The United States has long served as a favorite destination for foreign investors. While U.S. national security concerns have been raised from time to time, such considerations seldom have served as a major impediment to foreign investment. In a post-9/11 world, however, national security considerations will continue to play an increasingly prominent role in terms of how the U.S. government views inbound foreign investment. Certain critical sectors, such as defense, telecommunications, energy, transportation, and cyberspace, are particularly susceptible to national security concerns, especially as they relate to foreign ownership or control.

While the relevant national security legislation and procedures have been in place for some time, foreign companies—and their U.S. partners and subsidiaries—have rarely been forced to confront these requirements. This article summarizes how certain domestic national security considerations may affect foreign merger, acquisition, or other investment opportunities in the United States. The article also reviews how entities owned or controlled by non-U.S. interests or foreign governments may be barred for national security reasons from access to certain classified information.

U.S. federal law and regulations limit foreign investment in certain cases to protect national security. Most notably, the Exon-Florio Amendment authorizes the President to suspend or prohibit any acquisition, merger, or takeover of a U.S. company by a foreign entity—regardless of the dollar value of the transaction—if the President determines that the transaction will impair the national security. Since Exon-Florio does not define the term "national security," its application extends beyond the military sector and includes any domestic industry deemed critical to the national defense. Exon-Florio provides the President with the power to order the Attorney General to seek appropriate relief in the district courts, including a post-acquisition divestiture of the sale of the U.S. company to a foreign entity. The President can exercise Exon-Florio authority if he finds that: (1) there is credible evidence that the foreign entity exercising control might take action that threatens national security, and (2) the provisions of law, other than the International Emergency Economic Powers Act, do not provide adequate and appropriate authority to protect the national security.

In making an Exon-Florio determination, the President relies upon a review mechanism that is implemented by the Committee on Foreign Investment in the United States ("CFIUS"). CFIUS is an inter-agency committee chaired by the Secretary of the Treasury whose other members include the Homeland Security Secretary, the Secretaries of State, Defense, and Commerce, the Attorney General, the Director of the Office of Management and Budget, the U.S. Trade Representative, and the Chairman of the Council of Economic Advisers. CFIUS’ mandate is to balance U.S. investment policy and national security interests.

In complying with Exon-Florio, companies may choose to submit a notice to CFIUS for review of a proposed sale to protect against the possibility of a future forced divestiture. Under applicable regulations, CFIUS initially conducts a 30-day review of voluntary submissions. If CFIUS believes that there is credible evidence that a proposed acquisition may threaten national security, CFIUS can initiate a supplemental 45-day investigation. Upon completion of this investigation, CFIUS submits a recommendation to the President who then has 15 days to decide whether to allow the acquisition to move forward. Thus, an Exon-Florio review must usually conclude within 90 days.

Exon-Florio lists a number of factors that the President (or his designee) may consider in determining the effects of a foreign acquisition on national security. These factors are:

• domestic production needed for projected national defense requirements;

• 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;

• the control of domestic industries and commercial activity by foreign citizens as it affects the capability and capacity of the United States to meet the requirements of national security;

• 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 or biological weapons; and

• the potential effects of the transaction on U.S. technological leadership in areas affecting U.S. national security.

In addition to serving as a preemptive measure, a voluntary CFIUS notice further acts as a screening mechanism whereby the proposed transaction can gain greater legitimacy. Although CFIUS reviews occasionally become the focus of public attention—such as Chinese attempts to buy the bankrupt telecommunications company Global Crossing—CFIUS applications are held confidentially and not made public.

To date, the CFIUS review process has not resulted in numerous investigations or blocked transactions. A September 2002 General Accounting Office (now known as the Government Accountability Office) ("GAO") report states that of 320 acquisitions notified to the Committee from 1997 through 2001, only four were investigated, and only one resulted in a presidential determination. Earlier statistics indicate that between 1988 and 1999, CFIUS investigated 17 of nearly 1,300 voluntary reports received, and only one resulted in a presidential determination. These statistics, however, largely reflect a pre-9/11 mentality and do not account for transactions that have been restructured or otherwise abandoned in order to avoid potential CFIUS investigations. Exon-Florio and the CFIUS process will play an expanded role in future U.S. efforts to balance national security considerations and foreign investment.

