Inbound Investment And U.S. National Security: Which Transactions Will The CFIUS Review And Why?

Monday, October 4, 2010 - 01:00

The Foreign Investment and National Security Act of 2007 ("FINSA") amended the Exon Florio Amendment of 1988 to expand the reach and rigor of foreign investment reviews conducted by the Committee on Foreign Investment in the United States ("CFIUS"). In particular, FINSA requires CFIUS to consider whether a foreign acquisition of control over U.S. "critical infrastructure" creates national security risks, and, if so, to investigate fully and mitigate any such risks. The adoption late in 2008 of FINSA's final implementing regulations (the "CFIUS Regulations") and other guidance provided by CFIUS have clarified the law's implications for foreign investors while leaving substantial room for interpretation. As a consequence, transaction parties now need to consider the role of CFIUS and attendant political considerations in a much broader range of circumstances than only a few years previously.

Relevant questions and answers for prospective foreign investors in U.S. business operations include:

What Is CFIUS?

CFIUS is an inter-agency committee chaired by the Treasury Secretary. Among other participants from the Executive Branch, CFIUS has six other permanent voting members: the Secretaries of the Departments of State, Defense, Homeland Security, Commerce, Energy, and the Attorney General; and two permanent non-voting members: the Secretary of Labor and the Director of National Intelligence. CFIUS designates a "lead agency" for each of its reviews, which typically would be the Department of Homeland Security ("DHS") for infrastructure deals.

Over What Transactions Does CFIUS Have Review Authority?

CFIUS has authority to review the acquisition by non-U.S. persons, or an entity ultimately controlled by non-U.S. persons, of "control" over a U.S. business. Even the acquisition of a corporation already owned by non-U.S. persons and/or headquartered outside the United States is subject to CFIUS review to the extent of its U.S. business operations. In all cases, however, the acquisition must involve an existing U.S. business rather than a "greenfield" project. Moreover, if the acquisition target is based outside the United States, the President's blocking and divestiture authority generally applies only to the U.S. portion of its business.

By broadly interpreting the concept of "control," CFIUS has asserted jurisdiction over minority as well as majority investments. The CFIUS Regulations define "control" to include " the power, direct or indirect " by anymeans to " cause decisions " of importance to a U.S. business. Under one example in the Regulations, acquiring a nine percent voting interest provides control if combined with " the right to veto the dismissal of senior executives " among other veto rights over " important matters ." In contrast, a 13 percent shareholding and one seat on a seven-member Board do not provide control if the investor's only veto rights relate to non-dilution.

CFIUS will look at all potential means and attributes of control in conducting its jurisdictional analysis. What may vary over time is how the nationality of the acquirer and/or nature of the target company might influence the determination of control in particular cases; i.e., does a 15 percent stake held by a Chinese acquirer more readily produce a finding of control by CFIUS than the identical stake held by a Canadian acquirer? Nothing in the CFIUS Regulations would preclude CFIUS from commingling its "control" analysis and its analysis of underlying security risks in this manner, because there is no "bright line" test for control.

For example, in 2008, CFIUS blocked Huawei of China from acquiring a 16.5 percent interest in 3Com, a telecoms equipment supplier, through Bain Capital. More recently, in August 2010, a proposed investment of 14 percent by Anshan Iron & Steel Group of China in a U.S. steel mill project encountered fierce opposition from a block of U.S. Congressmen who asked CFIUS to investigate the transaction.

When Does FINSA Require CFIUS To Conduct A Review?

FINSA mandates CFIUS to conduct a full investigation of two specific types of transactions:

• Acquisitions by a foreign-government-owned or controlled entity of any U.S. business;

• Acquisitions of U.S. "critical infrastructure" regardless of whether the non-U.S. acquirer is foreign government owned, but only if CFIUS determines that "the transaction could impair national security and that risk has not been mitigated."

Thus, CFIUS can clear an acquisition of critical infrastructure by a non-government-controlled entity without conducting a full investigation if the transaction presents no security risks. In regard to certain acquisitions by government-controlled entities, however, CFIUS may waive the full investigation requirement only if the Secretary of the Treasury, as Chair of CFIUS, together with the head of the lead agency ( e.g. , DHS for most infrastructure deals), or their Deputy Secretaries, jointly determine that the acquisition does not present a national security risk.

What Is The Definition Of Critical Infrastructure?

