April 2006

CFIUS Reform: National Security and International Investment

Recent events surrounding the proposed acquisitions of U.S. assets by foreign investors have brought into focus the Committee on Foreign Investment in the United States (CFIUS) and the Exon-Florio provisions of the Defense Production Act, which allow the executive branch to halt the acquisition by foreign firms of U.S. operations that infringe upon national security. A number of legislative changes to the CFIUS process are now being discussed by Congress. Panelists at an April 21 AEI conference discussed the CFIUS process and concerns relating to national security and the role of foreign investment in the United States. 

Phillip L. Swagel
AEI

After the attempt to acquire U.S. port terminals made by Dubai Ports World (DP World) and the bid by CNOOC to acquire Unocal, people have started to question whether CFIUS is working and whether it can be improved. Sometimes the debate is presented as security versus economics, but I do not think that both sides are blind to each others’ concerns. I believe that there is a balance to be struck.

Clark K. Ervin
Aspen Institute

Apart from scuttling the Dubai Ports World deal, which was a very good thing, the public debate about it has also highlighted the vulnerability of our ports and the importance of the CFIUS process. When the acquirer is a foreign company, rather than a foreign government, there is a thirty-day review by the CFIUS committee, which then has the unilateral power to approve or disapprove of the deal, with no requirement for the White House or Congress to be involved. This procedure is not appropriate for a post-9/11 world. Even when the acquiring company is from as close an ally as Great Britain, it appears to me that the review process is too short.

In the DP World deal, where the acquirer was a foreign government with a mixed record on terrorism, it seems to me that the additional forty-five-day investigation and presidential involvement should have been called for. I would go beyond that. If treaties and trade agreements are important enough to require Congressional concurrence, I believe that the acquisition of an asset with critical national security implications ought to, as well.

I believe that the Department of Homeland Security (DHS) should chair the CFIUS process, since it is more likely to make security its principle concern than the Department of the Treasury. Apparently the Coast Guard raised some objections over the ports deal, and I have my doubts that their concerns were fully allayed during the review process. According to Senator Charles Schumer (D-N.Y.), the customs and border protection services likewise raised objections during the review process.

There is some question about whether the definition of national security should be broadened to include critical infrastructure, such as port terminals. To me it is clear that port terminals are part of critical infrastructure and that the acquisition of this infrastructure by a foreign company has national security implications.

This debate raises the larger question regarding whether there are other entities within the U.S. government that have the power to approve deals like this. Just a few weeks ago, the Associated Press reported that there is another pending transaction being negotiated by a compartment of the Department of Energy, the National Nuclear Security Administration, whereby the Hong Kong-based conglomerate Hutchison Whampoa would have its employees in the port of the Bahamas operate nuclear detection equipment for cargo that is bound for the United States. The employees of this company, which has ties to China, would be responsible for operating nuclear radiation detection equipment. There should be a full-blown bipartisan Congressional investigation regarding which government agencies should have the power to approve such deals.

I am not suggesting that we should cease to be internationally oriented with regard to trade and investment--indeed, our national security would collapse if ceased to be as attractive to foreign investment as we have been to date. But, there is a huge difference between permitting foreign government s to acquire U.S. commercial assets and critical infrastructure. In the age of terror, where the margin for error is zero, no foreign country should be able to acquire critical infrastructure--especially when those countries have, at best, a mixed record with regard to terrorism.

David Marchick
Covington & Burling

I agree with Clark Ervin that no one wishes to compromise national security for the benefit of any foreign investment or transaction. You can, however, promote foreign direct investment and defend national security. Indeed, by increasing productivity, bringing new technology, enhancing competition, and providing critical assets to the Defense and Homeland Security departments, foreign investment contributes to our national security.

Post-9/11, we are increasingly facing security issues in broader sectors of the economy,. The Defense Department has long had clear procedures for allowing foreign countries to participate in the sale of products and services. For example, foreign companies that sell to the Defense Department have to create a foreign subsidiary within the United States, run by Americans and with an independent board of governors, in order to create confidence within the Defense Department that they can have access to the best technology, products, and services without compromising national security.

When you have foreign investments in parts of the economy that have not been extensively regulated by the Defense Department or other agencies but are considered sensitive assets post-9/11, there are often not policies or procedures in place, and so frictions and uncertainties are created.

