Save U.S. from CFIUS The Foreign Investment and National Security Act of 2007 and Its Effect on Foreign Investment
by Ralph Ferrara and Carlo Mosoni

In early 2006—less than five years after 9/11 and amid national fear that terrorists and bombs could enter the United States through any of the millions of goods imported annually at U.S. ports—an Arab company sought to win a bid to manage six major U.S. seaports. The bid actually was not detrimental to the U.S., but Congress disallowed it even though it would have been good for the country.

Primarily as a response to China’s controversial bid for U.S. oil company Unocal and the now infamous unwinding of the Dubai Ports World (“DPW”) deal, on July 26, 2007 President Bush signed into law the Foreign Investment and National Security Act of 2007 (“FINSA”). The main goal of FINSA is to reform the Exon-Florio Amendment to the Omnibus Trade and Competitiveness Act (“Exon-Florio”), which provided the process governing national security reviews of foreign investments in the United States. The recurring calls to overhaul Exon-Florio arose against the backdrop of 9/11 and the overstated fear that foreign investment would compromise national security.

Exon-Florio was passed in 1988 to establish a process to review, investigate, and, when necessary, restrict foreign acquisitions of U.S. entities. The Amendment sought not to threaten or slow foreign acquisitions generally but rather to affect only those transactions that implicate U.S. interests in “national security.”1 Under Exon-Florio, parties to a transaction could voluntarily submit notice to the Committee on Foreign Investments in the United States (“CFIUS”)—a group overseen by the Treasury Department and consisting of six cabinet secretaries and six highlevel White House aides. Then the committee would evaluate the transaction while considering a list of factors set out by Exon-Florio, including whether the transaction would affect the ability of the United States to defend itself, and whether the transaction would provide military equipment to hostile countries. After receiving notice, CFIUS would have 30 days to either (1) approve the transaction or (2) initiate a more intense 45-day “investigation” and present its recommendation to the U.S. President to make a final decision and report the decision to Congress.

Under FINSA, much of the basic assessment process stays the same: review is voluntary and CFIUS has 30 days to either approve the transaction or begin a secondary investigation with resulting presidential decision-making.

FINSA, however, changes the process’s scope in ways that perilously decrease CFIUS’s flexibility and increase congressional involvement.2 First, FINSA decreases CFIUS’s flexibility by expanding and stiffening the definition of “national security.” FINSA increases and specifies the types of transactions subject to mandatory investigation. For instance, unless CFUIS officials personally sign off that national security is not impaired, it requires investigation of all transactions involving government-owned investors. It also requires that CFIUS evaluate sectors not traditionally related to security such as “critical U.S. infrastructure,” which is broadly defined to include energy-related capacity that is “physical or cyber-based.” CFIUS must also consider new factors, including those not directly related to the transaction such as whether an acquiring country complies with U.S. counter-terrorism efforts. Second, FINSA increases the role of Congress in the process. It requires that CFIUS submit to Congress notice and certified conclusions of all reviews. CFIUS must also take into account the recommendations of individual Congressional members and committees.

Despite the balance between foreign investment and national security that FINSA purports to strike, the new legislation is problematic. By reducing CFIUS’s flexibility in responding to crisis, it limits CFUIS’s ability to consider transactions on a case-by-case basis. By mandating increased Congressional involvement, it creates new obstacles for foreign investment3 and risks blurring the line between legitimate national security concerns and protectionism.

Despite the balance between foreign investment and national security that FINSA purports to strike, the new legislation is problematic. By reducing CFIUS’s flexibility in responding to crisis, it limits CFUIS’s ability to consider transactions on a case-by-case basis.

