FW speaks with Joseph G. Falcone and Karen Ip, partners at Herbert Smith Freehills LLP, about the outlook for CFIUS cases.
FW: Could you outline the basic role and function of the Committee on Foreign Investment in the United States (CFIUS)?
Falcone: CFIUS is an inter-agency US government committee chaired by the US Department of Treasury. Its members include representatives of various US government agencies and departments, including the Departments of Defense, State, Justice, Commerce, Energy and Homeland Security. CFIUS is charged with reviewing ‘covered’ transactions in which non-US persons – or ‘foreign’ persons, in CFIUS parlance – may gain control of US businesses, in order to determine whether such transactions would pose a threat to US national security or to critical US infrastructure or technologies. CFIUS review formally begins when the parties to a proposed transaction file a voluntary notice with CFIUS. The filing is ‘voluntary’ as US law does not require parties to seek CFIUS review; however, if CFIUS approval is not obtained, the US government may subsequently order the divestiture of any covered transaction which is deemed harmful to US national security. Even if the parties to a transaction do not seek CFIUS review, CFIUS may learn of a transaction via other sources, such as public filings or press announcements, and has authority to initiate its own review of acquisitions and to request parties to submit a notice, even post-closing. Once a formal notice is filed, CFIUS has 30 days to review the transaction. A majority of transactions are cleared at the end of this period. If a security concern is raised but not resolved in the initial review, CFIUS will undertake a subsequent 45-day investigation. If a security threat exists, CFIUS can impose conditions on the parties to mitigate those threats, but if mitigation will not resolve the issue, CFIUS can refer the matter to the President, who then has 15 days to allow the transaction, or else suspend or block it in the interest of national security.
FW: Historically, CFIUS has been particularly interested in potential acquisitions by state owned businesses and sovereign wealth funds. To what extent has the profile of these acquirers changed to include private companies and funds?
Falcone: CFIUS will continue to scrutinise any covered transaction where the acquiring party is controlled by a foreign government, and the regulations in fact require a 45-day investigation where the transaction would transfer control to a foreign government – unless CFIUS can determine, based on the 30-day review, that the transaction will not impair US national security. Also of concern to CFIUS are transactions where the foreign person, be it state- or privately owned, comes from a country with a record on non-proliferation or other national security matters, or which has a history of taking or threatening actions that could impair US security. Ultimately, while CFIUS will take a very close look at acquisitions by foreign governments, I think CFIUS will focus equally on the type of business being acquired and the potential security concerns its acquisition presents, regardless of whether the acquirer is state or privately owned.
Ip: Private Chinese investment in the US has outgrown state-owned enterprise (SOE) investment in number and value of transactions. As recently as 2012, private Chinese investors in the US had invested significantly less value than SOEs, even while making twice the number of investments. As of the third quarter of 2014, however, the value of US investment by private Chinese investors has exceeded SOE investment value by around 25 percent. Given the perception that even private Chinese investors can be subject to significant state influence, however, it seems likely that CFIUS will not relax its scrutiny of Chinese investors.
FW: What types of sectors and industries are likely to be reviewed by CFIUS for pending deals? Is the range broadening?
Falcone: CFIUS jurisdiction extends to just about any foreign investment transaction involving a US business that presents national security concerns, and not just in the traditional defence-related industries. For example, in 2012 – the latest year for which statistics are publicly available – the majority of the CFIUS notices filed, totalling 114, related to acquisitions in the manufacturing sector, at 39 percent, with about half involving the computer and electronics products subsector. Thirty-three percent of the 2012 notices were in the finance, information and services sectors, and included increased filings in the wired telecommunications subsector. The remaining notices were in mining, utilities and construction with 20 percent, and in the wholesale, retail and transportation sectors with 7 percent. In recent years, CFIUS has paid particular attention to transactions involving energy, as well as acquisitions in the computer and data arena, given the cyber security threats increasingly facing the US.
FW: Could you explain exactly what aspects of a deal CFIUS will review, and what assessments they are likely to make?