The United States has an $800 billion current account deficit, which requires us to import a corresponding amount of foreign capital. We can balance this with bonds, securities, or direct investment, which create jobs and productivity gains. In manufacturing, 20 percent of output is accounted for by foreign-owned firms. What we do at home affects what others do abroad. The United States has over $2 trillion invested overseas, and if we start blocking investments in the United States, others will start blocking our investments abroad.

The CFIUS process has worked well. Exon-Florio is a flexible amendment, which has expanded its definition of national security post-9/11. Previously it focused on securing the traditional defense supply-chain. This has shifted to protecting critical infrastructure, including ports. The CFIUS approval process has become much tougher, as has its enforcement. There have been more investigations in the past three years than in the past ten years combined. The DP World controversy created the perception that transactions breeze through CFIUS, but nothing could be further from the truth.

The DP World process first examined the substantive question of whether the transaction threatened national security. In my view, it did not. The substantive issue is less important than the process issue, which will effect transactions in the future. Some feel that the decision was made at too low a level--the president did not know about it, nor did the secretaries or undersecretaries in the Treasury and Homeland Security Departments, or Congress. These processes can be fixed with legislation, but we should not fix problems that do not exist, and there is a danger that Congress will over-legislate.

Senators Richard Shelby (R-Ala.) and Paul Sarbanes (D-Md.) created a bipartisan bill which passed twenty to zero. It strengthens the membership of CFIUS, formalizes the role of intelligence agencies, and creates more visibility into the process for Congress. At a recent hearing Senator Robert Bennett (R-Utah) said, “We need a process that creates credibility, so that CFIUS can make the tough and politically unpopular decisions without Congressional second-guessing,” and I think that the Shelby bill does this. They also deserve credit for not putting in a Congressional veto provision, strengthening CFIUS’s enforcement powers, and not broadening the scope of review powers to include “economic security,” which would have been used as a cover for economic protectionism.

However, the bill unnecessarily adds time to the review process. Companies can already be expected to undertake extensive pre-filing consultation with CFIUS. Senator Evan Bayh (D-Ind.) said this well: “We need to make the process better, not longer.” Adding time does not necessarily enhance substantive security.

The notification and reporting requirements are excessively broad and cumbersome. I am not sure that creating 140 notices to Congress will enhance visibility, since there will be so much paperwork. If reporting focuses on individual cases, rather than aggregate data, this could be used for competitive rather than national security purposes.

The process must be tough enough to handle deals with real national security implications, but flexible enough to quickly handle those which do not involve such issues. Otherwise you will be deterring foreign investment and creating regulatory obstacles where they do not need to exist.

The Shelby Bill creates almost a presumption that foreign investment in critical infrastructure creates national security risks. The definition of critical infrastructure is taken from the Patriot Act, which includes “economic security” and “public health or safety.” Although the language specifies “a debilitating impact,” it has been interpreted to expand to virtually 25 percent of the U.S. economy. For example, if Evian were to acquire Poland Spring water, this would be considered critical infrastructure, and there would be a presumption that the transaction creates a national security risk.

Moving the chairmanship of CFIUS to Homeland Security reverses the presumption that foreign investment is positive unless there are national security issues. I worry that the current political environment will make the CFIUS agencies so cautious and hesitant to make tough decisions, since no one in these agencies will want to be the person who signs their name to the next Dubai Ports deal, that there will likely be a collective risk-aversion, which will negatively effect the investment environment in the United States.

Thomas Donnelly
AEI

We should think about the Exon-Florio amendment as a product of the early 1990s, when it was thought that nations did not struggle for power, but struggled to be wealthy, and that geopolitics would therefore not be a zero-sum game. At the same time, there was an incredible contraction in defense industries around the world, which forced those companies to be more aggressive in their sales and marketing strategies.

Even in the initial legislation and amendments, Senator Robert Byrd (D-W.Va.) was worried about the French acquisition by Thomson-CSF of the LTV missile division, shortly after a large competition for army and other contracts. Until that point, there had not been much of a history of foreign acquisition of U.S. defense firms.

As these issues evolved, they become inextricably intertwined with the nature of China’s rise and policy regarding its geopolitical implications. Issues related to giving the Chinese access to U.S. space technology were part of the environment in which this played out and has continued to this day.

With DP World, CNOOC, and Hutchison Whampoa, we have seen these issues continue on a fairly regular basis. These issues have substance to them, and the questions are quite legitimate. The business and merger and acquisition (M&A) community have a political tin ear to these concerns. As the CFIUS process has been toughened up, you can hear dealmakers become increasingly irritated by what they see as an excessive burden.