In addition to limiting mergers and acquisitions, U.S. national security considerations may affect strategic foreign investments in U.S. companies with access to classified information. The National Industrial Security Program and its operating manual ("NISPOM") specifically cover such information-sensitive U.S. companies that come under "foreign ownership, control, or influence" ("FOCI"). A FOCI issue is raised whenever a foreign interest has the power, direct or indirect, whether or not exercised, and whether or not exercisable through the ownership of the U.S. company’s securities, by contractual arrangements or other means, to direct or decide matters affecting the management or operations of that company in a manner which may result in unauthorized access to classified information or may affect adversely the performance of classified contracts.

The following factors are considered in the aggregate by the relevant agency to determine whether an applicant company is under FOCI:

• foreign intelligence threat;

• risk of unauthorized technology transfer;

• type and sensitivity of the information requiring protection;

• nature and extent of FOCI;

• record of compliance with pertinent U.S. laws, regulations, and contracts; and

• nature of bilateral and multilateral security and information exchange agreements that may pertain.

FOCI is actually determined during the initial phase of processing a facility for a security clearance.

Existing companies who are deemed subject to FOCI are ineligible for a facility security clearance ("FCL"). When a company that already has an FCL enters into negotiations for a proposed merger, acquisition, or takeover by a foreign person, the applicant must submit notification to the appropriate cognizant security agency ("CSA"). The submission must include the type of transaction under negotiation, the identity of the potential foreign person investor, and a plan to negate the FOCI. All relevant papers (i.e., loan, purchase and shareholder agreements, annual reports, articles of incorporation) also need to be filed along with the notification.

If FOCI is a consideration, the CSA will discuss appropriate mitigation options. FOCI mitigation plans may include a Board Resolution, a Voting Trust Agreement and Proxy Agreement, a Special Security Agreement and Security Control Agreement, or a limited FCL. Representatives of the CSA are required to meet at least annually with senior management officials of companies operating under a mitigation plan to review the purpose and effectiveness of the clearance arrangement. Failure on the part of the company to ensure compliance with the terms of any approved security arrangement may constitute grounds for revocation of the company’s FCL and loss of the contract.

Most foreign investments in U.S. companies involved in national security programs require a FOCI analysis. Even a minority interest by a foreign entity could be construed as indirect control of a U.S. company, thereby triggering the FOCI requirements. Additional national security legislation limits foreign government participation in transactions involving certain U.S. government agencies. Specifically, Department of Defense ("DoD") or Department of Energy ("DoE") national security program contracts are subject to heightened scrutiny if the awardee is an "entity controlled by a foreign government." This term is defined to include any domestic or foreign organization or corporation that is effectively owned or controlled by a foreign government and any individual acting on behalf of a foreign government. For DoD contracts, the Defense Federal Acquisition Regulations Supplement ("DFARS") defines "effectively owned or controlled" to mean that a foreign government or any entity controlled by a foreign government has the power, either directly or indirectly, whether exercised or exercisable, to control the election, appointment, or tenure of the Offeror’s offi cers or a majority of the Offeror’s board of directors by any means, e.g., ownership, contract, or operation of law (or equivalent power for unincorporated organizations). The statute does provide the DoD and DoE Secretary with the authority to waive the bar against contractors if the

Secretary determines that waiver is essential to the national security interests of the United States. In the case of the DoD, however, the Secretary has reportedly never exercised this waiver authority.

National security considerations are increasingly dictating how the United States deals with international trade and investment. This influence can be seen in numerous areas, such as the bioterrorism and container security initiatives introduced by Customs, the enhanced enforcement of U.S. export controls, and the Treasury Department’s new anti-money laundering requirements for financial institutions. Inbound foreign investment is likely to come under similar increased scrutiny, especially in such areas as national defense and critical infrastructure (transportation, telecommunications, cyberspace, etc.). Therefore, parties involved in the U.S. market—foreign companies, entities owned by foreign governments, U.S. businesses with foreign ownership—need to understand current national security requirements and take appropriate proactive measures to ensure that national security considerations do not disrupt merger, acquisition, and other business opportunities in the United States. Reed Smith’s Export, Customs and Trade team can assist your company in identifying and addressing Exon-Florio, FOCI, and other national security issues to facilitate inbound investment transactions. 

This article is presented for informational purposes only and is not intended to constitute legal advice.

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