Defense Trade: National Security Reviews of Foreign Acquisitions of U.S. Companies Could Be Improved
Published: 2007-03-23T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Exon-Florio amendment to the Defense Production Act of 1950, enacted in 1988, authorized the President to suspend or prohibit foreign acquisitions of U.S. companies that pose a threat to national security. The Committee on Foreign Investment in the United States--chaired by the Department of Treasury with 11 other members, including the Departments of Commerce, Defense, and Homeland Security--implements Exon-Florio through a four-step review process: (1) voluntary notice by the companies of pending or completed acquisitions; (2) a 30-day review to determine whether the acquisition could pose a threat to national security; (3) a 45-day investigation period to determine whether concerns require possible action by the President; and (4) a presidential decision to permit, suspend, or prohibit the acquisition. Over the past decade, GAO has conducted several reviews of the Committee's process and has found areas where improvements were needed. GAO's most recent work, conducted in 2005, indicated concerns remained.
section_title: What GAO Found
paragraphs: Exon-Florio reviews are meant to serve as a safety net when other laws may be inadequate to protect national security. GAO found that several aspects of the review process may have weakened the law's effectiveness. First, member disagreement about what defines a threat to national security may have limited the Committee's analyses. Some argued that reviews should be limited to concerns about export-controlled technologies or items, classified contracts, or specific derogatory intelligence concerning the company. Others argued for a broader scope, one that considers potential threats to U.S. critical infrastructure, defense supply, and technology superiority. Committee members also differed on the criteria that should be used to determine when an investigation is warranted. Some applied essentially the criteria in the law for a presidential decision--that is, there is credible evidence that the foreign controlling interest may take action that threatens national security and that no other laws other than the International Emergency Economic Powers Act are adequate to protect national security. Others argued that these criteria are inappropriate because the purpose of an investigation is to determine if credible evidence of a threat exists. While most cases can be completed within the 30-day review period, complex acquisitions may require more time. Concerned that an investigation could discourage foreign investment, the Committee allowed companies to withdraw notifications rather than proceed to investigation. While this practice can provide additional review time without chilling foreign investment, it may also heighten the risk to national security in transactions where there are concerns and the acquisition has been completed or is likely to be completed during the withdrawal period. Finally, because few cases are investigated, few require a presidential decision, giving Congress little insight into the Committee's process.

section_title: Letter
paragraphs: I am pleased to be here today to take part in this hearing on issues related  to foreign ownership of U.S. assets and potential effects on national  security. As you know, U.S. export control laws, national disclosure  policy, the National Industrial Security Program, and other processes and  programs have been established to protect defense technologies and other  critical assets from falling into the wrong hands, and for other reasons.  Similarly, the Exon-Florio amendment to the Defense Production Act of  1950, enacted in 1988, authorized the President to suspend or prohibit  foreign acquisitions, mergers, or takeovers of U.S. companies that pose a  threat to national security. Exon-Florio is meant to serve as a safety net  when laws other than the International Emergency Economic Powers Act  may be ineffective in protecting national security.
Exon-Florio is administered by the Committee on Foreign Investment in  the United States, currently made up of 12 members: the Department of  the Treasury, which serves as Chair; the Departments of Commerce,  Defense, Homeland Security, Justice, and State; and six offices in the  Executive Office of the President. On the surface, the Exon-Florio review  process is fairly straightforward. According to regulations, after a  company voluntarily files a notice of a pending or completed acquisition  by a foreign concern, the Committee conducts a 30-day review to  determine whether there are any national security concerns. If the  Committee is unable to complete its review within 30 days, the Committee  may either allow the companies to withdraw the notification and refile or  initiate a 45-day investigation. If a case undergoes an investigation, the  Committee submits a report to the President, including a recommendation  for action. Cases that result in a presidential decision are reported to the  Congress.
As requested, my comments today will summarize our reports on  weaknesses in the Exon-Florio process that GAO has identified over the  past decade. Before I begin, however, it is important to provide some  context to Exon-Florio. Specifically, implementing Exon-Florio can pose a  significant challenge for the federal government because of the potential  for conflict with U.S. open investment policy—a policy that, in recognizing  the economic benefits associated with foreign investments, calls for  foreign investors to be treated no differently than domestic investors. This  challenge has increased significantly since September 2001, when threats  facing the nation were fundamentally redefined to include threats against  the homeland, including those to our critical infrastructure. At the same  time, the economy has become increasingly globalized, as countries open  their markets and communicate regularly through the Internet.  Government programs established decades ago are often ill-equipped to  grapple with these emerging complexities. GAO, therefore, designated the  effective identification and protection of critical technologies as a  governmentwide high-risk area, which warrants a strategic reexamination  to identify needed changes. In terms of Exon-Florio, legislation has been  introduced to reform the Exon-Florio process.
