Was DP World Just the Beginning?

Hedge funds should factor in national security concerns

Originally published in the July 2007 issue

Nothing in life is simple. Just ask DP World, which, when it dutifully approached the Committee on Foreign Investment in the United States (CFIUS) in October 2005 (following the advice of former US President Bill Clinton) over its planned acquisition of British company P&O, it fully expected that its acquisition of the six port management leases P&O owned in the US would be approved. And it was, despite reservations raised by the US Coastguard.

Nobody in Washington DC’s legal community, or in the US government, seem to have anticipated the furore that would be sparked off when Eller & Company, a Florida firm with two joint ventures with P&O, hired a semi-retired lobbyist to represent its objections to Capitol Hill. Once New York senator Chuck Schumer (D) had got on board, the story’s profile was raised, provoking more questions in Congress, and ultimately led to the eventual sale of P&O’s US operations to AIG for an undisclosed sum.

The important point here is the role played by CFIUS. The agency, which is tasked with ensuring that US companies that are of a nationally strategic character (including everything from software firms with government contracts to utilities) do not fall into the hands of hostile states, has been around since the closing days of the Reagan administration. During the Clinton years there was very little concern about foreign transactions in the US, and consequently CFIUS’ role was somewhat overlooked in the euphoria that followed the end of the Cold War.

Since 2003, however, bids by companies from countries like China, France, Israel, and the UAE of course, have come under an enhanced degree of scrutiny. The Chinese National Oil Company’s bid for Unocal was derailed in 2005, again by hostility to the deal in Congress. Despite a hands-off policy from the White House – which has generally been more positive about foreign acquisitions in order not to alienate important allies – cross-party concerns in Congress about a communist-owned entity acquiring a major US energy firm prevailed.

The pattern here seems to be one of hysteria being stoked up by lobbyists who raise the spectre of national security at a time when fears over terrorist attacks have produced a high level of domestic paranoia about the intentions of foreign governments. The fact that some of these suitors are largely owned by foreign governments has exacerbated the issue.

All this fuss has left CFIUS in a difficult position. Despite having approved the DP World deal, it has seen DP World largely forced to sell off P&O’s US operations via political interference. It is now having to consider new bids far more carefully, rather than risk a repeat performance. But the after-effects of the DP World fracas are still being felt, with Congressmen much readier to listen to complaints from their constituents about proposed acquisitions by foreign companies.

Where does all this leave hedge funds? For starters, major acquisitive moves have tended to attract funds interested in the merger arbitrage opportunities they represent, and DP World/P&O was no exception in this respect. It is also no coincidence that AIG’s investment management arm, which has interests in hedge funds, real estate, and private equity, was on hand to buy the US port operations when they came up for sale.

“The US economy needs a net inflow of capital of $3 billion a day to keep it afloat, yet all the body language is ‘go away'”

Deals on this scale are increasingly becoming familiar territory for many managers. What makes things more difficult is the involvement of government agencies like CFIUS and US politicians. Foreign acquirers of US assets from countries like China and the UAE may now be less likely to bid for big US businesses, but there is still every possibility they will succeed. Similarly, some M&A funds might want to steer clear of a dealthey think looks too controversial to receive approval from CFIUS, but it is worth keeping as informed about the details of the case and the likely outcome as it is possible to be.

There is an emerging trend in US investment management for funds to consult counsel on the likely outcome of a hearing that could affect the share price of an investment. The same goes for a referral to CFIUS. Expert legal advice can help a portfolio manager to make an educated assessment of which way a ruling is likely to fall. It is not something that is easy to quantify, but it might provide a hedge fund with a critical informational edge over the market.

The birth of CFIUS

Although CFIUS was created in the 1970s, it achieved more importance via its use by the President to implement the requirements of the Exon-Florio Amendment to the Defense Production Act of 1950. The law was amended in 1992, but since then regulations concerning foreign takeovers of US companies have become more formalised. The legislation has deliberately not defined national security, however, allowing it be applied as widely as possible. Indeed, according to Barry Cohen, a partner with Crowell & Moring in Washington DC, “National security encompasses today some 65% of US businesses. It can be invoked over something as banal as closing a plant or transferring jobs overseas.”

