Defense Trade: Enhancements to the Implementation of Exon-Florio Could Strengthen the Law's Effectiveness
Released: 2005-09-28T00:00:00

Letter

Background

In 1988, the Congress enacted the Exon-Florio amendment to the Defense Production Act, which 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 this investigative authority to the Committee on Foreign Investment in the United States. The Committee is an interagency group that was established by executive order in 1975 to monitor the impact of and coordinate U.S. policy on foreign investment in the United States. The Committee is chaired by the Secretary of the Treasury, and its membership includes representatives from executive branch departments and the Executive Office of the President (see table 1). The President added the Department of Homeland Security to the Committee in 2003, reflecting an increased focus on domestic security in the aftermath of the September 11, 2001, terror attacks and subsequent global war on terror.

In 1991, the Treasury Department issued regulations to implement Exon- Florio. As shown in figure 1, Exon-Florio and the regulations establish a four-step process for reviewing a foreign acquisition of a U.S. company: voluntary notice, 30-day review, 45-day investigation, and presidential decision.

Notifying the Committee of an acquisition is not mandatory. However, any member agency is authorized to submit a notification of an acquisition if the companies have not done so. To date, no agency has submitted a notification of an acquisition. Instead, when a member agency becomes aware of an acquisition that may be subject to Exon-Florio, the agency informs Treasury, as Chair, and Committee staff contact the companies to encourage them to officially notify the Committee of the acquisition to begin a review. Committee officials noted that companies have an incentive to notify the Committee prior to completing the acquisition because Exon-Florio provides the President with the authority to order companies to divest completed acquisitions found to pose a threat to national security.

Under Exon-Florio, after receiving notification of a proposed or completed acquisition, the Committee begins a 30-day review to determine whether the acquisition could pose a threat to national security. The Treasury Department, as Committee Chair, forwards the notification documentation to the lead office in each of the member agencies. Lead offices forward the information to other offices within their agency. For example, the Defense Technology Security Administration, the lead office for the Department of Defense, forwards notification to 12 other offices within the department. These other offices may also forward the notification, as appropriate. In one case, the point-of-contact in the Office of the Under Secretary of Defense for Acquisition, Technology, and Logistics, one of the initial 12 offices, forwarded the notification to four other offices within that organization.

In most instances, the Committee completes its review within the 30 days. However, 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. If the Committee concludes a 45-day investigation, it is required to submit a report to the President containing its 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.

Under Exon-Florio, 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. The President may take action upon a determination that (1) there is credible evidence that leads the President to believe that a foreign controlling interest might take action that threatens to impair national security and (2) laws other than Exon- Florio and the International Emergency Economic Powers Act are inadequate or inappropriate to protect national security. Under the regulations, the President’s divestiture authority, however, cannot be exercised if (1) the Committee has informed the companies in writing that their acquisition was not subject to Exon-Florio or had previously decided to forego investigation or (2) the President has previously decided not to act on that specific acquisition under Exon-Florio. The Committee may reopen its review or investigation and revise its recommendation to the President if it determines that the companies omitted or provided false or misleading information. In some cases, the companies will decide not to proceed with the transaction because of concerns that a presidential decision would be unfavorable. However, the President has ordered divestiture in only one case. In 1990, the President ordered a Chinese aerospace company to divest its ownership of a U.S. aircraft parts manufacturer.

Under the original Exon-Florio law, the President was obligated to report to the Congress on the circumstances surrounding a presidential decision only after prohibiting an acquisition. In response to concerns about the lack of transparency in the Committee’s process, in 1992 Congress passed the Byrd Amendment to Exon-Florio, requiring a report to the Congress if the President makes any decision regarding a proposed foreign acquisition.

Companies can request to withdraw their notification at any time prior to the President announcing a decision. A Treasury official told us that the Committee generally grants withdrawal requests. After the Committee approves a withdrawal, any prior voluntary notices submitted no longer remain in effect. Any subsequent refiling by the parties is considered as a new, voluntary notice to the Committee.

The Committee’s Implementation of Exon-Florio May Limit Its Effectiveness

The manner in which the Committee implements Exon-Florio may limit its effectiveness because (1) Treasury, in its role as Chair, has narrowly defined what constitutes a threat to national security and (2) the Committee is reluctant to initiate a 45-day investigation because of a perceived negative impact on foreign investment and a conflict with the U.S. open investment policy. As a result of the narrow definition, some issues that Defense, Homeland Security, and Justice officials believe have important national security implications, such as security of supply, may not be addressed. In addition, the reluctance to initiate the 45-day investigation compresses the time available to consider issues. This compressed time frame limits agencies’ ability to complete their analysis of some cases. The Committee encourages companies to request withdrawal of their notification to provide additional time to resolve issues and to avoid the need for investigation. However, when companies that have already completed the acquisition are allowed to withdraw, there is a substantially longer time before they refile, and in some cases they never do, leaving unresolved any outstanding concerns.

Threats to National Security Are Narrowly Defined

Under the statute, the President or the President’s designee may make an investigation to determine whether a foreign acquisition might threaten the national security of the United States. Neither the statute nor its implementing regulations define national security. This permits a broad interpretation of the term. The statute does provide factors to be considered in determining a threat to national security; however, consideration of these factors is not mandatory. These factors include the following: 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 the requirements of national security.

