oversight

Issues Relating to Foreign Investment and Control of U.S. Airlines

Published by the Government Accountability Office on 2003-10-30.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

United States General Accounting Office
Washington, DC 20548



          October 30, 2003


          The Honorable Trent Lott
          Chairman
          The Honorable John D. Rockefeller
          Ranking Minority Member
          Subcommittee on Aviation
          Committee on Commerce,
           Science, and Transportation
          United States Senate

          Subject: Issues Relating to Foreign Investment and Control of U.S. Airlines

          In May 2003, the Bush Administration proposed amending the legislation that
          currently restricts foreign ownership of U.S. airlines, raising the allowable percentage
          of total foreign ownership of voting stock in U.S. airlines from 25 to 49 percent. The
          Department of Transportation (DOT) suggested that implementing this amendment
          could provide significant benefits to U.S. consumers and airlines, particularly by
          providing access to additional capital, which would help the financial health of the
          industry. DOT and the Department of State also maintain that these new limitations
          would bring the United States in line with current foreign ownership laws of the
          European Union (EU).

          Concerned about the effect that changes in foreign ownership and control
          requirements might have on the aviation industry, national interests, and
          consumers—and recognizing that we examined this issue in 1992 when DOT earlier
          proposed increasing the level of foreign ownership—you asked us to discuss two
          related topics: (1) current proposals to revise U.S. limits on foreign ownership and
          control, including information on current shareholders and past examples of efforts
          by foreign interests to purchase significant equity in U.S. air carriers and (2) whether
          key analytic issues raised in our 1992 report on foreign ownership and control remain
          relevant.1 This report summarizes the information we provided to Committee staff
          during our June 25, 2003, briefing pursuant to your request. The briefing slides,
          which provide more details about our analysis, are attached as enclosure I.




          1
          U.S. General Accounting Office, Airline Competition: Impact of Change Foreign Investment and
          Control Limits on U.S. Airlines, GAO/RCED-93-7 (Washington, D.C.: December, 1992).


                                                            GAO-04-34R Foreign Investment in U.S. Airlines
In summary:
    • Foreign airlines have attempted to invest in and influence the operations of
      U.S. airlines several times since the late 1980s. These foreign airlines have on
      occasion invested significant amounts of capital into U.S. airlines, only to later
      disinvest due in part to U.S. policies concerning airline control. The
      Administration’s proposal does not seek to change U.S. law regarding control
      of air carriers.
    • Our 1992 report identified five key issues relating to raising the limit on foreign
      investment in U.S. airlines. In general, those issues covered the potential
      impact of foreign investment on domestic competition, national security,
      employment, safety, and international competition. Because the current
      economic environment and the state of the aviation industry are similar to that
      in existence at the time of the prior report, we believe that most of these
      issues remain relevant today.

Background
Congress first enacted citizenship requirements for U.S. airlines with the Air
Commerce Act of 1926. That act required that U.S. citizens own at least 51 percent of
any individual aircraft in order for it to be registered in the United States. Under the
Civil Aeronautics Act of 1938, Congress required that U.S. citizens own or control at
least 75 percent of the voting interests of U.S. airlines. This standard has remained
the same since then.2

Under current U.S. law, in order to operate as a U.S. airline, an entity must obtain a
certificate of public convenience and necessity or an exemption from the certification
requirement from DOT. A prerequisite for obtaining such authority is U.S.
“citizenship.” Current U.S. law defines a “citizen of the United States” as an
individual U.S. citizen, a partnership whose members are U.S. citizens, or a
corporation or association organized under U.S. law where at least 75 percent of the
                                                          3
voting interest is owned and controlled by U.S. citizens. The law also specifies that
the President, as well as at least two-thirds of the Board of Directors of the
corporation, must be U.S. citizens. In practice, DOT has interpreted control to mean
that day-to-day management decisions must be made by U.S. citizens, even if there is
substantial foreign investment in the airlines. That is, the law has been construed as
requiring actual control of the enterprise to rest with U.S. citizens.