After an initial spurt of cautionary filings, practitioners soon became comfortable that only business whose technology or products were significant to defence or intelligence efforts posed a concern. Post-Dubai Ports Congress has suggested (and CFIUS has followed) looking at ‘critical infrastructure.’ It is this broadened via of national security which, if codified in the new legislation, will be likely to encompass 65% of US business.

CFIUS pursues a very specific mandate: lending transactions are outside its purview, as are the establishment of US subsidiaries by foreign companies. “CFIUS is interested even if a target is developing technology that could have applications in a sensitive area,” says Alan Gourley, another partner with Crowell & Moring in Washington DC. “This is not just the preserve of government contractors.”

At the moment consultation of CFIUS remains a voluntary program, although the agency is known to closely monitor the pages of the Wall Street Journal and the newswires and does occasionally inquire when foreign firms are planning to file their request for review. There is every chance in the current political climate that it will eventually become compulsory for prospective acquirers from a given list of states to lodge an application with CFIUS. Crowell & Moring’s Cohen advises his clients to file regardless, well ahead of any news of a prospective deal becoming public knowledge. “It is unlikely that a transaction of significance will escape notice,” Cohen says. “A transaction not submitted to CFIUS is subject to unwinding at a later time. There is also no appeal once CFIUS decides it is not subject to judicial review as it falls under national security. However, once you get approved, that’s it, even if subsequent events indicate some degree of threat.”

Fund managers specialising in the M&A space need to be aware of just how far this legislation travels; even a foreign to foreign transaction could stumble if significant underlying subsidiaries are subject to CFIUS. There is also no list of countries which are considered to be more likely to provoke a CFIUS review, but Cohen advises clients in the grey area to err on the side of caution.

A CFIUS investigation is composed of a two-stage process, an initial review that has to be completed within 30 days to determine whether a filing is required, and a second review that can be triggered following the primary investigation, lasting for 45 days. Transactions that are investigated by CFIUS are then referred to the President, who has 15 days to approve them. If CFIUS determines in the initial 30 day review that there is not a sufficient threat to national security to investigate the transaction, then that is the end of the matter. The kinds of questions raised during the review, and by which the application will be measured, include the ownership of the buyer (as well as whether that buyer is controlled by a foreign government or has a foreign government as a substantial shareholder), whether the target currently does business with the US government, and what the intentions of the buyer are for the US business (eg. will jobs be moved offshore?)

As if this were not enough, Cohen and Gourley are warning clients that there is a whole slate of new legislation before Congress at the moment which could further modify CFIUS’ role or affect foreign acquisitions more widely. By their estimate, there were 20 separate bills on foreign acquisitions before the last Congress of which two were passed, one in the House, and one in the Senate. Amongst the proposals are one for the existing legislation to be codified to cover “critical infrastructure” and another for CFIUS to become a statutory body. Other US government departments could be added to the committee (eg. the Department of Energy and the Department of Labour might take a hand), and CFIUS could be given the power to call witnesses, although not to subpoena them.

“The Government Accountability Office is concerned that there is no monitoring of what is happening to the transaction if it is withdrawn,” says Gourley. “A material breach of the mitigation agreement is grounds for a new review. Some 35 to 40% of transactions will have some degree of mitigation. We want to avoid the Dubai Ports situation by keeping Congress informed.”

Can fund managers expect to see the whole issue of foreign acquisitions becoming increasingly regulated? Cohen finds it hard to predict: “I don’t know whether we’re still moving in the direction of greater regulation,” he says. “Certain civilian and all military technology is already subject to export controls, for example. Export is defined as not only transmission outside the US, but disclosure in the US to foreign persons. This can apply to US technology and products even if incorporated into a foreign company’s products. Technology companies, for example, have had to compartmentalise R&D into US and non-US segments. Subsidiaries of firms which have significant interests from sanctioned countries cannot sell to the Department of Defense.”

