On November 14, 2008, the Treasury Department issued in final form new regulations implementing the so-called “Exon-Florio Amendment” to the Defense Production Act of 1950 (50 U.S.C. app § 2170), as amended by the Foreign Investment and National Security Act of 2007 (“FINSA”). The new regulations will take effect on December 22, 2008. Compared to the existing regulations, the new regulations increase significantly (i) the scope of transactions subject to Exon-Florio review and (ii) the burdens and risks associated with making an Exon-Florio filing. However, compared to the regulations as initially proposed in April of this year, the final regulations clarify intended coverage in some areas and reduce somewhat the information required as part of an Exon-Florio filing.
I. The Exon-Florio Amendment and FINSA
The Exon-Florio Amendment provides the President with the authority to investigate and, where necessary, block or unwind mergers and acquisitions by foreign persons that could threaten national security. The President’s Exon-Florio powers apply whenever a foreign person is acquiring control over an existing U.S. business, directly or indirectly, regardless of whether the U.S. business is already foreign-owned. The President’s investigatory powers (but not his power to block or unwind transactions) are exercised by an interagency group chaired by the Treasury Department – the Committee on Foreign Investment in the United States (“CFIUS”). Through the Treasury Department, CFIUS has issued implementing regulations (31 C.F.R. Part 800); these are the regulations that have just been reissued, to reflect the adoption of FINSA and changes in CFIUS practices.
FINSA addressed a number of Congressional concerns with the Exon-Florio process, many of which were triggered by CFIUS’ handling of the Dubai Ports World transaction. FINSA for the first time addressed the composition, powers, and responsibilities of CFIUS, which had previously been determined by the President by executive order. FINSA also reinforced certain elements of the CFIUS review process that had already been introduced by the Bush Administration after the Dubai Ports World controversy. These include (i) high-level agency review and performance of intelligence threat assessments for every case, (ii) heightened sensitivity to foreign control over critical infrastructure, and (iii) increased emphasis on the use and enforcement of mitigation agreements and other conditions.
II. The Final Regulations
Although many of the changes contained in the final regulations are directed by FINSA and/or reflect current CFIUS practice, the regulations increase the scope of foreign investment transactions subject to Exon-Florio review and increase the burdens on parties that choose to make an Exon-Florio filing. The most important problem areas appear to be (i) the scope of Exon- Florio jurisdiction, (ii) the information/disclosure requirements for parties who choose to file (or are asked to file by CFIUS), and (iii) the new penalty provisions.
A. Scope of Exon-Florio Jurisdiction
Although Exon-Florio provides the President with the power to investigate “mergers, acquisitions, and takeovers . . . by or with foreign persons which could result in foreign control of persons engaged in interstate commerce in the United States,” the final regulations apply CFIUS’ review powers to transactions that would not normally be thought of as a merger, acquisition, or takeover or as conveying control to a foreign person. The existing regulations strongly suggest that, absent other factors, foreign control is not created where a U.S. person and a foreign person have equal voting power in a U.S. business. By contrast, the new regulations indicate that multiple parties can have “control;” and that a non-U.S. minority shareholder can obtain “control” even when there is a U.S. majority shareholder, depending on the level and nature of blocking powers held by that minority shareholder. In addition, while the existing regulations suggest that ultimate control is the key in deciding whether an entity (U.S. or non-U.S.) should be considered a “foreign person” for Exon-Florio purposes, the new regulations create uncertainties by placing heightened emphasis on the place of formation and on ownership.
The following are examples of the expanded scope of Exon-Florio jurisdiction under the final regulations:
- An acquisition by a foreign person of a minority voting interest in a U.S. business majority-owned by a U.S. company will be subject to Exon-Florio review if the foreign person will be able to block decisions that could affect the strategic direction or day-today operations of the U.S. business.
- An acquisition by a foreign person of options, warrants, or convertible debentures that can be exercised for or converted into voting equity may be treated as voting equity for Exon- Florio purposes, depending on such factors as (i) how quickly conversion can occur, (ii) whether conversion depends on factors within the control of the holder, and (iii) whether the relative voting power and other rights that would be acquired upon conversion can be reasonably determined.
- A loan or similar financing arrangement may be subject to Exon-Florio review where the foreign lender will acquire an interest in the profits of a U.S. business, the right to appoint members of the board of directors of a U.S. business, or “other comparable financial or governance rights characteristic of an equity investment but not a typical loan.”
- A corporate reorganization where the ultimate parent of a U.S. business will not change is nonetheless subject to Exon-Florio review where a non-U.S. parent in the ownership chain will change.
