oversight

Foreign Investment: Analyzing National Security Concerns

Published by the Government Accountability Office on 1990-03-29.

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

                         House of Ikpresentat.ives

March   1990
                         FOREIGN
                         INVESTMENT
                         Analyzing National
                         Security Concerns




               RESTRICTED--Not         k be released outside the
               General   Accounting   Of&e   unless s-e
               approved by the Office of Congressio~
               Belatione.
National !Security and
International AfWn3 Division

B-234611

March 29,199O
The Honorable John D. Dingell, Chairman
Subcommittee on Oversight and Investigations
Committee on Energy and Commerce
House of Representatives

Dear Chairman Dingell:

This is one of a series of reports responding to your request that we examine the effects of
foreign direct investment in the United States. This r-e&t discua~ the national security
concerns related to foreign investment and the availability and types of data neededto
analyze them.

The first report in this series was Foreign Investment: Federal Data Collection on Foreign
Investment in the United States (GAO/NWW%BR,        October 1989). Other reports are in
preparation.

As you requested, we did not obtain formal agency comments on this report, but we did
discuss our findings with agency representatives.

Unless you publicly announce its contents earlier, no further distribution of this report will
be made until 30 days from its issue date. At that time, we will provide copies to other
interested parties.

This report was prepared under the direction of Mr. Allan I. Mendelowitz, Director of Trade,
Energy, and Finance Issues,who may be reached on (202) 275-4812. Other major
contributors to this report are listed in appendix I.




Frank c. ccmahan
Assistant Comptroller General
Executive Summaxy


                  The possibility that key segmentsof defense-related industries could
                  come under foreign control is one of the central concernsin the debate
                  about ‘increasedforeign investment in the United States.

                  At the request of the Chairman, Subcommittee on Oversight and Investi-
                  gations of the House Committee on Energy and Commerce,GAO
                  examined national security concernsrelating to increased foreign invest-
                  ment in the United States. More specifically, GAO examined

                  (1) the definition of industry sectors and technologies that are national
                  security related, (2) the government’s system for learning of foreign
                  investments before they take place, (3) the difficulties the government
                  encounters in analyzing specific investments, and (4) the broader ques-
                  tions not addressedin the present system of analyzing foreign
                  investments.


                  In responseto concerns about the national security implications of for-
Background        eign investment, in 1988 Congressenacted the Axon-Florio Amendment
                  to the DefenseProduction Act. This amendment gave the President new
                  authority to investigate and block foreign investments threatening to
                  impair national security. To exercise this blocking authority, the Presi-
                  dent must fiid that (1) credible evidence exists that the foreign interest
                  might take action that threatens to impair U.S. security and (2) provi-
                  sions of law, other than the International Emergency Economic Powers
                  Act, do not provide adequate authority to protect the national security.

                  The President delegated his authority to review transactions to the
                  existing interagency Committee on Foreign Investment in the United
                  States, which is chaired by the Treasury Department.


Resultsin Brief   National security has not been precisely defined, in terms of identifying
                  specific technologies and firms critical to U.S. defense leadership. The
                  DefenseDepartment can identify its direct contractors, but it cannot
                  systematically identify the firms supplying these contractors or foreign
                  investments in these fii.       There is no information base or government
                  agency systematically tracking foreign acquisitions of component sup-
                  pliers. It is thus difficult to answer the general question of how much of
                  the defense industrial base has been acquired by foreign-owned firms.
                  As a result of the 1988 amendment, the interagency Committee now
                  receives information on specific foreign investments; and, basedon


                  Page 2                                       GAO/NSIALMWB4   Forem   Investment
                             Executive Sommary




                             recent experience, it appears the Committee will have advance knowl-
                             edgeof a wide range of proposed investments relating to national secur-
                             ity. However, the Committee is not performing analyses of foreign
                             investment by industry sector. Foreign investments in start-up compa-
                             nies are excluded from review by the Committee, becausethe Exon-
                             Florio Amendment refers only to mergers and acquisitions of ongoing
                             businesses.
                             Difficulties experienced by the Committee in analyzing specific invest-
                             ments do not stem from lack of information about the transactions.
                             Rather, they stem from uncertainties about (1) how the investment may
                             affect the future direction of technology transfers, (2) the likelihood of
                             continued supplies to the DefenseDepartment or its direct contractors,
                             and (3) the existence of reliable, alternate suppliers.

                             Broader concerns about the national security implications of foreign
                             investment are not addressedin the present system of analyzing spe
                             cific, proposed investments. Important questions persist, for example,
                             about how to preserve the commercial competitiveness of U.S. industry
                             sectors underpinning defense technology leadership, or how to assess
                             overall technology transfer effects.


Principal Findings

Defining National Security    The defense industrial base supporting national security includes some
                              fii    whose business is primarily commercial but whose leading edge
                              technologies are important to U.S. defensetechnology leadership. These
                              fii    may not be direct contractors to the DefenseDepartment and
                              would not necessarily be included in information baseson critical
                              defense suppliers, becausethe DefenseDepartment cannot systemati-
                              cally identify the firms supplying its direct contractors. Neither the
                              Committee nor any other US. government agency systematically tracks
                              foreign investments on a sectoral basis, to provide analyses of whether
                              foreign acquisitions of such commercially driven fii     have contributed
                              to any erosion of component suppliers in the defense industrial base.