For companies in the aerospace and defence sectors, it is already a minefield, but now many other US sectors are being affected, including healthcare and IT. Rupert Murdoch’s famous 1985 decision to take US nationality was based on the restriction barring foreigners from owning television stations, but we are increasingly seeing such restrictions being spread to unlikely areas of US business. Smartmatic, a Dutch firm, had its proposed acquisition of Sequioa Voting Systems reviewed on the grounds that it had helped Venezuela with its new elections machinery. In this case, the fact that a company had Venezuela’s government as its client, not as its shareholder, was sufficient to prompt action.

Would a change of government make things easier or harder for foreign acquirers? It is difficult to say, given the cross-party support for further legislation. If anything, the White House has been trying to discourage too hostile a hearing for foreign investors in the US economy, and indeed went into bat for DP World. “The Democrats may be even more sensitive,” says Cohen, pointing at their links with unions and concerns about US jobs being migrated offshore.

But there are voices being raised in opposition. Former Reagan administration official Clyde V. Prestowitz Jr told the New York Times last year that the US economy would need a net inflow of capital of US$3 billion a day to keep it afloat, “yet all the body language is ‘go away’.”


It has been the increased degree of concern evidenced on Capitol Hill that has really pushed CFIUS’ activities into the limelight, and made it more concerned about the detail with which it vets applications. Major deals that fall under CFIUS’ jurisdiction are highly likely to become heavily politicised. As Gourley points out, “This is fertile ground for lobbying…economic nationalism is becoming a force behind what Congress is doing.”

It has been the increased degree of concern evidenced on Capitol Hill that has really pushed CFIUS’ activities into the limelight, and made it more concerned about the detail with which it vets applications. Major deals that fall under CFIUS’ jurisdiction are highly likely to become heavily politicised. As Gourley points out, “This is fertile ground for lobbying…economic nationalism is becoming a force behind what Congress is doing.”


Partner, Crowell & Moring

Barry E Cohen divides his time between Crowell & Moring’s International Practice Group, which represents domestic US and foreign businesses on international trade and dispute resolution matters, and its professional responsibility practice area.

In the trade area, he has over 25 years of experience in the regulation of trade by the US, foreign governments and international organisations. He represents US domestic industries and importers on matters arising on US customs laws, including valuation, classification, audit, and enforcement matters. He also counsels clients on export controls trade remedy (eg. anti-dumping and countervailing duty) laws, and the Foreign Corrupt Practices Act.

Cohen’s practice includes counselling, business planning, and representation in government agency and judicial proceedings. Cohen regularly litigates trade cases before the US Court of International Trade. Prior to joining Crowell & Moring he worked for the Department of Defense, where he advised defence agencies on export control and international law issues.

Partner, Crowell & Moring

Alan W H Gourley is a partner in Crowell & Moring’s Washington DC office, and advises clients on a wide range of international and government contract issues. He has extensive experience with all aspects of international contracts, both government and commercial. He counsels and defends clients with respect to compliance with US export controls and sanctions regulations, the Buy American Act, Berry Amendment and Trade Agreements Act requirements, the Foreign Corrupt Practices Act, the Foreign Military Financing program, foreign military sales, US AID grants and procurements, World Bank procurements and other laws and regulations applicable to international transactions. He also counsels clients concerning US laws and regulations applicable to foreign investment and ownership in the US, such as Exon-Florio and the National Industrial Security Program, and with respect to investment protection provided overseas by various Bilateral Investment Treaties (BITs) and Free Trade Agreements.

Gourley is admitted to practice in the US Supreme Court as well as in several federal and district appellate courts throughout the country. He has litigated numerous contract cases against the US and arbitrated cases against foreign governments and international organisations.