The Committee on Foreign Investment in the United States ("CFIUS"), a multiagency US regulatory body empowered to review investment transactions involving a foreign person and a US business that may affect US national security, recently delivered its unclassified Annual Report to Congress for the calendar year 2014 (“Annual Report”). The most notable trends are that CFIUS filings increased significantly in 2014, while the frequency of 45-day investigations and mitigation measures decreased. Also, for the third straight year, Chinese investors have filed the greatest number of CFIUS notices.
As in previous years, and as required by the Foreign Investment and National Security Act of 2007 (“FINSA”), the Annual Report summarizes CFIUS’ 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 2014 calendar year activities in comparative and cumulative perspective for the years 2009- 2014.
We have set forth below a brief summary of the key data points of the Annual Report, which highlights the need for parties to consider CFIUS-related issues in the transactional context. 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 involving US businesses.
KEY DATA POINTS
In 2014, 147 CFIUS notices were filed and determined to describe “covered transactions,” or transactions within CFIUS’ regulatory purview. The number of notices filed in 2014 represents a significant increase compared to the 97 notices filed in 2013. This increase is consistent with the general rising trend in CFIUS filings since 2009, and is the highest level since 2008. It largely reflects the strong M&A market in 2014, rather than any change in CFIUS practice. However, it may also reflect parties’ recognition of CFIUS’ broad view of national security and a greater willingness to file a voluntary notice in order to secure the CFIUS safe harbor, as well as increased investment from China and changing economic conditions in Asia.
- Withdrawn Notices
Of the 147 transaction notices filed, three were voluntarily withdrawn from CFIUS consideration during the initial 30-day review and nine were voluntary withdrawn from CFIUS consideration during the subsequent 45-day investigation phase. According to the Annual Report, only one of these notices was resubmitted in 2015. While CFIUS notices may be withdrawn for a variety of reasons (both related and unrelated to CFIUS itself), these statistics at least indicate the possibility that certain deals were scuttled as a result of the CFIUS process.
- Investigations and Presidential Review
In 2014, 51 (or 35%) of the 147 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 decreased from 2012 (39%) and 2013 (49%). It is also marginally lower than the 39% average since 2009. However, the 35% investigation rate from 2014 is much closer to this historical average, and it seems that 2013’s high-water mark may have been an outlier. Also, while the percentage of notices going to the investigation phase may have decreased in 2014, the number (51) is the highest in recent years. This high number indicates that CFIUS continues to review many transactions that require additional time to process, due to various reasons ranging from increased transactional complexity to a backlog in CFIUS’ workload. The large number of investigations is also important in the transactional context because a prolonged process may create delay and uncertainty regarding timing.
The President did not block any transactions in 2014. The last year in which there was a blocked transaction was 2012.
- Notices Filed by Country of Origin
Transaction notices were filed in 2014 by prospective acquirers from 27 different countries. In 2014, the following countries accounted for the highest number of notices:
- China (24)
- United Kingdom (21)
- Canada (15)
- Japan (9)
- Germany (9)
These countries have remained at the top of the list for several years, except that Germany substituted for France this year. China remains in the top spot for the third year in a row. Anecdotal data suggest that this pattern has continued into 2015 and 2016 due to increased liquidity in Asia and Chinese companies’ search for new markets in light of the slowdown of the Chinese economy.
There were notable increases in filings since 2013 from Germany, Israel, the Netherlands, South Korea, Switzerland, and the United Kingdom. The Annual Report also indicates a reversal of a notable trend from 2013, in which year filings from Japan increased significantly while filings from the United Kingdom and the Netherlands fell. It is possible that 2013 was an outlier for those countries. Finally, filings were made by acquirers in the following countries that had not made filings in 2012 or 2013: British Virgin Islands, Finland, Indonesia, Liechtenstein, and Qatar.
- Mitigation Measures
In 2014, nine (or 6%) of the covered transactions were approved by CFIUS subject to the acceptance of mitigation arrangements, compared to 11 (or 11%) in 2013, and the 2012-2014 average of 8%. These mitigation arrangements were negotiated by CFIUS in connection with transactions in the software, services, and technology industries.
Pursuant to these arrangements, the parties are required to take one or more of the following actions:
- Ensure that only authorized persons have access to certain technology and information;
- Establish a Corporate Security Committee and other mechanisms to ensure compliance with all required actions, including the appointment of a US Government (“USG”) approved security officer or member of the board of directors and requirements for security policies, annual reports, and independent audits;
- Establish guidelines and terms for handling existing or future USG contracts, USG customer information, and other sensitive information;
- Ensure that only US persons handle certain products and services, and ensuring that certain activities and products are located only in the U.S.;
- Notify security officers or relevant USG parties in advance of foreign national visits to the US business;
- Notify relevant USG parties of any awareness of any vulnerability or security incidents; and/or
- Provide the USG with the right to review certain business decisions and object if they raise national security concerns.
The final measure of allowing the USG to review certain business decisions and object is only being included in this Annual Report for the second time, while the other measures are more longstanding.
In addition, it is 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:
- Periodic reporting to USG agencies by the companies;
- Onsite compliance reviews by USG agencies;
- Third-party audits when required by the terms of the mitigation measures; and
- Investigations and remedial actions if anomalies or breaches are discovered or suspected.
- Industry Sectors
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 Finance, Information, and Services sectors. The notices filed in 2014 were divided among four industry sectors as follows: Manufacturing (47%); Finance, Information, and Services (26%); Mining, Utilities, and Construction (17%); and Wholesale Trade, Retail Trade, and Transportation (10%). This distribution is largely in line with historical averages, with manufacturing deals being slightly more common than average in 2014 and finance, information, and services deals being slightly less common than average.
Within the Manufacturing sector, computer and electronics products remained the largest subsector (42% in 2014), slightly below recent averages, with machinery and transportation equipment the next two largest sectors (13% each in 2014). Within the Finance, Information, and Services sector, professional, scientific, and technical services remained the largest subsector (37% in 2014), although also slightly below recent averages. In the Wholesale, Retail, and Transportation sector, over half of the filings related to support activities for transportation. This subsector includes air traffic control services, cargo handling, and motor vehicle towing, among other areas. Within the Mining, Utilities, and Construction sector, over half of the filings related to investments in utilities.
- Acquisition of Critical Technology Companies
Consistent with the previous year’s finding, the 2014 Annual Report noted that the US Intelligence Community (USIC) found that there “may be” an effort among foreign governments or companies to pursue transactions with US businesses “involved in research, development, or production of critical technologies for which the United States is a leading producer.” In the 2012 Annual Report, the USIC found that it was unlikely that there was a coordinated strategy among one or more foreign governments to acquire US critical technology companies. Whether a US business deals in critical technology is one national security factor that CFIUS must consider under FINSA. In line with prior reports, the 2014 Annual Report again noted that the USIC believes that it is “extremely likely” that foreign governments will use a range of collection methods, including espionage, to obtain US critical technologies.
The Annual Report shows the continuance of certain trends that have significant implications for parties to foreign investment transactions. CFIUS processing times may be significant in a large number of cases. At the same time, mitigation arrangements continue to be required on a regular basis and a non-trivial number of deals are abandoned during the CFIUS process. These and other factors indicate the importance of early planning in the transactional context. In order to decrease the risk that CFIUS disrupts a deal, it is critical to conduct CFIUS-related due diligence and account for the CFIUS process–including potential uncertainty in timing and consequences–in the transactional documents.