As discussed in a prior posting on this blog, the U.S. Department of the Treasury published on April 21, 2008 proposed rules designed to strengthen the process by which the Committee on Foreign Investment in the United States ("CFIUS") reviews and approves certain business transactions involving foreign investment. The proposed rules were issued under the Foreign Investment and National Security Act of 2007, Pub. L. No. 110-49 (“FINSA”), which requires a more intense CFIUS process that allows the government more discretion in investigating and altering business transactions that may impact national security. The U.S. Department of the Treasury invited comments on the proposed rules through June 9, 2008. Now that the comment period is over, we thought it might be worthwhile to see what types of comments were received. Not surprisingly, it is a mixed bag.
Many U.S.-based individuals (including those with whom the U.S. Department of the Treasury pre-coordinated its rulemaking effort) heaped qualified praise on the proposed rules. The Institute of International Bankers applauded the "care and openness" displayed by the Department of the Treasury, noting that the proposed rules "reflect careful consideration and balancing of national security interests and commitment to free markets of the United States."
Still, those praising the proposed rules cautioned that they must be narrowly tailored so as not to discourage foreign investment. Senator James Webb (D-Va) commented that the final rules must "welcom[e] foreign investment that promotes economic growth in the United States, [while] doing so in a manner consistent with protecting U.S. national security and the stability of our markets." Another comment called the proposed regulations, "a net plus for investment, affirming that the United States remains open to foreign investors and providing clarifications for when and how foreign investments should proceed through the CFIUS process."
Additional points of praise include:
- An open definition of "control" is preferred because it allows CFIUS to conduct a case-by-case inquiry into whether a particular transaction should be reviewed or investigated. Several comments welcomed the illustrative examples as very helpful in determining whether a transaction constitutes a "covered transaction" subject to CFIUS review. Most comments cautioned, however, that the concept of "control" needed to be carefully formulated in the final rules to ensure the proper scope of the regulations.
- Predictable processes are preferred. Several comments praised the proposed rules for the "narrow" formulation of key concepts such as "covered transactions" and "critical infrastructure," observing that such formulations provide a high degree of predictability to the CFIUS process. Once a company determines that it will be engaging in a "covered transaction," the pre-coordination and filing process is detailed in the proposed rules, and (hopefully) the review and investigation will be completed swiftly.
- Allowing CFIUS to require mitigation agreements can allow a transaction to proceed while still taking national security concerns into account. A number of comments welcomed the fact that the proposed rules seem more inclined to require a mitigation agreement rather than terminating the whole transaction. Some commented, however, that these agreements should be narrowly tailored and judiciously used, especially when other laws already serve to mitigate the national security risk.
- Limiting the CFIUS process to the United States and the impact on the U.S. economy appropriately limits the jurisdictional reach of the regulations. Several comments thanked the Department of the Treasury for clarifying that CFIUS does not concern itself with business activity outside the borders of the United States.
Not surprisingly, the comments had far more criticisms than they did praise. The predominant criticism from foreign companies (including foreign governments and foreign trade associations) was that these rules, while purporting not to discriminate against foreign investment in the U.S., actually do just the opposite. The China Securities Regulatory Commission criticized the proposed rules for reflecting "enshrouded protectionism, an obvious contradiction to the spirit of free competition the U.S. has championed since [a] long time ago."
While many of these criticisms have been raised since the Exon-Florio Amendment was originally enacted in 1988, the U.S. Government believes that the CFIUS process over the last twenty years has not unduly discouraged foreign investment and that the revised process will not have a significant adverse impact going forward. As with all things, only time will tell whether Congress is correct or not.
Some of the additional criticisms include:
1. The proposed terms are vague and overly broad, potentially leading to an unpredictable process.
- Terms such as "control," "national security," "transaction," and "critical infrastructure," are too broad and invite too much unpredictability into the process. Obviously, most foreign investors commenting on the rules preferred narrower definitions (in particular, providing additional examples to narrow the terms).
- By leaving certain key terms so loosely defined, several comments observed that the process is inherently unpredictable, with too much discretion vested in CFIUS and the individuals conducting the investigation. Such unpredictability (and risk of arbitrary treatment) is hardly inviting to foreign investors.
- Additionally, leaving such terms inherently vague will also inevitably expand the scope of transactions that CFIUS will be forced to review (whether because they are clearly a "covered transaction," or because they are arguably a "covered transaction"). This will increase the burden on CFIUS, and will also slow the process for all foreign investors.