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.

Despite the broad coverage of the factors under the statute, Treasury and some other Committee member agencies have continued to view threats to national security in the traditional and more narrowly defined sense. That is, they based their definition on a U.S. company’s possession of export- controlled technologies or items, classified contracts, and critical technology; or specific derogatory intelligence on the foreign company. The Departments of Justice and Defense have applied a broader view of what might constitute a threat to national security. And since being added to the Committee, the Department of Homeland Security has begun to analyze acquisitions both in traditional terms and more broadly in terms of the potential vulnerabilities posed by the acquisition. According to Justice, Homeland Security, and Defense officials, 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 conducting research on developing 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.

The agencies that favor applying the narrower, more traditional definition of what constitutes a threat to national security have resisted using Exon- Florio to mitigate the concerns being raised by the Department of Defense and others. For example, in reviewing a 2001 acquisition involving a U.S. company that produced precision optics and semiconductor manufacturing equipment, Defense and Commerce raised concerns about (a) foreign ownership of sensitive but unclassified technology used in reconnaissance satellites, (b) the possibility of this sensitive technology being transferred to countries of concern, and (c) maintaining U.S. government access to the technology. Treasury officials said that the concerns raised by Defense and Commerce were not national security concerns because they did not involve classified contracts, the foreign company’s country of origin was a U.S. ally, and there was no specific negative intelligence about the company’s actions in the United States.

During a more recent review, disagreement over the scope of Exon-Florio resulted in a weakening of the enforcement provisions in an agreement. The Defense Department had raised concerns about the security of its supply of specialized integrated circuits as a result of a proposed acquisition. These unique integrated circuits are used in a variety of defense technologies, such as unmanned aerial vehicles, the Joint Tactical Radio System, and communications protection devices including devices used for cryptography. A Defense Science Board task force recently noted that the functions performed by Defense-unique integrated circuits are essential to the national defense of the United States. However, in Treasury’s view, the Department of Defense’s concerns about its supply of integrated circuits were industrial policy concerns, not national security concerns, despite the importance of these circuits to a variety of defense technologies. Treasury, as Chair of the Committee, and several other members deemed the concerns outside the scope of Exon-Florio authority and would not allow the agreement between the Departments of Defense and Homeland Security and the companies to include any mention of the Committee. As a result, a provision that included strong enforcement language was deleted from an agreement with the acquiring company. In the absence of such language, presidential or Committee action can only result if the companies materially misrepresented information during the Committee’s review. In our view, without that provision, the consequences of failure to comply with the agreement are less certain.

The Standard for Investigation Limits the Number of Investigations

The Committee has been reluctant to initiate investigations, to avoid both the negative connotations of an investigation and the need for a presidential decision. As a result, the Committee has initiated few investigations. From 1997 through 2004, the Committee received 470 notices, including 19 refilings, for 451 proposed or completed acquisitions. The Committee initiated only eight investigations during the period (see table 2).

According to Treasury Department officials, the Committee reviews foreign acquisitions with a view to protecting national security while maintaining U.S. open investment policy, which provides for equal treatment of foreign and domestic investors. The office within Treasury that provides staff support to the Committee—the Office for International Investment—is also the office responsible for promoting the open investment policy. The Committee’s goal is to implement Exon-Florio without chilling foreign investment in the United States. According to Treasury officials, being the subject of an investigation may have negative connotations for a company. If it becomes public knowledge that the acquiring company is the subject of an investigation, it may be perceived that the government views the acquisition as problematic and the stock price of the company may fall. Thus, avoiding an investigation helps maintain the confidence of investors.

Consistent with its desire to avoid investigations, the Treasury Department, as Committee Chair, applies strict criteria in determining whether an acquisition should be investigated. The criteria for initiating an investigation are the likelihood that (1) there is credible evidence that the foreign controlling interest may take action to threaten national security and (2) no other laws are appropriate or adequate to protect national security. This is essentially the same criteria provided by the statute as the basis for the President to take action to suspend or prohibit an acquisition under Exon-Florio. The Defense Department and others have stated that these criteria are inappropriate for determining whether to initiate an investigation because the 45 days of the investigation should be used to determine whether the criteria are met to inform the Committee’s recommendation to the President. Exon-Florio does not provide specific guidance for the appropriate criteria for initiating a 45-day investigation. The statute merely 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.

Withdrawals Bypass Regulatory Time Frames

Committee guidelines require member agencies to inform the Committee of concerns by the 23rd day of the 30-day review allowed by Exon-Florio. According to one Treasury official, this time frame is necessary to meet the legislated 30-day requirement for completing a review. For some cases, particularly complex ones, the 23-day rule does not allow enough time to complete reviews and address concerns. For example, one Defense official said that, without advance notice of the acquisition, the time frames are too short to complete analysis and provide input for the Defense Department’s position. Another Defense official said that to meet Treasury’s deadline, analysts have between 3 and 10 days to analyze the acquisition. In one instance, Homeland Security was unable to provide input within the time frame.