In addition to DOT’s initial citizenship evaluation of an airline when it first applies for
certification, DOT again reviews the airline’s citizenship status following any
2
The United States has restricted ownership and control of U.S. airlines for four primary reasons: (1)
protection of the then-fledgling U.S. airline industry, (2) regulation of international air service through
bilateral agreements, (3) concern about allowing foreign aircraft access to U.S. airspace, and (4)
military reliance on civilian airlines to supplement airlift capacity. See U.S. General Accounting Office,
Airline Competition: Impact of Changing Foreign Investment and Control Limits on U.S.
Airlines, GAO/RCED-93-7 (Washington, D.C.: Dec. 9, 1992).
3
    49 U.S.C. 40102.



Page 2                                                  GAO-04-34R Foreign Investment in U.S. Airlines
substantial change in an airline’s ownership, management or operations.4 This is
done on a case-by-case basis. In a March 2003 review of DOT’s citizenship evaluation
process, the DOT Inspector General found that no single document defines the
process or criteria to be applied for the review and that DOT examines several
factors when determining the issue of control.5 These factors include any significant
contracts between the airline seeking citizenship and its business partners, voting
rights held by U.S. and non-U.S. citizens, and the terms of any debt instruments or
bankruptcy agreements. During its analysis, DOT determines whether a foreign
entity’s influence over any of these factors shifts the actual, day-to-day control of the
airline from U.S. citizens to foreign citizens.

DOT has previously proposed easing the restrictions on foreign investment in U.S.
airlines. In 1991, the Secretary of Transportation proposed allowing foreign investors
to own up to 49 percent of a U.S. airline’s voting stock, although no legislative
proposal was submitted to the Congress. According to DOT officials, the proposal
was made in response to heavy losses suffered by U.S. airlines in 1990 and 1991, and
experience gained in structuring foreign investments to maintain U.S. citizen control
by working with two major U.S. airlines (Northwest Airlines (NW) and Continental
Airlines) and their foreign investors. Congress did not adopt these proposals.

Proposed Legislation Would Affect Ownership and Control of U.S. Airlines
The latest efforts to change U.S. foreign investment and control restrictions were
submitted as two separate amendments to the Federal Aviation Administration (FAA)
reauthorization bill (H.R. 2115 and S. 824).

The Administration proposed an amendment that would relax the restrictions on
foreign-owned voting stock of U.S. airlines from 25 to 49 percent, while not changing
the policy that U.S. citizens control U.S. airlines. DOT suggested that increasing
allowable foreign ownership limits would provide access to additional capital, which
would provide several benefits that would help the financial health of the industry.
This includes encouraging more efficient market-driven networks, creating
opportunities for new airlines to enter the market, and bringing U.S. ownership
limitations in line with European laws. DOT also sought to find additional tools for
the airline industry to respond to unforeseen economic conditions, such as the recent
effects of the Iraqi War or the Sudden Acute Respiratory Syndrome outbreak in Asia.

A separate but related amendment addressed the issue of control of U.S. airlines. The
House and Senate conference agreement on the FAA reauthorization bill includes a
                                                        6
section that would revise the definition of “control.” The bill would amend Section
40102(a)(15)(C) of title 49 to include in the criteria for meeting the citizenship
4
    14 C.F.R. 204.5.
5
Department of Transportation, Office of Inspector General, Letter to the Honorable Don Young,
Chairman, Committee on Transportation and Infrastructure, U.S. House of Representatives, March 4,
2003.
6
    Section 807 of the conference report on H.R. 2115.


Page 3                                                   GAO-04-34R Foreign Investment in U.S. Airlines
requirement as “(airlines) which (are) under the actual control of citizens of the
United States.” In effect, this language would codify DOT’s existing practice.

There are differing levels of support by various aviation stakeholders for altering
current foreign ownership and control statutes. Several key aviation stakeholders
generally support the proposal of raising the allowable level of foreign ownership in
U.S. airlines. Most major U.S. airlines favor increasing their access to foreign capital,
and some have called for removing all restrictions regarding foreign ownership. The
Air Transport Association issued its support in June 2003, citing the potential to
create greater access to global capital for U.S. airlines, while also bringing U.S.
foreign ownership laws into line with those of other countries.7 Certain international
aviation organizations also support removing barriers to international investment and
open markets. Both the International Civil Aviation Association and the International
Air Transport Association support the liberalization of ownership and control. Other
stakeholders, especially various labor groups, oppose increasing foreign ownership
levels. For example, the Association of Flight Attendants has a preference that
foreign ownership be handled on a case-by-case basis and not just as a blanket lifting
of the limitations. They also support control of U.S. airlines by U.S. citizens. The
AFL-CIO’s Transport Trade Department also strongly opposes any relaxation of the
rules on foreign control of domestic airlines, citing both national security and the
economic welfare of U.S. workers among their concerns.