Our understanding of the Committee’s process is based on our 2005 work  but built on our review of the process and our discussions with agency  officials for our 2002 report.  For our 2005 review, and to expand our  understanding of the Committee’s process for reviewing foreign  acquisitions of U.S. companies, we met with officials from the  Departments of Commerce, Defense, Homeland Security, Justice, and the  Treasury—the agencies that are most active in the review of acquisitions— and discussed their involvement in the process. Further, we conducted  case studies of nine acquisitions that were filed with the Committee  between June 28, 1995, and December 31, 2004. We conducted our review  from April 2004 through July 2005 in accordance with generally accepted  government auditing standards.
To summarize our work in this area, we have found that several aspects of  the Committee’s process for implementing Exon-Florio may have  weakened the law’s effectiveness. First, we found a lack of agreement  among Committee members about the scope of Exon-Florio—specifically,  what defines a threat to national security. Neither the statute nor the  implementing regulation defines “national security.” However, the statute  provides factors that may be considered in determining threats to national  security. Despite these factors, some Committee members argued to apply  a more traditional definition—one limited to concerns about export- controlled technologies or items, classified contracts, and the existence of  specific derogatory intelligence on a foreign company. Other Committee  members have argued that a broader view is warranted, and in analyzing  the effects of an acquisition, considered the potential vulnerabilities that  an acquisition can create with regard to U.S. critical infrastructure,  defense supply, and defense technology superiority. These disagreements  may have limited the Committee’s analyses of proposed or completed  acquisitions.
Second, Committee members also had differing opinions on the criteria  that should be used to determine whether an investigation was warranted.  The criteria used by Treasury as the Committee Chair and others were  essentially the same criteria established in the current law for the  President to suspend or prohibit a transaction, or order divestiture—that  is, there is credible evidence that the foreign controlling interest may take  action that threatens national security and that no laws other than Exon- Florio and the International Emergency Economic Powers Act are  adequate to protect national security. Some Committee members have  argued that applying these criteria is inappropriate because the purpose of  an investigation is to determine whether or not credible evidence of a  threat exists.
Third, while most acquisitions are not problematic and the Committee’s  review can be completed within the 30-day period allowed by Exon-Florio,  some more complex acquisitions required more analysis or consideration  than the 30-day review period could accommodate. However, the  Committee has been reluctant to use the additional 45 days allowed by the  legislation because it would require initiating an investigation. The  Committee’s concern was that the negative perceptions surrounding an  investigation could discourage foreign investment in the United States,  thereby conflicting with U.S. open investment policy. To avoid  investigations, the Committee has in the past encouraged companies to  withdraw their notifications of proposed or completed acquisitions and  refile them at a later date. Between 1997 and 2004, companies involved in  18 acquisitions were allowed to withdraw their notification and refile at a  later time. The new filing is considered a new case and restarts the 30-day  clock. While withdrawing and refiling provides additional time for  Committee members to review a foreign acquisition while minimizing the  risk of chilling foreign investment, it may also heighten the risk to national  security in transactions where there are concerns and the acquisition has  been completed or is likely to be completed during the withdrawal period.  This was the situation in 4 of the 18 acquisitions cited above. One company  did not refile for 9 months, another did not refile for 1 year, and 2 had yet  to refile at the time of our review.
Finally, because very few cases required a presidential decision—the  criterion for reporting to the Congress on specific cases—the Congress  had little insight into the Committee’s process. Further, a 1992 amendment  to the legislation requires a report to the Congress every 4 years on certain  trends in foreign acquisitions. However, at the time of our work only one  report had been submitted, in 1994. I understand that another report, in  response to that requirement, has been issued.
Since our 2005 report, the Committee has taken some actions to reform  the process, such as increasing communication to interested congressional  committees. However, we have not examined how these changes are  working. It should be noted that because the law provides for  confidentiality of information filed under Exon-Florio, our ability to  discuss details of cases we examined is limited.
subsections: section_title: Background
paragraphs: Enacted in 1988, the Exon-Florio amendment to the Defense Production  Act authorized the President to investigate the effects of foreign  acquisitions of U.S. companies on national security and to suspend or  prohibit acquisitions that might threaten national security. The President  delegated investigative authority to the Committee on Foreign Investment  in the United States, an interagency group responsible for monitoring and  coordinating U.S. policy on foreign investment in the United States. Since  the Committee’s establishment in 1975, membership has doubled, with the  Department of Homeland Security being the most recently added member.  In addition to the Committee’s 12 standing members, other agencies may  be called on when their particular expertise is needed.
