By Elliot J. Feldman and John J. Burke

Chinese officials have long complained about American national security reviews, insisting they are an obstacle to Chinese investment in the United States. We have long pushed back, including in several articles posted on this blog in December 2009, January 2010, February 2011 , and May 2011, insisting the complaints have been exaggerated. Despite some celebrated instances that seemed very explicable (obstacles to Huawei, for example, because of its links to the PLA; objections to First Gold because of its proximity to military installations), almost all Chinese investments have proceeded without incident or challenge, and the American market has been open and welcoming.

The welcoming environment may be changing, both because Chinese investments may be of higher profile, and because there may be growing suspicions about Chinese intent. Two cases over the last year have led us to think that China’s complaints may be, at least to some degree, legitimate, and that there may be an anti-China prejudice beginning to manifest itself.

The first case involves a project that fell victim to the Committee on Foreign Investment in the United States (“CFIUS”) and presidential action, only the second of its kind. The second case has no discernible connection to national security and likely will be completed, but it has elicited an hysterical, xenophobic reaction reminiscent of the Japanese acquisition of Rockefeller Center twenty-four years ago.

Promoting Green Technology

         The Project And The Problem

Ralls Corporation, incorporated in Delaware and owned by two Chinese nationals –Dawei Duan and Jialing Wu — who are senior managers in the Sany Group in China, acquired interests in four Oregon wind farms, called the “Butter Creek Projects,” from Terna Energy USA Holding Corporation (Terna), a Greek company, in March 2012. There are many wind farms in this area of Oregon with turbines manufactured by a variety of companies, foreign and domestic. According to the Ralls owners, the location presents an excellent opportunity to showcase Sany’s Chinese turbine technology. They envisioned the installation of Chinese equipment to compete, potentially, with other turbines for projects all around the United States.

The Oregon project sites overlap a restricted airspace and bombing zone used by military aircraft out of Naval Air Station Whidbey Island. The original developers, Oregon Windfarms LLC, obtained in 2010 and 2011 a “Determination of No Hazard” from the Federal Aviation Administration (“FAA”) for each of the projects, which included a Department of Defense review to prevent, minimize, or mitigate adverse impacts on military operations and testing. Overall, the Naval Air Station is some two hundred miles from the Butter Creek projects.

Only one of the four Butter Creek projects intruded upon restricted airspace. The U.S. Navy alerted Ralls of concerns, and Ralls cooperated with the Navy to relocate the project. The new location required new approvals (approvals for the other three projects had conveyed with acquisition), and the Navy wrote to the Oregon Public Utility Commission on Ralls’ behalf.

Ralls and Terna did not submit a notification to CFIUS until after the transaction closed, two months after construction had begun, and only then because CFIUS requested that they do so. Notwithstanding advice from a Treasury Department official to postpone construction until after CFIUS’ review was completed, Ralls continued construction of Chinese wind turbines on the four sites.

Ralls was proceeding with confidence that the Butter Creek projects presented no national security questions. Three of the projects were outside restricted airspace and the fourth had been moved in cooperation with the U.S. Navy. Other foreign companies were erecting and operating wind farms in the same area. Solar and wind technologies were the primary subjects of agreements between Presidents Obama and Hu Jintao for Chinese-American cooperation in the development of green technologies. Chinese investment in the U.S. was being encouraged.

        CFIUS Intervention: A National Security State?

After conducting the initial 30 day review, CFIUS determined that a full investigation was needed. It also imposed an interim mitigation order on July 25, 2012, ordering Ralls to stop all construction and operations at the wind farms and prohibiting access to the project sites except by CFIUS-approved U.S. citizens. Ralls complied, and all construction stopped.

On August 2, 2012, CFIUS amended that order to prohibit Ralls from selling or transferring any Sany-produced items to third parties for use at the project sites and from selling the project companies without first giving CFIUS notice and opportunity to object to any intended buyer. These restrictions effectively took from Ralls all the value of its efforts.

President Obama issued an Order on September 28, 2012 prohibiting the ownership of the wind farm companies by Ralls, the two Chinese individuals who owned Ralls, or Sany, because of “credible evidence” that they, “through exercising control of the [companies,] might take action that threatens to impair the national security of the United States.” No evidence of this threat was offered to Ralls or Sany or the public.