The Perils of Decreased Flexibility

One of the strengths of the Exon-Florio provision was its lack of a firm definition of the term “national security.” This gave the CFIUS flexibility to effectively respond to emerging threats to national security involving diverse industrial sectors – not just those directly related to the defense industry. At the same time, this lack of a strict definition allowed CFIUS to avoid areas it reasonably deemed did not require review. The CFIUS process was not, however, without guidance. In lieu of a definition, the committee identified a number of criteria for evaluating potential threats.4 Importantly, these criteria were not unduly confining because the legislative history of Exon-Florio provided that the term “national security” be “read in a broad and flexible manner.”5

The Treasury Department has also been supportive of the need for flexibility and takes the view that “national security” is an organic term that constantly changes and narrowing its definition would be detrimental to the core mission of CFIUS. The Treasury Department has stressed the importance of a broad reading of the term “national security” because a strict reading could jeopardize the President’s veto power over industries that might fall outside of a narrowly prescribed definition. In following the Treasury Department’s lead, the committee, prior to FINSA, routinely rejected calls to clearly define “national security” because “[doing so] could improperly curtail the President’s broad authority to protect the ‘national security.’“6

After 9/11, the lack of an exact definition allowed for a dramatic increase in the number of transactions that underwent CFIUS review. CFIUS was able to expand the concept of national security to include situations which had not been previously covered, but which reasonably should be. For instance, the Bush administration took advantage of the open-ended definition to argue that economic security is an integral component of national security. Similarly, the flexible concept of “national security” had been used in the CFIUS review process to cover foreign investment in areas such as natural resources and communications. The proposed acquisition of Global Crossing, an American manufacturer of fiber optic, by Whampoa Limited of China is an example of how a pre-FINSA CFIUS effectively reviewed investments in an area that might fall outside a more restrictive definition of national security.

In reviewing the Whampoa transaction, the Department of Defense raised national security concerns because of fear that the ownership of the company by the Chinese government could expose U.S. communications. The significance of this particular transaction was that the technology that Global Crossing manufactured did not necessarily fit the traditional concept of the term “national security” because such technology was not directly used by the military. The Department of Defense was nevertheless concerned with its potential secondary uses as a military technology. Notably, Whampoa withdrew its bid on its own initiative before CFIUS released its final recommendation (and all indications suggest CFIUS was going to recommend that the bid be allowed to proceed).7 The Whampoa transaction shows that CFIUS already had the potential to effect wide-ranging transactions even before FINSA’s redefinition of “national security.”

However, explicitly extending the domain of “national security” too far creates problems. There has been a concerted effort from some political factions to define “national security” to include transactions which really do not concern national security. For instance, some claim the need to safeguard the nation’s oil supply within the definition. This movement to impose greater restrictions on foreign investment in American oil interests was spurred by China National Offshore Oil Corporation’s (“CNOOC”) high-profile bid for the American-based Unocal Corporation. Some members of Congress viewed CNOOC’s offer as a threat to the United States’s ability to obtain oil and gas and argued that China would dominate and control the oil supply for its own use. However, because of the fungible nature of oil, experts did not consider CNOOC’s bid problematic. They also pointed out that crude oil is regularly traded to balance the demand and supply at any given time. In other words, CNOOC’s purchase of Unocal would have offset purchases of oil China would have made elsewhere, thus freeing other oil for purchase by the United States. Finally, oil experts pointed out that even if China stockpiled the oil to increase its own reserves this would not translate into a price increase.8

There has been a concerted effort from some political factions to define “national security” to include transactions which really do not concern national security. For instance, some claim the need to safeguard the nation’s oil supply within the definition.

While opponents to the CNOOC transaction cited the strategic importance of oil as their main reason for their resistance to the merger, the relatively small size of Unocal and its limited involvement in North America point instead to protectionist concerns.9 Altering the meaning of the term “national security” and making oil a strategic asset that would always elicit a heightened CFIUS review would be detrimental to the investment environment because it could prevent legitimate mergers. Furthermore, a more detailed definition of the term “national security” under FINSA will take away the flexibility that CFIUS has to review transactions and make national security assessments of foreign investment in the United States on a case-by-case basis.

Protectionist-minded lawmakers argue that the real reason foreign acquisitions concern national security is their potential aggregate effects. Representative Tom Tancredo (R-CO), for instance, when speaking about the failed CNOOC transaction said, “By itself, this takeover may seem small, but a few more deals like this one and America could find itself hostage not just to the energy brokers in the Middle East but to China as well.”10 An expansive definition of “national security” could effectively chill foreign investment in certain areas because this “aggregate effect” argument can always be advanced by those with a protectionist agenda.