In 1991, the Treasury Department, as Chair of the Committee, issued  regulations to implement Exon-Florio. The law and regulations establish a  four-step process for reviewing foreign acquisitions of U.S. companies:  (1) voluntary notice by the companies; (2) a 30-day review to identify  whether there are any national security concerns; (3) a 45-day  investigation period to determine whether those concerns require a  recommendation to the President for possible action; and (4) a  presidential decision to permit, suspend, or prohibit the acquisition   (see fig. 1).
In most cases, the Committee completes its review within the initial  30 days because there are no national security concerns or concerns have  been addressed, or the companies and the government agree on measures  to mitigate identified security concerns. In cases where the Committee is  unable to complete its review within 30 days, it may initiate a 45-day  investigation or allow companies to withdraw their notifications. The  Committee generally grants requests to withdraw. When the Committee  concludes a 45-day investigation, it is required to submit a report with  recommendations to the President. If Committee members cannot agree  on a recommendation, the regulations require that the report to the  President include the differing views of all Committee members. The  President has 15 days after the investigation is completed to decide  whether to prohibit or suspend the proposed acquisition, order divestiture  of a completed acquisition, or take no action. Table 1 provides a  breakdown of notifications and committee actions taken from 1997  through 2004 (the latest date for which data were available at the time of  our 2005 review).
Over the past decade, GAO has conducted several reviews of the  Committee’s process and actions and has found areas where  improvements were needed. In 2000, we found that gaps in the notification  process raised concerns about the Committee’s ability to ensure  transactions are notified. Our 2002 review, prompted by a lack of  congressional insight into the process, again found weaknesses in the  process. Specifically, we reported that member agencies could improve  the agreements they negotiated with companies under Exon-Florio to  mitigate national security concerns. We also questioned the use of  withdrawals to provide additional time for reviews. While our most  recent work indicated that member agencies had begun to take action to  respond to some of our recommendations, concerns remained about the  extent to which the Committee’s implementation of Exon-Florio had  provided the safety net envisioned by the law.
section_title: Views Differed over What Constitutes a National Security Threat and When an Investigation Is Warranted
paragraphs: In 2005, we reported that a lack of agreement among Committee members  on what defines a threat to national security and what criteria should be  used to initiate an investigation may have limited the Committee’s analyses  of proposed and completed foreign acquisitions. From 1997 through 2004,  the Committee received a total of 470 notices of proposed or completed  acquisitions, yet it initiated only 8 investigations.
While neither the statute nor the implementing regulation defines “national  security,” the statute provides a number of factors that may be considered  in determining a threat to national security (see fig. 2).
Some Committee member agencies argued for a more traditional and  narrow definition of what constitutes a threat to national security—that is,  (1) the U.S. company possesses export-controlled technologies or items;  (2) the company has classified contracts and critical technologies; or   (3) there is specific derogatory intelligence on the foreign company. Other  members, including the Departments of Defense and Justice, argued that  acquisitions should be analyzed in broader terms. According to officials  from these departments, vulnerabilities could result from foreign control  of critical infrastructure, such as control of or access to information  traveling on networks. Vulnerabilities can also result from foreign control  of critical inputs to defense systems, such as weapons system software  development or a decrease in the number of innovative small businesses  researching and developing new defense-related technologies.
While these vulnerabilities may not pose an immediate threat to national  security, they may create the potential for longer term harm to U.S.  national security interests by reducing U.S. technological leadership in  defense systems. For example, in reviewing a 2001 acquisition of a U.S.  company, the Departments of Defense and Commerce raised several  concerns about foreign ownership of sensitive but unclassified technology,  including the possibility of this sensitive technology being transferred to  countries of concern or losing U.S. government access to the technology.  However, Treasury argued that these concerns were not national security  concerns because they did not involve classified contracts, the foreign  company’s country of origin was a U.S. ally, or there was no specific  negative intelligence about the company’s actions in the United States.
