In recent years, fewer transactions have been submitted for review before the Committee on Foreign Investment in the United States. Those transactions that do appear in front of CFIUS, however, are receiving greater scrutiny than ever before. These seemingly contradictory trends are two of the more interesting conclusions from CFIUS' 2009 Annual Report to Congress, which was released at the end of 2010.
Not as evident from the report, but clear from press and other publications, is the increase in political pressure being applied in CFIUS matters, particularly related to transactions involving Chinese buyers. In this environment, both U.S. sellers and non-U.S. buyers need to proceed carefully.
According to the report, between 2008 and 2009, the number of notices submitted to CFIUS for transactions designated as "covered transactions" subject to CFIUS review was more than halved, to 65 from 155. This dramatic reduction may be a product in part of the global economic slowdown or an effort by U.S. sellers to target transactions with U.S. buyers.
But it is also possible that the reduction is evidence of resistance on the part of transaction parties to make voluntary filings. This explanation seems likely given the marked increase in the proportion of matters proceeding to investigation in 2009. According to the report, nearly 40% of notified transactions in 2009 moved to a 45-day investigation. In 2008, an investigation occurred in only 15% of transactions submitted for review; in 2007, only 4% of notified transactions proceeded to investigation.
This statistic suggests that sellers may be entering into riskier transactions than in prior years. What seems more likely, however, is that CFIUS is scrutinizing proposed transactions more carefully than ever before. Correspondingly, parties considering transactions subject to CFIUS review should account for the possibility of a prolonged CFIUS review process, that is, both a 30-day review period and a 45-day investigation. In some cases, the review process may extend longer than these periods put together, if, for example, CFIUS asks parties to refile a notice, or it does not immediately start the official review period upon filing of a notice.
According to figures in the report, Chinese investment in the U.S. has been relatively modest and consistent in the past few years, at least as to investments about which CFIUS was notified. The report indicates that there were three filings involving Chinese investors in 2007, six filings in 2008 and four filings in 2009.
These figures are notable given the attention directed toward Chinese investment in the U.S. in recent months, particularly as such investment was highlighted during the January 2011 visit of Chinese President Hu Jintao to the U.S. During that visit, President Obama and Hu called for more Chinese investment in U.S. infrastructure and technology companies. Obama subsequently reiterated that the "United States is open for investment and would welcome it."
But there are complications. This professed openness to Chinese foreign investment appears to be somewhat at odds with CFIUS' practice of submitting foreign investments to greater scrutiny, especially as CFIUS has applied that scrutiny to deals involving investment from China.
Two recent examples are especially illustrative. In the Firstgold Corp. transaction from late 2009, proposed Chinese investment in a non-operating Nevada gold mine fell apart after CFIUS, citing the mine's proximity to a U.S. military installation, indicated that it intended to recommend that the Obama administration block the transaction. More recently, at the end of 2010, CFIUS took the unusual step of retroactively reviewing a completed acquisition of staff, intellectual property and servers from 3Leaf Systems Inc., a small U.S. server technology firm, even though the acquirer, Huawei Technologies Co. Ltd., was a well-established Chinese telecommunications company. Based on that review, CFIUS announced its intent to recommend that Obama block the transaction, ultimately unwinding the deal.
Despite these roadblocks, Chinese companies are continuing to seek investments in the U.S. For example, a February proposed acquisition of U.S. small-plane manufacturer Cirrus Industries Inc. by Chinese state-owned China Aviation Industry General Aircraft Co. Ltd. is currently under CFIUS review, likely entailing heightened scrutiny due to the non-U.S. government involvement. A positive outcome in that case would support the U.S. government's stated position of facilitating Chinese investment in the U.S. and help elucidate how CFIUS is addressing proposed Chinese acquisitions of U.S. companies.
The effective blocking of two deals involving Chinese investors in little more than a year calls into question how the close scrutiny of possible security issues related to certain investments may affect Obama's stated desire to bolster Chinese investment in the U.S. These incidents suggest that a blocked transaction, although still rare, may be increasingly likely for any acquisition of a U.S. business where there are national-security concerns about the acquirer. The risk of blocked transactions appears highest when the acquirer is Chinese.
Some U.S. officials apparently have encouraged potential Chinese investors to consider taking smaller stakes in large investment opportunities. Such an approach may be useful in some cases, as the CFIUS regulations create a safe harbor for certain transactions where the foreign acquirer maintains 10% or less of an outstanding voting interest in a U.S. business.
In cases where investors wish to seek a more active investing role in a U.S. business, preparation and a well-constructed CFIUS strategy are essential. Parties should recognize that significant time is needed to prepare for and navigate the CFIUS review process, particularly with the increased likelihood of investigation. Closing timelines may have to be extended. And in particularly sensitive transactions, the parties have to manage the political elements of the deal. Otherwise, as in the recent cases referenced above, the transaction may be suffocated under the increasing weight of CFIUS scrutiny.
Thad McBride is a partner and Mark Jensen is an associate specializing in international trade law at Sheppard Mullin Richter & Hampton LLP in Washington.