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The Devil Is in the Details: The New Executive Order on Foreign Investment Reviews

February 25, 2008

On January 23, 2008, President Bush issued amendments to Executive Order 11858 concerning foreign investment reviews. The amended Executive Order (first issued by President Ford in 1975) follows enactment of the Foreign Investment and National Security Act of 2007 ("FINSA"), which strengthens the process for national security reviews of mergers and acquisitions under the Exon-Florio Amendment to the Defense Production Act.

Section 1 of the Order states that U.S. policy "support[s] unequivocally [international investment in the United States], consistent with the protection of the national security." Nevertheless, despite this commitment to foreign investment, it is the last proviso of Section 1 that allows for "equivocation" in the open investment policies of the United States. FINSA was written to re-invigorate the process for investment reviews, and our experience under the statute thus far indicates that the Committee on Foreign Investment in the United States ("CFIUS") intends to ensure that foreign mergers and acquisitions get thorough reviews. While the vast majority of cases are still concluded within the 30-day statutory time frame for initial reviews, there are more questions from CFIUS member agencies — and the questions are more probing. Consequently, it is all the more clear that companies must do their homework before submitting a case to CFIUS, anticipate questions, and be prepared to address concerns promptly and completely.

FINSA appointed seven cabinet secretaries (or their designees) to CFIUS: Treasury (Chair), Homeland Security, Commerce, Defense, State, Justice, and Energy. FINSA also gave ex officio (nonvoting) slots to the Secretary of Labor and the Director of National Intelligence (CIA), and authorized the President to add to the list. In the Executive Order, the President adds the U.S. Trade Representative (USTR) and the Director of the Office of Science and Technology Policy as members of CFIUS, and instructs the Director of the Office of Management and Budget (OMB), the Chairman of the Council of Economic Advisors (CEA), the Assistant to the President for National Security Affairs, the Assistant to the President for Economic Policy, and the Assistant to the President for Homeland Security and Counterterrorism to observe the Committee's activities "and, as appropriate, participate in and report to the President...."

CFIUS was created by the original Executive Order — not by statute. Under the old Order, the Secretary of Energy was not a member of CFIUS — but the USTR, the Chairman of the CEA, the Director of OMB and other senior White House staff were all members. FINSA added the Secretary of Energy, but dropped all White House staff. The amended Executive Order puts the USTR and the White House science advisor back on CFIUS, but accepts the downgrading of the OMB director and other senior advisors to observer status. Nevertheless, the continued presence of these White House staff — seven in all, counting the observers — makes clear that CFIUS cannot act as a "free agent," unfettered by White House oversight. (The list is not static. Under FINSA, the President can add other members to CFIUS, on a case-by-case basis, as he — or she — deems appropriate.)

The Executive Order notes that any member of CFIUS may conduct its own inquiry concerning the national security risks presented by a transaction — but emphasizes that all communications with the parties must take place through or in the presence of the lead agency designated by the Treasury Department or, if there is no lead agency, by Treasury itself. This is a mixed blessing. For all of the obvious reasons, it is good to have a single agency coordinating questions. Nevertheless, the process continues to give anonymity to the questioner, making it difficult to put questions in context, or to assess potential concerns behind the questions.

CFIUS reviews run 30 days — and may be followed by a 45-day investigation in cases deemed to present national security risks. The Executive Order provides, however, that a formal investigation must be undertaken, in addition to the circumstances described in FINSA, if any member of CFIUS, following initial review, "advises the chairperson that the member believes that the transaction threatens to impair the national security of the United States and that the threat has not been mitigated." This greatly strengthens the power of any one agency to force an investigation.

The statute provides for investigation when the lead agency recommends, and the Committee concurs, that investigation is warranted. As written, however, the Executive Order would allow any agency to trump the Committee and force investigation, with or without Committee assent. In practical terms, it is highly unlikely that a solitary agency would buck the Committee in pursuing an investigation, or that the Committee would ignore risks sufficient to stir any one agency into action, but it is the apparent intent of the Executive Order to ensure investigation in any case where even a single agency sees a threat to the national security. This makes clear that there are no "minor" players on CFIUS, and highlights the importance of anticipating (or even negotiating) mitigation measures before a case is filed for review.

FINSA gave statutory recognition to mitigation agreements — pledges by the buyers to establish and maintain safeguards against perceived national security risks presented by any transaction. Such mitigation arrangements have always been required to retain security clearances, but CFIUS has used mitigation agreements in other cases as well. Responding to criticism that follow-up on mitigation agreements was inadequate, the new law requires the lead agency to monitor and enforce mitigation agreements, and directs CFIUS to implement compliance procedures. It is noteworthy that the Executive Order instructs the Committee, or the lead agency, to enter into mitigation agreements or impose conditions to mitigate national security, giving the green light to "take it or leave it" conditions when agreements cannot be reached.

Section 7(c) of the Order states that, except in extraordinary circumstances, mitigation agreements may not require a party to a transaction to "recognize, state its intent to comply with, or consent to the exercise of any authorities under existing provisions of law." There are two likely reasons for this seemingly odd bit of self-restraint. First, the White House may feel that commitments to abide by existing law are of little value, reasoning that the parties are merely agreeing to do what they are required to do anyway. Second, and somewhat contradictory to the first point, tying mitigation agreements to commitments to abide by "authorities under existing provisions of law" raises the prospect that deals could be undone by regulatory infractions that might or might not trigger national security concerns. As mitigation compliance programs are put in place, CFIUS could find itself policing compliance with laws and regulations that are rightfully the responsibility of other agencies. The result could be chaotic. Recognizing that the CFIUS process is intended to address situations that cannot be addressed under existing law, the Executive Order makes clear that mitigation agreements should be used only where existing laws and regulations, on their own, provide inadequate protection.

The importance of keeping the CFIUS process focused on national security is underscored by Section 7(e)(ii) of the Executive Order, which prohibits agencies from using CFIUS reviews to obtain or reward concessions under other provisions of law. After acknowledging that the Order does not limit the ability of agencies to conduct inquiries, communicate, or enter into contracts with the parties to a transaction — in the independent exercise of their authority under other laws and regulations (e.g., antitrust reviews) — the Order makes clear that a department or agency "shall not condition actions or the exercise of [such] authorities ... upon the exercise, or forbearance in the exercise, of its authority" under the Defense Production Act or the Executive Order. Therefore, government inquiries unrelated to the CFIUS process may not be held hostage to CFIUS approval, nor can CFIUS approval be used to force concessions on unrelated matters. The line gets blurry, however, when agency inquiries implicate national security, such as investigations tied to security clearances or export control laws. In such cases, compliance programs may be the basis of mitigation agreements. Indeed, where classified programs are involved, CFIUS clearance is likely to assume or require mitigation agreements, consistent with the National Industrial Security Program Operating Manual.

New regulations implementing FINSA are expected to be announced in April. In the meanwhile, the Executive Order provides a window into the CFIUS process. Companies contemplating foreign investment in the U.S. national security sector (including "critical infrastructure") should anticipate and prepare for rigorous CFIUS reviews.

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Copyright ©2008 by Kaye Scholer LLP. All Rights Reserved. This publication is intended as a general guide only. It does not contain a general legal analysis or constitute an opinion of Kaye Scholer LLP or any member of the firm on the legal issues described. It is recommended that readers not rely on this general guide but that professional advice be sought in connection with individual matters. References herein to "Kaye Scholer LLP & Affiliates," "Kaye Scholer," "Kaye Scholer LLP," "the firm" and terms of similar import refer to Kaye Scholer LLP and its affiliates operating in various jurisdictions.

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