Defense Trade: Implementation of Exon-Florio
Published: 2005-10-06T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The 1988 Exon-Florio amendment to the Defense Production Act authorizes the President to suspend or prohibit foreign acquisitions of U.S. companies that may harm national security, an action the President has taken only once. Implementing Exon-Florio can pose a significant challenge because of the need to weigh security concerns against U.S. open investment policy--which requires equal treatment of foreign and domestic investors. Exon-Florio's investigative authority was delegated to the Committee on Foreign Investment in the United States (Committee)--an interagency committee established in 1975 to monitor and coordinate U.S. policy on foreign investments. In September 2002, GAO reported on weaknesses in the Committee's implementation of Exon-Florio. This review further examined the Committee's implementation of Exon-Florio.
section_title: What GAO Found
paragraphs: Several aspects of the process for implementing Exon-Florio could be enhanced thereby strengthening the law's effectiveness. First, in light of differing views among Committee members about the scope of Exon-Florio--specifically, what defines a threat to national security, we have suggested that Congress should consider amending Exon-Florio to more clearly emphasize the factors that should be considered in determining potential harm to national security. Second, to provide additional time for analyzing transactions when necessary, while avoiding the perceived negative connotation of investigation on foreign investment in the United States we have suggested that the Congress eliminate the distinction between the 30-day review and the 45-day investigation and make the entire 75-day period available for review. Third, the Committee's current approach to provide additional time for analysis or to resolve concerns while avoiding the potential negative impacts of an investigation on foreign investment in the United Stated is to encourage companies to withdraw their notifications of proposed or completed acquisitions and refile them at a later date. Since 1997, companies involved in 18 acquisitions have been allowed to withdraw their notification to 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 while minimizing the risk of chilling foreign investment, withdrawal 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. We are therefore suggesting that the Congress consider requiring the Committee Chair to (1) establish interim protections where specific concerns have been raised, (2) specify time frames for refiling, and (3) establish a process for tracking any actions being taken during the withdrawal period. Finally, to provide more transparency and facilitate congressional oversight, we are suggesting that the Congress may want to revisit the criterion for reporting circumstances surrounding cases to the Congress. Currently, the criterion is a presidential decision. However, there have only been two such decisions since 1997 and thus only two reports to Congress.

section_title: Letter
paragraphs: I am pleased to be here today to discuss the implementation of Exon- Florio—an amendment to the Defense Production Act of 1950 that  authorizes the President to suspend or prohibit foreign acquisitions,  mergers, or takeovers of U.S. companies that pose a threat to national  security. As such, 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. As you know, implementing  Exon-Florio can pose a significant challenge for the federal government  because of the potential for conflict with the long-standing U.S. open  investment policy. This policy recognizes the economic benefits  associated with foreign investments. Accordingly, foreign investors are to  be treated no differently than domestic investors.
The Committee on Foreign Investment in the United States, originally  established in 1975 to monitor foreign investments, has been delegated  responsibility for investigating foreign acquisitions when necessary.  According to the 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 or initiate a 45-day investigation. At the  completion of the investigation, the Committee submits a report to the  President, including a recommendation for action. The Committee  currently has 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.  Other agencies may be called on when their particular expertise is needed.
The Department of Homeland Security was the most recently added  member, created as a result of the terrorist attacks of September 11th and  the recognition of the new security environment in which we exist.
Over the past decade, GAO has conducted several reviews of the  Committee’s actions and has found areas where improvements should be  made. For example, in September 2002, we reported that member agencies  could improve the agreements they negotiated with companies under  Exon-Florio to mitigate national security concerns. While our recent work  indicates that member agencies have begun to take action to respond to  some of our recommendations, concerns remain about the extent to which  the Committee’s implementation of Exon-Florio has provided the safety  net envisioned by the law. My comments today will focus on the process  the Committee follows in conducting its reviews, concerns about the  process, and suggestions we have made in our report on these issues. It  should be noted that because the law provides for confidentiality of  information filed under Exon-Florio, our ability to discuss certain details  of cases we examined is limited.
In summary, several aspects of the Committee’s process for implementing  Exon-Florio could be enhanced thereby strengthening the law’s  effectiveness. First, in light of differing views among Committee members  about the scope of Exon-Florio—specifically, what defines a threat to  national security, we have suggested that Congress should consider  amending Exon-Florio to more clearly emphasize the factors that should  be considered in determining potential harm to national security.