The last time a President of the United States acted this way (and the only previous time), George H. W. Bush issued a similar order in 1989, requiring Chinese divestment of an aircraft parts manufacturer. Aircraft parts, however, are more plausibly a national security risk than wind towers.
Ralls was given 90 days to divest and 14 days to remove all structures or physical objects from the project sites. The Presidential Order also prohibited Ralls and its agents from accessing the project sites.

        Ralls Strikes Back

Ralls sued on September 12, 2012, claiming that CFIUS’s interim mitigation order violates the Exon-Florio Amendment and the Administrative Procedure Act. Ralls subsequently amended its complaint to include President Obama’s order and a claim that the divestiture requirement is an unconstitutional “taking” of property without due process of law because Ralls was not given an opportunity to review, respond to, or rebut any evidence upon which CFIUS or the President based their orders.

The United States District Court for the District of Columbia, on February 26, 2013, dismissed Ralls’ claims that the President’s order violated the Exon-Florio Amendment and the Administrative Procedure Act, finding that the President acted within his powers under those laws and that the statute prohibits judicial review. The court found that it did have jurisdiction to consider the Constitutional challenge, however, and, therefore, allowed it to proceed without making any ruling on the merits of the claim. Meanwhile, Ralls has forfeited the projects and its investment, hoping to recover the latter through its Fifth Amendment constitutional claim.

Whose Pork?

On May 29, 2013, China’s Shuanghui International Holdings Ltd. announced it was acquiring Smithfield Foods, Inc., the largest U.S. publicly-traded, and the world’s largest, pork processor and hog producer. Shuanghui, a private holding company based in Hong Kong, owns China’s largest meat processor, which is publicly-traded, of the same name. Shuanghui Chairman Wan Long indicated his intention was to expand and improve service to the Chinese market and its growing demand for quality pork. Smithfield President and CEO Larry Pope said he did not think anything would change in Smithfield’s operations, but Smithfield’s ability and opportunities to export – a key international trade goal of President Obama – would improve.

Although there is no obvious national security interest in raising and slaughtering hogs, buying and selling pork, Smithfield voluntarily invited CFIUS review. It was prudent to do so. On the day of the announced merger, Senator Chuck Grassley (R-Iowa) called for a thorough CFIUS review, complaining that, “No one can deny the unsafe tactics used by some Chinese food companies,” asking, “How might this deal impact our national security? What role does the Chinese government play in Shuanghui, like it does in so many other ‘private’ companies?” He declared these questions “important” “for CFIUS to get answered.”

United States Senator and Agriculture Committee Chairwoman Debbie Stabenow (D-MI) opined on June 7 that her committee likely would hold hearings on the acquisition and that CFIUS should “proceed with caution.” She questioned Shuanghui’s food safety record while acknowledging that CFIUS had not previously addressed food safety. She complained, in the same breath, that CFIUS “typically” had been ”pretty narrow in terms of military security,” adding that, “We all say food security is national security.” Senator Stabenow encouraged alternative bids for Smithfield, apparently preferring buyers other than Chinese.

Senator Stabenow followed her June 7 statement with a letter on June 20, coauthored by the Ranking Member of the Agriculture Committee, Thad Cochran (R-MS), addressed to Treasury Secretary Jack Lew, raising food safety questions, as did the Chairman and Ranking Member of the Senate Finance Committee (Max Baucus, D-MT, and Orrin Hatch, R-UT) in a separate letter (the Senate Finance Committee controls international trade; its letter complained about Chinese barriers to imports of U.S. foodstuffs, particularly pork and beef). As we have written before, nothing seems to unite the divided, partisan Congress of the United States like China, and not in a good way.