                              A key issue is whether the defense industrial base should be defined to
                              include foreign-owned firms which maintain production in the United
                              States. On the one hand, foreign investments can bring new capital and



                              P8ge 2                                      GAO/-NSIAD&MM For&n Invatment
                            technology to U.S.-basedproduction facilities. On the other hand, ques-
                            tions can be raised about the long-term consequences of possible tech-
                            nology outflows and dependenceon foreign-based decision-making.


Advance Knowledge of        The Committee is the central point for gathering and analyzing informa-
                            tion about specific, proposed foreign investments in existing U.S. firms
Foreign Investments         relating to national security. The Exon-Florio Amendment does not spe-
                            cifically require foreign investors to notify the Committee of proposed
                            investments. However, the consequencesof not notifying the Committee
                            may be severe,becausethe investors may risk divestiture orders later.
                            Becauseof this risk and becausethe concept of national security is not
                            tightly defined, it is likely that the Committee will have advance knowl-
                            edge of a wide range of proposed investments.
                            Investments in start-up companies are not being reviewed by the Com-
                            mittee, becausethe amendment refers only to mergers, acquisitions, and
                            takeovers of “persons engagedin interstate commerce.”


Difficulties in Analyzing   The Committee has generally had adequate information to analyze spe-
                            cific investments as provided for by the amendment. Although official
Investments                 government investment statistics do not provide detailed information
                            about defense relationships and alternate suppliers, the Committee has
                            been able to gather neededinformation from a variety of public and pri-
                            vate sources.

                            The more difficult questions arising in specific caseswere those requir-
                            ing judgments about the likely future behavior of foreign investors.
                            These required assessments of foreign investor intentions regarding
                            technology transfer, continued supply to the DefenseDepartment or its
                            direct contractors, and use of any commercial advantages gained
                            through the investment.


Broader Policy Questions    The Committee does not focus on more general questions which have
                            arisen in public debate about the possible effects of foreign investment
                            on the U.S. industry’s commercial competitiveness. Yet, for commer-
                            cially driven industries that are critical to defense technology leader-
                            ship, important questions persist about (1) how to evaluate the
                            importance of a firm’s commercial strength to its defense role, (2) what
                            competitive factors lead US. firms to discontinue operations in sectors



                            P8ge 4                                      GAO/NSIAIMMM4 Fo~ign   Lnvestment
                  Executive Shunmuy




                  that foreign investors appear to value highly, (3) how to track the direc-
                  tion of technology transfers, and (4) whether and how the U.S. govern-
                  ment may need to respond to these competitive factors.

                  These questions need to be addressedat a higher policy-making level
                  and in a broader context than the case-by-caseapproach afforded by the
                  Committee.

                  This report contains no recommendations.
Recommendations
                  As requested, GAO did not obtain official agency comments on its report.
Agency Comments   However, responsible officialswere consulted during the review, and
                  their views were incorporated where appropriate.




                   P8gel%                                      GAO/NSIAD-WW Foreign Investment
Contents


Executive Summary
Chapter 1                                                                                      8
Introduction         Ekon-Florio Amendment                                                     9
                     Objectives, Scope,and Methodology                                         9

Chapter 2                                                                                     11
Defining National    ’
Security
Chapter 3
Advance Knowledge
of Foreign
Investments
Chapter 4                                                                                      16
Difficulties in          Guidelines for CFIUS Reviews
                         Government Statistics on Aerospace and Semiconductors
                                                                                               16
                                                                                               17
Analyzing Specific       Types of Questions Raised by CFIUS                                    18
Investments              Sourcesof Needed Information                                          19
                         Difficulties in Deciding Cases                                        20

Chapter 5                                                                                      24
Broader Policy           Conclusion                                                            26
Questions Persist
Appendix                 Appendix I: Major Contributors to This Report                         28




                         Abbreviations

                         CFIUS     Committee on Foreign Investment in the United States
                         DOD       Department of Defense
                         GAO       General Accounting Office


                         PUe6                                      GAO/BMAB8@94 Foreign Investment
Chapter 1

Introduction


                   Preserving U.S. industrial capabilities in sectors critical to national
                   security has been a traditional U.S. policy goal. An important concern in
                   the debate on foreign investment in the United States is the possibility
                   that key segmentsof industries critical to the national security could
                   come under foreign control through foreign investments here.’ Because
                   US. defense strategy relies on the deterrent effects of technological
                   rather than numerical superiority, concern about foreign investment
                   focuseson the U.S. government’s ability to identify technologies crucial
                   to defense systems and to act to preserve and promote US. leadership in
                   them.
                   Specific restrictions are in place to protect classified defense informa-
                   tion from foreign acquisition and to ensure continued U.S. production of
                   vital defense goods in a crisis. Foreign investments in U.S. firms per-
                   forming classified defense work are monitored under the DefenseIndus-
                   trial Security Program (based on Executive Orders 10460,10866, and
                   11662). Known as Foreign Ownership, Control, or Influence restrictions,
                   these provide authority to restrict or deny foreign accessto classified
                   information. Although they do not authorize denials of foreign invest-
                   ments, they can, in effect, deter potential foreign investors who are
                   seeking accessto classified information. The possibility that foreign
                   owners might suddenly close down U.S. production of vital defense
                   goods in a crisis is not a major concern, becausethe U.S. government has
                   statutory authority to ensure production at any facility in the United
                   States. The U.S. government, in addition, prohibits or restricts foreign
                    investment in certain sectors, such as energy resources,coastal and
                   domestic shipping, air transport, and broadcasting.