When agencies have needed more time to gather information or negotiate an agreement to mitigate national security concerns, the Committee generally suggests that companies request to withdraw their notification. If the company does not want to withdraw, the Committee can initiate an investigation. Exon-Florio’s implementing regulations permit the Committee to allow companies to withdraw their notifications at any time before a presidential decision.

When companies have withdrawn their notification prior to concluding an acquisition, the companies 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. Since 1997, companies involved in 18 acquisitions have withdrawn their notification and refiled 19 times. In one case, the company withdrew and refiled twice. In 16 cases, the acquisitions had not yet been concluded, and the time between withdrawal and refiling ranged between 0 days and 4 months (see fig. 2). In two cases, the companies had already concluded the acquisition, and 9 months and 1 year, respectively, passed before the companies refiled. In both cases, Defense or Commerce had raised concerns about potential export control issues. These concerns remained unresolved throughout the period.

In addition to cases where a company that completed an acquisition withdrew and subsequently refiled, we identified two instances in which companies that had concluded an acquisition before filing with the Committee withdrew and have not refiled. 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 another case, a company filed with the Committee over 6 months after completing its acquisition of an internet backbone company. The Committee allowed the company to withdraw the notification more than 2 years ago because the Committee was busy with another, high-profile acquisition. The Committee has not requested that the company refile even though analysts within one agency had concerns about the acquisition. As a result, the review process has never been completed. A Treasury Department official said that the member agency that has national security concerns about a particular transaction is responsible for ensuring that the company refiles. However, the Committee’s guidance to member agencies specifically states that Treasury will manage activities during withdrawal by specifying time frames and goals to be achieved.

In six of the eight investigations that have been undertaken since 1997, withdrawal was allowed after the investigation had begun. Withdrawal and refiling to restart the clock limits the potential negative connotation of an investigation. However, this practice also limits instances that require a presidential decision, contributing to the opaque nature of the Exon-Florio process because reporting to Congress on the results of Committee actions only occurs as a result of a presidential decision. Only two of the eight cases resulted in a presidential decision and a subsequent report to the Congress (see table 3).

Provisions for Monitoring Compliance Have Improved

In our 2002 report, we identified several weaknesses in the agreements that agencies negotiated with companies under the Exon-Florio Amendment. Specifically, the two agreements that we reviewed either did not specify (1) the time frame for implementing provisions of the agreement or (2) the action that would be taken if the company failed to comply within the stated time frame, thus providing no incentive for the companies to act or no penalty for noncompliance. And in one case, the company failed to meet the agreed upon time frame. In addition, the agreements did not specify which offices in Committee member agencies would be responsible for monitoring compliance with the agreements. We recommended in our 2002 report that, to ensure compliance with agreements, the Secretary of the Treasury, as Chair of the Committee, increase the specificity of actions required by mitigation measures in agreements negotiated under Exon-Florio and designate in the agreements the agency responsible for overseeing implementation and monitoring compliance with mitigation measures.

Three agreements negotiated between 2003 and 2005 contain specific time frames for actions to be taken: In a telecommunications agreement, the company was required to adopt and implement a visitation policy within 90 days after the agreement became effective.

In a software agreement, the company had to adopt mandatory policies and procedures to implement the agreement within 90 days and provide copies to the government points of contact.

In an electronics agreement, the company had to appoint a security officer and two security directors within 90 days of a vacancy to ensure compliance with the agreement, subject to approval by the Departments of Defense and Homeland Security.

Two of the three agreements also contained strong language concerning the consequences of noncompliance with the terms of the agreement. For example, these agreements stated that if the company (1) fails to comply with the terms of the agreement, (2) makes a materially false or incomplete statement, (3) increases foreign entity control, or (4) makes other material changes in circumstances, the Attorney General, the Secretary of Defense, or the Secretary of Homeland Security may raise concerns to the Committee or the President.

All three agreements also provided specific offices within the signatory agencies to which the companies are to report. For example, the telecommunications agreement designates as points of contact the Assistant Attorney General of the Justice Department’s Criminal Division, the General Counsel at the Federal Bureau of Investigation, the Deputy General Counsel for Acquisition, Technology, and Logistics at the Department of Defense, and the General Counsel at the Department of Homeland Security.

The Department of Homeland Security has taken the lead on monitoring compliance for those agreements that it has signed under Exon-Florio. According to Homeland Security officials, the agency maintains compliance tables to track companies’ compliance with time frames provided for in the agreements. To keep all interested parties informed, the Department sends out periodic e-mails to other agencies informing them of the status of companies’ compliance efforts.

The Departments of Defense, Commerce, and Justice significantly rely on Homeland Security to monitor companies’ compliance with the agreements. Homeland Security officials stated that Homeland Security Presidential Directive 7 gives the Department the authority to protect critical infrastructure assets such as telecommunications and information technology. According to a Defense official, the Department of Defense has no authority to enforce companies’ compliance with agreements signed pursuant to Exon-Florio. A Commerce Department official similarly stated that Commerce’s authority is limited to enforcing compliance with export control laws. As a result, the Department of Homeland Security is the only one of the three with broad enforcement authority. Further, according to Justice officials, while Justice has authority to seek enforcement of agreements signed pursuant to Exon-Florio and to which it is a signatory, the Department of Homeland Security has more resources for monitoring compliance as well as the legal mandate to act.

