The mysterious agency that can block a global merger
When Smithfield Foods CEO Larry Pope appears before the Senate Agriculture Committee this week, senators will likely grill him on whether U.S. consumers will be harmed by the proposed $4.7 billion sale to the Chinese firm Shuanghui. Some members of Congress have suggested the deal could hurt the U.S. food supply, even though the meat will be exported.
It seems probable that the deal will go through, but one hurdle is that it must receive approval from the little-known Committee on Foreign Investment in the United States (CFIUS). As foreign investment rises CFIUS, the federal committee created by President Ford that is barely known outside Beltway and M&A circles, will only become more central to investment by foreign firms. CFIUSâs opaque rules will reach even further into deals from candy companies to technology portals.
For the past few years, international interest in American companies has risen dramatically. Dealmakers in China, Russia, Japan, Europe and elsewhere are snatching up U.S. firms, real estate and other assets. In 2013, the U.S. claimed first place on the Foreign Direct Investment Confidence Index after dropping to fourth last year. And as the global economy continues to recover, overseas investors will be spendingÂ more cash on mergers and acquisitions — from New York to Houston.
CFIUS reviews are also on the rise. According to CFIUSâs Annual Report to Congress, the number of notices increased from 65 in 2009 to 111 in 2011, though this was in part a function of the recession. The number of CFIUS investigations has risen from 6 in 2007 to 40 in 2011. These inquiries into more concerning transactions are supposed to last 45 days, but some go on for months. Asia is particularly sensitive. Since 2007, CFIUS reviews of deals involving Chinese firms have tripled. Reviews of Japanese firms have increased sevenfold.
Despite this boom, CFIUS divulges little guidance or know-how to lawyers and companies navigating the regulatory swamp. No opinion is ever explained. Neither is inaction. And companies can’t challenge a CFIUS decision.Â That may have been understandable when foreign investments were limited and Cold-War-era concerns were at work. Even though there are still serious national security issues, now that global business currents are inextricably tied to the U.S. economy, the committee’s unwieldy structure and lack of transparency threaten to harm U.S. business interests by delaying deals and holding back investors from bidding, which lowers U.S. investment dollars.
Since the 1950s, the U.S. has conducted national security clearance on acquisitions by foreign firms. CFIUS was created by executive order in 1975, is chaired by the Secretary of the Treasury and has representatives from 16 executive departments and agencies, including Justice, Energy and Homeland Security. In 2007, it was amended by the Foreign Investment and National Security Act, which mandated secrecy. The legislation was passed in the wake of a Congressional uproar over whether the Bush administration and, by extension, CFIUS adequately investigated a deal for a state-owned company in the United Arab Emirates to buy a management firm that operated six U.S. ports. The reform added layers to the regulatory scheme, including a âcritical infrastructureâ review and âmitigation agreementsâ that require parties to restructure aspects of a deal in exchange for clearance. So it didn’t become all that easier for companies to predict how the process will unfold and anticipate hurdles.
Much of the way CFIUS operates is lore, rather than law. The terms that dictate the process are muddied. Some CFIUS lawyers aren’t even sure when a deal might need to be reviewed. A company files for review voluntarily, though the government can compel a review and this is occurring more frequently. Any deal involving “control” of a U.S. firm by a foreign individual can get scrutinized. As a result, “control” doesn’t necessarily touch on national security in a traditional sense. CFIUSâs definition of âcritical infrastructureâ is broad. It covers military weapons and technology, but also items used in computer software, bioterrorism, natural gas and oil lines, oil reserves and refineries, telecommunication and broadcast facilities, computers and IT products and bridges and ports.
Once a deal is reviewed, the risk analysis involves a three-prong test: Does the acquirer have an intent and capability to threaten U.S. security? Can the assets being acquired be exploited to the detriment of U.S. security? And what consequences would the exploitation of assets being acquired look like? But the threat can be high and the vulnerability minuscule. A candy company might pose a threat, but if the assets can’t be exploited, the risk profile is low.
In fact, CFIUS guidelines can change at a moment’s notice, with little warning. Last year, for example, CFIUS began to broaden its review scope to include a target firm’s proximity to national security facilities. Deals that have been in progress for years or are completed can be scuttled based on location alone. Two years after the Chinese-based Far East Golden Resources Investment Ltd. closed on its acquisition of a majority stake in U.S. mining company Nevada Gold Holdings, CFIUS launched an investigation because of the mining company’s proximity to the Fallon Naval Air Station, even though the company’s only business operations in 2011 was loaning money to the Chinese firm’s parent company. The Chinese firm was forced to divest its interest.
For all the chatter in 2007 to make CFIUS more transparent, it has blocked several high-profile deals with little explanation. In 2010, Chinese firm Huawei Technologies bought the intellectual property of 3Leaf, a software company, for $2 million. It didn’t file notice with CFIUS, which ultimately recommended that President Obama block the transaction. Huawei divested its assets in 3Leaf and tried to continue a dialogue with CFIUS. The House Intelligence Committee released a report urging U.S. businesses not to do business with Huawei, whose equipment was blocked a few months ago from Sprint and Softbank’s acquisition of Clearwire.Â Few know why.
Another case followed the same trajectory. President Obama ordered Chinese-owned Ralls to divest from four Oregon wind farms it had acquired that were located in airspace near a U.S. Navy training facility. Ralls challenged the order in federal court, which dismissed Ralls’ claims that the president lacked authority to order the company to divest its assets. Ralls still claims it is entitled to a more detailed explanation of the order.
While no one wants the U.S. to be vulnerable to national security attacks, meddling in global business with little guidance is akin to a parent who refuses to explain why television is allowed, but the Internet isnât. If CFIUS doesnât reform, its legitimacy — and the future of U.S. business — might be more threatened than the infrastructure it was designed to protect.
PHOTO: Smithfield hams line the shelves at the Taste of Smithfield restaurant and gourmet market in Smithfield, Virginia May 30, 2013. REUTERS/Rich-Joseph FacunÂ