Second, to provide additional time for analyzing transactions when  necessary, while avoiding the perceived negative connotation of  investigation on foreign investment in the United States we have suggested  that the Congress eliminate the distinction between the 30-day review and  the 45-day investigation and make the entire 75-day period available for  review.
Third, the Committee’s current approach to provide additional time for  analysis or to resolve concerns while avoiding the potential negative  impacts of an investigation on foreign investment in the United Stated is to  encourage companies to withdraw their notifications of proposed or  completed acquisitions and refile them at a later date. Since 1997,  companies involved in 18 acquisitions have been allowed to withdraw  their notification to 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 while minimizing the risk of chilling foreign  investment, withdrawal 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. We  are therefore suggesting that the Congress consider requiring the  Committee Chair to (1) establish interim protections where specific  concerns have been raised, (2) specify time frames for refiling, and (3)  establish a process for tracking any actions being taken during the  withdrawal period.
Finally, to provide more transparency and facilitate congressional  oversight, we are suggesting that the Congress may want to revisit the  criterion for reporting circumstances surrounding cases to the Congress.  Currently, the criterion is a presidential decision. However, there have  only been two such decisions since 1997 and thus only two reports to  Congress.
subsections: section_title: Background
paragraphs: The Exon-Florio amendment to the Defense Production Act, enacted in  1988, authorized the President to investigate the impact of foreign  acquisitions of U.S. companies on national security and to suspend or  prohibit acquisitions that might threaten national security. The President  delegated the investigative authority to the Committee on Foreign  Investment in the United States, an interagency group established in 1975  to monitor and coordinate U.S. policy on foreign investment in the United  States.
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 determine  whether the acquisition could pose a threat to national security; (3) a 45- day investigation 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. 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, the Committee 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 to the President containing recommendations. 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 to decide whether to prohibit or  suspend the proposed acquisition, order divestiture of a completed  acquisition, or take no action.
While neither the statute nor the implementing regulation defines “national  security,” the statute provides the following factors to be considered in  determining a threat to national security:    Domestic production needed for projected national defense  requirements.
The capability and capacity of domestic industries to meet national  defense requirements, including the availability of human resources,  products, technology, materials, and other supplies and services.
The control of domestic industries and commercial activity by foreign  citizens as it affects the capability and capacity of the United States to  meet national security requirements.
The potential effects of the proposed or pending transaction on sales of  military goods, equipment, or technology to any country identified  under applicable law as (a) supporting terrorism or (b) a country of  concern for missile proliferation or the proliferation of chemical and  biological weapons.
The potential effects of the proposed or pending transaction on U.S.  international technological leadership in areas affecting national  security.
section_title: Differing Views of What Defines A National Security Threat and When to Initiate an Investigation May Weaken Exon-Florio’s Effectiveness
paragraphs: 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 be limiting 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.
Some Committee member agencies, including Treasury, apply 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, argue that acquisitions should be analyzed in broader terms.  According to officials from these departments, vulnerabilities can 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 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 that we reviewed, disagreement over the  definition of national security resulted in an enforcement provision being  removed from an 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 has been eliminated as a remedy in the event of noncompliance.
Committee members also disagree 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. Currently,  Treasury, as Committee Chair, applies 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 the International Emergency Economic Powers  Act are appropriate or adequate to protect national security. However,  the Defense, Justice, and Homeland Security departments have 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 a  credible threat exists. Notes from a policy-level discussion of one  particular case further corroborated these differing views.
section_title: Allowing Withdrawal of Notifications to Avoid Investigations While Providing Additional Time May Leave National Security Concerns Unresolved
paragraphs: Committee guidelines require 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 poses 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 legislatively 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 have withdrawn their notification  and refiled 19 times. In two cases, the companies had already concluded  the acquisition and did not refile until 9 months to 1 year. Consequently,  the concerns raised by Defense and Commerce about potential export  control issues in these 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.