CFIUS has refused to define "critical infrastructure" in terms of broad asset categories. Rather, infrastructure becomes "critical" depending on " the national security effects of any incapacity or destruction of the particular system or asset. " In our experience, any acquisition involving large-scale power plants or transmission grids, significant oil and gas facilities, including refineries and pipelines, nuclear energy generation facilities, major airports, essential highway systems, securities exchanges, and other infrastructure assets with a significant economic or political profile would likely qualify as critical infrastructure. Although CFIUS might conduct only a preliminary review before providing a clearance in many of these cases, it would base such decision not only on the importance of the assets under review, but also on whether the foreign acquirer, because of its ownership or domicile, aroused political sensitivities or had any national-security-related "skeletons in the closet."

What Transactions Should Be Notified To CFIUS On A "Voluntary" Basis?

CFIUS administers a clearance procedure that enables transaction parties to submit voluntary notifications to CFIUS in an effort to resolve potential national security issues prior to closing. By obtaining a pre-closing clearance, parties can mitigate the risk that CFIUS might unilaterally initiate its own review, either pre or post-closing, and seek to impose national security undertakings and/or recommend that the President block or unwind the acquisition of the U.S. business.

The CFIUS Regulations do not require parties to file a "voluntary" pre-closing notification, even for transactions that FINSA requires CFIUS to review; rather CFIUS retains the power to compel the parties to submit information in that context, creating an incentive for parties to cooperate with CFIUS rather than provoke a potential confrontation. In all cases, however, the decision of whether to submit a voluntary notification prior to closing and trigger a CFIUS review will depend on a range of considerations involving, among other things: (1) the sensitivity and political profile of the transaction and transaction parties; (2) existing CFIUS precedent; and (3) the degree of risk aversion among the parties to possible adverse publicity or second-guessing in the future regarding whether they had properly anticipated and addressed U.S. political risks.

The greater the likelihood that CFIUS will express serious interest in a transaction unilaterally, the greater is the incentive for parties to notify CFIUS voluntarily in order to demonstrate cooperation and attempt to establish a positive tone for the ensuing national security review. However, transaction parties need to appreciate that voluntary notifications necessarily involve the provision of comprehensive information, which can be costly and intrusive to develop, and often lead to demands for even more information, sometimes of questionable relevance to the transaction.

How Does The Investigation Process Work?

CFIUS will initiate a review either on acceptance of a voluntary notification from the parties or under its own authority. The law provides CFIUS with up to 30 days to complete an initial review and to determine whether a full investigation is warranted. In the event of a full investigation, CFIUS will have 45 days either to clear the transaction on its own authority or to make a recommendation to the President. The President has 15 days to act upon receipt of a recommendation.

Thus, the statutory time periods for initial review, full investigation and Presidential action together contemplate a maximum clearance time of 90 days. However, the CFIUS Regulations encourage parties to submit draft notifications at least one week in advance of actual filing, and to begin informal consultations even sooner. Substantial discussion and negotiation can occur between the parties and CFIUS, both before and during the formal review period, in an effort to resolve national security concerns without sending a decision to the President.

CFIUS investigations are confidential and all submissions by the parties are entitled to confidential treatment, with the significant exception of consultations between CFIUS and Congress, which occur formally after investigations have concluded and are reputed to occur informally at other times. Thus, a parallel process of anticipating and addressing Congressional concerns (i.e. , "lobbying") often accompanies the submission of notifications to CFIUS in politically sensitive cases.

What Happens If CFIUS Finds A National Security Issue?

If, during a review or investigation, CFIUS identifies an unresolved national security concern, it may seek to resolve such concern through the imposition of undertakings on the parties, including in the form of commitment letters on specific issues or "mitigation agreements" addressing a broader range of security objectives. Parties that enter into such undertakings do so in exchange for a clearance from CFIUS, and to avoid the risk of Presidential intervention.

On occasion, however, CFIUS has rejected any solution other than the divestiture of U.S. assets or operations deemed too sensitive for the particular foreign acquirer to retain. In these cases, the parties typically will admit defeat rather than force the President to issue a formal divestiture order. The most recent examples include (1) the negotiated exit in December 2006 by Smartmatic International, a Venezuela-owned firm, from its ownership of Sequoia Voting Systems, a U.S. supplier of voting machine technology used for elections by many states; (2) the above-noted rejection of Huawei's proposed acquisition of a 16.5 percent interest in 3Com, and (3) the refusal by CFIUS, in November 2009, to clear the acquisition by China's Northwest Non-ferrous International Investment Company of a 51 percent stake in Firstgold. Firstgold, a small U.S. mining company, has properties in close proximity to a U.S. Navy air station and other highly-sensitive U.S. military installations in Nevada. Northwest, which had ties to provincial government authorities in China, chose to withdraw its offer rather than risk a blocking order by President Obama.

George Kleinfeld is a Partner in the International Regulatory Practice of the firm's Washington office.

Please email the author at george.kleinfeld@cliffordchance.com with questions about this article.