Current Status of Foreign Investment in U.S. Airlines
As of July 2003, the amount of foreign investment in U.S. airlines remained limited.
According to a major international investment bank, as of May 2003 no major
stockholders—U.S. or foreign—owned more than 20 percent of any major U.S.
                  8
network carrier. American Airlines and Delta Air Lines both had significant blocks
of stock owned by single shareholders, but these were U.S. financial service firms.
Both NW (18 percent), and Continental (13 percent) have shares held by Axa
Financial, a U.S. subsidiary of the French-based Axa Group.9

Past Examples Show Control Has Been the Central Issue
Foreign airlines have attempted to invest in and influence the operations of U.S.
airlines several times since the late 1980s. These foreign airlines have on occasion
invested significant amounts of capital into U.S. airlines, only to later disinvest due in
part to U.S. policies concerning airline control.

7
    The Air Transport Association is the principal trade organization for large U.S. airlines.
8
 Section 13(d) of the Securities Exchange Act of 1934, as amended, requires that any person who
obtains beneficial ownership of 5 percent or more of any equity security must provide notice to the
issuer of the security, to each exchange where the security is traded, and to the Securities and
Exchange Commission (SEC). The notice must include detailed information on citizenship, the
number of shares purchased, and other related business arrangements.
9
We omitted information on ownership for United Airlines and US Airways due to their respective
ongoing and recent emergence from bankruptcy.


Page 4                                                     GAO-04-34R Foreign Investment in U.S. Airlines
In 1989, NW announced that it would be acquired in a leveraged buyout by Wings
Acquisition, Inc. (Wings). KLM Royal Dutch Airlines (KLM) provided about 57
percent of the total equity in Wings and owned 5 percent of the voting shares of
Wings. KLM also proposed to gain the right to appoint one member of Wings’ 12-
member Board of Directors and to form a financial advisory committee to advise
Wings on the management of NW.10 In its review of the proposed transaction, DOT
objected to the proposed deal’s structure and issued a consent order, with NW and
Wings agreeing to (1) place KLM’s interest above 25 percent of the total equity in a
voting trust, (2) terminate KLM’s right to appoint a financial advisory committee, and
(3) disqualify KLM’s board member from participating in all decisions on competitive
and international aviation matters. NW petitioned for reconsideration in 1991. DOT
then permitted KLM to own 49 percent of the total equity investment in Wings and
allowed increased representation on Wings’ board, since the United States and the
                                                              11
Netherlands had an open skies bilateral aviation agreement. DOT ordered
modifications to the original investments and attached conditions to its approval to
ensure that NW retained its decision-making independence from its foreign airline
investor. In 1997, KLM decided to disinvest from NW and instead focused on building
up an alliance without direct financial investment. KLM and NW formed the first
                                                                         12
international code-sharing alliance granted antitrust immunity in 1993.

In 1992, British Airways (BA) proposed investing $750 million in USAir in an
arrangement that would have created the world’s largest airline alliance.13 In the
original proposal, BA’s investment would include about 44 percent of USAir’s total
equity, 21 percent of USAir’s voting stock and representation on USAir’s Board of
Directors.14 BA included some important conditions to its investment, including one
that it would have significant influence over major investment and financing
decisions by USAir. DOT initiated a review of the proposal. BA withdrew its
proposal before DOT issued a formal decision, in part because of changes being