We identified two cases in which companies that had concluded an  acquisition before filing with the Committee withdrew their notification.  In each case, the company has yet to refile. In one case, the company filed  with the Committee 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. Four  years have passed since the second withdrawal. 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.  That was more than 2 years ago.
section_title: Lack of Reporting Contributes to the Opaqueness of the Committee’s Process
paragraphs: In enacting Exon-Florio, the Congress, while recognizing the need for  confidentiality, indicated a desire for insight into the process by requiring  the President to report to the Congress on any transaction that the  President prohibited. 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 makes any decision regarding a proposed foreign  acquisition. In 1992, another amendment also directed the President to  report every 4 years on whether there is 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 are  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 limits the number of  cases that result in a presidential decision. Since 1997, 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, there has been only one report—in  1994.
In conclusion, in recognition of the benefits of open investment, Exon- Florio comes into play only as a last resort. However, since that is its role,  effective application in support of recognizing and mitigating national  security risks remains critical. While Exon-Florio provides the Committee  on Foreign Investment in the United States the latitude to address new  emerging threats, the more traditional interpretation of what constitutes a  threat to national security fails to fully consider the factors currently  embodied in the law. Further, the practical requirement to complete  reviews within 23 days to meet the 30-day legislative requirement, along  with the reluctance to proceed to an investigation, limits agencies’ abilities  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, will lose visibility over foreign  acquisitions of U.S. companies.
Our report lays 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 are suggesting 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.
Mr. Chairman, this concludes my prepared statement. I will be happy to  answer any questions you or other Members of the Committee may have.  -     -     -     -     -  For information about this testimony, please contact Katherine V.  Schinasi, Managing Director, Acquisition and Sourcing Management, at  (202) 512-4841 or schinasik@gao.gov. Other individuals making key  contributions to this product include Thomas J. Denomme, Allison  Bawden, Gregory K. Harmon, Paula J. Haurilesko, John Van Schaik, Karen  Sloan, and Michael Zola.
section_title: Scope and Methodology
paragraphs: Our understanding of the Committee on Foreign Investment in the United  States’ process is based on our current work and builds on our review of  the process and our discussions with agency officials for our 2002 report.  For our current 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 Department of Commerce, the Department  of Defense, the Department of Homeland Security, the Department of  Justice, and the Department of the Treasury. For prior reviews we also  collected data from and discussed the issues with representatives of the  Department of State, the Council of Economic Advisors, the Office of  Science and Technology, and the U.S. Trade Representative. Further, we  conducted case studies of nine acquisitions that were filed with the  Committee between June 28, 1995, and December 31, 2004. These case  studies included reviewing files containing company submissions,  correspondence between the Committee and the companies’  representatives, email traffic between member agencies, and minutes of  policy-level meetings attended by at various times all 12 Committee  members.
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. We also discussed our draft  report from our current review with officials from the Department of State  and the U.S. Trade Representative’s office to obtain their views on our  findings.
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.
section_title: Appendix I: Agencies Represented on the Committee on Foreign Investment in the United States
paragraphs: Office of International Investment: Coordinates policies toward foreign  investments in the United States and U.S. investments abroad.
International Trade Administration: Coordinates issues concerning trade  promotion, international commercial policy, market access, and trade law  enforcement.
Defense Technology Security Administration: Administers the  development and implementation of Defense technology security policies  on international transfers of defense-related goods, services, and  technologies.
Bureau of Economic and Business Affairs: Formulates and implements  policy regarding foreign economic matters, including trade and  international finance and development.
Criminal Division: Develops, enforces, and supervises the application of  all federal criminal laws, except for those assigned to other Justice  Department divisions.
Information Analysis and Infrastructure Protection: Identifies and  assesses current and future threats to the homeland, maps those threats  against vulnerabilities, issues warnings, and takes preventative and  protective action.
Performs analyses and appraisals of the national economy for the  purpose of providing policy recommendations to the President.
Directs all trade negotiations of and formulates trade policy for the United  States.
Evaluates, formulates, and coordinates management procedures and  program objectives within and among federal departments and agencies,  and controls administration of the federal budget.
Coordinates the economic policy-making process and provides economic  policy advice to the President.
Advises and assists the President in integrating all aspects of national  security policy as it affects the United States.
Provides scientific, engineering and technological analyses for the  President for federal policies, plans, and programs.
section_title: Appendix II: Notifications to the Committee on Foreign Investment in the United States and Actions Taken, 1997 through 2004
paragraphs: This is a work of the U.S. government and is not subject to copyright protection in the  United States. It may be reproduced and distributed in its entirety without further  permission from GAO. However, because this work may contain copyrighted images or  other material, permission from the copyright holder may be necessary if you wish to  reproduce this material separately.