Amendments To Exon-Florio Process Made By The Foreign Investment And National Security Act Of 2007 May Have A Chilling Effect On Foreign Investment In The United States

On July 26, 2007, President Bush signed into law the Foreign Investment and National Security Act of 2007 ("FINSA"), which makes significant changes to the foreign investment review process contained in the Exon-Florio amendment to the Defense Production Act. FINSA will become effective on October 24, 2007 and implementing regulations must be adopted no later than April 21, 2008. This political compromise has the potential to discourage foreign investment in the United States by:

• Broadening the scope of the existing review process;

• Prompting increased numbers of formal investigations of proposed foreign investments as well as heightened scrutiny of those investments;

• Increasing pressure on potential investors to "mitigate" the national security effects of their transactions; and

• Further politicizing the review process.

In order to appreciate the significance of the changes to the Exon-Florio process, a brief review of the history of Exon-Florio and the events leading up to the enactment of FINSA are necessary.

Background on the Exon-Florio Process

In 1988, the Exon-Florio provisions were added as Section 721 to the Defense Production Act of 1950 to address Congressional concerns regarding the impact on national security of certain foreign acquisitions of United States corporate entities and provided authority to the President to suspend or prohibit any foreign acquisition, merger or takeover that is determined to threaten the "national security" of the United States. Although "national security" is not defined either in the statute or the 1991 implementing regulations, the Exon-Florio provisions list the following factors to be considered in determining the effects of a foreign acquisition on national security:

1. Domestic production needed for projected national defense requirements;
2. The capability and capacity of domestic industries to meet national defense requirements, including the availability of human resources, products, technology, materials and other supplies and services;
3. The control of domestic industries and commercial activity by foreign citizens as it affects the capability and capacity of the U.S. to meet the requirements of national security;
4. The potential effects of the transaction on the sales of military goods, equipment or technology to a country that supports terrorism or proliferates missile technology or chemical and biological weapons; and
5. The potential effects of the transaction on U.S. technological leadership in areas affecting U.S. national security.

The Exon-Florio process typically begins when parties to a transaction file a voluntary notice to the U.S. government stating that a U.S. corporation will become subject to "foreign control." The advantage to a foreign investor of making a proactive, voluntary filing is to obtain official confirmation from the U.S. government that it will not later block or unwind a proposed transaction on national security grounds. The U.S. government has the right to self-initiate the process if a voluntary notice is not filed, although this right has rarely been invoked. Once notice is received, the U.S. government begins a comprehensive 30-day review of the transaction, which either terminates in the government stating that it intends to take no action with respect to the transaction in question or the government commencing a 45 day additional investigation of the proposed transaction. At the conclusion of any investigation, the President has an additional 15 days to announce a final decision and notify Congress of his final decision.

In 1992, the Byrd Amendment to the Exon-Florio provisions required that an investigation be conducted in cases where the acquirer is controlled by or acting on behalf of a foreign government and the acquisition "could result in control of a person engaged in interstate commerce in the U.S. that could affect the national security of the U.S."

The Exon-Florio process is administered by the Committee on Foreign Investment in the United States ("CFIUS"), which is an inter-agency committee originally created by Executive Order in 1975 to monitor and evaluate the impact of foreign investment in the U.S. CFIUS is chaired by the Secretary of Treasury.

Notwithstanding the authority granted by the Exon-Florio provisions, the President has rarely invoked his authority to block or suspend foreign acquisitions and the U.S. government has generally been hospitable to foreign investment. Although no recent transactions have been formally blocked, certain transactions were abandoned, and Exon-Florio filings withdrawn, because of negative media and political attention. Following the terrorist attacks of 9/11, the number of voluntary Exon-Florio filings increased significantly because of concerns by foreign investors that the U.S. government might change its views on foreign investment Also, although not provided for in the implementing regulations, the Departments of Defense, Justice and Homeland Security began to use mitigation agreements with increasing frequency. Mitigation agreements, between the CFIUS member-agencies and the parties to the transaction, address certain national security issues such as continued U.S. government electronic surveillance or restrictions on access by foreign person to sensitive technologies.

In 2005, the Government Accounting Office (GAO) issued a report revealing the lack of Congressional oversight and limited number of formal investigations. The aborted acquisition by China National Offshore Oil Corporation of UNOCAL in 2005 also provoked calls for Exon-Florio process reform.

The Exon-Florio process gained considerable national attention with the DP World acquisition in 2006 and the political firestorm surrounding that transaction gave impetus to the Exon-Florio reform process that resulted in the enactment of FINSA.

In February and March of 2006, a plan by DP World, which is ultimately owned and controlled by the government of Dubai, to acquire London-based Peninsular & Oriental Steam Navigation Company ("P&O") drew opposition from Members of Congress from both parties. P&O's U.S. subsidiary managed operations at several U.S. port facilities. The outcry from Congress centered on the fact that CFIUS had approved the transaction without conducting a detailed investigation of its potential national security implications.

As a result, Congress began the process in earnest to overhaul the Exon-Florio process and to include greater Congressional oversight of CFIUS and its activities. However, despite efforts during the 109^th Congress to pass legislation to reform the process, a final compromise was not reached prior to the close of the 109^th Congress. Consequently, at the beginning of the 110^th Congress, Exon-Florio reform legislation was reintroduced and finally adopted on July 11, 2007.