                   Foreign investments in U.S. firms producing unclassified but technologi-
                   cally sensitive military and civilian items are not reviewed under the
                   Defense Industrial Security Program. These investments are of principal
                   concern, in terms of questions about

               . how to define the range of industry sectors and technologies that are
                 national security related,
               l whether investments in crucial segmentsof such industries would come
                 to the attention of the US. government before they take place, and
               . whether the government has adequate information on foreign invest-
                 ment to be able to analyze the implications, particularly the technology


                    ‘Foreign investment refers to foreign direct investment; that is, investment resulting in foreign own-
                   ership or control of 10 percentor more equity interest in a US. business.



                   P8ge 8                                                        GAO/NSUD-@WdForeign Investment
                        transfer effects, of specific investments as they occur and of overall for-
                        eign investment levels in a sector.

                        The basic question, as many have posed it, is whether the U.S. defense
                        industrial base is being gradually “hollowed out” as foreign investment
                        takes place, not necessarily in plants directly producing defensesys-
                        tems, but in the lower tiers of component suppliers producing goods
                        with both military and civilian applications.


                        The congressional responseto this concern was the enactment of the
Exon-Florio             Exon-Florio Amendment as part of the Omnibus Trade and Competitive-
Amendment               ness Act of 1988 (amending Title VII of the DefenseProduction Act, 50
                        U.S.C. App. 2170), which provides presidential authority to investigate
                        and block or suspend new foreign acquisitions or mergers that threaten
                        to impair the national security. This act also formalized an existing gov-
                        ernment review process,conducted by the interagency Committee on
                        Foreign Investment in the United States (CFIUS).*

                        As of February 1,1990, only six proposed foreign investments were
                        selected as warranting the complete CFIUSinvestigation process,out of a
                        total of about 240 investments consideredby CFIUS     under the Exon-
                        Florio Amendment. Of these six, the President blocked one investment-
                        by ordering a Chinese firm to divest all of its interest in a U.S. aircraft
                        parts manufacturer. None of the other five investments were formally
                        blocked or dissolved, although two were withdrawn once the investiga-
                        tion phase began. (One of these was later resubmitted in a restructured
                        form approved by CFIUSmembers.) Three of the six investments
                        involved U.S. fums producing high technology electronics components,
                        two involved U.S. aerospacefirms, and one involved a U.S. manufac-
                        turer of extra-high-voltage transformers. The proposed foreign purchas-
                        ers were West German, Japanese,Indian, French, Chinese,and a Swiss-
                        Swedish partnership.


                        At the request of the Chairman, Subcommittee on Oversight and Investi-
Objectives, Scope,and   gations of the House Energy and CommerceCommittee, we’examined
Methodology             national security concernsrelating to increased foreign investment in

                        2By executive order, the President dekg&ed his authority to review Mnsactions to CFlUS. CFWS is
                        stillchairedbythelhasuryDepartment        and haa as other membem the Departments of State. Com-
                        merce, and lkfeme,    the U.S. Trade Representative, the council of Economic Advisors, the Attorney
                        General,andtheDirectoroftheOf&eofM          an@ment and EMget. Other agencies can be brought
                        into CFIUS discussions as appropriate.



                         Page 9                                                    GAO/NSIADMJ-94      Fodgn    Investmen
the United States. Our objectives were to examine (1) the definition of
industry sectors and technologies that are national security related,
(2) the government’s system for learning of foreign investments before
they take place, (3) the difficulties the government encounters in ana-
lyzing specific investments, and (4) the broader questions not addressed
in the present system for analyzing foreign investments.

To accomplish this, we reviewed relevant literature and talked with rep
resentatives of CFIUSmember agenciesand with academic and industry
experts. We focused on the data available in two industry sectors gener-
ally agreed to be of national security interest, aerospaceand semicon-
ductors, and we examined the CFIUSfries to analyze the types of
questions arising in the CFIUSprocessand the availability of data needed
to answer these. We did not review CFIUS’decision-making or compliance
procedures. We conducted our review from January through October
1989 and updated information in February 1990, in accordancewith
generally accepted government auditing standards.

As requested, we did not obtain formal agency comments on this report,
although we discussedour findings with agency representatives and
considered their views in completing this report.

This report is one in a series of recent reports on foreign investment.”