Falcone: CFIUS review will address a number of areas. First, CFIUS will examine the transaction and its business rationale, including the scope of the deal, its value, and the financial institutions involved. Second, it will look at the US business being acquired, including its business activities, government contracting, cyber security systems, and so forth. Finally, CFIUS will examine the foreign acquirer, including its business, corporate affiliates and certain shareholders, and its plans for the US business. CFIUS will assess the potential threat, if any, posed by the foreign acquirer – for example, is the acquirer controlled by a foreign government that poses security issues for the US? – as well as the vulnerability of the US given the business at issue – does the US business operate in critical infrastructure or technology or is it party to sole source or classified US government contracts? CFIUS will then determine whether the acquisition would compromise US security interests given the proposed foreign ownership of the US business.
FW: What challenges might the existence of US sanctions introduce to the CFIUS review process?
Falcone: A transaction that would violate US sanctions, such as the acquisition of a US business by a party on the Specially Designated Nationals List, or ‘SDN List’, generated by the US Office of Foreign Assets Control (OFAC), would not receive CFIUS approval, as transactions by US persons with individuals on the SDN List are prohibited. However, to the extent US sanctions against a particular foreign entity – such as an entity on OFAC’s Sectoral Sanctions List, or ‘SSI List’, introduced this year in response to the situation in Ukraine – do not impose outright prohibitions on that entity’s ability to engage in a covered transaction, then CFIUS presumably would review the transaction to assess its impact on US national security. As a practical matter, an entity subject to US sanctions via the SSI List probably would face significantly heightened CFIUS scrutiny, especially if the proposed deal involved transfer of critical infrastructure or technology.
Ip: The CFIUS process might also prove difficult if the non-US acquirer engaged in activity or transactions with a party on the SND List. For instance, if an acquirer from the People’s Republic of China supplied arms to Iran, then CFIUS approval might not be forthcoming.
FW: In your experience, do acquirers realise the importance of seeking counsel on CFIUS-related issues early in the deal process? What are the downsides of treating this issue as an afterthought?
Ip: Chinese investors tend to be quite conscious of the CFIUS process, and it is not uncommon for them to ask, during the initial meeting with counsel, whether their contemplated transaction will be subject to review. Chinese investors have often viewed CFIUS with suspicion, since they know that CFIUS can stop deals, and the conventional ‘wisdom’ in China has been that CFIUS decisions were influenced by US protectionism and other pressures outside of CFIUS’s control. Arguably, this is now changing with 2013 successes including China’s Wanxiang Group acquiring car battery maker A123 Systems, CNOOC’s purchase of energy company Nexen, and Shuanghui’s acquisition of Smithfield Foods. These deals involved careful planning and experienced counsel, and demonstrate a better chance of success when the CFIUS processes are proactively engaged.
Falcone: The risk of treating the CFIUS process as an ‘afterthought’ arises from CFIUS’s ability to halt a transaction prior to closing, require mitigation remedies that alter the structure of the deal, or recommend that the President divest a transaction that has closed. Such intervention by CFIUS, especially post-closing, could be extremely disruptive to the parties, so you want to get out in front of these issues. And, even if the parties intend to seek CFIUS review, leaving it to the last minute can delay the closing should the CFIUS process itself be delayed in the pre-filing stage or elsewhere in the review process.
FW: What considerations should acquirers make as part of their CFIUS risk analysis?
Falcone: The foremost one is whether a CFIUS filing is warranted. The parties need to assess whether the US business being acquired, for example, has classified or sensitive information, deals in technology or information subject to export controls or else is part of critical technologies or infrastructure, has contracts with US agencies, owns real estate proximate to sensitive US government facilities, or operates in an area of clear interest to CFIUS, such as energy, telecommunications and other critical infrastructure. The parties also need to weigh the downsides of not filing against its potential benefits, including chiefly the ‘safe harbour’ protection should CFIUS approve the transaction, which generally insulates the deal from subsequent review.
Ip: Acquirers also should consider their own ownership structure and background. For instance, are they controlled by a foreign government, or from a country with which the US has national-security-related concerns? These factors are likely to increase CFIUS scrutiny.