The thinly disguised antipathy toward Chinese ownership of Smithfield was expressed by others. Virginia Republicans (Frank Wolf and Randy Forbes) asked the Department of Justice for a market impact investigation. They alleged “evidence to suggest strong ties” between Shuanghui and the Chinese government, but could identify, when questioned, nothing more than a loan from the Bank of China. Massachusetts Democrats, Senator Elizabeth Warren and Congresswoman Rosa DeLauro, in a letter to the new U.S. Trade Representative Michael Froman, questioned foreign ownership of agricultural land, even though Massachusetts is not one of the eight states that restrict such ownership and agricultural land was not at the center of the transaction.

A group of seventeen farm, producers, consumer and rural organizations addressed a letter to CFIUS on July 9 opposing the acquisition by alleging threats to unnamed U.S. security interests, food security, safety of food supply, and even technology transfer for maintaining safety in food supply (implying that they would rather have China deficient in food safety than have China benefit from American experience and technology). The private sector letter was prelude to the Senate Committee hearing Senator Stabenow promised, which convened on July 10.

Larry Pope, President and CEO of Smithfield Foods, disarmed much of the criticism at the hearing. Declaring that, Smithfield’s operations would not be changed in any way by the Shuanghui acquisition, he concluded by declaring that “The bottom line is that this is all about US exports to the Chinese market, not Chinese exports, or a loss of US competitiveness.” He directly contradicted the complaints from the Senate Finance Committee about barriers to American exports of meat products to China: this transaction, Pope explained, was about opening the Chinese market.

The anti-Chinese sentiment, despite Pope’s reassurances, did not abate. Senator Sherrod Brown (D-Ohio) called on the Obama Administration, at the same Agriculture Committee hearing, to include officials of the United States Department of Agriculture in the CFIUS review of the transaction. He was reasserting the argument of a bipartisan letter he had addressed to Secretary Lew on June 20, co-signed by fifteen Senators, including most of the Agriculture Committee. He claimed the government, because of the sheer size of the transaction, should scrutinize the “long-term impact on workers, producers, and consumers,” notwithstanding that there is no legal basis for such an inquiry: “We need guarantees that under Chinese ownership, we will continue to see high-quality food products that comply with stringent American food safety and biosecurity standards.” Of course, U.S. laws and regulations do not discriminate between domestic and foreign owners: Chinese owners would be subject to the same régime as American owners for “food safety and biosecurity standards.”

Lessons And Ironies

The safety and security of American food supply is not without its critics. Europeans, Japanese, and Koreans all have refused to import American beef because of doubts about its quality and safety. The United States does not have a monopoly on a safe and secure supply of food.

Many analysts traced the 2009 swine flu epidemic to deplorable conditions at a Smithfield Foods compound in Mexico. Smithfield has been accused, although perhaps not as often as Shuanghui, of inhumane treatment of animals and doubtful food safety standards. The operating assumption in the U.S. Congress, however, is that no American operation could compare unfavorably to operations in China.

Without any legal basis for questioning the foreign acquisition of a food processor, Senators and Congressmen, Democrat and Republican, are looking to CFIUS to save their special interests and to express their anti-China sentiments. It is apparent, however, that CFIUS cannot (and should not) be bent into this new shape.

CFIUS has continued to approve potentially controversial deals involving China, recently a Chinese oil company’s acquisition of Nexen Energy. Nevertheless, the campaign to broaden the CFIUS mandate to Smithfield Foods threatens every future Chinese investment. Taken with the Ralls/Sany experience, Chinese wariness appears warranted.

The Ralls case reinforces at least three points. First, threats to national security can vary drastically based on the facts of the case. In Ralls, it was not what the target company did that created the national security issue. Ralls was building wind farms in Oregon, as were many other companies, foreign and domestic, an activity encouraged by the leadership in both China and the United States. Instead, it was who they were, and their location (and location could yet jeopardize aspects of the Smithfield acquisition).

The fact that the Ralls project is Chinese and has been treated differently from similar projects involving other foreign enterprises in the same geographic area is particularly troubling. Sany has said it wanted to develop wind farms in this location because it wanted to demonstrate the superiority of its products in direct competition with wind farms erecting turbines from Denmark, the United States, and other countries in the same geographic area. It then hoped to market its wind turbines elsewhere in the United States. Because CFIUS is secretive, the fact that the project was Chinese has not been identified as the salient cause for rejection, but the Butter Creek projects were proceeding without difficulty when owned by a Greek company.

