By John Lash
Since the end of World War II, the United States has maintained and enjoyed an open posture toward foreign investment. In 2016, it remained the largest recipient of foreign direct investment (FDI) globally, with an estimated inflow of $385 billion—a marked 11 percent increase from the year prior. 1 Much of this amount stemmed from several multibillion-dollar cross-border merger and acquisition (M&A) deals, whose total value had increased 17 percent from the 2015 levels.
While foreign buyers remain plentiful and varied, China—with its sights are still set on getting a strategic foothold in the U.S.—is likely to continue to be one of the U.S.’ largest investors, a development that has prompted some national anxiety. National security is an ever-present priority for the U.S. government. As foreign deal-making increases, so will the regulatory scrutiny of cross-border transactions.
The CFIUS Review Process
A critical element of FDI is the involvement of the Committee on Foreign Investment in the United States (CFIUS). Chaired by the U.S. Secretary of the Treasury, this interagency task force is responsible for the review of FDI that could result in the control of a U.S. business or U.S. critical infrastructure—defined as “a system or asset, whether physical or virtual… vital to the United States”—as well as the impact these transactions could have on national security. 2
While CFIUS review is not a mandatory process, many companies involved in cross-border deals will voluntarily notify CFIUS and initiate a review to gain the benefits of a safe harbor provision. This provision prevents future government challenges to the transaction, including unwinding it or requiring mitigating actions, should the review be cleared successfully. The review process includes up to three stages. The first stage begins with a 30-day initial assessment period, at which point a determination can be made. If unresolved concerns remain, the committee may initiate the second stage, a 45-day investigation period. Should that yield unsatisfactory results, a 15-day presidential review period begins, with the president rendering a final decision. Actual presidential decisions are rare, with only two transactions blocked during the Obama administration. Rather, most transactions are approved, adapted to mitigate CFIUS’ concerns or withdrawn by the parties if they suspect that the transaction will not be approved.
Cross-Border Manufacturing M&A
CFIUS filings have steadily increased over the last eight years, with manufacturing companies consistently representing the largest share of any industry since 2010. According to the most recent publicly available data, 69 manufacturing companies filed notices with CFIUS in 2014, comprising nearly half (47 percent) of all filings. Per the table to the right, the majority of notices within the manufacturing industry have come from the computer and electronic product, machinery and transportation equipment sectors.
When evaluating manufacturing M&A transactions for potential national security conflicts, there are several issues to consider. Manufacturers are vulnerable to national security risks ranging from physical facility security—including the security of facilities that produce key elements or products for defense, transportation or energy infrastructure—to location security, such as the proximity to military installations. Other major risks include those that may undermine U.S. and global supply chain reliability and security, as well as global trade compliance. Cybersecurity—and cyber espionage, in particular—is also top of mind, with concerns about threats from nation-state actors on the rise. FDI that involves the critical manufacturing sector—defined by the Department of Homeland Security as those manufacturing industries that are the most crucial for the continuity of other critical sectors and have significant national economic implications—is especially susceptible to scrutiny.
The Future of CFIUS
With the current administration’s heightened focus on national security and its stated “America First” platform, CFIUS could play a larger role in cross-border M&A activity in the year ahead, with potentially more stringent reviews and/or an increased use of mitigation measures. The practical guidance for identifying factors which constitute a national security risk may also be broadened to include economic security, a net U.S.-benefit test. At his January confirmation hearing, Treasury Secretary Steven Mnuchin discussed using CFIUS as a tool for “protecting American workers.”
The administration’s decisions regarding global trade partnerships—including its decision to withdraw from the Trans-Pacific Partnership (TPP) and promises to renegotiate the North American Free Trade Agreement (NAFTA)—may also lead to heavier scrutiny of deals proposed by geopolitical rivals versus those from “friendly” nations. These shifting relationships may also affect if and how the U.S. chooses to participate in parallel national security reviews with other countries. In addition, reciprocal market access may become a greater consideration factor in CFIUS review, with countries that do not “reciprocate,” or allow comparable U.S. investment in the same sector, facing more difficulties in obtaining CFIUS approvals than those who do.
Regardless of what lies ahead, manufacturers must be cognizant of how an M&A transaction may impact the reliability, availability and integrity of their resources, production activity and intellectual property, as well as any direct or indirect impacts on critical infrastructure. And to avoid a compliance bottleneck, manufacturing organizations (and their potential buyers) must proactively address potential national security risks so as to reduce the security optics of the transaction.
1 Global Investment Trends Monitor: February 2017 (Vol. 25, Rep. No. 25). (n.d.). United Nations (UNCTAD). Retrieved from http://unctad.org/en/PublicationsLibrary/webdiaeia2017d1_en.pdf
2 Lash, J. (2016, June 6). National Security a Top Priority in Cross-Border Deals. Retrieved from http://www.themiddlemarket.com/news/business_services/national-security-a-top-priority-in-cross-border-deals-260721-1.html
CFIUS Red Flags
What constitutes a national security threat? U.S. businesses that may come under CFIUS scrutiny include those that:
- Are in the defense, security and national security-related law enforcement sectors.
- Provide products and services to the government with potential security or defense applications.
- Constitute “critical infrastructure,” e.g., energy production, telecom or transportation.
- Have access to classified or sensitive government information.
- Engage in activities subject to U.S. export controls.
- Are in proximity to U.S. government facilities.
This article originally appeared in BDO USA, LLP’s “Manufacturing Output” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com