Tightening up the CFIUS Process

Foreign direct investment benefits the U.S. economy, but particular investments can raise national security concerns.  Congress and the President have created a mechanism to review proposed investments, to incorporate mitigating measures into particular deals, and to stop deals that are ultimately unacceptable. 

Last winter this system may or may not have adequately addressed the security issues when Dubai Ports World tried to buy the parent company of P&O Ports North America, a firm operating port facilities in the U.S.   It failed spectacularly in heading off a political firestorm.

Since then, even in the absence of new legislation from Congress, the U.S. has ratcheted up its scrutiny of foreign investments.  David Marchick lays out exactly how in Swinging the Pendulum Too Far: An Analysis of the CFIUS Process Post-Dubai Ports World  (National Foundation for American Policy Policy Brief, January 2007).

Remember the way the investment review system works.  The Committee on Foreign Investment in the U.S. (CFIUS) is an interagency committee, chaired by the Treasury Secretary.  CFIUS includes agencies responsible for the economy, as well as those more concerned with security.  CFIUS can review a transaction if one of the parties asks it to, or it can start a review on its own - even after a deal is completed.  Often, companies involved in a transaction that may have security implications consult informally with CFIUS staff before any formal request for review is made.   If companies think there will be security issues, they may request a review and work through mitigation issues to clear the air, and reduce the likelihood of a future CFIUS intervention - which could result in a required divestiture.

Once a transaction is "notified" to CFIUS, the committee has 30 days to complete an initial review.  CFIUS might not see any concerns, it may identify both concerns and adequate mitigation measures, or it might identify insuperable difficulties and the parties may withdraw from the transaction.  If the 30 day period ends, and concerns still exist, CFIUS can begin a secondary review (called an "investigation"), lasting up to 45 days.  The 45 day secondary review is required if an acquiring company triggers two conditions: it is (a) owned by a foreign government, and (b) the deal raises security concerns.    Ultimately, at the end of a secondary review, CFIUS reports to the President, who has 15 days to decide if a transaction can be allowed to go through.

Dubai Ports World went through this process at the end of 2005 and the start of 2006.  A review was completed, but the 45 day investigation wasn't triggered, even though Dubai Ports World was owned by a foreign government.  CFIUS evidently believed, after the review, and in light of any mitigating conditions that were required, that it was not a deal that raised security concerns.  Then everything blew up.  (I reviewed the Dubai Ports World CFIUS process up to the start of the controversy last march in Countdown to controversy: Dubai Ports World, Ben Muse, March 6, 2007).

Dubai Ports World ultimately was forced to divest itself of the port assets it had acquired (selling them this past December to AIG Global Investment Group of New York). This was a politically stressful experience for the administration and the agencies involved.    Marchick explains that the administration responded by tightening up the procedures to reduce the likelihood of a repeat:

• More filings, investigations, withdrawals and presidential decisions: In 2006, there were 113 filings (up 73 percent over 2005), 7 second-stage investigations (up 250 percent) and 5 withdrawals (up 150 percent) during the second-stage investigation period....  A number of other transactions were withdrawn during the initial 30-day period. Some of these transactions were re-filed and other transactions never went forward. Two transactions... were sent to the President for a decision. The data demonstrate two unassailable facts: (i) companies and their counsel are filing cases that would not have been filed the previous year; and (ii) transactions are being scrutinized like never before. All of this is evidence of CFIUS’s caution and extraordinary scrutiny in reviewing transactions post-Dubai Ports World.
• Longer reviews: While the statutory timetables have not changed, the more sensitive environment has resulted in longer review times for a number of transactions. Moreover, a number of transactions were withdrawn within the initial 30-day period, most likely because companies wanted to provide CFIUS with additional time to complete the review without entering the second-stage "investigation." Another five transactions required a full investigation. Other reviews took even longer.... Pre-filing consultations and withdrawals provide CFIUS with important flexibility without expanding the statutory timelines for all transactions. At the same time, if the pattern of longer time periods for certain CFIUS reviews continues, foreign investors could be less interested in investing in the United States.
• More mitigation agreements: CFIUS has also increased the number of "mitigation" or "national security agreements" negotiated as a condition for approval. For example, in 2006 DHS required more mitigation agreements than in the previous three years combined — DHS was a party, along with other agencies in certain agreements, to 15 mitigation agreements in 2006. By contrast, from 2003-2005, DHS was a party to only 13 mitigation agreements. Foreign investors now face a greater likelihood of having to enter into a mitigation agreement in order to secure CFIUS approval. This is particularly the case in the information technology sector and other sectors considered "critical infrastructure."
• New, tougher terms: CFIUS has also increasingly imposed tougher conditions on companies as a condition for approval. One of these provisions, the so-called “evergreen CFIUS” provision, which allows CFIUS to reopen a review and potentially order divestment for non-compliance with an agreement, drew criticism when its existence became public in the Alcatel-Lucent merger. CFIUS review and approval has commonly been understood to provide transaction parties with a legal safe harbor against divestment. This legal certainty has been an important prerequisite for foreign investors to invest in the United States. In the Alcatel-Lucent case, however, CFIUS required the parties to agree that the CFIUS review could be reopened if the “parties materially fail to comply with any of” the terms of a negotiated security agreement....  This “evergreen” CFIUS provision could negatively alter the incentives of foreign investors to invest and file with CFIUS.
• Higher-level reviews: One of the criticisms of CFIUS during the Dubai Ports transaction was that the issue was not handled at a sufficiently senior level. Congress complained that neither the President, the Secretaries of Treasury and Homeland Security nor other senior officials knew about CFIUS’s review. In response, most CFIUS agencies regularly brief either their Secretary or Deputy Secretary on every single transaction. CFIUS regularly meets at Deputy, Assistant or Deputy Assistant Secretary level to discuss particular cases and/or CFIUS policies and procedures.
• More reporting to Congress: CFIUS has also increased the level and frequency of reporting to Congress. The Department of Treasury and other CFIUS agencies are now promptly notifying Congressional committees with jurisdiction over foreign investment issues upon the completion of every case before CFIUS.
• Additional Resources: A number of CFIUS agencies have significantly increased staff resources and internal coordination within agencies to ensure all relevant factors are considered in CFIUS reviews...
• Enhanced enforcement of agreements: CFIUS agencies have also strengthened and enhanced their efforts to enforce national security agreements. These efforts include regular meetings with parties to a transaction during which the foreign investor is asked to explain and document implementation efforts provision-by-provision. CFIUS agencies have also increased the frequency of on-site audits by DOJ, the FBI or DHS.

Increasing the level of scrutiny increases the costs of investing in the U.S. and may actually reduce the effectiveness of the CFIUS process:

In the wake of the Dubai Ports World controversy, the process for securing approvals within CFIUS (the interagency Committee for Foreign Investment in the United States) has grown more difficult for foreign investors, adding to uncertainty and increasing the regulatory risk associated with certain foreign acquisitions. Such uncertainty could inhibit investment in the United States...

The more politicized environment surrounding CFIUS has created uncertainty for companies as to whether they should file a transaction with CFIUS. If a company does not file, then it risks CFIUS initiating its own review or opening a review after a deal has been finalized. Given CFIUS’s limited resources, a climate that encourages companies to file with CFIUS for transactions with only a limited nexus to national security actually impedes CFIUS's ability to protect national security by compelling CFIUS staff to focus on acquisitions with few genuine security concerns rather than cases that may require greater due diligence. While CFIUS's primary responsibility is to protect national security, a process which creates greater uncertainty for investments unrelated to national security is unlikely to make America more secure. U.S. national security depends in part on the strength of the U.S. economy, access to leading technologies and our relations with other countries. Therefore, Congress and the executive branch need to find the right balance to meet the twin objectives of protecting national security and promoting investment in the United States.

As the title of his paper suggests, Marchick thinks things have gone too far.

Marchick and Edward Graham co-authored US National Security and Foreign Direct Investment (Peterson Institute, May 2006), a detailed study of the CFIUS process.  The complete text is at the link.