New Legislation Aims at Strengthening Review of Foreign Investment in the United States

07.30.2007

International Regulatory Update

On July 26, 2007, President Bush signed the Foreign Investment and National Security Act of 2007 (the “Act”), which reforms the legal and procedural framework for the review of foreign acquisitions of U.S. companies. Although the legislation is less ambitious than earlier bills considered by Congress, the Act amends the current statute and, in many respects, modifies the formal procedures of the Committee on Foreign Investment in the United States (“CFIUS”). The Act will become effective 90 days after the President signed it into law. Some of the big-picture issues that transaction parties should take into account when assessing the impact of the new legislation are as follows:

• Foreign investors generally: The legislation guarantees that the U.S. government will continue to scrutinize foreign investment on national security grounds. Certain sensitive transactions will be accorded heightened scrutiny, including mandatory investigations. The addition of new CFIUS agencies likely will make energy, labor, and intelligence issues more prominent in the CFIUS vetting process. Increased congressional oversight ensures that Congress will continue to play an important role that, in some instances, might be outcome-determinative. Ensuring post-approval compliance with the terms of any mitigation agreement between the transaction parties and CFIUS agencies is critical, as the Act expressly authorizes CFIUS to reopen a transaction based on intentional material breach of obligations under such an agreement.
• Foreign government-owned or controlled investors: The Act makes a full 45-day investigation of the transaction mandatory based solely on the acquirer’s ties to a foreign government (subject to a possible waiver). This and other provisions calling for higher scrutiny of acquisitions by foreign government-owned or controlled entities will increase regulatory burdens on foreign investors falling under this category.
• U.S. sellers: Given the spotlight on foreign acquisitions, U.S companies should ensure that potential CFIUS-related issues are considered as part of the sales strategy and pre-acquisition due diligence. Vetting the CFIUS issues, including potential political sensitivities of the proposed transaction, early in the process is critical to navigating the CFIUS approval process. U.S. sellers should be mindful that even acquisitions by entities organized in the United States may fall under the statute because the term “foreign person” is broadly defined. For example, an acquisition by a private equity firm organized and operating in the United States could trigger the application of the statute if its general partners or key decision-makers were foreign nationals.

The new legislation comes on the heels of several high profile foreign acquisitions, including the Dubai Ports controversy, that generated negative congressional reaction on national security grounds. Importantly, the Act preserves the basic framework for the CFIUS process, including its key stages and the maximum 90 days for completion of the process. At the same time, the Act formalizes many aspects of the process. Among other things, it formally establishes CFIUS and its membership; adds the Department of Energy as a voting member and the Labor Department and the Director of National Intelligence as non-voting, ex officio members of CFIUS; heightens scrutiny of certain sensitive transactions; enhances congressional oversight functions; and mandates sign off by senior-level officials on certain required certifications to Congress.

Because the Act codifies many existing practices of CFIUS, it might not, as a practical matter, significantly impact the way most foreign acquisitions are handled. However, foreign companies contemplating certain sensitive U.S. acquisitions – particularly those involving foreign government-owned or controlled acquirers and critical U.S. infrastructure – should be prepared for intense scrutiny. The heightened scrutiny of such transactions is expressly mandated under the revised CFIUS process. Moreover, the Act puts a high burden on CFIUS to justify to Congress, on a transaction-specific basis, its determination that a proposed acquisition does not threaten national security. Below we summarize some of the highlights of the Act that foreign investors and U.S. sellers should take into account when assessing potential challenges that a transaction could face in the context of the revamped CFIUS process.

Increased Scrutiny of Acquisitions by Foreign Government-Owned Entities

The Act mandates a full 45-day investigation of any acquisition by an entity owned or controlled by a foreign government. The Act permits some flexibility by authorizing an exception from the mandatory investigation if the Treasury Secretary and the head of the lead agency determine, on the basis of the initial 30-day review, that the transaction will not harm U.S. national security. To increase chances of overcoming the exception from the 45-day investigation requirement, companies should ensure that key CFIUS concerns are identified early and addressed satisfactorily through “mitigation agreements” negotiated during the initial 30-day review (see below).

Further, acquisitions by foreign government-owned or controlled entities will also require an assessment of the relevant country’s export controls, the potential for diversion of technologies with military applications, and the country’s compliance with U.S. and multilateral counterterrorism and nonproliferation controls. In light of these factors, if, for example, the U.S. seller develops products or technology that are tightly controlled for export to the acquirer’s home country and that country’s government or companies have a history of diverting U.S. technology to sensitive applications or end-users, the parties should be prepared to address measures mitigating these concerns as early in the process as possible.

Focus on Critical Infrastructure

The Act also requires a 45-day investigation for transactions involving “critical infrastructure” if CFIUS determines that (i) the transaction could impair national security and (ii) such impairment to national security has not been mitigated by assurances provided or renewed with the CFIUS approval. The term “critical infrastructure” is loosely defined, without a reference to any specific industry. Thus, the meaning of critical infrastructure would be left to the CFIUS agencies to define, presumably to allow for flexibility in the CFIUS process. The term has been broadly defined in related contexts. For example, the Department of Homeland Security has defined “critical infrastructure” to include many significant sectors of U.S. economy, such as information and telecommunications, transportation, postal and shipping, banking and finance, energy, chemical industry, and industrial defense base.

Designation of Lead Agency for Each Transaction

The Act requires a designation of a lead agency for each transaction. The lead agency will be responsible for negotiating and monitoring mitigation agreements for CFIUS, including the enforcement of such agreements after the completion of the CFIUS review. The practical consequences of implementing the lead agency concept could be both positive and negative. A lead agency may play a constructive role by virtue of its expertise. On the other hand, other CFIUS agencies may tend to defer to the lead agency, thus potentially giving a single agency disproportionate power to shape both the focus of the review and its outcome.

Enforcement of Mitigation Agreements and Evergreen Provision

The lead agency is tasked with monitoring and implementing mitigation agreements entered into by the transaction parties and relevant government agencies to mitigate national security concerns. In addition to codifying the practice of conditioning the CFIUS approval on the entry into mitigation agreements, the Act also authorizes CFIUS to re-open approved acquisitions if parties materially breach such agreements. Thus, parties should implement robust internal controls to ensure compliance with mitigation agreements.

Expanded Oversight by Congress

Finally, the new legislation both strengthens and formalizes congressional oversight functions. It requires CFIUS to transmit to Congress certified notices and reports upon the completion of any CFIUS review or investigation. Each such notice and/or report transmitted to Congress must be signed by the Secretary of Treasury and the head of the designated lead agency. CFIUS is also required to transmit annual reports to Congress on the reviews and investigations conducted during the preceding 12-month period. These enhanced reporting requirements to Congress significantly increase the burden on CFIUS to justify its actions and determinations before Congress with respect to the reviews and investigations it undertakes. It remains to be seen how much, if at all, these formalized procedures will help CFIUS in deflecting political pressure in the context of its review of sensitive transactions.

Contacts

If you have any questions regarding this matter, please do not hesitate to contact the Heller Ehrman attorney with whom you regularly work or any of the Heller Ehrman lawyers listed below:

Paul D. Downs	+1 (212) 847-8767	Paul.Downs@HellerEhrman.com
Sturgis Sobin	+1 (202) 912-2080	Sturgis.Sobin@HellerEhrman.com
Sylwia A. Lis	+1 (202) 912-2524	Sylwia.Lis@HellerEhrman.com

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