 Page 10                                     GAO/NSUD9@94 Fore&n   Investment
Chapter 2

Defining National Security


                Concernshave arisen about how broadly to define the industries and
                technologies that are national security related. A narrow definition
                would include firms that do the majority of their businesswith the
                Department of Defense(DOD) or as subcontractors to DOD prime contrac-
                tors. A broader definition would include industries and firms whose bus-
                iness is driven by the civilian commercial sector but, becauseof their
                leading edge technologies, are important to overall defense technology
                leadership. Systematic information is available on foreign ownership of
                DOD’S direct contractors, but not on foreign ownership of lower-tier con-
                tractors or of commercially driven firms developing technologies critical
                to defense.
                The importance of a broad definition of the defense industrial base and
                an improved government capability to track developments in this base
                was highlighted by several recent advisory reports to DOD. For example,
                the DefenseScienceBoard, in its 1987 report on “Defense Semiconduc-
                tor Dependency,” noted that, despite the semiconductor sector’s crucial
                importance to national defense,DOD businessis of relatively small
                importance to the sector, and advancesin the industry are driven princi-
                pally by commercial considerations. As a result of basically commercial
                factors, it noted, U.S. semiconductor technology leadership has deterio-
                rated to the point where U.S. defensemay becomeunacceptably depen-
                dent on foreign sourcesfor stateof-the-art semiconductor technology.
                The Defense Policy Advisory Committee on Trade, in its 1986 policy
                statement on the defense industrial base, also noted (1) the need for a
                broader concept of the industrial basethan simple surge capacity in
                wartime, (2) the inadequacy of DOD funding and procurement by them-
                selves to ensure sufficient research and development in some sectors,
                and (3) the need to consider the interrelationships between the indus-
                trial base and general US. economic and trade policy.

                The Exon-Florio Amendment did not define “national security,” but the
                accompanying conference report noted that it is to be interpreted
                broadly and without limitation to particular industries. The proposed
                implementing regulations, issued in July 1989, also do not define
                national security and thus neither encouragenor preclude use of a broad
                definition of the defense industrial base. In our review of CFIUScases
                under Exon-Florio, we did not find evidence that the absenceof a spe-
                cific definition of national security affected CFIUS ability to investigate
                investments. As described in Chapter 4, CFIUScan review foreign invest-
                ments in a broad spectrum of industries.




            .   Page 11                                     GAO/NwADBogQ   Foreign Investment
Cbpter 2
Deflning~tl~seearity




As a result of the 1988 amendment, CFIUS now receives information on
specific foreign investments; and, basedon recent experience, it appears
that ems will have advance knowledge of a wide range of proposed
investments. However, CFIUS is not performing analyses of foreign
investment by industry sector.

Such analyses, addressing questions about whether sectors of the
defense industrial base are being “hollowed out” by foreign investment,
are more difficult to perform. One problem is the lack of systematic
information identifying key suppliers to firms considered to be in the
defense industrial base.DOD can identify its direct contractors but it can-
not systematically identify lower-tier suppliers to its direct contractors
and, therefore, cannot keep track of changesin their ownership to pro-
vide an information baseon foreign acquisitions of these firms. Someof
these lower-tier suppliers are commercially driven firms developing
technologies valuable to national security.

Representatives of several DOD direct contractors in the aerospacesector
told us that they do not systematically track foreign investment in their
lower-tier suppliers. For example, a representative of one major contrac-
tor told us his company is concernedwith quality, price, and delivery
experience, and that it could not keep track of changesin ownership in
the numerous tiers of its suppliers. For major systems these lower tiers
can include thousands of suppliers. The DefenseScienceBoard, in its
 1988 study on “The DefenseIndustrial and Technology Base,” found, as
well, that neither DOD nor industry has the means of specifically measur-
ing the extent of U.S. dependenceon foreign sourcesfor defense
components.

 One important difficulty in analyzing national security effects is in
 deciding whether foreign acquisition of a U.S. firm that maintains pro-
 duction in the United States should generate concernsabout foreign
 dependencesimilar to those raised by U.S. imports. On the one hand,
 foreign investments can bring new capital and technology to U.S.-based
 production facilities. On the other hand, foreign control means that deci-
 sions affecting research, product choice, and plant modernization can be
 made abroad. Assessingthe foreign owners’ intentions regarding the
 direction of technology transfer and the continuation of advanced
 research and development programs in the United States can be very
 difficult, even on a case-by-casebasis.




 P8ge 12                                     GAO/NCiIAD-WM Foreign Investment
Chapter 3

Advame Knowledge of Foreign Investments


              Before the Exon-Florio Amendment was enacted, legitimate questions
              could be raised about the ability of the government to learn about sensi-
              tive foreign investments before they occurred. The amendment does not
              specifically require foreign investors to notify CFIUSof proposed invest-
              ments in existing U.S. firms having any bearing on national security.
              However, the consequencesof not notifying CFIUSmay be severe,
              becausethe investors may risk divestiture orders later. Foreign inves-
              tors in start-up companies are not subject to the Exon-Florio Amend-
              ment and are, therefore, excluded from CFIUSreview.

              Foreign investors in firms performing classified work are required,
              under the DefenseIndustrial Security Program, to provide advance
              notice to DOD so that arrangements can be made to isolate or to safe-
              guard the classified work.