10
 In addition, other foreign investors held about 15 percent of Wings’ voting common stock, bringing
the total voting stock held by foreign investors to about 20 percent of Wings’ voting stock.
11
 DOT allowed expansion of KLM’s representation on Wings’ board when the number of directors was
increased and continued the disqualification provision regards decision on competitive and
international issues. However, the order stated that appointment of foreign representatives to key
positions on Wings’ board, especially the position of chairman, would be “cause for us to review the
citizenship of the affected air carrier.”
12
 “Code sharing” refers to the practice of airlines applying their names—and selling tickets via
reservation systems—to flights operated by other carriers.
13
     USAir officially changed its name to the current US Airways on February 27, 1997.
14
 In 1992, we reported that the proposed investment included a number of potential benefits for the
two airlines planning to integrate their services. It would have provided BA a secure partnership that
could feed U.S. passengers to its international flights and allow USAir to better compete with U.S.
airlines that have expanded their international routes systems by purchasing international route
authority from struggling U.S. airlines. See U.S. General Accounting Office, Airline Competition:
Impact of Changing Foreign Investment and Control Limits on U.S. Airlines, GAO/RCED-93-7
(Washington, D.C.: Dec. 9, 1992).


Page 5                                                   GAO-04-34R Foreign Investment in U.S. Airlines
sought in the bilateral aviation agreement between the United States and the United
Kingdom. BA later revised its proposal and invested $300 million, with an option to
invest an additional $450 million in the future, and eliminated the governance
condition. The alliance never functioned as the two airlines had hoped, according to
court motions filed by USAir in 1996, and the BA-USAir alliance ended in 1997.

Changes in the ownership, management, and operations of DHL Airways illustrate
that it is sometimes difficult to determine the control of an airline. DHL Airways
(now ASTAR Air Cargo) holds a certificate of public convenience and necessity from
DOT, and thus was found to meet U.S. citizenship requirements. In the fall of 2000,
DHL Airways reported to DOT that it had undergone a substantial change in
ownership, involving Deutsche Post, the German postal monopoly. DOT conducted
an informal review of its citizenship, as is standard practice, and in May 2002,
informed DHL Airways that it met U.S. citizenship requirements. However, Federal
Express and United Parcel Service petitioned for a public review, alleging that DHL
no longer met the citizenship requirement. DOT initiated a public proceeding to
examine the issue.

In April 2003, P.L. 108-11 directed that DOT use an Administrative Law Judge to assist
in resolving this issue. The Administrative Law Judge is to issue a recommended
decision by December 1, 2003. DOT will then review that decision.

Prior GAO Report Identified Five Key Issues Relating to Changes in Foreign
Investment Laws
In 1992, we reported on the potential impact of changing U.S. airline foreign
investment and control laws and evaluated DOT’s 1991 proposal to allow for
increased foreign investment in U.S. airlines.15 We found that the five key issues
identified in the prior report are still relevant today. This proposal, according to DOT
officials, was in response to the heavy losses suffered by U.S. airlines in 1990 and
1991, who were hurt by the generally weak economy. The report noted that six large
U.S. airlines had declared bankruptcy and three of them had ceased operations. The
report concluded that fewer airlines could mean less competition and higher fares.
The report addressed five key areas that may be affected by changing ownership and
control laws:




15
 U.S. General Accounting Office, Airline Competition: Impact of Changing Foreign Investment and
Control Limits on U.S. Airlines, GAO/RCED-93-7 (Washington, D.C: December, 1992).



Page 6                                            GAO-04-34R Foreign Investment in U.S. Airlines
     •   Domestic competition – Allowing greater potential access to foreign capital
         could give U.S airlines, particularly those in financial difficulty, additional
         capital which would allow them to enhance their domestic competitive
                   16
         position.
     •   National security – U.S airlines, through their voluntary participation in the
         Civil Reserve Air Fleet (CRAF) program, provide the Department of Defense
                                                                       17
         (DOD) with supplemental airlift capacity in emergencies. DOD was
         concerned that foreign investors might discourage continued participation in
         CRAF.
     •   Employment – Increased foreign investment could put jobs at risk—for
         example, those of U.S. pilots and crew on international routes; but it could
         also help stabilize U.S. airline employment by strengthening financially weak
         airlines.
     •   Safety - Increased foreign investment could place additional burdens on the
         Federal Aviation Administration’s safety oversight responsibilities if foreign
         aircraft are transferred to U.S. registry.
     •   International competition – The impact of increased foreign investment on
         international competition depends, in part, on existing bilateral aviation
         agreements. These agreements set the conditions under which U.S. and
         foreign airlines operate and compete, and can restrict competition by limiting
         the service that can be offered. There may be opportunities for relaxing
         operating restrictions in some bilateral agreements in exchange for relaxing
         restrictions on foreign investment in U.S. airlines. Eligibility to invest in U.S.
         airlines could be restricted to airlines from nations that allow greater access to
         their aviation markets or do not subsidize their airlines.