Second, the location, in proximity to military installations, created a basis for rejecting the projects. Nonetheless, it is significant that the U.S. Navy and the Department of Defense both had been involved directly in providing and even championing approvals for Ralls, and wind farms owned by other foreign interests were operating in the area.

Smithfield filed a voluntary notice for CFIUS review even though there was no apparent need for one. This step should not have been necessary, but probably was wise. Foreign businesses, especially Chinese, should give very serious thought to filing voluntary notices with CFIUS prior to closing a transaction, even when the project does not self-evidently raise a security question. In the wind farm case, Ralls certainly knew of military concerns, having been engaged by the U.S. Navy regarding location. Smithfield probably learned this lesson from Ralls, that it is better to volunteer for review regardless how doubtful the need may seem.

Because the courts cannot review the merits of a divestiture order from the President, working with CFIUS to address national security concerns prior to an acquisition is essential. Had Ralls done so, it might have been possible to work out some mitigation arrangement that would have allowed at least some part of the transaction to go through. Even were that not possible (and this case raises doubts because problems arose not from the nature of the project – wind farms – nor strictly from location – because other foreign operations were in the area – but apparently because the project was Chinese), Ralls might have avoided the costs and adverse press of an acquisition and forced divestiture. For Smithfield, it appears unlikely that CFIUS could question more than potential proximity to some security installations. The overall deal is likely to survive review.

There remain abundant opportunities for Chinese investment in the United States, and the Smithfield case, the largest ever, may be the best example. Nonetheless, the Ralls case does suggest, as Smithfield is experiencing, that Chinese investments may face particular scrutiny. It would be prudent for Chinese buyers, in particular, to err on the side of caution by voluntarily seeking CFIUS review when there appears to be even a remote possibility of national security concerns, and that they organize for effective diplomatic, political, and public relations before their projects go public.

Implications For A Bigger Picture

There is apparently a growing ambivalence in the United States toward China. The Obama Administration aggressively assailed Chinese cyberspying, only to face the Snowden leaks of American spying on allies and citizens. New reports have emerged that the Pentagon is sketching an AirSea Battle plan against China. American officials are promoting again the alliance with Japan in the presence of a nationalist Japanese Prime Minister who is rolling back even a glimmer of reconciliation with China following Japanese invasion and occupation during the last century.

These classic national security measures are being complemented by muscular economic policies. The Administration is pressing to complete the Trans Pacific Partnership, which conspicuously embraces almost everyone in the Pacific except China. Decisions of the U.S. Department of Commerce and the U.S. International Trade Commission have blocked imports from China of solar cells and wind towers, the essential elements of the green technology for climate change promoted by Presidents Obama and Hu Jintao.

Officially, publicly, and logically, China is not an enemy of the United States. There are critical planetary issues that require bilateral cooperation. Climate change, for example, requires the cooperation of the two leading producers of carbon. The global economy cannot right itself without the two leading producing and consuming nations managing together. The North Korean nuclear threat cannot be contained without the joint efforts of China and the United States. For all its occasional bravado, China remains a developing country that needs American support of its continuing reduction of widespread poverty.

Recent developments must be a source of worry. Americans do not have to be naïve to promote cooperation and friendship. They do not have to instill paranoia in a country too accustomed to foreign occupation and humiliation. CFIUS is perhaps the least transparent of American political processes. In the most recent cases reported here, it also appears to be discriminatory.

CFIUS, to remain credible as a defender of national security, must resist the anti-China sentiment demanding a mandate expanded to food safety. Further, it should recognize the constitutional implications of the Presidential Order divesting Ralls and find a way to compensate. The alternative is to discourage Chinese investment, Chinese confidence, and Chinese trust. American security will not be enhanced by growing distrust between China and the United States.

For their part, Chinese must recognize the sentiments being expressed in the Congress of the United States. Shuanghui, wise to invite CFIUS review for a project with no traditional implications for national security, should set an example for other Chinese investors. To get what they want and need, Chinese may have to go further than the law would seem to require. Mutual trust, it seems, remains still more aspiration than achievement.