While the legislative process was underway, the Executive Branch made certain procedural changes to require more security information from the parties to the transaction, to involve higher-level agency officials and to improve reporting to Congress. In addition, the Executive Branch embarked on a diplomatic tour of major commercial trading partners in an effort to convince them that the proposed changes to the Exon-Florio process should not be interpreted as a signal that the U.S. government no longer welcomes foreign investment in the U.S.

While codifying certain regulatory practices, FINSA makes a number of significant changes in the following key areas: (1) the composition and functioning of CFIUS; (2) the factors to be considered by CFIUS and the President in evaluating a proposed transaction; (3) mitigation agreements and enforcement; and (4) Congressional reporting.

• Confirms the membership and leadership of CFIUS as follows: the Secretary of Treasury (Chair), Secretary of Homeland Security, Secretary of Commerce, Secretary of Defense, Secretary of State, Attorney General of the United States, Secretary of Energy, Secretary of Labor (ex-officio), Director of National Intelligence (ex-officio), and the heads of any other executive department, agency, or office, as the President appoints to the Committee.

• Provides that the Director of National Intelligence (DNI) will make a thorough analysis of any threat to national security within 20 days of the commencement of any CFIUS review.

• Mandates the designation of a lead agency for each covered transaction, in addition to the Treasury Department, whose function is to oversee and negotiate any mitigation agreement.

• Requires sign-off at the deputy secretary level or above for each member agency.

• Transactions that involve foreign governments, a threat to national security or control of critical infrastructure must be subject to a formal investigation except if the Secretary or Deputy Secretary of Treasury and the lead agency certify that there is no threat to national security.

• CFIUS has the authority to re-open an investigation if materially false or misleading information is provided.

• Prohibits withdrawal of the voluntary notice once filed without the consent of CFIUS.

Factors to be Considered by CFIUS or the President. Adds six new factors for mandatory consideration, which include:

1. whether the transaction has a security-related impact on "critical infrastructure," including major energy assets,
2. whether the transaction has a security-related impact on "critical technologies,"
3. whether the transaction involves control by a foreign government;
4. a review of the current assessment of (i) the adherence of the subject country to nonproliferation control regime, including treaties and multilateral supply guidelines, (ii) the relationship of such country with the U.S., specifically on its record of cooperating with the U.S. in counter-terrorism and (ii) the potential for transshipment or diversion of technologies with military applications, including an analysis of national export control laws and regulations,
5. the long-term projection of U.S. requirements for sources of energy and other critical resources and material, and
6. such other factors as the President determines are appropriate.

• Authorizes mitigation agreements and enforcement by CFIUS or lead agency.

• Authorizes re-opening of investigation if mitigation agreement is breached.

• Requires semi-annual reports to CFIUS by lead agency on the implementation of the mitigation agreements and any modifications thereto.

• Requires CFIUS to develop methods for ensuring compliance without the imposition of undue burdens on the parties to the transaction.

• Requires CFIUS to provide a written report to designated members of Congress after the completion of an investigation subject to confidentiality safeguards, and, upon request, briefings on on-going transactions or investigations or compliance with mitigation agreements.

• Requires CFIUS to provide annual reports on its reviews and investigations to Congressional committees with oversight jurisdiction, unclassified versions of which will be made available to the public.

• Requires the Secretary of Treasury, in consultation with the Secretary of State and Commerce, to submit annual reports with respect to US investments by foreign governments or persons that comply with any boycott of Israel or do not ban organizations designated by the State Department as foreign terrorist organizations.

Although FINSA represents a political compromise that was ultimately embraced by the Executive Branch and the business community, it has the potential, depending upon how it is ultimately administered, to have a chilling effect on foreign investment in the U.S. Based on a close reading of FINSA and the underlying Congressional intent, it is possible to speculate what the practical effects may be for foreign investment transactions.

First, given the absence of a definition of national security and the broad definitions of "critical infrastructure" and "critical technologies" there will likely be a larger number of voluntary Exon-Florio filings by foreign investors to obtain the comfort that a foreign investment transaction will not later be questioned on national security grounds. It remains to be seen whether the implementing regulations will provide any greater clarity to foreign investors as to whether a particular transaction should be submitted for Exon-Florio review.

Second, there will likely be a more interactive process between the foreign investor and CFIUS with CFIUS asking many more questions and requiring additional information from the foreign investors relating to the expanded factors to be considered. Pre-submission meetings with CFIUS will become more common as foreign investors attempt to anticipate the likely issues of concern to CFIUS.

Third, there will likely be an increase in the number of formal CFIUS investigations of specific transactions-and not just with respect to acquisitions by foreign governments-because of the enhanced reporting obligations to, and oversight by, Congress.

Fourth, there will likely be an increase in the number of mitigation agreements requested by CFIUS or the lead agency to address specific national security issues and to reduce any subsequent Congressional criticism that CFIUS has been soft on national security issues. Enhanced enforcement of these mitigation agreements could cause approved foreign investment transactions to be subsequently re-opened.

Finally, because of the enhanced reporting by CFIUS to Congress and, notwithstanding the confidentiality safeguards, the Exon-Florio review process is likely to become more politicized and any foreign investor engaged in a transaction involving critical infrastructure or technology should be prepared in advance not only with a legal but a governmental relations strategy.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.