CFIUS v. Nippon Steel

Black boxes make for great thought experiments, but tricky investments.

I have talked a bit on Valorem and on podcasts about the Kelly criterion and assigning odds to my convictions. Particularly for binary outcome, event-driven theses, you need to have some sort of view on the underlying odds to determine a reasonable position size. But as we saw with Spirit, those odds can be difficult to pin down when the thesis depends on a sole adjudicator who doesn’t have a repertoire of perfect precedent. Unlike Chancellor McCormick who, prior to the Twitter merger, had ruled on a nearly identical case, Judge Young had taken exactly zero antitrust cases to trial. Consequently, we had to rely on cases from other judges—often out-of-Circuit and out-of-date—to arrive at our conclusion. This didn’t work out the way I expected it to, but of course hindsight is 20/20. That isn’t to say such a world is always indecipherable. This is exactly what lawyers do every day, drawing parallels from other cases in support of their ultimate conclusion. It’s fair to assume in broad strokes, however, that with lower quality precedent there is lower quality conviction.

So what do you do if you have next to no case law?

That’s the scenario investors find themselves in when the Committee on Foreign Investment in the U.S. (“CFIUS” or phonetically “sih-fee-us”) reviews a proposed merger.

There are some CFIUS scenarios that require little explanation or would come as little surprise. Of course the U.S. would intervene if a Chinese entity tried to buy Lockheed Martin. We don’t sell the F-22 Raptor to our own allies; we sure as hell aren’t letting adversarial countries gain access, whether by espionage or M&A. Similarly, we wouldn’t allow a Russian politician to purchase a bunch of land in Langley, VA next to the CIA headquarters. It doesn’t matter how tall the fences are.

It’s easy to look at the proposed Nippon / U.S. Steel merger and conclude that it is very different from either of the above scenarios, and that there is no threat to national security. Japan is an ally. Steel is a commodity. We aren’t worried about countries getting secret steel manufacturing plans. Nor are we worried about, well… any country really, having access to land in Troy, Michigan or Gary, Indiana.

But knowing when CFIUS may object is not always so simple. Even the history of the agency is not as straightforward as you might expect. If I told you CFIUS was created via executive action by Gerald Ford and expanded under Ronald Reagan, you’d probably conclude that it was events from the Cold War that precipitated the creation and development of the agency. However, when President Reagan augmented CFIUS powers from “monitoring” foreign investment to substantively reviewing and making recommendations with respect to foreign investment, he wasn’t looking at the U.S.S.R. He was looking at Japan.

Japan had been quietly acquiring U.S. assets for several years during the early 1980s, a spree gestating concern among the American executive branch. One such concerning transaction was the investment by a Japanese entity into a U.S. steel business, Rouge Steel Co—a subsidiary of the Ford Motor Co. So when Fujitsu subsequently tried to acquire Fairchild Semiconductor in 1986—several years into the Japanese buying spree—broad public panic ensued, with some calling it an “economic Pearl Harbor.”

The U.S. would go on to enact the Omnibus Trade and Competitiveness Act of 1988, which included the Exon-Florio Amendment. The Exon-Florio Amendment authorized the President to suspend or prohibit foreign acquisitions of U.S. companies where "there is credible evidence that leads the President to believe that the foreign interest exercising control might take action that threatens to impair the national security.” Reagan immediately delegated the review process to CFIUS. CFIUS would go on to issue hundreds of notices for potential transactions and subsequently review many of the same, but the reviews rarely culminated in executive action. Rather, the weight of the review itself was often enough to scupper the deals.

CFIUS powers continued to evolve over the decades. The Byrd Amendment to the 1993 National Defense Authorization Act required review of transactions involving foreign state actors. The Foreign Investment and National Security Act of 2007 (FINSA) formalized many aspects of the agency, adding roles for the Director of National Intelligence and the Secretary of Labor, along with adding the authority—and indeed, mandate—for CFIUS to review all “covered transactions.” These covered transactions were defined broadly:

Despite a lack of definition under FINSA, the term “Control” has been extensively defined by subsequent regulations. “National Security,” however, has not, leaving broad room for interpretation as to what transactions pose a threat to the U.S.

