National Security Mergers and Investment

1. National Security Mergers and Investment Jesse R. Lambert Se Yeon Lee Maryanna Maistros April 20, 2011

2. Contents

3. Definitions A Merger may be defined as the combination of two or more independent business corporations into a single enterprise, usually involving the absorption of one or more firms by a dominant firm. Mergers Acquisition Acquisition may be defined as an act of one enterprise of acquiring, directly or indirectly of shares, voting rights, assets or control over the management, of another enterprise. Foreign Investment Foreign investment refers to the net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. 2

4. Mergers & Acquisition Fact Sheet • Mergers and Acquisitions (M&A) by foreign firms support U.S. jobs, increase business productivity, and finance the U.S. current-account deficit. M&A is a major part of foreign investment flows and accounts for most FDI into the United States U.S. Businesses Acquired As a Percentage Of FDI U.S. Exports (Billions of Dollars) Generated by Foreign Firms in the United States Abundant liquidity exists through out the world, it is easy to convert corporate reserves into corporate bids Source: International Trade Administration 3

5. Timeline for U.S. Legislation • Summary of Legislation and Other Governing Statutes  1950 1975 1988 1992 2007 Process • The Defense Production Act of 1950 • Establishment of CFIUS as an interagency panel • The Exon-Florio amendment strengthened and better focused the review of acquisitions and mergers • Byrd Amendment: • Report to Congress • if President makes • any decision. • Congress enacted the Foreign Investment and National Security Act (FINSA) • Primarily to monitor foreign direct investment into the U.S. • This change was included as a provision of the Defense Production Act. • Authorized the President to suspend or prohibit foreign acquisitions of U.S. companies that pose a threat to national security • Report every four • years whether there is credible evidence. • Various amendments require greater reporting to Congress Details Source: Global Mergers and National Security by Stuart S. Malawer Cross-Border Mergers and Acquisitions by Troy R. Braegger 4

6. Exon-Florio Amendment & CFIUS Review • Summary of Legislation and Other Governing Statutes President’s Authority CFIUS Membership Parties To A Transaction Foreign Control Nature of The Transaction CFIUS Review • The Exon-Florio Amendment to the Omnibus Trade and Competitiveness Act of 1988 • Grants the President broad authority to review, suspend, or block the transactions • “threatens to impair the national security of the United States” • Exon-Florio define the terms • U.S. person: not the nationality of the owner rather whether the company engaged in US interstate commerce. • Foreign person: individual or entity controlled by a foreign interest, not where it does business • Any transaction that could result in foreign control of “persons” engaged in the interstate commerce in the U.S. • The percentage of ownership but also on who has potential decision-making power • The implementing regulations use the term “acquisition” (including mergers, and takeover) • The term includes without limitation • Voting security • Review is voluntary however CFIUS may review on its own accord . • CFIUS can review completed transactions. • CFIUS may insist upon safeguards to prevent the foreign entity from accessing sensitive materials. • 12 members • Department of Treasury (Chair) • Department of Commerce, Defence • Homeland Security • Justice, and State • 6 offices in the Executive Office of the President • Committee conducts review 5

7. CFIUS – National Security Concerns Examples of the types of transactions that the Department of Treasury has stated may pose national security concerns to CFIUS include the following Government Contractors & Subcontractors Energy, Transportation & Financial Industries Advanced Technologies & Export-Controlled Goods Services Foreign Government Acquisitions • Transactions where a foreign person acquires a U.S. business that is involved in the development of certain advanced technologies, and specifically technologies that may be useful in defending, or seeking to impair, national security. • Production or supply of cryptography, data protection, Internet security and network intrusion protection • Companies that have access to U.S. classified information (including in the defense, security and law enforcement sectors) may be of particular interest to CFIUS • CFIUS may apply scrutiny to foreign acquisitions of U.S. businesses that supply goods or services to U.S. agencies involved in national security. • U.S. businesses involved in the energy, transportation and financial industries to present national security implications. • These types of businesses may include, for example, businesses that transport natural resources, convert national resources to power, or provide power to U.S. citizens or the government. • CFIUS may be interested in transactions that could result in control of a U.S. business by a foreign government or a person controlled by or acting on behalf of a foreign government (including foreign government agencies, state-owned enterprises, government pension funds and sovereign wealth funds). National Security Concern 6

8. CIFUS TIME LINE/PROCESS It could take up 90 days for review process from the voluntary submission by the acquiring party. Source: www.cfr.org 7