Conclusions

In the aftermath of the September 11, 2001, terror attacks on the United States and the subsequent war on terrorism, the nature of threats facing this country has changed. In addition to traditional threats to national security, vulnerabilities in areas such as the nation’s critical infrastructure have emerged as potential threats. Exon-Florio provides the latitude for the Committee on Foreign Investment in the United States to address these threats. But the effectiveness of Exon-Florio as a safety net depends on the manner in which the broad scope of its authority is implemented. The narrow, more traditional interpretation of what constitutes a threat to national security fails to fully consider the factors currently embodied in the law. Further, the time constraints imposed on agencies to develop a position before the statutory deadline limits member agencies’ ability to complete in-depth analyses. Those time constraints, together with the Committee’s reluctance to initiate investigations, can result in the Committee permitting companies to withdraw their notifications. When companies withdraw after completing an acquisition, the Committee may lose visibility over the transaction, and the companies may choose not to refile.

The initial legislation provided for congressional oversight through a requirement that the circumstances surrounding any negative decision by the President be reported to the Congress. To improve congressional oversight, the Byrd amendment expanded required reporting to include the circumstances surrounding all presidential decisions. However, the Committee’s reluctance to proceed to investigation, coupled with the use of withdrawal to resolve cases without the need for presidential decisions, has resulted in the circumstances surrounding only two cases being reported to the Congress since 1997. This criterion for reporting contributes to the opaque nature of the Committee’s process and is limiting the information that is provided to the Congress. In addition, where companies have concluded the acquisition prior to filing with the Committee and concerns have been identified, permitting withdrawal expands the opportunity for harm to national security before the Committee takes action.

Matters for Congressional Consideration

In light of the differing views within the Committee on Foreign Investment in the United States regarding the extent of authority provided by Exon- Florio, the Congress should consider amending Exon-Florio by more clearly emphasizing the factors that should be considered in determining potential harm to national security. In addition, to address Treasury’s concern with the impact of investigations on U.S. open investment policy and the member agencies’ concerns with having sufficient time to address relevant issues concerning the acquisitions, the Congress should consider eliminating the distinction between a review and an investigation and make the entire 75-day period available for review. The Committee could then be required to submit recommendations to the President only if presidential action was necessary. Also, to provide more transparency and facilitate congressional oversight, the Congress should revisit the criterion for reporting circumstances surrounding cases to the Congress. For example, the Congress could require an annual report on all transactions that occurred during the preceding year. Such a report could provide the Congress with information on the nature of each acquisition; the national security concerns raised by Committee member agencies, if any; how the concerns were mitigated; and whether each acquisition was concluded or abandoned, in addition to any presidential decisions required under the statute.

In addition, in view of the need to ensure that national security is protected during the period that withdrawal is allowed for companies that have completed or plan to complete an acquisition prior to the Committee completing its work, the Congress should require that the Secretary of the Treasury, as Committee Chair, establish (1) interim protections where specific concerns have been raised, (2) specific time frames for refiling, and (3) a process for tracking any actions being taken during the withdrawal period.

Agency Comments and Our Evaluation

We provided a draft of our report to the Departments of Commerce, Defense, Homeland Security, Justice, and Treasury for comment. In responding, the Department of Treasury noted that it was providing comments on behalf of all the members of the Committee on Foreign Investment in the United States. However, the Department of Justice provided comments in a separate letter.

Overall, Treasury disagreed with our findings. At issue is our characterization of the Committee’s process and the adequacy of insight into the Committee’s deliberations—concerns that Treasury states have caused the Committee to question our understanding of how it operates.

Our understanding of the Committee’s process is based on an extensive examination of Committee guidelines, case files, and memorandums; discussions with member agencies, including Treasury, on the process and the time frames the Committee uses to come to a decision; and a review of the laws and regulations that provide the Committee with criteria against which to assess threats to national security.

Treasury asserts that all Committee decisions are reached only by consensus among member agencies. However, during the course of our review, certain member agencies raised concerns about the Committee’s process that indicated fundamentally differing views among Committee members when reviewing certain cases. These disagreements involved different views on what constitutes a threat to national security, the sufficiency of the time allowed for reviews, and the appropriate criteria for initiating an investigation. While we agree that opposing views can, and should, be vigorously debated, such a debate does not demonstrate that issues have been fully vetted or that consensus has been reached, as Treasury implies. In fact, in a number of cases, we found evidence that indicates otherwise, for example: In one case we reviewed where member agencies disagreed over what should be deemed a national security concern, the narrower definition—one that excludes national security concerns raised by certain member agencies—has prevailed, in that the notice has been withdrawn instead of the case proceeding to investigation.