- A U.S.-controlled non-U.S. entity -- including an offshore fund or company -- will be treated as a foreign person for Exon-Florio purposes where (i) its principal place of business is outside the United States or (ii) its equity securities are primarily traded on one or more foreign exchanges, unless the non-U.S. entity can demonstrate that a majority of its equity is ultimately owned by U.S. nationals. (Note that the focus here appears to be on such factors as place of formation, ownership, and where equity securities are traded rather than on the fundamental factor of control.)
Despite the new emphasis on minority stakes, the final regulations do indicate that, by themselves, minority board seats and some minority shareholder protections do not confer control. The list of minority protections identified as not conveying control consists of (i) the power to prevent the sale or pledge of all or substantially all of a U.S. business' assets or its voluntary filing for bankruptcy or liquidation, (ii) the power to prevent a U.S. business from entering into contracts with, or guaranteeing the obligations of, majority investors or their affiliates, (iii) antidilution rights, (iv) the power to prevent the change of existing legal rights or preferences of the particular class of stock held by minority investors, and (v) the power to prevent the amendment of a U.S. business' organizational documents in these areas. In addition, although the final regulations provide only that other types of minority protections will be considered for similar treatment “on a case-by-case basis,” the explanatory text accompanying the regulations identifies certain other minority protections that CFIUS is generally prepared to view as not conferring control when the filing parties so argue, including (i) the power to prevent fundamental changes in the business or operation strategy of the U.S. business, (ii) the power to prevent substantial new indebtedness outside the ordinary course of business, and (iii) the power to prevent fundamental changes to the U.S. business’ regulatory, tax, or liability status.
B. Information/Disclosure Requirements for Filing Parties
For transactions parties that choose to make an Exon-Florio filing (or are asked to do so by CFIUS), the final regulations expand substantially the scope of documents and information that must be filed concerning the U.S. business being acquired, the foreign acquirer, and (to a lesser degree) the transaction itself. That said, the filing burden presented by the final regulations has been reduced compared to the regulations as proposed in April – and many of the items that must be supplied are already commonly requested by CFIUS in practice.
With respect to the transaction and the foreign acquirer, information must now be provided in the Exon-Florio filing concerning (i) all financial institutions involved in the transaction, including advisers, underwriters, and sources of financing and (ii) the main branches and offices of each parent of the foreign acquirer. In addition, the foreign acquirer must file information concerning the members of its board of directors and its senior executives and those of its parent companies, as well as individuals who are five percent stockholders of the foreign acquirer or its ultimate parent, including (i) biographical information and (ii) in a separate filing (which will not go to all CFIUS agencies), a range of “personal identifier information,” including date and place of birth, passport and national identification numbers, and dates and nature of foreign government or senior military service.
As required by FINSA, the final regulations also provide that each party to the Exon- Florio filing must certify, at a senior executive level, that the information supplied concerning itself and the transaction – and all information it subsequently submits to CFIUS as part of the Exon-Florio review – is accurate and complete in all material respects and fully complies with Exon-Florio, the Exon-Florio regulations, and any mitigation agreement or condition previously imposed by CFIUS or a CFIUS agency. Any failure to provide either the certification or the information required under the regulations is grounds for CFIUS to reject the Exon-Florio filing.
FINSA contains an unusual provision stating that the new Exon-Florio implementing regulations are to provide for the imposition of unspecified civil penalties for any violation of Exon-Florio or any mitigation agreement or condition imposed under authority of Exon-Florio. In the final regulations, CFIUS implements this statutory directive by establishing a civil penalty of up to $250,000 per violation for any person who, intentionally or through gross negligence, submits a material misstatement or omission in an Exon-Florio filing or makes a false certification. In addition, a person who, intentionally or through gross negligence, violates a material commitment or condition imposed under Exon-Florio may be subject to a civil penalty of up to the greater of $250,000 or the value of the transaction, and may also be subject to liquidated or actual damages as specified in the mitigation agreement.
Finally, the explanatory text accompanying the final regulations notes that the bases on which CFIUS may reopen a completed Exon-Florio case are set forth in FINSA, and that the procedures that would be followed for a reopened investigation are the same as those set forth in the final regulations with respect to an Exon-Florio review initiated by a CFIUS agency. FINSA provides that CFIUS may reopen a completed Exon-Florio case where there has been (i) a material misstatement or omission in the original Exon-Florio filing or subsequent submission to CFIUS or (ii) an intentional material breach of a mitigation agreement or condition imposed during the prior case.