9. Foreign Security-CHINA The State Council of the People’s Republic of China (PRC) issued a new regulation to implement the requirement for national security reviews of mergers and acquisitions involving domestic enterprises by foreign investors- the “Circular” Circular-Effected on March 5, 2011 1. Security Review Authority • “Inter-Ministerial Joint Conference for Security Review” • Responsible for conducting a security review on M&As 2. Security Review Scope • Two categories of mergers and acquisitions • The military industry, fundamental infrastructures • Farming, energy and resources, transportation • Key technology, major equipment manufacturing industries 3. Contents of Security Review • The Key technology R&D capacity of national security • National security • Domestic production capacity, domestic services capacity • and relevant equipment and facilities. • The stable development of national economy • The Basic order of society 4. Security Review Procedure • General Review: 35 days • If any department can request a special review procedure • Special Review (Joint Conference): 60days 5. Security Review Result • Terminate the transaction or take measures • Transfer relevant shares, assets or other measures to eliminate • the impact on the state security 8

10. Foreign Security- Other Countries • Other countries have mechanisms like CFIUS to review and restrict foreign mergers and investments regarding national security. Canada Investment Canada Act South Korea FIPA-Article 5 Restrictions on FDI UK OFT/ SOS Competition Commission • CANADA: The legislation authorizes the government to review investments that impair or threaten to impair national security and, if necessary, take appropriate action. • UK: Office of Fair Trading (OFT) and Competition Commission (CC) are authorized to do merger review. Secretary of State (SoS) may intervene if the merger affects national security. • South Korea: Minister of Knowledge Economy (Article 5.(1).2 of the Enforcement Decree of the FIPA) to review the FDI to decide whether or not it threatens the maintenance of national safety pursuant to Article4.(2).1 of the FIPA. 9

11. Definition of Risk • specific issue is amount of • risk taken • changes globally caused increase in risk for mergers 10

12. Definition of Risk The risk of losing money due to market conditions, poor business practices, or lack of investment and funding. Business risk Political risk Merging with a company that is politically poisonous to one’s industry or against the wishes of the home country’s citizen. Technological risk The risk of leaking technology to other companies through a mole or unprotected documents. 11

13. National Security National Security Greatest Global Mergers Since Jan. 2001. • Examine national security risk in relations to mergers and acquisitions • there was a boom in mergers brought on by the end of the Cold War through 9/11, with a sharp decrease • slowly back on the rise Source: Wall Street Journal 12 Wall Street Journal 1.13.06. Global Mergers & National Security (Updated 2010) 12

14. CFIUS Definition CFIUS Definition • During the review period, CFIUS members • examine the transaction in order to identify and • address, as appropriate, any national security • concerns that arise as a result of the transaction.  • During the review period, CFIUS members, • through the Department of the Treasury as • Committee Chair, may request additional • information from the parties.  13

15. NSA Definition The Information Assurance mission confronts the formidable challenge of preventing foreign adversaries from gaining access to sensitive or classified national security information. The Signals Intelligence mission collects, processes, and disseminates intelligence information from foreign signals for intelligence and counterintelligence purposes and to support military operations. This Agency also enables Network Warfare operations to defeat terrorists and their organizations at home and abroad, consistent with U.S. laws and the protection of privacy and civil liberties. 14

16. Risk After Major Global Event The end of the Cold War 9/11 Global Recession 15

17. Competing Interests Go against competing interests Use competitive drive to break into new markets The 1990s had a business environment conducive to mergers Rising concern over national security used for competitive purposes Different cultural and business practices globally Prices are on the rise 16

18. Define National Security Risk Too broad of a definition Need to consider foreign relations Need to maintain a healthy business environment while protecting national security: not an easy task Need to define national security before being able to assess the risk 17

19. Case Study: CFIUS Examination of Huawei Technologies

20. Huawei (1/3) • Chinese manufacturer of telecom network equipment • Founded in 1987 by former Chinese army officer • 14.4% market share; #2 behind Sweden’s Ericsson • 2010 revenues: $28 billion • New contracts: Europe, Africa, Middle East • Security concerns • Accusations of ties to Chinese government and military • Response: Offered access for 3rd party inspection

21. Huawei (2/3) • 2000s: Two lawsuits with Cisco and Motorola • 2008: Blocked from acquiring 3Com • 2010: Failed attempts to buy into deals with Sprint-Nextel, Motorola, and 2wire • May 2010: Entered $2 million deal with 3Leaf Systems • November 2010: Huawei submitted a CFIUS application • 10 February 2011:Senators called for close scrutiny of the 3Leaf deal • February 2011: CFIUS recommended against deal • Huawei withdrew its attempt for approval

22. Huawei (3/3) • Chinese Response • Issue for U.S.-China relations • China Ministry of Commerce Statements: • Major problems: • Global supply chains • U.S. Perspective • Reliance on Chinese in highly sensitive industries • Chinese companies’ unfair advantage: • Government Support • Chinese Perspective • Chinese companies to increasingly turn elsewhere

23. Treatment of National Security vis-à-vis Foreign Investment

24. Treatment in the United States: Historical Cases • Laws restricting foreign investment date back to 1872: • Merchant Marine Act of 1920 • Communications Act of 1934 • Federal Aviation Act of 1958 • September 11th 2001