In sum, prior to FINSA, the flexible concept of “national security” allowed CFIUS to effectively review transactions on a case-by-case basis. However, by more stiffly defining “national security” and explicitly requiring review of certain industries, FINSA adds another layer of uncertainty and delays legitimate acquisition bids. This raises the cost of transactions and may prevent them from occurring altogether.

The Perils of Increased Congressional Involvement

Under FINSA, CFIUS will now have to notify Congress about each transaction it reviews and answer detailed questions from a number of Congressional committees. This political approach is problematic because it could potentially bias a review by bringing unwanted attention and external pressures similar to the vitriolic outcry over the DPW bid.

One of the strengths of the Exon-Florio provision was that it permitted CFIUS to function in an environment that was usually isolated from political concerns. The committee’s relative independence was important because it preserved the balance between national security and an open foreign investment policy. Precisely due to the lack of congressional interference, CFIUS has historically received very little publicity. This has the beneficial effect of ensuring that the process generally would not be obstructed by members of Congress whose districts might be impacted by a merger or an acquisition.

The heavy opposition against the CNOOC and DPW transactions demonstrates that Congress already involves itself in the CFIUS process when there are significant transactions. Similarly, Congressional members have shown that they individually may become involved when their state agendas are concerned. For instance, Senator Evan Bayh of Indiana (D-IN) opposed the acquisition of Indiana-based Magnequench by a Chinese corporation.

The heavy opposition against the CNOOC and DPW transactions demonstrates that Congress already involves itself in the CFIUS process…. Similarly, Congressional members have shown that they individually may become involved when their state agendas are concerned.

FINSA’s call for greater congressional authority in reviewing CFIUS transactions may further politicize the process and foster instability and unpredictability in the business community. By making CFIUS more of a protectionist tool rather than a legitimate means of enhancing national security, FINSA has the unfortunate consequence of threatening the health of the U.S. economy. Thus, while congressional oversight for certain transactions might be warranted, congressional involvement should be the exception and not the rule. Pervasive congressional involvement in the review process will likely impair CFIUS’s ability to make objective decisions regarding proposed foreign investments in the United States.

The Congressional reaction to CNOOC’s bid is also troubling because it reveals the “increasingly confrontational approach Congress is taking towards China.”11 Many foreign corporations already view CFIUS as a tool that can be used as an anti-takeover defense in a merger. As such, it is not surprising that foreign investors are skeptical of FINSA and an expanded congressional role. More congressional involvement might allow corporations to lobby members of Congress in order to seek their support to block a takeover. CFIUS would then cease to be a committee that balances national security and foreign investment and would become an avenue for corporations to fend off takeover attempts, leading to market distortions.

The consequences of FINSA and its expanded congressional mandate over CFIUS could also affect American investment abroad by inciting nations to retaliate. The Chinese government, to take the most salient example, could respond by enacting its own protectionist laws and regulations to block American investment in China. Thus, increased restrictions in future Chinese transactions in the United States could be counter to the government’s efforts to achieve greater investment openness in the Chinese market—a market that ironically, has become increasingly receptive to foreign investment in the last couple of years.12 This is especially true if we are to take into account that other non-Chinese foreign companies (besides DPW, of course), such as British Petroleum face fewer hurdles when investing in U.S. energy assets.13 This double standard is unlikely to be perceived as fair by the Chinese government and could result in a decline in permitted U.S. investment in China.

The seemingly targeted scrutiny that Chinese investment has been subjected to is reminiscent of the opposition that Japanese investors faced in the 1980s. In fact, the Exon-Florio provision was passed in large part because of concerns about expansive Japanese investment and the irrational fear among American politicians that Japan would slowly take over the United States through the acquisition of its assets. Just before CNOOC announced its bid to purchase Unocal, Federal Reserve Chairman Alan Greenspan and Treasury Secretary John Snow appeared before a Senate committee to discuss free trade policy with China. In their comments, they specifically compared China’s recent U.S. investment with Japan’s in the 1980s.14 Many observers believe that because of the recent number of bids by Chinese corporations to acquire major U.S. companies, FINSA might also be an attempt to curtail China’s corporate shopping spree.