Towards the end of the CFIUS review process, the paramount question becomes (as it often does in M&A work), “What is it going to take to get the deal done?” The conclusion is set in concrete; the question is: “How do we get there?” With attitudes like this, there is no surprise that the DP World deal was handled as it was. The public diplomacy of the M&A community has been pretty atrocious in this regard.

With reference to the Shelby bill, as a former Congressional staff member, I am naturally wary of anything that passes twenty to zero. Involving Congress, other than by allowing them to do some general oversight, would be a bad idea. Expanding the definition of security to include “economic security” is generally a tactic to sneak through protectionist measures. It is hard enough to figure out what real security ramifications are, particularly with military technology and dual-use technologies, so I would think it inadvisable to expand the definition of security.

CFIUS ought to remain essentially an executive branch function and will always be a reflection of the administration’s policy. If you are unhappy with what comes out of CFIUS, you should try to get the administration to pay closer attention to it. I am wary of many of our post-9/11 reforms, which were often too hasty and poorly conceived. A knee-jerk reaction to the DP World case, rather than more serious policymaking, does not strike me as a wise way to go.

Kristin Forbes
MIT Sloan School of Management

CFIUS is highly confidential, and therefore is not transparent to a certain extent. I do worry that with CNOOC and CFIUS there has been immense attention to security risks, but very little to economics.

Academic economists think that every decision can be reduced to cost-benefit analysis. In practice this is difficult, since many of the values are not quantifiable. It is hard to put exact numbers on investment in the United States, but the overall framework is very useful. We need to focus on the risks, but we must not ignore the costs. At one extreme, if we thought that immigration and foreign investment represented risks to the United States, we could seal off our borders. This would reduce the risks, but would also create huge costs for the United States. On the other side, we could remove all checks on mobility, but that is also unrealistic.

The CFIUS process is very good at representing different interests and considerations. CFIUS includes the Departments of State, Commerce, Defense, Justice, the Office of Management and Budget, the Council of Economic Advisors, the U.S. Trade Representative, the Office of Science and Technology Policy, the National Security Council, the National Economic Council, Homeland Security, and members from intelligence communities, the Department of Energy, and nuclear regulatory commissions. That is a strength that we should not ignore when we propose reforms. Keeping the process in CFIUS ensures that we keep this balance of views when evaluating foreign transactions.

This process ensures that each view has immense power in the process. If the DHS has a serious concern about the threat of the transaction and no one else does, it can block the transaction or force it to undergo the extended review and the president’s scrutiny.

We focus on the security risks of foreign investment, but there are substantial economic risks. We should not undermine our security, but we should be careful about not blocking transactions that are of no threat, since these will have serious economic costs. Foreign investment puts competitive pressure on U.S. firms and forces them to be more productive. In the 1980s, Japanese investment in the auto sector helped raise productivity in the U.S. car industry. From the 1980s to the mid 1990s, 14 percent of U.S. productivity growth came from foreign investment.

Foreign investment helps create high-paying jobs and allows U.S. companies better access to foreign markets, networks, and production chains. Many foreign companies also use the United States as a platform for their exports. Foreign investment provides capital for the United States, which helps to compensate for the low U.S. savings rate.

The $800 billion capital account surplus that the United States needs to finance its trade has come in relatively easily to date. Foreign central banks have been particularly willing to provide this financing. If we provide the signals that this investment is not welcome, we risk undermining this flow of capital into the United States, which could lead to a sharp fall in the dollar, rising interest rates, and recession. Worryingly, only $100 billion of the $800 billion capital flow into the United States is investment, with the rest being what economists call “hot money,” which can very easily be pulled out.

CFIUS reform is not just a trade-off between security and economics. Economic strength can build strength in security. Foreign investment leads to better productivity, technology, and expertise, which can allow them to be more secure. From the discussions regarding the Dubai Ports deal, I had the sense that the Dubai company does have better technology and expertise than many of the U.S. companies that were running these ports. Allowing the deal to go through could have improved the functioning, monitoring, and efficiency of the ports.

Also, the CFIUS committee plays a very active role by adding mitigation measures. The deal can only go through if the company agrees to beef up certain parts of its security. So, by the time the deal goes through, that company often has much tighter security than existing U.S. companies. Senior officials of companies may have to go through pretty difficult security clearances, which U.S. companies do not need to.

AEI research assistant Chris Pope prepared this summary.