              Under the ems processprior to the amendment’s enactment, proposed
              foreign investments in other U.S. firms would come to U.S. government
              attention only when those firms voluntarily notified CFIUS.They might
              also have been indirectly referred to CFIUS as a result of (1) filings with
              the Securities and Exchange Commission, required when a foreign firm,
              like any U.S. firm, makes stock purchases of 5 percent, a level consid-
              ered to signify intent to seek control, (2) premerger notifications to the
              Justice Department and the Federal Trade Commission, which perform
              antitrust reviews for foreign and domestic acquisitions, and (3) industry
              or intelligence agency notifications. Before August 1988 the President
              had the authority to block a foreign acquisition of a U.S. firm through
              theInternational Emergency Economic Powers Act (50 U.S.C. 1701-06),
              but only if the President declared a national emergency in responseto
              an unusual and extraordinary threat to the U.S. national security, for-
              eign policy, or economy.

              These types of prior notification, however, could not ensure that all for-
              eign investments in key, high technology U.S. firms would come to the
              attention of the U.S. government before completion. Filings with the
              Securities and Exchange Commission are generally required only for
              publicly traded companies, not for privately owned fil.     Filings for
              antitrust review are not required for transactions involving smaller
              firms4 SomeU.S. firms in the semiconductor and aerospacesectors are

              4Under the~artsoOtt-Rodino Antitrust Improvements Act, notiaz of the intended acquisition must be
              madewherethefollowingconditionearemet:(1)atleastonepartytotheacquisitionhas%1oOmil-
              lionormoreinannualnetsaiesortotalassets,(2)theoWerpartyhasSl0millionormoreinannual
              net sales or total assets; and (3) the acquiring paty will hold either 16 percent or S15 million of the
              acquired party’s voting securities or assets (UU.S.C. sec. Ma).



              P8ge 13                                                      GAO/NSlAD-WM         Foreign Investmen
iidvmm Knowledge of Foreign Investment




small, privately owned companies,and foreign investors would not be
required to file with the commission or for antitrust review. Nor would
foreign acquisitions of such companies necessarily come to the attention
of the government through industry or intelligence sources.Even if for-
eign investors complied fully in reporting to the CommerceDepartment
under the reporting requirements of the International investment and
Trade In Services Survey Act of 1976” , prior notification is not required
under the act.
The Exon-Florio Amendment does not specifically require foreign inves-
tors to notify CFIUSof their investments in national security related
firms. However, the consequencesof not notifying CFIUSmay be severe,
becausethe parties may risk divestiture orders later. The investment
that the President ordered blocked on February 1,1990, was one that
had been completed before CFIUSfmished its investigation. Therefore,
blocking the investment in this caserequired divestiture.

The proposed regulations have been criticized as too broad, because
they do not provide a clear definition of national security or the criteria
to be used in evaluating proposed foreign investments. Consequently, as
noted in public comments filed in responseto the proposed regulations,
attorneys representing potential foreign investors feel compelled to
clear most foreign investments with CFIUS before completing the transac-
tions. Thus, at this point, it appears likely that CFWSwill have advance
knowledge of a wide range of proposed investments, although only some
will receive its full attention. So far, the vast majority of the approxi-
mately 240 investments considered by CFIUSsince enactment of Exon-
Florio have been reported to CFIUS voluntarily, rather than referred by
interested agencies.

 One type of foreign investment that is excluded from CFIUSreview is
 “greenfield” investment, i.e., investment in start-up companies.As Trea-
 sury stated in its proposed regulations, the Exon-Florio Amendment
 refers only to mergers, acquisitions, and takeovers of “persons engaged
 in interstate commerce in the United States. Since ‘greenfield’ invest-
 ments are not ongoing businessesand therefore not ‘persons engaged in
 interstate commerce’, they are not subject to [the amendment]“.


 “This act (P.L. 94-472, JZ2USC. 3101 to 3108, as amended) requires foreign investors to supply
 information on their ihwtments    to the Bureau of Economic Analysis of the Commerce Depanment.
 Individual investor responses are considered business proprietary information and only aggregated
 data are publicly released.



 Page 14                                                    GAO/NSI,4lMW4 Foreign Investment
Advance Knowledge of Foreign Invabnen~




This exclusion may result in some national security related investments
not being reported to CFKJS. One law firm, commenting on the proposed
regulations, noted that “this exemption thus potentially removes the
Exon-Florio controls on someof the most advanced technologies being
developed today.” While such start-up investments are generally pre-
sumed to be beneficial in bringing new capital and technology into the
United States, there are some technology transfer concernsabout the
possibility that U.S. firms’ most skilled scientists and researchersmay
be hired by these new, foreign-owned companies.




 P8ge 15                                   GAO-          Fodgn   Investment
Chapter 4

Difficulties in Amilyzing Specific Investments


                       CFWS,under the authority delegated to it by the President, is the focal
                       point for government reviews of specific foreign investments relating to
                       national security. Becausenational security is not specifically defined in
                       law, CFIUScan review investments in a broad spectrum of industry sec-
                       tors. The President’s authority to block an investment, however, is more
                       narrowly defined.

                       CFWShas generally had adequate information to analyze specific foreign
                       investments as provided for by the law. Although official government
                       investment statistics do not provide the type of detailed information
                       about defense relationships and alternate suppliers neededby CFIUSin
                       evaluating individual cases,CFIUS has been able to gather neededinfor-
                       mation from a variety of public and private sources.

                       In caseswhere agency views have initially differed, the key concerns
                       related to difficult questions about the desirability of foreign depen-
                       dence and the potential for technology transfers out of the United
                       States.