Issues Identified in Prior GAO Report Still Relevant Because Current Aviation
Environment Is Similar to 1992
Although 11 years have passed since we reported on the potential effect of changing
foreign investment and control limits on U.S. airlines, most of the issues that we
identified still appear to be relevant. As in the early 1990s, the U.S. commercial
airline industry in 2003 faces a weak economy, relatively high fuel prices, and military
action in the Middle East. These conditions, as in the past, have contributed to weak
passenger demand, decreased airlines revenues, and some airline bankruptcies. The
airlines have likewise used some of the same basic strategies to control operating
costs. For example, major airlines responded to the 1992 economic downturn by

16
 The 1992 GAO report (GAO/RCED-93-7) noted that while foreign investment had potential benefits
for U.S. airlines, it was not a panacea for preserving domestic competition, because other factors—
such as airline control over gates and other facilities at major U.S. airports—also affect airline
competition.
17
 Under the CRAF program, U.S. airlines commit and put under contract aircraft and crew for DOD’s
use during emergencies. The commercial airlines receive no compensation for their participation in
the program unless they are activated, but they are given an incentive to participate by being made
eligible to bid for DOD’s peacetime airlift business and General Services Administration’s city pair
program. Airlines are paid for missions they fly at predetermined rates based on a weighted average of
their costs plus a return on investment.


Page 7                                               GAO-04-34R Foreign Investment in U.S. Airlines
implementing cost-cutting programs, laying off employees, canceling or delaying
aircraft deliveries and refocusing service. These same strategies have been
implemented again since 2001 by major airlines. For example, United and American
have made huge employee cutbacks, and Continental Airlines announced in July,
2003 that it plans to defer prior orders for additional Boeing planes until the domestic
economy recovers. Some airlines also are again expressing interest in acquiring
capital through foreign investment. Therefore, general issues identified in our prior
report appear to be still relevant to U.S. interests.

     •   Domestic competition – U.S. airlines have made significant reductions in
         service, but continue to have more capacity than passenger demand. Airlines
         are seeking additional capital to provide operating funds to survive the
         reduced passenger traffic and revenues and avoid bankruptcy. The effect that
         airline bankruptcies might have on domestic competition is uncertain. Since
         most U.S. “legacy” airlines’ balance sheets are considerably weaker than in
         1992, DOT believes that the ability to access international capital markets is
         even more valuable to the airlines in the current economic environment.18

     •   National security – While DOD has traditionally been concerned about
         increasing foreign ownership due to the belief that any foreign control of U.S.
         airlines would negatively affect CRAF, it presently has no official comment on
         the administration’s latest proposal. Questions already exist regarding the
         effectiveness of DOD's program incentives, and it is unclear if these incentives
         will be affected by changes in foreign ownership restrictions.

     •   Employment – The impact of increased foreign investment on employment
         remains unclear. There are differing views on how changes in foreign
         investment restrictions could affect employment—would additional
         investment stimulate domestic aviation, thus domestic aviation employment,
         or would foreign investment lead to jobs being transferred to foreign
         workforces? DOT indicated that there is no evidence to suggest that increased
         foreign investment in U.S. airlines would have any effect on labor. DOT
         commented that, due to existing collective bargaining agreements and other
         regulatory requirements governing U.S. airlines and their employees, the
         administration’s proposal would not affect the rights of labor or the obligation
         of airlines with respect to labor.

     •   International competition – While bilateral “open skies” agreements between
         the United State and many EU member states have improved the access, level
         of integration, and volume of travel across the Atlantic, other aviation
         agreements, such as the Bermuda II Accord, continue to limit airline
         integration and efficiencies.19 As the United States and EU start negotiations
18
 “Legacy” airlines generally refer to major U.S. airlines that operate network service, including both
domestic and international operations, such as United, American, and Delta.
19
 The “Bermuda II Accord” is the 1977 agreement between the United Kingdom and the United States
that restricts UK and U.S. flights serving London Heathrow Airport to two airlines from each countries.


