1
FEBRUARY 4, 2013
A year in review: CFIUS’ latest report provides valuable insight
on past filings and on new national security concerns affecting
the acquisition of U.S. businesses by foreign parties
By Alexandra López-Casero
Last week, the Committee on Foreign Investment in the United States (CFIUS) cleared the
controversial $257 million acquisition of bankrupt car battery maker, A123 Systems Inc., by
Wanxiang Group, a Chinese auto parts maker. After a year that has seen CFIUS increasingly flexing
its muscles and the president blocking a transaction for the first time since 1990, this decision may
come as a surprise, even though Wanxiang Group apparently agreed not to buy the military and
government contract assets. The CFIUS process can seem opaque to foreign and U.S. companies
alike, given its confidential nature. Moreover, some of the factors that CFIUS analyzes are either not,
or only vaguely, defined, allowing CFIUS greater flexibility to consider a transaction on a case-bycase basis. It is, hence, useful to scrutinize the data that CFIUS provides in its annual reports to
Congress. This Alert analyzes the unclassified version of CFIUS’ latest report. The report covers the
2011 calendar year (the 2012 data will not be published until the end of 2013). Many of the trends
from the 2011 report, however, were exemplified in CFIUS decisions from 2012. While the
unclassified version does not provide details about specific transactions, it offers valuable insight on
recent filings and new national security considerations affecting cross-border transactions.
CFIUS authority and review process
CFIUS is a U.S. multi-agency regulatory body charged with reviewing and investigating transactions
that could result in the control of a U.S. business by a foreign person. CFIUS normally begins its
review of a pending transaction upon receiving a voluntary notice from the parties. While there is no
requirement to submit a notice to CFIUS, there are significant benefits to a voluntary submission.
Transactions that have not been reviewed and cleared by CFIUS remain subject to an investigation
by CFIUS before and after closing, and may even be undone if CFIUS determines that a transaction
threatens to impair national security.
As recently as September 2012, the president blocked the acquisition of four wind farm project
companies by a Chinese acquiror post-closing. Although it is still rare that the president blocks a
transaction, a number of transactions are abandoned by parties every year as a result of unfavorable
CFIUS reviews. In these cases, the parties prefer not to let it come to a formal blocking order.
Companies familiar with the CFIUS process will remember the 2011 acquisition of 3Leaf Systems
(3Leaf), a California-based provider of cloud computing technology, by Huawei Technologies
Company (Huawei), the leading Chinese manufacturer of telecommunications equipment. According
to press reports, members within the U.S. government believe that Huawai is closely connected to
the Chinese Communist Party. Huawei did not submit a voluntary notice to CFIUS pre-closing.
Post-closing, CFIUS threatened that the president would order to unwind this transaction. Huawei
first wanted to await the formal decision by the president, but ultimately agreed to divest the assets
“voluntarily.”
Moreover, it is common for CFIUS to suggest modifications to the structure of the transaction to
avoid an impact on national security and, therefore, a negative recommendation. Further below we
list the mitigation measures or “verifiable actions” that CFIUS required businesses to take in 2011(as
noted above, the data for 2012 has not yet been released).
Key trends and highlights from the latest report
Two notable trends that we discern from the latest report are the continuously high number of
notices that CFIUS subjects to second-stage investigations and the assertion by the intelligence
community that there is a coordinated strategy among foreign governments and companies to
acquire U.S. businesses with “critical technology.”
Increase in number of covered transactions; more second-stage investigations
According to the latest report, parties to M&A transactions submitted significantly more voluntary
notices to CFIUS in 2011 than in prior years (almost 20% more than in 2010). As noted above, the
2012 numbers will likely not be released until the end of this year. CFIUS credits the uptick in
voluntary notices to the recovery from the global financial crisis. In addition, this increase may also
have been triggered by heightened awareness among M&A lawyers and deal parties of the intricacies
of the CFIUS process and the benefits of filing a voluntary notice.
The latest report also shows that, in 2011, CFIUS did not clear a fairly high amount of notices (37%)
during the initial 30-day review period. These notices were further scrutinized during the secondstage investigation period, which generally lasts 45 days. Although in 2011 the amount of secondstage investigations was fairly consistent with the 2009 and 2010 levels, it was significantly higher
than in prior years (15% in 2008 and 4% percent in 2007). The higher amount of second-stage
investigations likely reflects the changes to the CFIUS regulations that came into effect on December
22, 2008, and which generally require a second-stage investigation for transactions involving foreign
governments or resulting in foreign control over critical U.S. infrastructure.
A number of parties voluntarily withdrew notices; none of the 2011 notices (but one 2012
notice) were blocked by the president
The latest report points out that the president did not block any transaction in 2011. The unclassified
version of the report does not reveal why CFIUS or the president did or did not take certain actions.
But it is likely that parties who received unfavorable CFIUS reviews in 2011 simply decided to
withdraw their notices to avoid mitigation measures or a formal blocking order. In some cases,
parties re-filed their notices in 2011, and CFIUS concluded action in those cases. In two cases, the
parties re-filed in 2012. From a practical standpoint, re-filing a notice helps a party address, and
attempt to mitigate, a particular national security concern that CFIUS raised during its original
review.
-2-
Given that the latest report only covers 2011, it does not mention that in 2012, the president blocked
the acquisition of four wind farm project companies by Chinese-owned Ralls Corporation (Ralls).
Ralls acquired the project companies in 2012 without notifying CFIUS. The underlying wind farms
were all within or in the vicinity of restricted air space at the Naval Weapons Systems Training
Facility Boardman in Oregon. After being contacted by CFIUS post-closing, Ralls filed a CFIUS
notice. Based on CFIUS’ recommendation, the president ordered, among other things, that Ralls
divest its interest in the wind farm project companies. Ralls has since sued CFIUS, the president and
the secretary of the treasury in the U.S. District Court for the District of Columbia.
Areas of particular national security concern to CFIUS
The latest report confirms, but also expands, previous guidance regarding the national security
considerations that CFIUS examines to determine whether a transaction could adversely affect U.S.
national security and pose a national security risk. The report lists the following national security
considerations:


Foreign control of U.S. businesses that:
o
Provide products/services to U.S. government (USG), state, or local agencies with
functions that are relevant to national security;
o
Provide products/services that could expose national security vulnerabilities,
including potential cyber security concerns, for example through the U.S. business’s
position in the supply chain;
o
Implicate businesses that involve critical infrastructure or various aspects of energy
production, including extraction, generation, transmission, and distribution;
businesses that affect the national transportation system; and businesses that could
significantly and directly affect the U.S. financial system;
o
Produce certain types of advanced technologies that may be useful in defending, or
in seeking to impair, U.S. national security, which may include businesses engaged in
the design and production of semiconductors and other equipment or components
that have both commercial and military applications, or the design, production, or
provision of goods and services involving network and data security;
o
Engage in the research and development, production, or sale of technology, goods,
software, or services that are subject to U.S. export controls;
o
Have access to classified information or sensitive government or government
contract information, including information about employees;
o
Are in the defense, security, and national security-related law enforcement sectors;
o
Are involved in activities related to weapons and munitions manufacturing,
aerospace, satellite, and radar systems; or
o
Are in proximity to certain types of USG facilities.
Acquisition of control by foreign persons that:
o
Are controlled by a foreign government;
o
Are from a country with a record on nonproliferation and other national security
related matters that raise concerns; or
o
Have historical records of taking or intentions to take actions that could impair
U.S. national security.
-3-
Notably, the list now also includes businesses that are in proximity of military or other sensitive
facilities, such as the wind farms in the Ralls acquisition described above. Moreover, the latest report
clarifies and expands which businesses in the energy sector can trigger national security concerns,
namely those “that involve various aspects of energy production, including extraction, generation,
transmission, and distribution.” Additionally, the list now specifically includes businesses in the
satellite industry (which were previously already a concern because of the export control restrictions
imposed on them). Finally, CFIUS has now also included businesses that have access to unclassified
“sensitive government or government contract information, including information about
employees.” It is important to note that these national security concerns are not spelled out in the
CFIUS regulations. Parties to covered transactions should keep these new factors in mind and
confirm whether any apply before filing a notice. For example, the question of whether a U.S.
business is closely located to military or other sensitive facilities (or their restricted air space, as in the
Ralls acquisition) may not be immediately apparent to foreign acquirors and their counsel. One way
to address this issue, is to include a question about potential proximity to military or other sensitive
facilities, including proximity to restricted air space, in CFIUS questionnaires that are prepared and
completed by the parties.
Mitigation measures
The latest report also reveals that, in 2011, CFIUS agencies imposed mitigation measures for seven
percent of covered transactions. The affected transactions were in the following industries: software,
computer programming, computer and electronic manufacturing, electrical equipment and
component manufacturing, aerospace manufacturing, and finance.
Specifically, CFIUS required the businesses involved to take the following “verifiable actions,”
including, for example:






Establishing a corporate security committee, security officers, and other mechanisms to
ensure compliance with all required actions, including annual reports and independent
audits;
Requiring a proxy entity to perform certain functions and activities of the U.S. business;
Ensuring compliance with established guidelines and terms for handling existing or future
USG contracts and USG customer information;
Ensuring only U.S. persons handle certain products and services, and ensuring that certain
activities and products are located only in the United States;
Notifying relevant USG parties of any material introduction, modification, or
discontinuation of a product or service, as well as any awareness of any vulnerability or
security incidents; and
Ensuring continued production of certain products for relevant USG parties for specified
periods.
The latest report also provides insight on the means that CFIUS now uses to monitor and enforce
compliance by the companies that are subject to the measures, including




