U.S. Foreign Direct Investment Review - FINSA, Executive Order 11858 and the Road Ahead

Focus On Trade Policy


The United States historically has welcomed foreign direct investment with open arms. Although recent events -- most notably 9/11, followed by the CNOOC and Dubai Ports World deals -- have led many to re-evaluate this fundamental tenet of U.S. economic policy, recent changes to the underlying U.S. policy regime, built around CFIUS or the Committee on Foreign Investment in the United States, have not substantially altered U.S. foreign direct investment policy.

CFIUS is an interagency committee that initially was charged with monitoring foreign investment in the United States and coordinating U.S. policy in response. Over the years, Congress and the President expanded the role of CFIUS. CFIUS was charged with investigating the effect of foreign acquisitions, mergers and takeovers on U.S. national security, with a focus on controlling the diversion of high technology, and was empowered to block or unwind transactions deemed a threat to national security.

In early 2006, CFIUS set off a firestorm in the U.S. Congress by approving the sale of certain U.S. port operations to Dubai Ports World, the world’s largest port operator, and an entity owned by the United Arab Emirates. This contretemps followed Congressional outrage over a hostile bid by CNOOC for assets being sold by Unocal. In response to these controversial cases, in which national security risks were thought to have been overlooked and the flow of information to Congress was deemed unsatisfactory, Congress passed and President Bush signed into law FINSA or the Foreign Investment and National Security Act of 2007 (PL 110-49, July 26, 2007). FINSA formalized and overhauled the CFIUS investment review process, but it left a number of gaps to be filled via regulation.

As the Bush Administration begins to fill these gaps, national security review of foreign investment in the United States will remain at the forefront of issues facing the global business and investment community in 2008. On January 23, President Bush took the first step in implementing FINSA -- he issued an Executive Order clarifying both the scope of mitigation agreements, which many thought had been abused by agencies in recent high-profile transactions, and the chain of command in the CFIUS review process. See Executive Order: Further Amendment of Executive Order 11858 Concerning Foreign Investment in the United States (January 23, 2008). Regulations pursuant to FINSA are expected this spring.

The Executive Order should reassure the business community that the United States is not closing the door to foreign investment. In addition, as explained below, the Executive Order increases the predictability of the CFIUS review process, which should assist merger parties with strategic planning.

The 2007 Legislation -- FINSA

As we reported in October 2007, FINSA formalized and overhauled the CFIUS review process while leaving it largely intact. See Miller & Chevalier International Alert, Vol. 14, Issue 6, “The New Law Governing CFIUS National Security Review of Foreign Investment.” Congress passed FINSA in large part to address procedural grievances -- the apparent lack of accountability of the CFIUS staff to political appointees and to Congress, and the failure of CFIUS to provide annual reports to Congress. With regard to the latter, FINSA clarified and expanded provisions requiring CFIUS to report to Congress, including post-review and -investigation reports and annual reports of withdrawals. Most importantly, FINSA statutorily established CFIUS with the authority to review and investigate transactions, as well as to negotiate and enforce mitigation agreements.

Changes to the factors reviewed and the manner in which CFIUS conducts reviews were not as onerous as the investment community feared. For example, the 30-day review and 45-day investigation periods were not lengthened. In addition, although “national security” was expanded to specifically include “homeland security,” it was not expanded to include “economic security.” The business community also was relieved by the addition of a waiver provision to one of the main features of earlier versions of the legislation -- the requirement of second-stage investigations of transactions involving government-controlled entities and critical infrastructure. Under FINSA, given a justification by senior officials, there is no requirement of a second-stage investigation.

FINSA has a number of gaps, which Congress instructed the President to fill via regulation. The Executive Order is President Bush’s first step in filling these gaps.

The Executive Order Clarifies Mitigation Agreements, but Leaves Key Issues -- Critical Infrastructure and Sovereign Wealth Fund Investments -- for Regulations Expected this Spring

The business community was largely pleased with FINSA -- indeed, some felt it was necessary to rein in a CFIUS that was bending over backwards to satisfy “security hawks”. However, Congress left a number of important issues for the Administration to address in regulations, including the scope of mitigation agreements and critical infrastructure, as well as the treatment of investments by sovereign wealth funds. The Executive Order addresses mitigation agreements in detail, but leaves the other issues for specific regulatory guidance, a draft of which is expected by the end of March.

Many observers were concerned last year that U.S. agencies with their own regulatory agendas unreasonably imposed onerous requirements upon the Alcatel-Lucent merger and other transactions. The Executive Order addresses these concerns. It reaffirms the Treasury Department’s role as the principal agency in the CFIUS process and clarifies that CFIUS will oversee agencies that propose and negotiate mitigation agreements.

Regarding the apparent imposition of “evergreen” requirements (open-ended reviews), Section 7 of the Executive Order reaffirms that mitigation agreements should not be a substitute for other existing laws (even inadequate ones). First, a mitigation agreement (or conditions imposed) may be concluded where the national security risk posed by the transaction is not adequately addressed by another provision of law. Second, before risk mitigation measures are proposed to parties to a transaction, CFIUS must approve the measures based on a written justification from an agency that, among other things, identifies the risk and sets forth the measures that an agency believes are “reasonably necessary” to address the risk. Third, Section 7(c) prohibits agencies from attempting to make a violation of another U.S. law (e.g., a law under their regulatory control) a violation of the conditions of CFIUS approval. Moreover, agencies cannot condition CFIUS approval on requirements that fill gaps in laws under their regulatory control, and mitigation agreements cannot be “evergreen” other than in exceptional circumstances (such as an intentional violation of an agreement).

These features provide substantial needed protections to investors. They should assuage most, if not all, of the investment community’s concerns regarding the substance and process of recent mitigation agreements.

There are several other interesting provisions of the Executive Order. For instance, it clarifies that, in situations not involving government-controlled entities or critical infrastructure, investigations will be undertaken if a member of CFIUS advises the Treasury Department that a national security threat has not been mitigated.

Strategic Considerations

What does this mean for foreign investors interested in acquiring a U.S. company? First, the Executive Order provides clarity regarding mitigation agreements and attempts to rein in certain government agencies. However, absent policing by CFIUS and the Department of the Treasury, the Departments of Defense, State and Commerce will remain active in the process. Second, unless the regulations expected this spring are to the contrary, we recommend notifying transactions involving a government-controlled investor or a critical sector target (at a minimum, the traditional sectors of defense, aerospace, telecom and high tech, as well as infrastructure, energy, transportation, power generation and financial services). We also recommend notifying transactions where the acquiring firm is from a country that is on Congress’s radar, such as China, Russia and, as the Dubai Ports deal shows, the Gulf States. Third, note that, although the existing regulations arguably provide sufficient guidance, the regulations expected this spring may address sovereign wealth funds.

FINSA and the Executive Order should provide foreign investors with some reassurance that the national security review of their transactions will be subject to a transparent, fair and predictable process. Nonetheless, parties to transactions such as those described above should proceed with care. We strongly recommend that, before filing with CFIUS, they design and initiate an effective public policy strategy addressing the concerns of agencies that are likely have a say in the approval. In certain cases, approaching Congress also may be advisable.

For more information, please contact:

Larry Christensen, lchristensen@milchev.com, 202-626-1469

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