Page 8                                                 GAO-04-34R Foreign Investment in U.S. Airlines
         for a new aviation agreement, one of the primary negotiations points for EU
         officials will be the relaxing of current U.S. foreign investment and control
         restrictions.20 The effect that recent legislative proposals codifying control
         standards could have is unclear. DOT has stated that since 1992, many U.S.
         airlines have formed international alliances. These alliances may find mutual
         investments more desirable, either to sustain a valuable alliance partner
         experiencing financial difficulties or to solidify commercial relationships.

At this time, we do not believe that the FAA safety workload issue raised in the 1992
report continues to be a significant relevant concern in the current environment. In
addition to any legal obstacles to transferring foreign aircraft to U.S. registry, it is not
clear what incentives exist that would encourage a foreign investor to do so. U.S.
carriers have grounded a significant number of aircraft and have been operating less
frequency with existing fleets over the past 2 years as a result of the downturn in
demand. Also, even if such a change were to occur, it is unlikely that aircraft would
be added in such numbers so as to materially increase FAA's safety oversight
responsibilities over and above its current workload.

Scope and Methodology
To address the administration’s current proposal and discuss the potential affect on
domestic competition, national security, airline employment, airline safety, and
international competition, we conducted interviews with key stakeholders and
industry experts. This included representatives from DOT, the European Union,
various member states, and U.S. airlines. In addition, we reviewed the literature
regarding foreign ownership regulations and implications, studied transcripts of
speeches by key U.S. government personnel, and reviewed financial regulations and
materials. Finally, we examined documents filed with DOT regarding citizenship of
airlines.
                                         ----

Agency Comments
We provided a draft report with briefing slides to DOT for review and formal
comment. DOT provided technical comments, which we have incorporated into this
report as appropriate.

As agreed with your office, unless you publicly announce the contents of this report
earlier, we plan no further distribution until 30 days from its date. At that time we will
send copies to the Secretary of Transportation and other interested parties. We will
also send copies to others upon request. In addition, this report will be available at
no charge on our Web site at http://www.gao.gov.




20
 DOT has noted that any U.S.-EU agreement, which includes provisions on foreign investment would
require implementing legislation.


Page 9                                             GAO-04-34R Foreign Investment in U.S. Airlines
For further information on this report, please contract JayEtta Hecker at (202) 512-
2834. Individuals making key contributions to this report included Steve Martin,
Emily Pickrell, Tim Schindler, and Matt Zisman.




JayEtta Z. Hecker
Director, Physical Infrastructure Issues


Enclosure




Page 10                                      GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I




                           Commercial Aviation

               Issues Relating to Foreign
              Investment and Control of U.S.
                         Airlines

           Briefing for the Subcommittee on
                          Aviation
          Committee on Commerce, Science
                    and Transportation
                      U.S. Senate

           U.S. General Accounting Office
                  June 25, 2003




Page 11                                        GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Contents

              Overview of GAO Briefing on Foreign
                  Investment and Open Skies
          • Objectives

          • Background

          • Proposed legislation

          • Status of foreign investment

          • Past examples of foreign investment and control

          • Major issues related to changing foreign ownership limits




          1




Page 12                                      GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I




                                 Objectives

          • Discuss the current proposals to revise U.S. limits on foreign
            ownership and control, including information on current
            shareholders and past examples of efforts by foreign interests
            to purchase significant equity in U.S. air carriers

          • Discuss key analytic issues raised in the 1992 GAO report on
            foreign ownership and control, including an assessment of
            whether those issues remain relevant today




          2




Page 13                                   GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Background

                                 Background

          • Air Commerce Act of 1926 required U.S. citizens own at least
            51 percent of any individual aircraft in order for it to be
            registered in the United States.

          • The Civil Aeronautics Act of 1938 provided that U.S. citizens
            own or control 75 percent of the voting stock of U.S. airlines.

              • This requirement remains in place today.




          3




Page 14                                    GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Background

              Definition of U.S. Aviation Citizenship

          • To fly in the United States as a U.S. airline, an airline must meet
            aviation “citizenship” criteria.

          • “Citizen of the United States” is defined as,

                 • an individual who is a citizen of the United States,
                 • a partnership whose members are U.S. citizens, or
                 • a corporation or association in which at least 75 percent of
                   the voting interest is owned or controlled by persons that
                   are citizens of the United States (49 U.S.C.
                   40102(a)(15)(C)).


