When Dubai Ports World (DPW) announced its intention in 2006 to purchase the U.S. sea terminal operations owned by Peninsular and Oriental Steam Navigation Co., based in the UK, it catapulted the Committee on Foreign Investment in the United States (CFIUS), charged with examining the national security aspects of foreign takeovers of U.S. corporations, into the political limelight.
Indeed, CFIUS scrutiny posed little meaningful regulatory risk to business before the DPW debacle reared its head.
"With very few exceptions, the CFIUS system worked well before DPW, with little or no Congressional interest or oversight, and only an occasional critical GAO [General Accounting Office] report," says Stephen Canner, staff chair of CFIUS from 1988 to 1992 and currently vice president, investment policy, at the New York-based U.S. Council for International Business.
But arriving as it did on the heels of the furor surrounding Chinese National Offshore Oil Corp.'s proposed purchase of Unocal, it wasn't long before the fallout from DPW led to cries for legislative reform. These culminated in passage of the Foreign Investment and National Security Act of 2007 (FINSA). The legislation, which took effect in October 2007, formally ended the halcyon days of the CFIUS rubber-stamp era.
It wasn't until six months later, however, that CFIUS got around to drafting proposed regulations to address the changes to the law and codify the administrative practices that define the regulatory process.
When CFIUS finally released the proposed regulations in April, Wall Street observers--many of whom feared that the regulations would discourage investment from abroad--were relieved.
"The regulations do a good job of sending signals to the market that the U.S. is open for foreign investment," Canner says.
In other words, apart from implementing the changes mandated by law, the regulations define key concepts and provide guidance to the way CFIUS will administer its broad authority to screen foreign investment without creating additional procedural barriers in the review process.
"The message is one of little substantive change from current procedures, providing continuity of process, greater transparency and more certainty about what will happen and how the process will be conducted," says Edward Rubinoff, a partner at Akin Gump Strauss Hauer & Feld. This is not to say the regulations are perfect, or perfectly clear.
"There is less certainty than is desirable on a number of issues, including the key concept of 'control,'" Rubinoff says. "That's significant because the regulations make it clear that CFIUS will consider each transaction on a case-by-case basis, with no bright-line test."
The difficulty is that "control" is the cornerstone of FINSA, as CFIUS screens only those investments that would result in control by a foreign person over a U.S. business that would threaten national security.
The new regulations define control in terms of the power to influence important matters affecting a business and not in terms of specific percentages of shares or board seats held.
In the past, a 10 percent interest had been considered the dividing line between control and no control. The new regulations, however, expressly state that threshold to be irrelevant unless "the transaction is solely for the purpose of investment."
"Congress got spun up because buyers were coming in at 9.9 percent," says Mark Plotkin, a partner at Covington & Burling.
Indeed, in March 2008, Rep. Barney Frank (D-Mass.), head of the House Banking Committee, wrote a letter to CFIUS asking that the regulations make it clear that the 10 percent level would not be a hard and fast dividing line.
What the regulations do provide is an exemplary list of factors that CFIUS will review in its determination of control. These include direct or indirect arrangements through means such as proxies, contracts or informal agreements.
By contrast, the regulations also provide that the ability to exercise certain types of negative power, which are generally used to protect minority shareholders' rights, will not automatically constitute control. These include the power to prevent dilution of minority interests, to prevent the sale of all the assets of a business and to prohibit the company from entering into contracts with majority owners.
Still, absent greater particularity as to the weight CFIUS will accord various factors in determining control, foreign investors may find themselves in a conundrum.
"The difficulty remains that a foreign buyer will never know where it stands because theoretically any transaction could produce a finding of control," says Aki Bayz, a partner at Morrison & Foerster. "So the regulations don't help in deciding whether to file for review with CFIUS."
Aggravating the issue is the fact that CFIUS has no procedure for advisory opinions on threshold issues.
"When you have the kind of open-ended standards that exist in these regulations, perhaps it's time to consider such opinions on threshold procedural issues like control," Bayz says.
But that's not likely to happen.
Making it Final
The proposed regulations were subject to a comment period ending June 9. But observers expect few changes in the final version.
"While the final form of the regulations may contain further clarifications and revisions, we do not expect them to be materially different from those proposed, and CFIUS is likely to conduct its reviews and investigations in the meantime in accordance with the provisions of the proposed regulations," Bayz says.
However that may be, the message for foreign acquirers and their targets from a transactional perspective is evident.
"What these regulations emphasize is the need for more attention to national security due diligence in a deal, both in determining whether it is subject to CFIUS review and the issues that might arise in such a review, as well as apportioning a proper risk allocation related to CFIUS issues in the transaction documents," Bayz says.