Recently, the Committee on Foreign Investment in the United States ("CFIUS"), a multi-agency regulatory body empowered to review transactions involving a foreign person and a U.S. business that may affect U.S. national security, delivered its unclassified Annual Report to Congress for the calendar year 2011 (“Annual Report”). In accordance with the legal prohibition against public disclosure of such information, the Annual Report contains no information with respect to specific transactions. Nonetheless, it remains a remarkable window into the reach and operation of CFIUS, and its impact on transactions by foreign persons involving U.S. businesses.
As in previous years, and as required by the Foreign Investment and National Security Act of 2007 (“FINSA”), the Annual Report summarizes CFIUS’s activities during the covered period, including the number and disposition of CFIUS notices, the nature and prevalence of mitigation arrangements, and the geographic source and sector concentration of covered transactions. In addition, the Annual Report describes its 2011 calendar year activities in comparative and cumulative perspective for the years 2009-2011.
We have set forth below a brief summary of the key highlights of the Annual Report, along with a discussion of emerging trends in the CFIUS review process. The results of the Annual Report foreshadow the high profile activities of CFIUS in 2012, including the first Presidential action blocking a transaction since 1990.
In 2011, 111 CFIUS notices were filed and determined to describe “covered transactions,” or transactions within CFIUS’s regulatory purview. The number of notices filed in 2011 represents a 19% increase in filings as compared to the 93 such notices filed in 2010. In our judgment, this notable increase in filings is more likely the result of improving market conditions for merger and acquisition activity, rather than a marked change in CFIUS’s regulatory vigor. In addition, and as discussed below, the geographic shift in filings underscores, in part, the macro-trend of increased capital liquidity in China and may suggest a heightened sensitivity by acquirers from those countries for CFIUS’s reach and power.
Of the 111 transaction notices filed, one was voluntarily withdrawn from CFIUS consideration during the initial 30-day review and five were voluntary withdrawn from CFIUS consideration during the subsequent 45-day investigation phase. According to the Annual Report, the parties resubmitted new notices in four cases, and in two cases withdrew the transaction and re-filed the CFIUS notice in 2012.
Investigations and Presidential Review
In 2011, 40 (or 36%) of the 111 notices for “covered transactions” went beyond the initial 30-day review and into the 45-day investigation phase. The percentage of notices moving into the investigation phase remained fairly constant from 2010 (38%) to 2011 (36%).
- In 2011, the parties ultimately withdrew their notices in one of the 40 (2.5%) cases that went to investigation. In 2010, the parties ultimately withdrew their notices in six of the 35 (17%) cases that went to investigation.
- Notably, the President did not block or prohibit any transactions in 2011. While not discussed in the Annual Report, the President blocked a transaction in 2012 for the first time since 1990. In a historic shift in policy, on September 28th, 2012, President Obama, following an initial recommendation by CFIUS, signed an executive order blocking the foreign investment by Ralls Corp., a firm owned by two Chinese nationals who are executives of Sany Group, in four windfarm project companies located in Oregon, for national security reasons.
In 2011, eight (or 7%) of the covered transactions were approved by CFIUS subject to the acceptance of mitigation arrangements. These mitigation arrangements were negotiated by CFIUS in connection with transactions in the software, computer programming, computer and electronic manufacturing, electrical equipment and component manufacturing, aerospace manufacturing, and finance sectors.
Pursuant to these arrangements, the subject parties are required to take one or more of the following actions:
- Establishing a Corporate Security Committee, security officers, and other mechanisms to ensure compliance with all required actions, including annual reports and independent audits;
- Ensuring compliance with established guidelines and terms for handling existing or future U.S. Government (“USG”) contracts and USG customer information;
- Ensuring that only U.S. persons handle certain products and services, and ensuring that certain activities and products are located only in the U.S.;
- Notifying relevant USG parties in advance of foreign national visits to the U.S. business;
- Notifying relevant USG parties of any material introduction, modification, or discontinuation of a product or service, as well as any awareness of any vulnerability or security incidents;
- Ensuring continued production of certain products for USG parties for specified periods; and/or
- Requiring a proxy entity to perform certain functions and activities of the U.S. business.
In addition, it’s important to note that CFIUS member agencies have taken a number of steps to enhance their ability to monitor compliance with the mitigation arrangements they may require, including:
- Assigning staff the responsibility for compliance monitoring;
- Designing tracking systems to monitor required compliance reports; and
- Instituting internal instructions and procedures to ensure that in-house expertise is drawn upon to analyze compliance with measures.
This continuing development and maturation of a CFIUS compliance infrastructure represents one of the least articulated and most significant developments since the passage and implementation of FINSA.
As in previous years, notices were filed in connection with transactions in a wide variety of sectors, with the bulk of transactions in the manufacturing and the finance, information, and services sectors. The notices filed in 2011 were divided among four industry sectors as follows: manufacturing (44%); finance, information, and services (34%); mining, utilities, and construction (14%); and wholesale trade, retail trade, and transportation (7%). Notices in connection with transactions in the manufacturing sector continued to increase from 32% of the filings in 2009 and 39% in 2010.
Notices Filed by Country of Origin
Transaction notices were filed by prospective acquirers from 24 different countries. In 2011, the following countries accounted for the highest number of notices:
- United Kingdom (26)1;
- France (14);
- China (10);
- Canada (9); and
- Netherlands and Japan (7 each).
There was a sharp increase from 2010 in notices filed from China, France, and the Netherlands. Prospective acquirers from China and France filed six transaction notices in 2010 and prospective acquirers from the Netherlands filed two notices in 2010.
From 2009 to 2011, the number of covered transactions by acquirers from China has steadily increased, from four in 2009 to 10 in 2011. Of the 20 transactions by Chinese acquirers between 2009 and 2011, 60% of the transactions were in the manufacturing sector and no other sector accounted for more than five transactions. As discussed above, the manufacturing sector has come to represent a larger percentage of all covered transactions, moving from 32% in 2009 to 44% in 2011.
This increase in investment in the United States manufacturing sector is consistent with China’s most recent Catalogue for Guiding Foreign Investment (2011 Revision) which promoted global investment, including investment in foreign manufacturing among other industries. China’s outward foreign direct investment in manufacturing rose by 108% in 2010 from the prior year.2
In connection with increased investment by Chinese acquirers, the U.S. government has begun to scrutinize closely the national security implications of such investments. In early October, the U.S. House of Representatives Permanent Select Committee on Intelligence issued a report regarding the national security threat posed by two Chinese companies, Huawei Technologies Company and ZTE. The committee report described the companies, which are the two leading telecommunications equipment manufacturers in China, and their investments in the U.S. telecommunications industry as a threat that could undermine U.S. national security. Among other items, the report recommended that CFIUS block any potential U.S. acquisitions by Huawei or ZTE.