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It's been some 18 months since the Foreign Investment and National Security Act of 2007 (FINSA) came into force. Its enactment followed the debacle surrounding DP World's aborted 2006 attempt to purchase the U.S. sea terminal operations owned by Peninsular and Oriental Steam Navigation Co., based in the United Kingdom.

FINSA permits President Obama to block acquisition of U.S. companies when they threaten national security. Parties to transactions subject to FINSA may voluntarily file a notification with the Committee on Foreign Investment in the United States (CFIUS), providing the government an opportunity to review the transaction. If the transaction passes muster, it acquires a safe harbor from further review.

With FINSA's passage, the Treasury Department-led interagency CFIUS emerged from obscurity as a rubber-stamp body with vague powers to prohibit foreign acquisitions that threaten national security to become an entity that is very much in the national limelight.

It wasn't until November 2008, however, that CFIUS issued final regulations addressing changes to the law and codifying the administrative factors that define the regulatory process. Just a few weeks later, the agency followed up with the first guidance since its inception as a creature of the 1988 Exon-Florio Amendment to the Defense Production Act.

“Although the regulations and guidance underscore CFIUS's discretion to consider each transaction on a case-by-case basis, they do offer some visibility into the circumstances that might present national security considerations by providing examples of industry categories and transactions that fit,” says Edward Rubinoff, a partner at Akin Gump Strauss Hauer & Feld. “So at least we have some transparency and predictability in an otherwise opaque process.”

Most important is the light shed on the concept of “control.”

Clarifying Control

“Control” is the cornerstone of FINSA, as CFIUS screens only those investments that would result in control by a foreign entity over a U.S. business. CFIUS defines control broadly as the power “to determine, direct, or decide important matters affecting an entity.”

Previously, practitioners had focused on a 10 percent ownership interest as the one below which CFIUS would not find control.

“But the final regulations explicitly reject any ownership threshold, unless the interest
in the company is solely for the purpose of 'passive investment,' and unless the investor maintains that intent and takes no action to the contrary,” says Simeon Kriesberg, a partner at Mayer Brown.

What the regulations do is identify a nonexclusive list of minority shareholder rights that, standing alone, would not confer control.

“Anti-dilution and anti-self dealing rights, for example, would not by themselves amount to control,” says Larry Christensen, a member at Miller & Chevalier.

The regulations also provide examples of transactions that do not qualify as “covered transactions” under FINSA and therefore are not subject to CFIUS review. These include greenfield investments; asset acquisitions where purchase of assets does not amount to purchase of a business; long-term leases except where the foreign lessee makes substantially all business decisions concerning the operation of a leased business; and lending transactions unless the foreign person acquires financial or governance rights characteristic of an equity investment rather than a loan, or where there is an imminent default giving a foreign person control of a business.

Otherwise, while it has always been clear that covered transactions reviewed by CFIUS get a safe harbor from further review, the regulations provide an important clarification. “CFIUS gets only one bite at the battle,” Christensen says. “So, for example, an acquirer who is cleared in purchasing a 40 percent interest in a business will not need to go back to CFIUS for approval if it decides to acquire the remaining 60 percent or some part of it in the future.”

The guidance that followed on the regulations, however, focuses on national security considerations as opposed to control.

Reviewing Risk

“Although the guidance provides only a minimal set of examples as to what will raise national security considerations, its issuance is good government because it clarifies a lot of things that might not occur to foreign investors,” Christensen says. “For example, it isn't every foreign investor that would think buying into a telecom manufacturing company would be a matter of national security, but it can be.”

According to the guidance, CFIUS will review national security risk as a function of the interaction between threat, a foreign person's ability to cause harm, and vulnerability, the potential of the target business to harm national security.

The guidance lists transactions involving U.S. businesses with government contracts and those that have relevance to national security as two broad categories that present national security risks.

In assessing the risks, CFIUS will examine the factors listed in FINSA, including the potential impact on production for national defense; international technological leadership and critical technologies; energy sources and critical infrastructure; the likelihood of chemical, biological and nuclear proliferation; and the adherence of the acquirer's home country to nonproliferation regimes.

And while the regulations duck the issues relating to sovereign wealth funds, the guidance provides a more detailed discussion of the subject.

“CFIUS seems to be suggesting that the transparency with which a sovereign wealth fund conducts business, its corporate governance policies in general and the existence of guidelines emphasizing commercial considerations for the acquisition may all be highly relevant,” Kriesberg says. “But it's also clear that the mere fact that a transaction is foreign-government controlled does not make it a national security risk.”

Still, uncertainty surrounding CFIUS abounds.

Crystal Clear

“For all the guidance, there's a clear message that CFIUS has a broad discretion applying and interpreting the law,” Rubinoff says. “This means there are still vast gray areas whether a transaction is covered and whether it has national security implications.”

At the same time, there's little doubt that CFIUS will be a more prominent feature of the foreign investment landscape.

“You have a regulatory process that is more expansive and reflects more intense scrutiny than before,” Kriesberg says. “The upshot is that many more foreign investors and the U.S. interests they deal with will have to adopt the CFIUS process as part of a fairly common regulatory oversight.”

Rubinoff says that filings are already on the rise.

“People get nervous with all the saber-rattling that's gone on about foreign investment and the new rules that seem to expand CFIUS's jurisdiction,” he says. “So the increase in filings has occurred partly because people are more prone to file as a precautionary measure.”

Some silver lining, however, can be found in the way CFIUS framed its guidance. The agency, the guidance states, operates in the context of an “open investment policy” and focuses on “any genuine national security concerns” and not on “other national security interests.”