In one proposed acquisition, disagreement over the definition of national  security resulted in an enforcement provision being removed from a  mitigation agreement between the foreign company and the Departments  of Defense and Homeland Security. Defense had raised concerns about the  security of its supply of specialized integrated circuits, which are used in a  variety of defense technologies that the Defense Science Board had  identified as essential to our national defense—technologies found in  unmanned aerial vehicles, the Joint Tactical Radio System, and  cryptography and other communications protection devices. However,  Treasury and other Committee members argued that the security of supply  issue was an industrial policy concern and, therefore, was outside the  scope of Exon-Florio’s authority. As a result of removing the provision, the  President’s authority to require divestiture under Exon-Florio was  eliminated as a remedy in the event of non-compliance.
Committee members also disagreed on the criteria that should be applied  to determine whether a proposed or completed acquisition should be  investigated. While Exon-Florio provides that the “President or the  President’s designee may make an investigation to determine the effects  on national security” of acquisitions that could result in foreign control of  a U.S. company, it does not provide specific guidance for the appropriate  criteria for initiating an investigation of an acquisition. At the time of our  work, Treasury, as Committee Chair, applied essentially the same criteria  established in the law for the President to suspend or prohibit a  transaction, or order divestiture: (1) there is credible evidence that the  foreign controlling interest may take action to threaten national security  and (2) no laws other than Exon-Florio and the International Emergency  Economic Powers Act are adequate and appropriate to protect national  security. However, the Defense, Justice, and Homeland Security  Departments argued that applying these criteria at this point in the process  is inappropriate because the purpose of an investigation is to determine  whether or not credible evidence of a threat exists. Notes from a policy- level discussion of one particular case further corroborated these differing  views.
section_title: Committee Allowed Withdrawal of Notifications to Avoid Investigations
paragraphs: Committee guidelines required member agencies to inform the Committee  of national security concerns by the 23rd day of a 30-day review—further  compressing the limited time allowed by legislation to determine whether  a proposed or completed foreign acquisition posed a threat to national  security. According to one Treasury official, the information is needed a  week early to meet the legislated 30-day requirement. While most reviews  are completed in the required 30 days, some Committee members have  found that completing a review within such short time frames can be  difficult—particularly in complex cases. One Defense official said that  without advance notice of the acquisition, time frames are too short to  complete analyses and provide input for the Defense Department’s  position. Another official said that to meet the 23-day deadline, analysts  have only 3 to 10 days to analyze the acquisition. In one instance,  Homeland Security was unable to provide input within the 23-day time  frame.
If a review cannot be completed within 30 days and more time is needed to  determine whether a problem exists or identify actions that would mitigate  concerns, the Committee can initiate a 45-day investigation of the  acquisition or allow companies to withdraw their notifications and refile at  a later date. According to Treasury officials, the Committee’s interest is  to ensure that the implementation of Exon-Florio does not undermine U.S.  open investment policy. Concerned that public knowledge of  investigations could devalue companies’ stock, erode confidence of  foreign investors, and ultimately chill foreign investment in the United  States, the Committee has generally allowed and often encouraged  companies to withdraw their notifications rather than initiate an  investigation.
While an acquisition is pending, companies that have withdrawn their  notification have an incentive to resolve any outstanding issues and refile  as soon as possible. However, if an acquisition has been concluded, there  is less incentive to resolve issues and refile, extending the time during  which any concerns remain unresolved. Between 1997 and 2004,  companies involved in 18 acquisitions withdrew their notification and  refiled 19 times. In four cases, the companies had already concluded the  acquisition before filing a notification. One did not refile until 9 months  later and another did not refile for 1 year. Consequently, concerns raised  by Defense and Commerce about potential export control issues in these  two cases remained unresolved for as much as a year—further increasing  the risk that a foreign acquisition of a U.S. company would pose a threat to  national security.
For the other two cases, neither company had refiled at the time we  completed our work. In one case, the company had previously withdrawn  and refiled more than a year after completing the acquisition. The  Committee allowed it to withdraw the notification to provide more time to  answer the Committee’s questions and provide assurances concerning  export control matters. The company refiled, and was permitted to  withdraw a second time because there were still unresolved issues. When  we issued our report in 2005, 4 years had passed since the second  withdrawal without a refiling. In the second case, the company—which  filed with the Committee more than 6 months after completing its  acquisition—was also allowed to withdraw its notification. At the time we  issued our report, 2 years had passed without a refiling.
section_title: Lack of Reporting Contributed to the Opaqueness of the Committee’s Process and Diminished Oversight
paragraphs: In response to concerns about the lack of transparency in the Committee’s  process, the Congress passed the Byrd Amendment to Exon-Florio in 1992,  requiring a report to the Congress if the President made any decision  regarding a proposed foreign acquisition. In 1992, another amendment also  directed the President to report every 4 years on whether there was  credible evidence of a coordinated strategy by one or more countries to  acquire U.S. companies involved in research, development, or production  of critical technologies for which the United States is a leading producer,  and whether there were industrial espionage activities directed or assisted  by foreign governments against private U.S. companies aimed at obtaining  commercial secrets related to critical technologies.