In complex cases in which national security concerns have been raised and for which Exon-Florio is the relevant statute, case documentation we reviewed revealed the significant pressures some agencies face to complete analysis within 23 days. In its comments on our draft report, the Department of Justice shared our concern with respect to the time constraints imposed by the current process. Specifically, Justice stated that “gathering timely and fully vetted input from the intelligence community is critical to a thorough and comprehensive national security assessment. Any potential extension of the time available to the participants for the collection and analysis of that information would be helpful.”

Policy-level officials from two member agencies have indicated that the debate over the criteria for initiating an investigation remains unresolved.

Given these fundamental differences, we concluded that the extent to which issues are vetted and consensus is reached on certain cases is, at best, uncertain.

Treasury also cites Committee guidelines on withdrawals—which state that parties, not member agencies, have the authority to request a withdrawal—to dispute our position that the Committee has encouraged companies to withdraw notifications to provide additional time to examine acquisitions. Guidelines stating that certain actions should be taken do not necessarily provide evidence that such actions were indeed taken. In five cases that we reviewed, letters from the companies requesting withdrawal and/or letters from Treasury, as Committee Chair, approving the requests to withdraw cited the need for more review time on the part of the government as the reason for the withdrawal. Regardless, Treasury’s detailed discussion of the withdrawal process ignores the key issue. Allowing companies to withdraw notices to provide more time for a review without initiating an investigation significantly increases the risk that companies will not refile in a timely manner—particularly in cases where the foreign acquisition has been completed—and that national security concerns will remain unaddressed. Avoiding investigations by using withdrawals also contributes to the opaque nature of the process because without an investigation there is no presidential decision and required reporting to the Congress.

Understandably, Treasury is cautious about providing details into the Committee’s deliberations, given the sensitivity of the information discussed and the need to protect it. And we appreciate the challenges each case presents. However, despite Treasury’s assertion that the oral briefings provided by agency members to duly authorized committees of the Congress when requested are appropriate, the fact that our review was prompted by congressional concerns about the Committee’s review and investigation process suggests otherwise.

Finally, Treasury criticized our review methodology—specifically, it questioned whether we spoke to all appropriate parties. We focused on the agencies that were most active in Exon-Florio reviews, as we noted to Treasury at the beginning of our review. During our preliminary discussions and throughout the review, none of the Committee member agencies, including Treasury, raised concerns with our methodology or suggested that we contact the Department of State, the United States Trade Representative, or the Council of Economic Advisers. Our reviews of the official Committee files, located at the Treasury Department, supported our view that the Departments of Commerce, Defense, Homeland Security, Justice, and Treasury were the most active agencies. Regardless, when it became clear to us that information from other Committee members could be germane, as was the case with the National Security Council, we attempted to contact them. In the case of the National Security Council, officials declined to meet with us. At the time we sent the draft report for comment, we were contacted by the Department of State and the U. S. Trade Representative who wanted to discuss the draft report. We met with representatives of both agencies to discuss their concern that our report did not adequately recognize the importance of open investment and was too focused on national security.

We recognize that in implementing Exon-Florio, the Committee must consider national security in the context of open investment—a challenge we point out in the opening statement of our report. However, the purpose of the Exon-Florio amendment is to protect national security in the context of U.S. open investment policy. It is how national security is protected through the Committee process that needs to be better understood. We believe that understanding can be enhanced by improved insight and oversight of the process.

The Department of Justice in its letter also provided technical comments, which we incorporated as appropriate. Treasury’s letter, along with our responses to specific comments, is reprinted in appendix I. Justice’s letter is reprinted in appendix II.

Scope and Methodology

To examine the process used by the Committee and its member agencies to review and investigate foreign acquisitions, we analyzed case files and discussed with Committee staff members the factors considered when cases are reviewed, the process and time frame the Committee uses to come to a decision, and the laws and regulations that provide the Committee with criteria against which to assess threats to national security.

We examined in depth nine acquisitions notified to the Committee on Foreign Investment in the United States between June 28, 1995, and December 31, 2004. We selected acquisitions based on recommendations by Committee member agency officials 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 previously notified the Committee of a prior acquisition; or (4) GAO had conducted a prior review. The objective of the case reviews was to understand and document the Committee’s and its members’ approaches to and processes for reviewing foreign acquisitions of U.S. companies. We did not attempt to validate the conclusions reached by the Committee on any of the cases we reviewed.

We also obtained information about other foreign acquisitions that we did not conduct case reviews on, and we also used information on other acquisitions obtained during prior GAO reviews. We obtained and analyzed data from relevant Committee member agencies, including the Departments of Commerce, Defense, Homeland Security, and Treasury. While we were not granted access to files held by the Department of Justice, we discussed individual cases with Justice officials and obtained adequate information to meet our objectives. We also discussed the Committee’s approach and process with Committee staff officials from member agencies most actively involved—namely, the Departments of Commerce, Defense, Homeland Security, Justice, and Treasury.

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 and compared these agreements with those GAO had previously analyzed. We discussed with Committee staff members the steps that they are taking to monitor agreements and enforce compliance.

We conducted our review from April 2004 through July 2005 in accordance with generally accepted government auditing standards.

