World incident where the potential acquirer agreed to resell the U.S. port operations it acquired. Had the approval of this acquisition been given by CFIUS before it became highly controversial?
Smith: Yes. It was the perceived failure of CFIUS to identify the supposed national security implications of this transaction that led to significant changes in the Exon-Florio law in 2007. At Willkie we point to this case to highlight the need for the parties to a transaction to anticipate the political and public relations issues that may come up and to develop a strategy for dealing with them.
Editor:Could you describe the multi-billion dollar merger of two European information technology companies with manufacturing facilities in the U.S. in which the firm participated for which a "mitigation agreement" was required?
Smith: These two companies manufactured the same product, incorporating similar advanced technology. They both sold to the U.S. government and other common customers. CFIUS agencies were concerned that the combination could mean that, in the event of a security breach, breakdown, or other problem, they would no longer have an alternative source of supply. They sought commitments from the parties to notify the agencies in the event of such a problem and to allow periodic government inspection of their facilities, among other conditions.