On July 26, 2007, President Bush signed into law the Foreign Investment and National Security Act of 2007 (FINSA), which will take effect on October 23, 2007, and is aimed at reforming the longstanding "Exon-Florio" process governing a national security review of foreign investments in US entities.

FINSA largely keeps intact the basic procedures used by the interagency Committee on Foreign Investment in the United States (CFIUS) in assessing whether a foreign investor threatens US national security. FINSA also is less restrictive than many similar legislative initiatives proposed in the past two years. However, that may be cold comfort to foreign investors now facing a new set of risks.

Although FINSA leaves basic elements of CFIUS procedures unchanged, it "tightens the screws" on the review of foreign investment, thus increasing the risk of delays, scrutiny and political and bureaucratic interference in proposed business transactions.

From now on, prospective foreign investors must take these elevated risks and uncertainties into account. This could be especially vexing in bidding situations where foreign firms compete with US firms, foreign government-owned enterprises compete with private bidders or bidders from US-allied countries bid against bidders from countries viewed as higher security risks.

The "Least Bad" Regulatory Option

FINSA's enactment ends a lengthy debate — among Congress, the administration and the business community — which erupted in 2005 during the controversy surrounding the bid by China's CNOOC for the US oil company Unocal and culminated with the now infamous unwinding of the Dubai Ports World (DPW) deal in 2006.

Widespread outrage in Congress in the wake of the CNOOC and DPW deals was channeled into numerous bills to reform Exon-Florio, many of them highly intrusive and restrictive of foreign investment. In the end, the business community and the administration supported FINSA, not so much because they favored a strengthening of the CFIUS review process, but rather because they viewed FINSA as the "least bad" option in an environment where some form of legislative overhaul seemed inevitable.

Key Changes Mandated by FINSA

Importantly, FINSA largely maintains the most fundamental CFIUS rules and procedures for assessing whether foreign investors threaten US national security. For example, parties to a transaction involving foreign investment in a US entity may still file a voluntary notice, upon which CFIUS has 30 days either to (i) clear the transaction, or (ii) conduct a more thorough "second-stage" 45-day investigation and recommend to the president whether to block or unwind the transaction.

At the same time, FINSA increases the obstacles to foreign investment in several key ways:

  • Broader Mandate Means More Foreign Investment Transactions Reviewed. FINSA makes clear that foreign investments subject to national security review go well beyond those in the traditional defense sectors and include investments in "critical US infrastructure," which includes energy-related capacity. These, in turn, are defined expansively to include "any systems and assets, whether physical or cyber-based" that could negatively affect national security, "including national economic security and national public health or safety." As a sign of this broader focus, FINSA adds the US Energy Department and Labor Department to CFIUS as new members. Although CFIUS filings are voluntary, foreign investors in a broad range of US economic sectors may feel compelled to file such notices, because they cannot rule out the possibility that their transactions may fall within FINSA's purview.
  • Increased Risk of Delay. FINSA will pressure CFIUS to extend more national security reviews beyond the 30-day clearance period to the supplemental 45-day investigation phase. FINSA does so by mandating an investigation of acquisitions involving sensitive critical infrastructure unless upper level CFIUS officials sign off that no investigation is needed. Prior law only mandated investigations where CFIUS affirmatively determined that a supplemental investigation was necessary (and CFIUS's failure to initiate an investigation in the DPW port deal review was a key catalyst galvanizing Congress to draft FINSA and other bills to overhaul Exon-Florio). By reversing this presumption and calling out upper level agency officials to stand behind a decision not to investigate, FINSA biases the process in favor of extended review times of up to two months or longer.
  • Tougher Treatment of Government-Owned Investors. FINSA also mandates that acquisitions by state-owned entities automatically go to the investigation stage unless a senior official certifies that the transaction will not impair national security. Moreover, where a government-owned entity is involved, FINSA requires the consideration of factors not necessarily related to the transaction at hand, such as a country's compliance with US and multilateral counter-terrorism, non-proliferation and export control regimes. This can present difficult questions for investors from China, Russia and the Middle East.
  • Increased Congressional Involvement Means Higher Political Risk. FINSA significantly enhances Congress's role in the national security review process by obligating CFIUS to adhere to a system of congressional briefings and annual reporting. After each transaction it considers, CFIUS must provide Congress with notice of the transaction, the actions taken and certifications of conclusions by CFIUS officials. Under FINSA, CFIUS must answer to a broad array of officials and committees in both houses of Congress, including: (i) majority and minority leaders of the House and Senate, (ii) the chair and ranking members of the Senate Banking Committee and the House Financial Services Committee, (iii) any House or Senate committee having oversight over the lead agency in the CFIUS review, (iv) Senators and Members of Congress from the district concerned, and implicitly (v) governors whose states "interact" with the critical infrastructure involved. Such broad ranging, transaction-by-transaction Congressional involvement in the potentially explosive issue of foreign investment can only raise the risk of political mischief, particularly where US constituents have an interest in opposing a competing foreign investor or have an ax to grind against an investor's home country.
  • More Scrutiny of Deals Means Higher Risk of Interference. FINSA raises the bureaucratic profile of the national security review process, creating a new Assistant Treasury Secretary responsible for CFIUS reviews, requiring the Director of National Intelligence to perform an intelligence review of each transaction, and, as noted, mandating that higher level CFIUS officials sign off on key decisions. More importantly, FINSA provides explicit statutory authority for CFIUS to require changes to a deal in exchange for CFIUS approval — that is, conditions imposed via a "mitigation agreement" (e.g., restructuring, spinning off or walling off sensitive operating units, allowing law enforcement access, etc.). Under FINSA, a "lead agency" within CFIUS, in addition to its chair, the US Treasury Department, is empowered to negotiate mitigation agreements. Although CFIUS already has been imposing mitigation conditions on deals to "mitigate" foreign threats, especially since the Homeland Security Department joined CFIUS, FINSA's codification of this authority — and the assignment of responsibility for pursuing these conditions to a "lead agency" within CFIUS — all under Congress's more watchful eye, certainly increases the likelihood that government "mitigation" changes to a deal will be on the increase.
  • "Evergreen" Provision Means Clearance Not Necessarily Final. FINSA also includes an "evergreen" provision providing statutory authorization for CFIUS to reopen and reverse at any time a previously reviewed and cleared transaction upon a finding of intentional omission or falsehood with the original notification to CFIUS or the party's material breach of a "mitigation" agreement.

Effect of FINSA on Current Practice

Despite the significant changes to existing practices, FINSA will not have an immediate dramatic effect on the national security review process, largely because CFIUS and foreign investors have been acting in anticipating the legislation for some time. For example, notifications to CFIUS in 2006 were 74% higher than the previous year, despite the fact that there was not a corresponding increase in foreign investment. There also were dramatic increases in 2006 in deals escalated to 45-day second-stage investigations, in deals to which CFIUS attached mitigation conditions, and in "informally blocked" deals wherein investors simply pulled out of the CFIUS review process.

In short, FINSA's teeth have already begun to bite even before it goes into effect. The added risks of delay, political and bureaucratic interference under FINSA will clamp down harder with time.

Still to Come: Regulations and Guidance

FINSA will come into force three months after the President's execution, on October 23, 2007. FINSA also mandates that CFIUS issue regulations and administrative guidance within six months of the effective date. While these regulations may shed further light on future CFIUS practice, it is already clear that foreign investors in US infrastructure must be prepared for more scrutiny, delay and risk.