          4




Page 15                                       GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Background

              U.S. Airline Citizenship Requirements

          • Department of Transportation (DOT) has interpreted control
            to mean day-to-day management decisions made by U.S.
            citizens, even with substantial foreign investment in the
            airline.
          • DOT evaluates actual control on a case-by-case basis.
          • Factors used include,
              • the quality and design of any significant contracts;
              • voting rights (whether there are disproportionate voting
                rights, power to veto and buy-out clauses); and
              • any debt-instrument clauses or agreements.
          5




Page 16                                    GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Background

              Prior Attempts to Change Ownership
                              Laws
          • In 1991, the Secretary of Transportation proposed changing
            foreign investment limitations to 49 percent.

              • The proposal responded to heavy financial losses by the
                airlines in 1990 and 1991.

              • DOT believed that its past experiences with U.S. airlines
                and their foreign investors would allow it to structure
                foreign investment to retain U.S. control.

          • Congress did not adopt the proposal.

          6




Page 17                                   GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Proposed Legislation

                         Administration’s Proposal

          • The administration has proposed legislation that would relax
            restrictions on foreign-owned voting stock of U.S airlines.

              • Maximum percentage of voting stock that could be
                foreign-owned would increase from 25 to 49 percent.

              • No change to policy that U.S. airline be controlled by U.S.
                citizens.

          • This legislation mirrors DOT’s 1991 proposal.



          7




Page 18                                    GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Proposed Legislation

                       DOT Rationale for Proposal

          • According to DOT, significant benefits arise from increasing limit to
            49 percent, including,

              • allowing U.S. airlines greater access to global capital;

              • encouraging U.S. airlines to develop more efficient, market-
                driven networks;

              • creating opportunities for airlines to enter into new markets; and

              • consistency with the European Union (EU) and other bilateral
                partner’s foreign investment restrictions.


          8




Page 19                                       GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Proposed Legislation

                 Congressional Action on Foreign
                      Control Restrictions
          • House and Senate conference agreement on Federal
            Aviation Administration (FAA) reauthorization bill addresses
            the issue of “control.”
              • H.R. 2115, Section 807, would change 49 U.S.C.
                40102(a)(15)(C) to define carrier citizenship as: “…
                which is under the actual control of citizens of the United
                States.”
          • This language codifies the existing practice that airlines be
            under the control of U.S. citizens.


          9




Page 20                                    GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Proposed Legislation

                 Stakeholder Positions on Foreign
               Investment and Control Restrictions
          • Several key stakeholders in the aviation industry support increases
            in foreign investment limits:

               • major U.S. network carriers,

               • The International Civil Aviation Organization, and

               • The International Air Transport Association.

          • Some labor groups do not support relaxing current foreign
            investment restrictions.



          10




Page 21                                         GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Status of Foreign Investment

                   Current Airline Stock Major Owners

                     Carrier               Largest holder (%)a                   Total holders above 5% share
                                                                                        U.S.                   Foreign

                                                   Lord Abbett
               American                                                                   3                          0
                                                    (18.3%)
                                                 Axa Financial
               Continental                                                                3                          1
                                                   (12.6%)
                                          Primecap Management
               Delta                                                                      3                          0
                                                 (12.5%)

                                                 Axa Financial
               Northwest                                                                  5                          1
                                                   (17.8%)
               aLord Abbett and Primecap Management are U.S. companies; Axa Financial is the U.S. subsidiary of a French-based
               conglomerate.


          11




Page 22                                                                      GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Status of Foreign Investment

               Current Airline Market Capitalizations
                            (in billions)a
          • American: $1.7               • Northwest: $0.9

          • Alaska Airlines: $0.6        • Southwest: $13.1

          • America West: $0.2
                                         • JetBlue; $2.7
          • Continental: $1.0
                                         • Air Tran: $0.8
          • Delta: $1.8

          a
          July 1, 2003.


          12




Page 23                                  GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Past Examples

               Determining Ownership and Control:
                          KLM and NW
          • In 1989, KLM Royal Dutch Airlines (KLM) attempted to
            purchase significant equity in Northwest Airlines (NW)
            through a KLM-owned company (Wings Acquisition, Inc.).
          • Original proposal provided KLM with significant governance
            over NW.
          • DOT reviewed proposal and ordered modifications, and
            added conditions to ensure NW would remain in control of
            U.S. citizens.
          • In 1997, KLM ultimately disinvested in NW and instead
            focused on a stronger international code-share alliance.