FW: What is your advice to acquirers on navigating the CFIUS process and maximising the chance of obtaining deal approval?
Falcone: Engage early. While not required by the regulations, CFIUS expects that the parties will submit a draft notice before filing the formal submission. This pre-filing enables parties to consult with CFIUS regarding potential concerns implicated by the transaction, and to address inquiries and requests for additional information from CFIUS without the timing issues in the formal review process. This also enables CFIUS to have an early discussion with the parties about the potential for restructuring or otherwise including measures to address security concerns, such as mechanisms to restrict access to certain technologies or to ensure how government contracts are handled.
Ip: While the CFIUS process is separate from political considerations, it is generally good practice to proactively manage both. Engaging a public relations firm during the strategic planning stage of an acquisition, for example, can ensure that company executives are not left fighting two fires – CFIUS review and public opinion – at the same time. This is perhaps the key lesson to be learned from Dubai Ports World’s failed 2006 acquisition, which passed CFIUS review but failed in the court of public, and political, opinion.
FW: What lessons can we draw from the outcome of recent CFIUS reviews?
Ip: There have been some high-profile deals in recent years, in particular by Chinese investors, that were withdrawn due to regulatory concerns. But, in 2012, China led all nations in the number of transactions submitted for CFIUS review, with 23, and over the past three years CFIUS filings by Chinese investors have more than tripled. Chinese investors have secured approval of high-profile acquisitions, most notably Shuanghui International’s 2013 acquisition of Smithfield Foods. And, despite its early failure to acquire Unocal, in early 2013 CNOOC obtained CFIUS clearance to acquire Nexen Inc. Thus, while CFIUS will continue to closely scrutinise transactions, recent experience shows that Chinese investors nevertheless can secure regulatory approval of their US investments.
Falcone: I’d add that earlier this year, a US federal appellate court, in Ralls Corp. v. CFIUS, provided a rare victory to CFIUS applicants – in that case, Chinese nationals – by finding that they were entitled to review the unclassified information on which CFIUS based its decision. This ruling, if left undisturbed, may result in greater transparency in what has traditionally been a fairly opaque review process.
FW: Looking ahead, what trends do you expect to see in the way CFIUS handles reviews in the months and years ahead? How do potential acquirers need to respond?
Falcone: CFIUS will be busy. It will likely maintain, if not expand, its broad view of the types of industries that fall within its national security ambit. CFIUS may be even more aggressive in demanding that relevant transactions be submitted for review where the parties do not file voluntarily. CFIUS may be increasingly inclined to require mitigation measures to address national security risks. And, from the acquirers’ perspective, the Ralls decision may motivate more acquirers to seek judicial review of CFIUS decisions.
Ip: For potential acquirers, this all means that they will need to carefully assess whether a CFIUS filing is appropriate, and may well need to have some flexibility with respect to the terms of their transaction should CFIUS require mitigation as a condition for approval. For instance, China’s Wanxiang Group paved the way for its CFIUS clearance by strategically removing A123’s defence contract from the deal. Ultimately, Chinese investment in sectors that are not sensitive will continue to be welcomed.
Joe Falcone is a partner with Herbert Smith Freehills New York LLP. He has nearly 20 years’ experience representing domestic and international corporations in a variety of matters, including cross-border issues and disputes. Mr Falcone has advised on CFIUS matters and other US regulatory issues, and has represented companies in complex commercial, product liability, consumer and class action litigation. He has also counselled businesses on risk management strategies in connection with data and records management and related issues. Mr Falcone can be contacted on +1 (917) 542 7805 or by email: firstname.lastname@example.org.
Karen Ip is a partner in the Beijing office of Herbert Smith Freehills LLP. She has over 18 years’ experience in advising clients doing business in China, including the establishment and operation of representative offices, wholly foreign-owned enterprises and joint ventures in China. She is principally involved in China inbound and outbound M&A transactions and advising on antitrust and other regulatory issues in China. Ms Ip can be contacted on +86 10 6535 5135 or by email: email@example.com.
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