The Committee on Foreign Investment in the United States (“CFIUS”), the inter-agency group that conducts national security reviews of foreign acquisitions of U.S. businesses, recently issued its Annual Report to Congress for Calendar Year 2012. That reports show that China surpassed the United Kingdom in 2012 as the source for the largest number of foreign investments undergoing national security reviews.
Out of the 114 proposed foreign acquisitions of U.S. businesses that CFIUS reviewed in 2012, 39 involved Chinese investors. Perhaps not coincidentally, 2012 saw substantially more notices withdrawn than in previous years. It also saw only the second time the President has ordered the divestment of a foreign acquisition since the Exon-Florio amendment granted the President that authority in 1988.
CFIUS cleared 67 transactions during the initial 30-day review phase and an additional 24 after a full 45-day investigation. The parties to 12 of the reviews withdrew their notifications, either to allow more time for CFIUS’s consideration, or to account for changes in the transaction. They subsequently refiled.
The parties to ten transactions withdrew their notifications before the CFIUS process was completed. They never refiled. Some of them withdrew the notifications because the deals fell apart for normal commercial reasons, but some were abandoned, either because they understood the transaction would not be cleared by CFIUS, or the parties found the conditions required to obtain CFIUS clearance would have made the transactions commercially untenable.
As reported previously in this blog in July 2013 and October 2013, President Obama ordered the divestment of Ralls Corporation’s acquisition of four wind farm sites in Oregon. The Report states that the reasons were that Ralls is owned by Chinese nationals, and the “wind farm sites are all within or in the vicinity of restricted air space at Naval Weapons Systems Training Facility Boardman in Oregon.”
Not since 2008 have so many transactions been withdrawn from CFIUS review. Twenty-three transactions were withdrawn in 2008, 22 in 2012. However, in 2008 the great majority (18) were withdrawn in the initial review stage, largely because the global economic collapse made the transactions financially too difficult. . By contrast, 20 of the transactions withdrawn in 2012 occurred after CFIUS decided to initiate a full 45-day investigation, at which point it is more likely the notification was withdrawn due to problems arising in the CFIUS process, rather than due to economic conditions.
The Annual Report does not identify the nationality of the foreign investor in the withdrawn transactions, but it probably is not coincidental that 2012 saw a dramatic increase in both the number of transactions withdrawn (from 6 in 2011 to 22 in 2012) and the number of transactions involving Chinese investors (from 10 in 2011 to 23 in 2012). The CFIUS process is not necessarily hostile to Chinese investors, but it is no secret that Chinese investment receives higher scrutiny than investments from long time U.S. allies who are also major investors, such as the United Kingdom, Canada, France and Japan.
Virtually all projects with CFIUS problems now seem to involve either cyber security or “proximity” (“persistent co-location,” in the Department of Defense’s vernacular). It has been reported that one of the exacerbating concerns is the presence of government contractors in industrial parks, making the “proximity” issue more widespread than once thought. The Department of Defense, it is being said, is particularly sensitive to Chinese projects in the vicinity of its contractors.
CFIUS notes in the report that CFIUS agencies entered into eight legally binding mitigation agreements in 2012 to resolve national security concerns. The Annual Report provides the following examples of mitigation measures that were adopted in those agreements:
- Ensuring that only authorized persons have access to certain technology and information.
- Establishing a Corporate Security Committee and other mechanisms to ensure compliance with all required actions, including the appointment of a USG-approved security officer or member of the board of directors and requirements for security policies, annual reports, and independent audits.
- Establishing guidelines and terms for handling existing or future USG contracts, USG customer information and other sensitive information.
- Ensuring only U.S. citizens handle certain products and services, and ensuring that certain activities and products are located only in the United States.
- Notifying security officers or relevant USG parties in advance of foreign national visits to the U.S. business for approval.
- Notifying relevant USG parties of any awareness of any vulnerability or security incidents.
- Termination of specific activities of the U.S. business.
Chinese and other foreign persons who are considering acquisitions in U.S. businesses that may present national security concerns should think about whether these types of mitigation measures might resolve those national security concerns while still preserving the economic value of the transaction. It is better to think through possible mitigation measures in advance, rather than try to develop them during the short timeframes of a CFIUS review or investigation.
Finally, CFIUS identified in the Annual Report a number of perceived adverse effects on national security of foreign control of U.S. businesses in the transactions that it reviewed during 2012. Some of the perceived threats based on the U.S. business being acquired that are less than obvious include:
- Provide products or services that could expose national security vulnerabilities, including potential cyber security concerns, or create vulnerability to sabotage or espionage. This includes consideration of whether the covered transaction will increase the risk of exploitation of the particular U.S. business’s position in the supply chain.
- Have operations, or produce or supply products or services, the security of which may have implications for U.S. national security, such as businesses that involve infrastructure that may constitute critical infrastructure; businesses that involve various aspects of energy production, including extraction, generation, transmission, and distribution; businesses that affect the national transportation system; and businesses that could significantly and directly affect the U.S. financial system.
- Are in proximity to certain types of USG facilities.
The Report also identified the following perceived threats when the foreign persons who would be the acquirer:
- Are controlled by a foreign government.
- Are from a country with a record on nonproliferation and other national security-related matters that raises concerns.
- Have historical records of taking or intentions to take actions that could impair U.S. national security.
These concerns would appear to be aimed primarily at Chinese investment. All but 29 of the covered transactions that CFIUS reviewed in 2012 were from countries that are long-term U.S. allies. Chinese persons accounted for 23 of those 29 transactions.
The United States remains open to foreign investment, including investment from China. Most acquisitions of U.S. businesses continue to be approved. But, when Chinese companies, especially, seek to acquire existing U.S. businesses, they should notify the proposed transaction to CFIUS, and plan thoroughly for political and public relations processes favorably promoting the project. Chinese projects may have raised more questions than projects from other countries because of their substance, but they may also raise more questions because they are Chinese. The obstacles can be overcome, and the investments likely continue to be profitable and worthwhile, but they may take longer, requiring more planning, and more sophisticated execution.