          13




Page 24                                   GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Past Examples

               Determining Ownership and Control:
                    British Airways and USAir
          • In 1992, British Airways (BA) proposed investing $750 million (44
            percent total equity) in USAir.
          • BA investment included purchasing 21 percent of USAir’s voting
            stock and representation on USAir’s board.
          • DOT initiated a review of the proposal. BA withdrew its proposal
            before DOT issued a formal decision, in part because of changes
            being sought in the bilateral aviation agreement between the United
            States and the United Kingdom.
          • BA revised proposal invested $300 million while the governance
            requests were dropped.
          • The alliance never functioned as planned and ended in1997.
          14




Page 25                                      GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Past Examples

           Defining U.S. Citizenship: DHL Airways

          • In the fall of 2000, DHL Airways (now ASTAR Air Cargo) reported to
            DOT a substantial change in ownership.
          • These changes involved Deutsche Post, the German postal monopoly.
          • DOT conducted an informal review of DHL Airways’ citizenship and in
            May 2002 determined it met U.S. citizenship requirements.
          • Federal Express and United Parcel Service petitioned for public
            review, alleging that DHL no longer met the citizenship requirement.
          • In April 2003, Public Law 108-11 directed DOT to use an administrative
            law judge to resolve this issue.
          • An administrative law judge is to issue a decision by December 2003,
            which DOT will review.
          15




Page 26                                       GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Major Issues

                   Most Major Issues Identified in
                 1992 GAO Report Remain Relevant
          • The aviation industry suffered heavy financial losses in 1990 and 1991 due
            to a weak economy.
          • In response to these conditions, DOT proposed in 1991 to increased the
            foreign investment restrictions from 25 to 49 percent.
          • In 1992, GAO reported on the implications of changing U.S. airline foreign
            investment restrictions.
          • This report identified five major issue areas,
             • domestic competition,
             • national security,
             • employment,
             • airline safety oversight, and
             • international competition.

          16




Page 27                                           GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Major Issues

               Relevance of Issues Identified in 1992
              Report Related to Economic Conditions
          •    Relevance today of issues identified in 1992 report depends on
               similarities in economic environment.


                                                     1990-1992          2001-2002

                   Industry profit(loss) –          ($13.2 billion)   ($19.7 billion)
                         In 2002 constant dollars




               Number of airline bankruptcies             27                 6


               Jobs losses at majors airlines       19,000 (3.6%) 86,000 (14.7%)


          17




Page 28                                              GAO-04-34R Foreign Investment in U.S. Airlines
Enclosure I



          Major Issues

               Most Issues From 1992 Report Remain
                          Relevant Today
          •    There are several key issues related to changing foreign investment restrictions
               that are still relevant today:

                1.   Domestic Competition

                     •   Access to foreign capital seen as beneficial during a period of financial
                         difficulty.

                     •   U.S airlines are seeking additional capital to provide operating funds to
                         survive the reduced passenger traffic and revenues.

                2.   National Security

                     •   DOD has traditionally opposed increasing foreign ownership but has no
                         official comment on the current proposal.

                     •   New questions may exist regarding the efficacy of U.S. airlines’ fleets in
                         meeting possible DOD airlift needs.
          18




Page 29                                                 GAO-04-34R Foreign Investment in U.S. Airlines
            Enclosure I



                   Major Issues

                        Most Issues From 1992 Report Remain
                               Relevant Today (cont’d)
                          3. Employment
                             •    There are questions whether changes in foreign investment
                                  restrictions would stimulate domestic aviation, thus domestic
                                  aviation employment, or lead to jobs being transferred to foreign
                                  workforces .
                          4. International Competition
                             •    As the United States and European Union (EU) start negotiations
                                  for a new aviation agreement, one of the primary negotiations
                                  points for EU officials will be the relaxing of current U.S. foreign
                                  investment and control restrictions.

                             •    The effect that recent legislative proposals codifying control
                                  standards could have is unclear.
                   19




(544062) Page 30                                          GAO-04-34R Foreign Investment in U.S. Airlines
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