2. Need to clarify the relationship between minority shareholder rights and "control."
- Perhaps more than any other topic, this issue was most commonly raised in the comments. Some, such as Senator Webb, felt that the rules should be clarified to be more restrictive and should broaden the types of minority shareholder rights that could constitute "control." The overwhelming bulk of the comments, however, felt that the rules relating to minority shareholders needed to be loosened, pointing out that a number of inherent shareholder rights under state law could easily trigger the "control" threshold under the proposed rules. The Institute of International Bankers observed, "ironically, it is precisely because they do not control the business that they require the negative rights that are characterized as ‘control’ in the proposed regulations."
- Rather than forcing minority foreign shareholders into the position of disclaiming a substantial portion of their legal rights (many of which are purely ministerial and not designed to exercise "control" over the company in any meaningful sense), several comments suggested reexamining the provisions relating to the ability of minority shareholders to exert control over the U.S. entity, considering the cumulative effects of such rights.
- Several comments suggested that there should be a clear delineation between the concepts of "control" (which should be limited) and "influence" (which should not trigger the "covered transaction" requirement).
- Both the Representative of German Industry and the Trade and Emergency Committee for American Trade encouraged CFIUS to make an "early-stage determination" of whether control exists in order to shortcut (potentially) an otherwise unnecessary review process.
- Many comments observed that the overwhelming bulk of lending transactions should be beyond the scope of the CFIUS review process and that the final rules should be so clarified.
3. The proposed rules request too much information, including much that will likely be completely irrelevant to the CFIUS review.
- Given the massive amounts of information that should be assembled to prepare for a CFIUS filing, many comments observed that much of the information is simply irrelevant or, at most, marginally relevant.
- Several comments suggested that the large laundry-list of information that would be required as part of a CFIUS filing should be limited to "material" information, and that the actual information CFIUS would require could be further refined during the pre-coordination process.
- Others cautioned that additional protections should be guaranteed for highly personal and confidential information, including civil remedies if the information is improperly disclosed.
4. There should be limits on the ability of the government to disturb consummated transactions.
- Many comments, particularly those raised by foreign companies, emphasized that the sweeping power of CFIUS to re-review any transaction it chooses or to unilaterally reverse a fully completed transaction (including those dating back to 1988) added a large degree of risk and unpredictability that would discourage foreign investment.
- The Representative of German Industry and Trade encouraged that the regulations be clarified to describe the due process and procedural rights that will be observed if the U.S. Government invokes this review authority to disturb completed transactions.
5. Parties should be given additional time to respond to CFIUS requests for additional information.
- The proposed rules require parties to respond to additional requests within two days. Given that many of the parties are international, working different business hours than those in the U.S., many comments suggested expanding this time period and limiting the severe penalty of dismissal for failure to meet the short deadline.
Other Policy Considerations
- Many comments predict that the proposed rules will discourage foreign investment and cause an unintended backlash in the international community as other countries follow the lead of the United States in establishing protectionist and discriminatory policies. Already, Russia has enacted restrictions on foreign investment to protect its national security, and other countries will undoubtedly follow suit.
- Other comments observed that the extensive and elaborate CFIUS process will inevitably drive up operational costs associated with any foreign investment in the U.S., which may force foreign investors to re-think whether the U.S. is truly the best market in which to invest their money.
- The China Ministry of Commerce pointed out that the new CFIUS process would have a disparate effect on Chinese investment, as most of the Chinese companies are actually government-owned, thereby triggering the mandatory CFIUS investigation for all "foreign government-controlled transactions."
- In its comments on the proposed rules, the Service Employees International Union specifically singled out sovereign wealth funds (due to their "lack of transparency") as a particular type of foreign investor that CFIUS needs to scrutinize closely. CFIUS will undoubtedly not be alone in closely scrutinizing these sovereign wealth funds – on June 11, 2008, the Senate Foreign Relations Committee held hearings to discuss the growth of these funds and the risks associated with their increased influence. Senators Joseph Biden (D-Del) and Webb both expressed severe skepticism that investments from sovereign wealth funds were not something to be feared.
The Department of the Treasury has given no indication as to when it will publish the final rules. In the meantime, companies should be aware that FINSA went into effect on October 24, 2007, making many of the requirements embodied in the proposed rules applicable to all current and pending transactions. While the details of the CFIUS process may remain undetermined, the general requirements of FINSA are clear. Considering that many of the criticisms leveled against the proposed rules run counter to the express statutory mandate in FINSA, we expect the final rules will remain substantively in line with the proposed rules. Only time will tell.