Stigmatizing legitimate business transactions as security risks may weaken the world’s “confidence in the dollar as the major global currency.”15 FINSA might cause foreign investors to question whether it is worth subjecting themselves to CFIUS review if protectionist pressures could derail a bid. The foreign investment in question is by no means insignificant. In 2004 alone, foreign investors put more than $100 billion dollars in the United States.16 At the same time, a Congressional Research Service Report for Congress estimates that the “cumulative amount of direct [foreign] investment in the United States on a historical cost basis increased…in 2003 to nearly $1.4 trillion.” 17 Outside economic observers have already noted that any slowing of foreign investment in the United States could have potentially devastating economic effects because the United States remains dependant upon foreign investment to service the government deficit.18

Stigmatizing legitimate business transactions as security risks may weaken the world’s “confidence in the dollar as the major global currency.” FINSA might cause foreign investors to question whether it is worth subjecting themselves to CFIUS review if protectionist pressures could derail a bid.

Ironically, the enhanced ability of Congress to curtail foreign investment might also be detrimental to America’s national security. This is especially true in the case of Chinese investment since China has turned to other countries that have fewer restrictions on foreign trade. Post-Unocal, China has invested in oil fields in countries like Venezuela, Iran, and Sudan—all countries that not only have more lenient commercial regulations, but countries that are also openly hostile to the United States. China recently became Iran’s biggest oil and gas buyer and signed long-term contracts worth more than $200 billion.19 America’s protectionist hurdles have pushed China, desperate to satisfy its enormous energy needs, to increase its dealings with such countries, undermining the efforts of the United States to isolate those countries.

FINSA’s greater scrutiny and potential veto on foreign transactions might also cost the United States the opportunity to pressure countries into adopting more open-door stances with respect to foreign investment. For instance, instead of automatically opposing the CNOOC bid, the United States could have used it as leverage to press China to afford fewer limitations to future U.S. investments.

Given the U.S.’s position as the leader in global investment and the influence that U.S. policy has abroad in defining the policies governing the acceptance of foreign capital worldwide, allowing Congress to implement a protectionist stance that limits foreign investment would have consequences that could resonate around the globe. A policy like FINSA will thus be detrimental to U.S. companies and their efforts to invest abroad because similar regulations could be adopted by U.S. trade and business partners. Consequently, all the bilateral, regional, and international efforts that have allowed establishment of national and supra-national regimes favorable to foreign direct investment could be threatened by the passage of FINSA. Paradoxically, at a time when the perceived economic benefits of foreign investment have fueled the worldwide movement towards liberalization, national security concerns and protectionist-minded politicians have provided a dangerous counterweight to free trade.

Conclusion

FINSA raises the prospect of decreased foreign investment in the United States without demonstrably making the U.S. any safer. Thanks to a stiffer re-definition of the term “national security,” CFIUS now must scrutinize industries that reasonably should not undergo review, and it may have less flexibility to review transactions not included in the definition. Additionally, FINSA’s required expansion of Congress’s role on every transaction that goes before review will undoubtedly raise the risk that legitimate foreign investments will be obstructed by protectionists acting under the guise of national security. FINSA’s changes to the CFIUS review process may create market distortions because offering the highest bid, and even overcoming anti-trust barriers, will no longer be a guarantee of winning the deal, especially in situations where foreign firms are competing against U.S. firms.