As we agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution of it until 30 days from the date of this letter. At that time, we will send copies of this report to the Chairman and Ranking Minority Member of the House Committee on Financial Services and to other interested House and Senate committees and subcommittees. We will also send copies to the Secretaries of Commerce, Defense, Homeland Security, and Treasury and the Attorney General. We will also make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov.

Please contact me at (202) 512-4841 or calvaresibarra@gao.gov if you have any questions regarding this report. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. A list of major contributors to this report is listed in appendix III.

Appendix I: Comments from the Department of Treasury

The following are GAO’s comments on the Department of the Treasury’s letter dated August 12, 2005.

GAO’s Comments

1. Our understanding of the Committee’s process is based on an extensive review of Committee guidance and case files and structured interviews and discussions with member agencies, including Treasury. Further, except where changes in Committee make-up and proceedings have occurred since 2002, our discussion of the laws and the Committee’s process is consistent with our 2002 report. 2. As we point out in our evaluation of agency comments in the report, certain member agencies raised concerns that indicated fundamental disagreement among members when reviewing certain cases. Given these fundamental disagreements, we concluded that the extent to which issues are vetted and consensus is reached on certain cases is, at best, uncertain. 3. To analyze cases notified to the Committee and determine whether threats to national security exist, each agency effectively operationalizes its own definition of national security. The implication that individual agencies do not apply a definition is unrealistic. 4. We agree that Exon-Florio should be used judiciously as a safety net when laws other than Exon-Florio and the International Emergency Powers Act may not be effective in protecting national security—a point we make in the opening paragraph of our report. However, in cases where Committee members disagree on whether Exon-Florio applies, we have found that a more narrow definition of national security often takes precedence or the companies are allowed to withdraw their notification to avoid investigations. Treasury's rather lengthy discussion in its comment letter on the need to protect U.S. open investment policy underscores our concern. 5. In numerous case documents GAO reviewed, the definitional bounds agencies used in considering national security concerns are apparent. Some agencies followed routine analytical processes, searching specific databases related to export controls, acquisition history, and critical technology information—sources that would reveal whether the foreign acquisition involved any export-controlled technology or item or classified contracts, or whether there was specific derogatory intelligence on the foreign company. Other agencies prepared specific vulnerability or threat assessments that have their own methodological parameters. The debate among Committee members on each notification is fueled by these differing definitions. 6. We agree that, taken in total, member agencies consider a broad range of national security factors when cases are analyzed. We also agree that anything other than the broad consideration of a range of national security factors by the Committee would inappropriately limit the President’s necessary discretion to protect national security. 7. While only the President decides what constitutes a threat to national security and what actions are in the interest of U.S. national security in cases that are sent for a determination, only two cases have reached this stage since 1997. Further, only 8 of 451 cases have undergone investigations. By allowing withdrawals of notifications rather than initiating investigations, the Committee effectively pre-empts the President from using his discretion to make a determination. To this end, the Committee has defined what constitutes a threat to national security, not the President. Further, since only those few cases that go to the President for a determination require reporting to the Congress, there is little insight into the Committee’s deliberations. Our review found that for specific cases, there has been significant disagreement among member agencies on what constitutes a threat to national security and what actions are in the interest of national security. In two such cases, companies were allowed to withdraw their notices, and to date, they have yet to refile, leaving the concerns unresolved. 8. Again, Treasury’s response skews our finding. In two cases we reviewed, when an agency raised what it deemed a national security concern and other Committee members did not agree, the narrower definition of national security—which excludes the concern raised— prevailed, in that the notice was withdrawn instead of the case proceeding to investigation. Regardless, the case Treasury refers to was cited in our 2002 report as an example of an agreement in which nonspecific language made the agreement difficult to implement. For example, to mitigate a concern about access to technology, the agreement required a “good faith effort” to divest a subsidiary. When the company divested part, but not all, of the subsidiary—citing lack of interested buyers as the rationale—government officials could not determine whether the company’s efforts were made in good faith because the agreement did not include criteria defining what actions would constitute a good faith effort. In addition, the agreement contained no consequences for failure to comply with the monitoring terms of the agreement within the stated time frames, and as we noted, the company failed to meet the terms of one provision. Given this outcome, it is unclear how Treasury can assert that “extensive mitigation measures were put in place” or how this case exemplifies that all member agencies participate in the Committee’s decision- making process. 9. We agree that the decision to undertake an investigation demands careful deliberation on the part of all Committee members. However, in two cases we reviewed, documentation shows that in determining whether to initiate an investigation, Treasury, as Committee Chair, applies essentially the same criteria that the Exon-Florio amendment directs the President to use to decide whether to take action to suspend or prohibit a transaction. While Treasury states that an investigation is entirely appropriate if national security issues remain unresolved at the end of the 30-day review period, we found that rather than initiating an investigation, the Committee commonly allows companies to withdraw their notifications and refile at a later date to provide more time for review. Our report has not cited cases where a Committee decision not to investigate was the result of the application of an overly strict standard for deciding whether to investigate because where we noted the application of this standard, the companies withdrew their notice.