                       Many of the investments reviewed by CFIUS have been in the aerospace
                       or semiconductor sectors, and so we were able to identify the types of
                       questions arising in the review processfor these investments and to see
                       how they were answered.


                       CFWSwas created in 1975 by executive order to review foreign invest-
Guidelines for CFIUS   ments that “might have major implications for United States national
Reviews                interests.” Before the Exon-Florio Amendment was enacted in 1988,
                       CF+IUSoperated, under the chairmanship of the Treasury Department, on
                       an informal, ad hoc basis, mostly reviewing investments by foreign gov-
                       ernments in US. firms and never formally making negative determina-
                       tions about investments.

                       The Exon-Florio Amendment provided the President with new authority
                       to investigate, block, or suspend foreign mergers, acquisitions, or take-
                       overs that may threaten to impair the national security. It authorizes
                       the President to exercise this blocking authority only if he finds that

                       (1) there is credible evidence that the foreign interest might take action
                       that threatens to impair the national security, and




                        Page 16                                     GAO/N!3IAD6@64Foreign Investment
                        w-4
                        Dlfncllltlerln   Andping   Spedfk   lnvestmenta




                        (2) provisions of law, other than the International Emergency Economic
                        Powers Act, do not provide adequate authority to protect the national
                        security.
                        The amendment also formalizes the CFIUSreview processby providing a
                        maximum go-day review of individual foreign investments. This period
                        includes 30 days to determine whether to initiate an investigation,
                        45 days to complete an investigation, and a final 15 days for the Presi-
                        dent to act.
                        CFIUSissued proposed regulations for implementing the Exon-Florio
                        Amendment in July 1989, but these have not yet been finalized.


                        Both aerospaceand semiconductors are generally recognizedas sectors
Government Statistics   that drive defense technology and that are crucial to U.S. technological
on Aerospace and        leadership. Yet, under the U.S. government’s official foreign investment
Semiconductors          data system (maintained by the CommerceDepartment’s Bureau of Eco-
                        nomic AnalysW ), data cannot be broken out for either of these sectors.
                        Aerospace is included in the larger category of “Other transportation
                        equipment,” and semiconductors fall in the larger “Electronic compo
                        nents and accessories”category. The CommerceDepartment’s Intema-
                        tional Trade Administration collects public announcementsof foreign
                        investments in different sectors (including aerospaceand semiconduc-
                        tors) and publishes the data yearly, but this information is not consid-
                        ered complete and does not show cumulative foreign investment
                        positions in the industry sectors. Industry analysts in Commerce’sInter-
                        national Trade Administration also may follow foreign investment
                        trends, but their focus is primarily on export promotion.

                         The DefenseDepartment, as noted in chapter 2, does not have a compre-
                         hensive database that would show foreign investments in national
                         security related sectors, although it doestrack foreign investments in
                         firms doing classified work through the DefenseIndustrial Security Pro-
                         gram. Defenseis now attempting to improve its knowledge of the extent
                         of dependenceon foreign sourcesin certain weapons systems, but this
                         effort is focused on identifying imports rather than foreign investments.




                         “U.S. government fondgn investment databass     a~ discussed in
                         Collection on Foreign Investment in the United States (GAO/NS



                         Page 17                                                   GAO/lSUDWM   Foreign Lwmtment
                     Industry analysts in the government and private sector told us that,
                     becauseCommercedata are not useful to them, they rely on private sec-
                     tor data sourceswhen considering investment questions. Someof the
                     private sector data is considered very useful.

                     Foreign direct investments in the US. aerospacesector are generally
                     thought to be minimal, although increasing over the past l-1/2 years.
                     Other types of technology- and production-sharing arrangements are of
                     relatively greater concern to businessand government officials, mostly
                     becauseof their implications for national security and the aerospace
                     industry’s commercial competitiveness.

                     Foreign investments in the semiconductor sector, however, are consid-
                     ered significant and have been the subject of recent scrutiny in the CFTUS
                     process.As a result, the government’s knowledge base in this particular
                     sector has advanced well beyond the officially collected data It is
                     known, for example, that foreign firms have been active in the semicon-
                     ductor materials and equipment sector. For example, key manufacturing
                     processes,such as silicon wafer manufacturing and ceramic packaging,
                     are now dominated by foreignowned firms.

                     Many industry analysts maintain that segmentsof the semiconductor
                     industry have been “hollowed out” incrementally as a result not only of
                     foreign acquisitions but also of US. firms’ difficulties in competing
                     against foreign firms. These commercial competitive factors include
                     superior foreign technologies and product quality, but they also reflect
                     differing U.S. and foreign industry structures. For example, large, verti-
                     calIy integrated Japaneseconglomeratescan better withstand the steep
                     downturns in business cycles that are characteristic of this industry,
                     becauseprofits earned from consumer product sales can sustain the
                     firms’ other operations.


                     Once an investment comesto the attention of CFIUS,    either through self-
Types of Questions   notification or through agency referral, CFWSexamines the investment
Raised by CF’IUS     to determine whether to initiate a full investigation. For casesselected
                     as warranting a full CFIUSinvestigation, the same types of questions
                     examined in the initial review are pursued in greater depth.