25. Treatment in the United States: Policy Basis • National treatment policy for FDI, • Need for investor predictability • Expansion of international trade and investment: a U.S. national security priority • Presidential powers • Executed by CFIUS

26. Treatment in the United States: Definition of “National Security” (1/3) • Foreign government control • Control of U.S. critical infrastructure • PATRIOT Act: critical infrastructure industries • Telecommunications • Energy • Financial services • Water • Transportation • No attempt by Congress or Presidents to define • CFIUS member agencies each apply own definitions

27. Treatment in the United States: Definition of “National Security” (2/3)

28. Treatment in the United States: Definition of “National Security” (3/3) • Circular, ambiguous definition • CFIUS’s Purpose: Identify and address national security riskposed by covered transactions. • National Security Risk:Risk is a function of the interaction between threat and vulnerability, in light of the potential consequences of that interaction for U.S. national security. • National Security Considerations:Considerationsare facts and circumstances, with respect to a covered transaction, that have potential national securityimplications. • Relevance of National Security Considerations: CFIUS analyzes all national security considerationsto assess whether a covered transaction poses national security risk. Transactions that present such considerationsdo not necessarily pose national security risk. • CFIUS Reform: Guidance on National Security Considerations (2008)

29. Treatment in the United States: Future Issues • Sovereign Wealth Funds (SWFs) • Portfolio Investment • CFIUS may have negative impact on FDI inflows • Adds to market uncertainty • Spurs behavior that can damage economy as a whole • Some firms are spending significant resources to avoid • investigations • Some firms are terminating transactions • Burden of proof • Paradigm shift • Economic activities as component of national security • Economic national security

30. International Treatment (1/3) • Diverse definitions of national interests • Some factors include: • Public safety • Public order • Economic concerns • Cultural policies • “National Security” per se • Some countries do not use • Most countries do not define • Most, but not all countries, perform review process

31. International Treatment (2/3)

32. International Treatment (3/3)

33. Treatment in China • “National economicsecurity” • Self-sufficient economic growth • Stable economic development • Prohibited from foreign investment: • Weapons and ammunition • Radioactive materials • Rare earth metals • Power networks • Film, television, book publishing, and other media production • Exceptions for advanced technology brought into China

34. Policy Proposal: Amendment toAgreement on Trade Related Investment Measures (TRIMS)

35. TRIMS Article X: Treatment of National Security • Definition of “National Security” for Investment • Sectors Exempted from National Treatment • Exemptions from the general commitments • Sectoral exemptions • Set of criteria for special case industries • Application Guidelines • Transition periods (especially for • developing nations)

36. Questions Should this issue be managed by individual nations or coordinated internationally? If coordinated internationally, by the WTO or somewhere else?

37. References • Barboza, New York Times: “China Telecom Giant, Thwarted in U.S. Deals, Seeks Inquiry to Clear Its Name,” 26 Feburary 2011 • Braegger: “Cross-Boarder Mergers and Acquisitions: What You Should Know About Foreign Investment in the United States and National Security Considerations” • Bussey, New York Times: “Huawei’s Bid to Crack Market, U.S. Sees a Threat from China, Inc.,” 28 February 2011 • Calvaresi-Barr, GAO: “National Security Reviews of Foreign Acquisitions of U.S. Companies Could Be Improved,” GAO 07-661T, 23 March 2007 • CFIUS: “CFIUS Reform: Guidance on National Security Considerations,” 1 December 2008 • Drabek, WTO: “A Multilateral Agreement on Investment: Convincing the Sceptics,” ERAD-98-05, June 1998 • Hille, Financial Times: “China and the U.S.: Access Denied,” 8 April 2011Jackson, CRS: “Foreign Investment, CFIUS, and Homeland Security: An Overview,” RS22863, 4 February 2010 • Jackson, CRS: “The Committee on Foreign Investment in the United States (CFIUS),” RL33388, 29 July 2010 • GAO: “Laws and Policies Regulating Foreign Investment in 10 Countries,” GAO 08-320, February 2008 • GAO: “Laws Limiting Foreign Investment Affect Certain U.S. Assets and Agencies Have Various Enforcement Processes,” GAO 09-608, May 2009 • Malawer: “Global Mergers and National Security” • Raice and Dowell, Wall Street Journal: “Huawei Drops U.S. Deal Amid Opposition,” 21 Feburary 2011 • UK Competition Commission and Office of Fair Trading: “A Quick Guide to UK Merger Assessment” • Wall Street Journal: “Small Deal Brings Scrutiny to Huawei,” 19 November 2010 • West: “National Security Implications of Foreign Investment in U.S. Government Contractors” • WTO: “Agreement on Trade-Related Invesetment Measures” • WTO Secretariat: “United States Trade Policy Review,” WT/TPR/S/200, 5 May 2008 • Yu: “National Security Review System for Mergers and Acquisitions by Foreign Investors will be set up in China”