Further, by applying the Presidential decision-making criteria at the conclusion of the 30-day review, the Committee effectively preempts the President’s opportunity to make a determination. In a 2004 case, documentation from a policy-level meeting shows that the appropriateness of applying these criteria in Committee deliberations was debated; the debate was not resolved at the time, and officials from two separate agencies told us that the debate continues. The implementing regulations for Exon-Florio make no distinction between the activities the Committee undertakes during the review and investigation periods—other than preparing a report to the President at the end of an investigation—and provide no criteria for determining when to initiate investigation. It is, in part, for this reason that we are proposing that the entire 75-day period be available for analyzing cases, if needed. Eliminating the distinction between the review and investigation periods would help ensure that sufficient time is available for thorough analyses of cases and that the presidential decision-making criteria are only applied by the President. 10. Guidelines requiring that certain actions be taken do not provide evidence that such actions were indeed taken. For example, in one 2004 case we reviewed, after a policy-level decision to initiate an investigation was made, some Committee member agencies, including the Chair, placed calls to corporate counsel informing them of the pending investigation and advising that their clients withdraw their notices. Because the companies withdrew, an investigation was never initiated. 11. As stated in our report, we understand that the purpose of the 23-day rule is to enable the Committee to meet its obligations under Exon- Florio’s statutory time limits for 30-day reviews. For the majority of cases where national security concerns either do not exist or agency members agree that concerns are addressed by other laws, the 23-day rule may help facilitate the closure of cases before the expiration of the 30-day review period. However, in complex cases—cases in which national security concerns have been raised and for which Exon-Florio is the relevant statute—case documentation we reviewed revealed the significant pressures some agencies face to complete analysis within 23 days. In five cases that we reviewed, letters from the companies requesting withdrawal and/or letters from Treasury, as Committee Chair, approving the requests to withdraw cited the need for more review time on the part of the government as the reason for the withdrawal. In one such case, an electronic message we reviewed cited the Committee’s workload on another high profile case as the reason that the Committee sought to have a notice withdrawn. In that case, the transaction had already been completed and the company had requested withdrawal on day 23, before agencies completed their analysis to determine whether to request an investigation. Because the company never refiled a notice, the national security concerns identified by two member agencies have not been further examined. Further, it should be noted that in its comments, the Department of Justice said that any additional time that could be made available to collect and analyze information needed to conduct a thorough and comprehensive national security assessment would be helpful. 12. We have acknowledged the use of mitigation agreements in our current report as a major tool used by the Committee. In fact, we point out that the more recent mitigation agreements have addressed several of the problems with such agreements that we noted in our 2002 report. However, strengthening or increasing the number of mitigation agreements does not ensure that all national security concerns raised by member agencies are sufficiently examined. Further, the particular passage cited by the Under Secretary is not disputing that mitigation agreements are often negotiated but rather is pointing out that there is not agreement on when these mitigation agreements are needed. As we reported, agencies that apply the more traditional definition of what constitutes a threat to national security have resisted using Exon- Florio to mitigate or address the concerns raised by other Committee members. 13. We have revised our report to reflect that the Departments of Defense, Commerce, and Justice significantly rely on DHS to monitor companies’ compliance with the agreements. 14. We did not mean to imply that Justice does not have the authority to undertake enforcement actions and have clarified that in the report. 15. We agree that the Federal Bureau of Investigation and other Justice Department components have been and continue to be a very active and critical participant in the Committee’s process. We also acknowledge there are other Committee agency components that are also critical to the process such as the Bureau of Industry and Security in the Department of Commerce; the Office of the Under Secretary of Defense for Acquisition, Technology and Logistics–Industrial Policy, and the Central Intelligence Agency. Committee member agencies use many internal resources as part of their process. 16. A remedy is defined as a legal means of preventing or redressing a wrong or enforcing a right. A Defense official confirmed that the provision in question that was deleted from the agreement stated that if the company (1) fails to comply with the terms of the agreement, (2) makes a materially false statement, (3) increases foreign entity control, or (4) makes other material changes in circumstances, the Attorney General, the Secretary of Defense or the Secretary of Homeland Security may raise concerns to the Committee or the President. Without having this provision, it is unclear what remedy will be available to the Committee and its member agencies to enforce this mitigation agreement. 17. Despite what is stated in the guidelines, in practice the Committee has allowed companies or parties to withdraw their notices to provide member agencies additional time to complete their analyses or to negotiate mitigation measures. Documentation from Committee files shows that 12 of the 20 withdrawals we identified that have been granted since 1997 to companies that intended to continue the acquisition were granted to allow member agencies to either negotiate mitigation agreements, continue obtaining information from the companies, or otherwise continue analyses. 18. Of the 26 letters granting withdrawal that we reviewed, only three explicitly stated conditions for the withdrawal: in two cases, the companies were abandoning the transaction; in the third, the company agreed to divest its U.S. acquisition. 19. We recognize that the President retains the authority to take action if the Committee’s review is not completed. However, our review of case files does not support the Under Secretary’s assertion that Treasury, as Chair, tracked developments on the withdrawn cases that were notified after the transactions were closed. Further, it is unclear how Treasury could conclude that refiling is unnecessary in these cases, given that the withdrawals were granted to provide additional time to resolve specific concerns raised by other agencies. For example, in one case, a Treasury official told us that she was unaware that the Department of Defense had concerns. By not having the companies refile, Defense’s concerns were not fully vetted. In another case, a Defense official provided documentation indicating that the Defense Department’s position remained that conditions should be imposed on the transaction. In our view, refiling serves two purposes: (1) it provides assurances to the companies that action will not be taken at a future date and (2) it permits Committee member agencies to ensure that no national security concern was overlooked. 20. The documentation we reviewed clearly showed that Treasury and Defense have different views of what constitutes a threat to national security. For example, in one case, Treasury officials wrote three separate memos stating that in Treasury’s view, Defense and Commerce Department concerns about (a) foreign ownership of sensitive but unclassified technology used in reconnaissance satellites, (b) the possibility of this sensitive technology being transferred to countries of concern, and (c) maintaining U.S. government access to the technology were not national security concerns. 21. We agree that vulnerabilities can result from a variety of things not addressed by Exon-Florio. We merely provided examples of the kinds of vulnerabilities that may result from foreign control. We were not addressing the universe of vulnerabilities, only some of those addressed by Exon-Florio, the subject of our report. 22. We agree that Exon-Florio provides broad latitude for the Committee to consider whether foreign acquisitions constitute a threat to national security. Our concern is how Exon-Florio is being implemented. Given the internal disagreement among Committee members and the lack of transparency as to how disagreements are resolved, we believe that additional guidance from the Congress would be beneficial. 23. We recognize that, in most instances, 30 days is sufficient to conclude reviews. If Exon-Florio were amended, then we expect that the Committee could manage the process so that the vast majority of cases would continue to be completed within 30 days. However, Exon-Florio is to be used when other laws are inadequate—in short, to act as a safety net. The ability to complete “a vast majority” of reviews in 30 days is not relevant to Exon-Florio’s importance as a safety net. Moreover, as we point out in our report, some agency officials have stated that 30 days is insufficient in complex reviews. The Justice Department, in its official comments, stated that any potential extension of the time available to the participants for the collection and analysis of information from the intelligence community would be helpful (see page 2 of Justice Department comments in app. II).