                     CFIUS’main interest in reviewing investments has been to learn the
                     nature of the U.S. firm’s relationship with defense-related work-i.e.,
                     whether it performs classified work for DOD, what contracts it may have
                     with DOD, what percent of its production is defense-related, and what


                      Page 18                                     GAO-           Fore&n Investment
                    portion of its research and development is defense related. CFIUStries to
                    learn whether the foreign purchaser would be acquiring (1) sensitive
                    U.S. technology subject to U.S. export licensing, or (2) control over a
                    scarcesupply of goods that bear on national security. It also seeksinfor-
                    mation on the U.S. and foreign firms’ market shares and on the availa-
                    bility of alternate suppliers, both domestic and foreign, for the US.
                    firm’s product. Occasionally, it needsto evaluate allegations regarding
                    unfair trade or anticompetitive practices on the part of the foreign firm.
                    Identifying and assessingthe new owner’s plans for the U.S. firm consti-
                    tutes another set of CFIUSinterests. CFIUS questions foreign investors
                    about their intentions to continue production and research and develop-
                    ment in the United States, to pursue particular product lines, to continue
                    supplying DOD, and to relocate U.S. plants. In somecases,specific techni-
                    cal questions arise regarding the nature or uniquenessof the product or
                    technology in question.


                    Virtually none of the information used in the CFIUS review processcame
Sources of Needed   from formal U.S. government statistics on foreign direct investment.
Information         Commercedata, even if it were to exist for aerospaceand semiconduc-
                    tors, do not provide the kind of detail about defense relationships, the
                    firm’s technology, alternate suppliers, or the new owner’s intentions
                    that are needed in the review process.

                    The DefenseDepartment can identify whether the U.S. firm performs
                    classified work, and though it cannot systematically provide informa-
                    tion on lower-tier subcontracting, this can be learned for specific firms.

                    To learn whether there may be “credible evidence” that the foreign
                    interest might take action threatening the national security, Commerce,
                    Defense,and State can search their export control records for licensing
                    and enforcement information, and the intelligence agenciescan be called
                    on to check, for example, for known unauthorized technology transfers.
                    The Justice Department, the Federal Trade Commission, and Commerce
                    can provide information regarding evidence of anticompetitive behavior.
                    Information on alternate suppliers doesnot readily exist in U.S. govem-
                    ment databasesbut can be obtained from government and private sector
                    industry analysts for some specific products.
                    Technical questions that arise in the review processcan be addressedby
                    consulting government and industry analysts and technical specialists.


                    P8ge 19                                      GAO/Nf3IMMW4 Fondgn Investment
                           CFIUSalso seeksinformation directly from the investing and selling com-
                           panies through correspondenceand discussions,particularly regarding
                           plans for continued US. production and research efforts.


                           In the several CFIUS caseswe examined where agenciesraised serious
Difficulties in Deciding   questions about the foreign investment, the key concernscould not be
Cases                      allayed by further investment data collection. Rather, the concerns
                           related to the future consequencesof U.S. dependenceon foreign-owned
                           suppliers resulting from reduced US. commercial competitiveness and
                           technology transfers in some sectors. The following casesillustrate the
                           types of concerns which have been raised by CFIUS members both before
                           and after enactment of the E&on-Florio Amendment.


Semiconductor              The 1989 sale to a West German firm of the last major U.S. merchant
Investments                producer of silicon wafers--the basic element used in semiconductor
                           chips-raised difficult questions about erosion of important parts of the
                           U.S. semiconductor industry. It was also the first full CFIUSinvestigation
                           to take place under the Exon-Florio Amendment.

                           At the time of the CFTUS investigation, it was well known that the U.S.
                           firm was the last major U.S. merchant producer of silicon wafers
                           (although some large U.S. electronics firms still have captive units that
                           produce for internal use). It was also public knowledge that Japanese
                           and German firms had purchased other U.S. silicon and wafer fabrica-
                           tion firms in recent years and that, with the sale of this U.S. firm, the
                           share of the world market held by U.S.-owned firms would drop from 14
                           percent to 4 percent, and their share of the U.S. market would drop from
                           45 percent to 8 percent. The 1987 DefenseScienceBoard study had
                           already pointed out the importance of semiconductor materials and
                           equipment suppliers in determinin g the competitive state of the art in
                           the semiconductor industry. It had also revealed that the United States
                           was leading its closest competitor, Japan, in only 1 of the 14 materials
                            and processing technologies the Board had studied.
                            An additional important issue was the investment’s effect on the newly
                            created business-governmentconsortium Sematech,which Congresshad
                            authorized in 1987 to promote a U.S. capability to manufacture
                            advanced technology semiconductors. The question was whether the
                            United States neededto have a U.S.-ownedfirm supplying Sematech.
                            The U.S. firm was not a large supplier directly to the DefenseDepart-
                            ment, but it was to be a key supplier to Sematech.Questions that arose


                            Pye20                                       GAO-          Foreign Investmenr
Chapter 4
Dlfllcnltiea in AndyAng Sped& Invumntr




related to the possible technology outflow that might result from a for-
eign firm being a supplier to Sematech,the capability of remaining U.S.-
owned firms to supply Sematech,the capabilities of alternate foreign
suppliers, and the reliability of continued supplies of wafers to
Sematech and to other U.S. semiconductor firms. Answers to someof
these questions could be provided by private sources,but someques-
tions required judgments about the future intentions of foreign firms.