Periodic reporting to USG agencies by the companies,
On-site compliance reviews by USG agencies,
Third-party audits when provided for by the terms of the mitigation measures, and
Investigations and remedial actions if anomalies or breaches are discovered or suspected.
-4-
Coordinated strategy
For the first time, CFIUS revealed that the U.S. Intelligence Community judges with “moderate
confidence” that there is likely a coordinated strategy among one or more foreign governments or
companies to acquire U.S. companies involved in research, development, or production of “critical
technologies”1 for which the United States is a leading producer. This marks a significant change
from prior reports, where CFIUS indicated that such a coordinated strategy was “unlikely.” Not
surprisingly, the public version of the latest report does not provide information supporting this
assessment. But the report lists examples of suspect behaviors that could be evidence of a
coordinated strategy, such as:



A pattern of actual or attempted acquisitions of U.S. firms by foreign entities (however,
legitimate business goals of a single company to enter the U.S. market, increase market share
or sales, access new technologies, or diversify out of mature industries, absent indications of
specific foreign government direction, are not considered to be a coordinated strategy);
Evidence that specific completed or attempted acquisitions of companies with critical
technologies had been ordered by foreign governments or foreign government-controlled
firms; or
The provision of narrowly targeted incentives by foreign governments or foreign-controlled
firms to acquire U.S. firms with critical technologies (for example, grants, concessionary
loans, or tax breaks), especially those that appear to market observers to be
disproportionately generous.
The change in the U.S. Intelligence Community’s assessment that there is a coordinated strategy
among some foreign governments to acquire U.S. companies with critical technologies is important
for U.S. companies to keep in mind when they “diligence” potential foreign acquirors. Transactions
where CFIUS may suspect a coordinated strategy will, at a minimum, be subject to additional scrutiny
and mitigation measures, if they are at all allowed to go forward. Although U.S. companies will
generally not have the means to look through the real objectives of a potential foreign acquiror and
its true ties to a foreign government, U.S. companies with critical technologies should view the issue
of a coordinated strategy as another red flag to look for during the diligence process. U.S. companies
with critical technologies may, for example, want to review media releases for a pattern of actual or
attempted acquisitions by the foreign acquiror and specifically ask potential foreign acquirors in their
bidding documents and CFIUS questionnaires about foreign government involvement, including
whether a foreign government will provide incentives to acquire the U.S. firm, such as grants,
concessionary loans, or tax breaks, and whether those incentives are standard or above “market.”
The CFIUS regulations define “critical technologies” as:
(a) Defense articles or defense services covered by the United States Munitions List (USML), which is set forth in the
International Traffic in Arms Regulations (ITAR);
(b) Those items specified on the Commerce Control List (CCL) that are controlled pursuant to multilateral regimes (i.e., for
reasons of national security, chemical and biological weapons proliferation, nuclear nonproliferation, or missile technology),
as well as those that are controlled for reasons of regional stability or surreptitious listening;
(c) Specially designed and prepared nuclear equipment, parts and components, materials, software, and technology specified
in the Assistance to Foreign Atomic Energy Activities regulations, and nuclear facilities, equipment, and material specified
in the Export and Import of Nuclear Equipment and Materials regulations; and
(d) Select agents and toxins specified in the Select Agents and Toxins regulations.
1
-5-
Increasing number of transactions involving Chinese acquirors
The latest report also points out that the number of notices filed by Chinese acquirors is growing
each year. Sixty percent of the transactions involving Chinese acquirors were in manufacturing.
While the uptick in notices from Chinese acquirors is noteworthy, there is clearly some tension
underlying the national security review of transactions involving Chinese acquirors. The acquisitions
involving Huawai and Ralls are stark examples of these underlying tensions. Moreover, given the
confidential nature of CFIUS proceedings, it is likely that other potential acquisitions by Chinese
companies were not approved by CFIUS and that the parties abandoned the transactions
“voluntarily.” The U.S. government officially still welcomes Chinese investment, but the change in
the U.S. Intelligence Community’s assessment that some foreign governments collaborate with
foreign companies to acquire U.S. companies with critical technologies, will probably have an effect
on the national security review of transactions involving critical technologies and Chinese acquirors.
Moreover, a recent report from the U.S. House of Representatives Permanent Select Committee on
Intelligence about Huawei and another Chinese telecommunications equipment manufacturer, ZTE
Corporation (ZTE), openly recommended that CFIUS “must” block acquisitions, takeovers, or
mergers involving Huawei and ZTE and that the United States should view with suspicion the
continued penetration of the U.S. telecommunications market by Chinese telecommunications
companies.
Conclusion
While the latest report does not signal a material change in the review process, it does indicate a
harder stance for transactions involving critical technologies, foreign governments, U.S. targets in
proximity of military or other sensitive facilities, and the other areas of particular national security
concern listed above. In 2012, we have seen several cases confirming this harder stance.
Given the current focus on national security in the United States, the CFIUS process should be
considered by any party considering a merger, acquisition, or takeover of a U.S. business by a foreign
person.
For a copy of the latest report, or for more information about the CFIUS review process, please
contact your regular Nixon Peabody attorney or:


Alexandra López-Casero at 202-585-8372 or [email protected]
David A. Martland at 617-345-6145 or [email protected]
-6-