The final major overhaul to CFIUS’s powers came under Title XVII Subtitle A of the National Defense Authorization Act for Fiscal Year 2019, aka the “Foreign Investment Risk Review Modernization Act,” or “FIRRMA.” Under FIRRMA, CFIUS was charged with not only reviewing mergers and acquisitions for national security purposes, but with reviewing any form of transaction (including, e.g., minority stake ownership) which challenged U.S. technological supremacy. Only investments in non-existent businesses (i.e., “greenfield investments”) fall outside of CFIUS’s jurisdiction. In other words, the issue is now expressly about preserving U.S. dominance:

from Title XVII REVIEW OF FOREIGN INVESTMENT AND EXPORT CONTROLS

So how does CFIUS review work, in practice?

First, it’s generally true that CFIUS initiates its review sua sponte, and companies undergoing a merger are not required to file a notice with CFIUS. If the transaction is big enough and important enough, CFIUS will hear about it, particularly now that the Hart-Scott-Rodino Notice pathway requires disclosure of such large transactions to the FTC and DOJ. Only if the business being acquired or receiving investment is a “TID US business” (“Technology, Infrastructure, or Defense,” e.g., businesses collecting sensitive U.S. citizen data, businesses involved in critical infrastructure like nuclear energy, or businesses involved in critical defense contracting), does FIRRMA require a declaration pursuant to 31 C.F.R. § 800.308 Subpart D. Failure to notify CFIUS of such a transaction within 30 days of consummating the deal may result in penalties up to the value of the transaction itself. Given CFIUS’s broad scope, it’s usually best to provide notice to CFIUS, even if the transaction is not a TID US Business transaction.

Where a declaration is not necessary, the parties will submit a pre-filing notification, triggering a 1-2 week back and forth with CFIUS, after which they will submit a formal notification of the transaction. The filing is then followed by an initial 30-day review. If the transaction requires further inquiry, CFIUS will conduct a 30- or 45-day investigation (extendable by one 15-day period), after which it will (1) issue a “no action” letter effectively allowing the transaction, (2) provide recommendations to the parties on how to address issues with the transaction or (3) end in a formal recommendation to the President to block the transaction. The President then has 15 days to formally block.

In total, the pre-investigation back and forth, notice period, review and investigation can take months:

from Cooley’s CFIUS Overview

Unfortunately for companies whose transactions draw the ire of the president in the form of a presidential block, such action is not subject to judicial review under the Exon-Florio Amendment. That means we don’t get case law which pressure tests why transactions are blocked. There is no express guidance for companies, nor is there a commitment to abide by historical rationale.

So while the Nippon Steel transaction appears reminiscent of the Rouge Steel deal from 1982, the reality is that we cannot know the fate of the transaction with any semblance of certainty absent a peek behind the CFIUS curtain. Moreover, CFIUS has morphed several times over since the Reagan administration, and is, at its core, still a highly political agency subject to the whim of the current administration. All we have to base our guesses on are some broad statistics from CFIUS’s annual report to Congress:

from the 2022 CFIUS Annual Report to Congress

from the 2022 CFIUS Annual Report to Congress

In CFIUS’s entire history, only one case has actually been litigated, casting a dim light on an otherwise pitch-black box. When the Obama administration ordered the Chinese Ralls Corporation to divest wind farm land that was too close to a DoD facility, Ralls Corp. sued, claiming its due process rights were violated. The District of D.C. ruled Ralls’ claims moot and dismissed the case for failure to state a claim. In a reversal of the District of D.C., the Court of Appeals for the D.C. Circuit ruled that Ralls’ due process rights had in fact been violated because Ralls Corp. was not given any opportunity to rebut even unclassified, non-privileged information against it in the CFIUS review process. Ralls and the Obama administration would go on to settle the case, stymying any hopes for additional clarity on CFIUS reviews.

THE U.S. STEEL TRANSACTION