Treasury officials have pointed out that being the subject of an investigation may have negative connotations for a company, and that the Committee tries to avoid initiating investigations. By eliminating the distinction between investigations and reviews, this negative connotation and the potential impact on investment would no longer exist.

The Under Secretary expressed concern that extending the time frames would deter filings but did not explain the basis for his concern. However, the Committee need not rely solely on voluntary filings. The implementing regulations state that “any member of the Committee may submit an agency notice of a proposed or completed acquisition to the Committee through its staff chairman if that member has reason to believe, based on facts then available, that the acquisition is subject to section 721 and may have adverse impacts on the national security. In the event of agency notice, the Committee will promptly furnish the parties to the acquisition with written advice of such notice.” 24. The Congress has made numerous efforts to conduct oversight of the Committee’s activities—first in the original Exon-Florio legislation by requiring a report when the President prohibited an acquisition, and again in 1992 by passing the Byrd Amendment to require a report when the President makes any decision regarding a foreign acquisition. In addition, in requesting our review, the Senate Banking Committee cited the “opaque nature” of the Exon-Florio process as a reason for its request, which suggests that the Committee on Foreign Investment in the United States has not been successful in keeping the Congress adequately informed. We agree that the confidentiality afforded to the companies under Exon-Florio should not be compromised. However, subsection (c) of the statute provides that the confidentiality provisions “shall not be construed to prevent disclosure to either house of Congress or to any duly authorized committee or subcommittee of the Congress.” Therefore, we stand by our suggestion that the Congress may wish to revisit the congressional reporting requirement. 25. As we stated in our 2002 report, the regulations should not call for negotiating interim measures, but rather for the Committee to use its authority to impose them as a condition of withdrawal where the transaction has been completed or will be completed during the withdrawal period. Further, as we state in our report, “the Committee’s guidance to member agencies specifically states that Treasury will manage activities during withdrawal by specifying time frames and goals to be achieved.” Because Treasury has declined to implement our recommendation, we are including our recommendation as a matter that Congress may wish to consider.

Appendix II: Comments from the Department of Justice

Appendix III: GAO Contacts and Staff Acknowledgments

GAO Contact

Acknowledgments

In addition to the contact named above, Thomas J. Denomme, Assistant Director, Allison Bawden, Gregory K. Harmon, Paula J. Haurilesko, Karen Sloan, John Van Schaik and Michael Zola made key contributions to this report.

Related GAO Products

Defense Trade: Mitigating National Security Concerns under Exon- Florio Could Be Improved. GAO-02-736. Washington, D.C.: September 12, 2002.

Defense Trade: Identifying Foreign Acquisitions Affecting National Security Can Be Improved. GAO/NSIAD-00-144. Washington, D.C.: June 29, 2000.

Foreign Investment: Implementation of Exon-Florio and Related Amendments. GAO/NSIAD-96-12. Washington, D.C.: December 21, 1995.

Foreign Investment: Foreign Laws and Policies Addressing National Security Concerns. GAO/NSIAD-96-61. Washington, D.C.: April 2, 1996.