While the Byrd Amendment expanded required reporting on Committee  actions, few reports have been submitted to the Congress because  withdrawing and refiling notices to restart the clock has limited the  number of cases that result in a presidential decision. Between 1997 and  2004, only two cases—both involving telecommunications systems— resulted in a presidential decision and a subsequent report to the  Congress. Infrequent reporting of Committee deliberations on specific  cases provides little insight into the Committee’s process to identify  concerns raised during investigations and determine the extent to which  the Committee has reached consensus on a case. Further, despite the 1992  requirement for a report on foreign acquisition strategies every 4 years, at  the time of our work there had been only one report—in 1994.  However,  another report, in response to this requirement, was recently delivered to  the Congress.
In conclusion, the effectiveness of Exon-Florio as a safety net depends on  how the broad scope of its authority is implemented in today’s globalized  world—where identifying threats to national security has become  increasingly complex. While Exon-Florio provides the Committee on  Foreign Investment in the United States the latitude to define what  constitutes a threat to national security, the more traditional interpretation  fails to fully consider factors currently embodied in the law. Further, the  Committee guidance requiring reviews to be completed within 23 days to  meet the 30-day legislative requirement, along with the reluctance to  proceed to an investigation, limits agencies’ ability to complete in-depth  analyses. However, the alternative—allowing companies to withdraw and  refile their notifications—increases the risk that the Committee, and the  Congress, could lose visibility over foreign acquisitions of U.S. companies.  The criterion for reporting specific cases to the Congress only after a  presidential decision contributes to the opaque nature of the Committee’s  process.
Our 2005 report laid out several matters for congressional consideration to  (1) help resolve the differing views as to the extent of coverage of Exon- Florio, (2) address the need for additional time, and (3) increase insight  and oversight of the process. Further, we suggested that, when withdrawal  is allowed for a transaction that has been completed, the Committee  establish interim protections where specific concerns have been raised,  specific time frames for refiling, and a process for tracking any actions  being taken during a withdrawal period. We have been told that some of  these steps are now being taken.
Madam Chairwoman, this concludes my prepared statement. I will be  happy to answer any questions you or other Members of the  Subcommittee may have.
For information about this testimony, please contact Ann M. Calvaresi- Barr, Director, Acquisition and Sourcing Management, at (202) 512-4841 or  calvaresibarra@gao.gov. Other individuals making key contributions to  this product include Thomas J. Denomme, Gregory K. Harmon, Paula J.  Haurilesko, John J. Marzullo, Russell Reiter, Karen Sloan, and Marie  Ahearn.
section_title: Scope and Methodology
paragraphs: Our understanding of the Committee’s process is based on our 2005 work  but built on our review of the process and our discussions with agency  officials for our 2002 report. For our 2005 review, and to expand our  understanding of the Committee’s process for reviewing foreign  acquisitions of U.S. companies, we met with officials from the  Departments of Commerce, Defense, Homeland Security, Justice, and the  Treasury—the agencies that are most active in the review of acquisitions— and discussed their involvement in the process. Further, we conducted  case studies of nine acquisitions that were filed with the Committee  between June 28, 1995, and December 31, 2004. We selected acquisitions  based on recommendations by Committee member agencies and the  following criteria: (1) the Committee permitted the companies to withdraw  the notification; (2) the Committee or member agencies concluded  agreements to mitigate national security concerns; (3) the foreign  company had been involved in a prior acquisition notified to the  Committee; or (4) GAO had reviewed the acquisition for its 2002 report.  We did not attempt to validate the conclusions reached by the Committee  on any of the cases we reviewed. To determine whether the weaknesses in  provisions to assist agencies in monitoring agreements that GAO had  identified in its 2002 report had been addressed, we analyzed agreements  concluded under the Committee’s authority between 2003 and 2005. We  conducted our review from April 2004 through July 2005 in accordance  with generally accepted government auditing standards.
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