The Committee on Foreign Investment in the United States (“CFIUS”), comprised principally of executive branch agencies, reviews foreign direct investments and acquisitions that could affect the national security of the United States. Transactions deemed to threaten U.S. national security are referred for Presidential review. The President may block and even unwind transactions that pose a threat to national security. National security concerns are interpreted broadly. As might be expected, CFIUS reviews include acquisitions involving key Federal government contractors and subcontractors, companies that manufacture or distribute export-controlled technologies, and companies that support U.S. “critical infrastructure.”1 But CFIUS also looks at investments that involve facilities in proximity to sensitive U.S. government installations, even though the acquisition itself poses no direct threat to national security.
Ostensibly voluntary, filing is effectively mandatory for transactions that plainly fall within the statutory categories for review or that involve companies with U.S. facility security clearances. CFIUS also can and does initiate reviews on its own. Acquisitions that sidestep CFIUS review therefore proceed at their peril, as was clearly demonstrated by the President’s decision last year to unwind the Chinese-financed acquisition of a group of wind farms located near a critical U.S. Navy base, discussed further below.2
Each year, CFIUS publishes an Annual Report summarizing its activity in the preceding calendar year. Despite the delay, the report offers insight into trends in Foreign Direct Investment (“FDI”). The most recent Annual Report summarizes CFIUS reviews in 2011. Because Kaye Scholer LLP participated in over one-fifth of these transactions, we believe we are in a unique position to comment on the annual report. Here’s what we see:
- There were 111 reviews in 2011, compared to 93 reviews in 2010, and 65 in 2009. The total reported value of all U.S. mergers and acquisitions in 2011 by foreign direct investors (including transactions not reported to CFIUS) was $184 billion—almost 50% more than the $124 billion reported in 2010. The increase signals significant growth in FDI, although the numbers continue to lag behind the $300B levels posted in 2008.
- Most CFIUS reviews are accomplished in 30 days, but the law provides for additional 45- day investigations in cases that cannot be resolved during the initial review. Such full investigations are required for acquisitions by foreign-government controlled companies as well as, in certain cases, transactions involving critical infrastructure. In 2010 and 2011, more than 1 in 3 transactions went to investigation—75 in all. Although 2012 data is not yet public, we believe the trend continued to hold true last year. Investors should anticipate the likely possibility of investigation in any complex transaction. At a minimum, investors should plan for investigation in any case that involves governmentcontrolled entities or critical infrastructure.
- Six of 2011’s 111 notices were withdrawn (one during review, five during investigation). Filings can be withdrawn for a number of reasons; some complex deals are withdrawn simply because government reviewers need more time to address open questions, others because it becomes apparent that the deal must be restructured to survive review. All six notices withdrawn in 2011 were later re-filed: four in 2011, and two in 2012.
- As a practical matter, CFIUS is much more likely to propose a “mitigation” agreement (which adds conditions to CFIUS approvals to address perceived national security concerns) than to recommend that a deal be blocked. Mitigation agreements are determined by the threat posed by the foreign investor and the vulnerabilities associated with the U.S. business being acquired, not the size of the deal. Even small deals can result in mitigation. Though still applied to only a small minority of cases, it is not surprising that CFIUS mitigation agreements are now more common than in years past. They can be standalone agreements or add-ons to mitigation agreements required for, among other things, security clearances. Eight CFIUS mitigation agreements were written in 2011 (nine in 2010), involving acquisitions of U.S. companies in a broad array of industries: software, computer programming, computer and electronic manufacturing, electrical equipment and component manufacturing, aerospace manufacturing, and finance.
- Importantly, the report identifies several new mitigation measures that have been applied to transactions. Mitigation measures include: Corporate Security Committees, annual reports, and independent audits; guidelines for handling existing or future U.S. Government contracts and customer information; allowing only U.S. persons to handle certain products and services, and requiring that identified activities and products be located only in the United States; requiring advance notice to the U. S. Government of visits by foreign nationals; requiring notice to the U.S. Government of vulnerability or security incidents, as well as any “material introduction, modification, or discontinuation” of a product or service; requiring continued production of certain products for relevant U.S. Government customers for defined periods; and requiring that certain functions and activities of the U.S. business be performed by a proxy entity. The scope and degree of mitigation will depend on the national security factors at play in the transaction.
- Overall, the United Kingdom, with 25 transactions, led foreign investors represented in CFIUS reviews in 2011, followed by France (14) and China (10). Consistent with the overall growth in FDI, the number of transactions notified by French and Chinese investors increased by 133% and 66.6% respectively. Indeed, the most striking fact, is the pace of Chinese investment: between 2005 and 2007, China submitted a total of 4 transactions for CFIUS review. In the past three reported years (through 2011), China submitted 20 acquisitions for review, a five-fold increase.
- FDI in the Manufacturing sector and the Finance, Information, and Services sector continued to account for the greatest number of covered transactions (49 and 38 transactions, respectively). Computer and electronic products account for 50% of all notices in the manufacturing sector.
For the first time, the report notes that the U.S. Intelligence Community “judges with moderate confidence” that a “coordinated strategy” likely exists “among one or more foreign governments or companies” to acquire U.S. companies with critical technologies. The report states that information supporting the assessment is provided in the classified report. The unclassified report notes only that “foreign governments are extremely likely to continue to use a range of collection methods to obtain U.S. critical technologies.” This finding is in line with anecdotal news accounts of cyber-attacks on U.S. companies, and may result in additional CFIUS scrutiny for acquisitions made by certain nations.
Although it post-dates the report, the U.S. District Court for the District of Columbia recently issued an Order dismissing all but one claim made by Ralls Corporation in its challenge to CFIUS’s authority.3 Ralls, a Chinese owned company, was ordered by the President to unwind its acquisition of wind farms located near a U.S. Navy base. Although the court dismissed Ralls’ other claims, it did agree to hear Ralls’ due process claim to determine what “procedural protections were due, and whether [Ralls] was denied those protections” by the CFIUS process. The court was clear that it would not hear any attack on the President’s findings but would hear argument on whether Ralls is entitled to know the reasons for the Presidential order of divestment. Interestingly, the court’s Memorandum Opinion appeared to leave open the possibility that a Presidential action in any given case might go beyond the authority provided under the statute, giving rise to judicial challenge.
As mentioned above, CFIUS can and does request post-transaction filings by parties who do not voluntarily file prior to closing, as happened in the Ralls case. In our experience, CFIUS is actively looking for transactions that were not voluntarily filed, and the data supports our anecdotal experience. The upshot is that parties to foreign acquisitions should always assess their potential to come under the CFIUS umbrella. It is fair to say that transactions that are not voluntarily filed and are later reviewed begin at a distinct disadvantage. In our experience, the harshest mitigation measures put forward by CFIUS have come in response to transactions that were not initially notified to the Committee. CFIUS mitigation measures can significantly affect the value of a transaction, as well as plans for synergies between the U.S. company and its (new) foreign parent. For all of these reasons, it is prudent to file in any case where a transaction implicates national security, even if the acquisition does not itself involve classified contracts or controlled technology.