Notes

1. See, e.g., Committee on Foreign Investments in the United States (CFIUS), U.S. Dep’t. of Treasury Office of the Assistant Secretary Intn’l Affairs Office of Intn’l Investment, at http://www.treas. gov/offices/international-affairs/exon-florio/... (“The intent of Exon-Florio is not to discourage generally, but to provide a mechanism to review and, if the President finds necessary, to restrict [foreign direct investment] that threatens the national security”, at http://www.treas.gov/ offices/international-affairs/exon-florio/.)
2. Other changes in FINSA that expand the process’s effect include expanding CFUIS to include members from the U.S. Energy Department and Labor department; increasing pressure on CFIUS to complete more secondary investigations by requiring more approval to end review; creating a new Assistant Treasury Secretary position responsible for CFUIS reviews; requiring the Director of National Intelligence to review each transaction; and explicitly authorizing CFIUS to demand transaction changes in exchange for approval.
3. Indeed, while the review process remains voluntary, foreign investors have unsurprisingly reacted to FINSA by erring on the side of caution and submitting more filings to CFIUS. Even though foreign investors recognize that the bureaucratic profile of the national security review process creates subtle rather than major changes or obstacles, there has already been increased demand for attorney assistance with the process.
4. CFIUS did not define the term “national security” rather, it identified a number of criteria in evaluating a potential threat. These criteria include the domestic production needed for projected national defense requirements; the capability of domestic industries to meet national defense requirements; the control of domestic industries by foreign citizens; the potential effects of the transaction on the sales of military goods, equipment , technology to a country that supports terrorism or proliferates missile technology or chemical and biological weapons; and the potential effects of the transaction on US technological leadership in areas affecting US national security. Exon-Florio Amendment, App., § 2170(f).
5. Statement of Senator Exon, Congressional Record 134 (April 25, 198): S483.
6. Regulations Implementing Exon-Florio, Code of Federal Regulations, title 31, sec. 800, App. A (198).
7. Jonathan Peterson, Panel Has a Big Say in Foreign Purchases; Security Clearance for a Chinese Bid for Unocal Would Hinge on Obscure U.S. Committee, L.A. Times, July 5, 2005, at C4.
8. Paul Blustein, Many Oil Experts Unconcerned Over China Unocal Bid, Wash. Post, July 1, 2005, at D1.
9. Dick K. Nanto et al., China and the CNOOC Bid for Unocal: Issues for Congress 3, 10 (2005).
10. James A. Dorn, Policy Analysis: U.S.-China Relations in the Wake of CNOOC, Pol’y Analysis, Nov. 2, 2005, at 5.
11. Dorn, supra note 8, at 1.
12. Edward M. Graham, Op-Ed., No Reason to Block the Deal, Far E. Rev., July 2005.
13. Dorn, supra note 8, at 4.
14. 14. Diane M. Grassi, China’s Bid for Unocal: More Than Meets the Eye, Am. Chron., July 19, 2005, http:// www.americanchronicle.com/articles/ viewArticle.asp?articleID=1237.
15. Robert J. Samuelson, Save Us from Our Politicians; The Controversy Over Dubai Ports World Was a Great Victory for Them—But a Defeat for Candor and Sensible Security and Economic Policies, Newsweek, Mar. 20, 2006, at 33.
16. James K. Jackson, Congressional Research Service (CRS) Report for Congress, Foreign Direct Investment in the United States: An Economic Analysis 1 (2005).
17. Id. at 2.
18. Edward M. Graham & David M. Marchick, Op- Ed., A Misplaced Curb on Investment, Fin. Times (London), Oct. 5, 2005, at 15. The United States finances its deficit by borrowing and equivalent amount to that being invested and then uses that money to make payments to its lenders.
19. Antoaneta Bezlova, Seeking Oil In Troubled Waters, IPS-Inter Press Service, Sept. 19, 2005, available at http://www.speroforum.com/site/ print.asp? idarticle=1921.

Ralph C. Ferrara is a partner Dewey & LeBoeuf LLP and former General Counsel of the United States Securities and Exchange Commission. Carlo Mosoni is a third-year student at the University Of Pennsylvania Law School and served as a Summer Associate with Dewey & LeBoeuf during the summer of 2007. Mr. Ferrara provided the inspiration and direction for this article, and Mr. Mosoni provided its intellectual content. Contact: rferrara@llgm.com.