The law did not provide a clear basis for blocking the investment,
becausethere was no “credible evidence that the foreign interest might
take action that threatens to impair the national security”; nor could
other laws, such as export control laws, be shown to be inadequate in
protecting the national security. The casedid raise questions about what
could be cited as credible evidence regarding the future intentions and
behavior of foreign investors, particularly those from allied countries.
Oncean investment casebecomespublic, it can be awkward for an
agency to argue that the foreign fm’s intentions are malevolent, in
terms of “threatening” national security, particularly if the foreign firm
makes a formal statement of positive intentions.

One other important CFIUScasein the semiconductor sector-occurring
in late 1986, before the Exon-Florio Amendment was enacted-involved
a Japanesefirm’s proposed purchase of a major U.S.-basedsupplier of
semiconductors to DOD. The U.S.-basedfirm was already foreign owned
(by a French oil field services firm). But its acquisition by a large, verti-
cally integrated Japaneseelectronics firm that competed directly with
U.S. firms raised questions about technology transfer, reliability of sup
ply both to DOD and to U.S. businesses(which included a key U.S.
supercomputer firm), and effects on the overall commercial competitive
ness of the U.S. semiconductor industry.

 The U.S.-basedfirm was known to be losing money, however, and the
 infusion of capital promised by the acquisition could also have the effect
 of strengthening the company as a supplier to DoD.Onceit became
 apparent that the investment would be opposed by the Secretary of
 Commerceon general grounds of unacceptable foreign dependence,the
 Japanesefirm withdrew its purchase offer. No further U.S. government
 action was needed (although it is not clear what would have been done,
 since at that tune there was no specific statutory authority to block a
 foreign investment).

 The answers to questions raised in the CFIUSprocesson this casewere,
 again, not the type to be found in formal U.S. government statistics on


 P8ge 21                                      GAO/NsIADBob)l   Foreign Invemtment
                        foreign direct investment. They required policy judgments about the
                        consequencesof dependenceon foreign semiconductor firms for both the
                        U.S. civilian and military sectors.Such decisions would require making
                        assumptions about the Japanesefirm’s intentions regarding the market
                        power and technology transfer that it would gain from the acquisition.


Aerospace Investments   Foreign investments in the aerospacesector have also raised technology
                        transfer questions in the CFIUSprocess.A 1983 aerospacecaseraised
                        important questions about the technology transfer implications of for-
                        eign investment, in terms of foreign accessto controlled, but not classi-
                        fled, U.S. technology and the ability of the export control system to
                        monitor such potential transfers. In this case,a large Japanesefirm was
                        seeking to acquire a U.S. manufacturer of specialty alloys used in air-
                        craft engines. Opponents of the investment argued that since the tech-
                        nology had never been allowed to be exported and was not included in
                        U.S.Japan technology-sharing agreements,the Japanesefirm should not
                        be allowed simply to purchase the manufacturer.

                        Particular questions were raised about the ability of the export control
                        system to protect technology acquired through foreign investments. The
                        export control laws do apply to technology transfers resulting from vis-
                        its of foreign scientists to U.S. plants, but DOD believed that the technol-
                        ogy could be transfered becauseof the difficulty in keeping the
                        Japanesefirm’s scientists isolated from the U.S. firm’s experts. Ques-
                        tions Werealso raised about whether the technology might leak to the
                        Soviet Union becauseof concerns as to whether Japan had procedures
                        to protect the technology.

                        The investment never took place, once DefenseDepartment officials dis-
                        cussedU.S. government concernswith the proposed Japaneseinvestor.
                        But the lack of definitive U.S. policy answers on the technology transfer
                        questions generated an interagency attempt to examine technology
                        transfer issues related to foreign investment. The complexity of the
                        issue and the existence of differing agency viewpoints prevented the
                        interagency group from issuing joint findings or recommendations.A
                        similar attempt to examine technology transfer issueswas made by the
                        National Security Council staff in 1986-87but they, too, were unable to
                        come to specific conclusions.

                        National security concerns about technology transfer and reliability of
                        supply were raised again in the 1984 acquisition by Japan’s largest ball-
                        bearing manufacturer of a U.S. firm considered to be one of the most


                        Pye 22                                       GAO/NSLADW94 Foreign   Investment
important suppliers for missile guidance systems and for major military
contractors. Debate about this investment included congressionalhear-
ings, and concerns were allayed by the Japanesecompany’s stated com-
mitments to continue investments and research in the plant and to fulfill
military contracts.

A 1989 aerospacecase,for which a full CFIUS investigation took place,
also focused on technology transfer concerns.In this case,a French firm
was seeking to buy divisions of a major U.S. aerospacefirm whose main
business involved producing technologically sensitive items for DOD and
the National Aeronautics and SpaceAdministration under classified con-
tracts. Technology transfer concernswere allayed by obtaining from the
French firm a detailed plan for observing U.S. export control laws, in
addition to limiting foreign accessto classified information through
DOD’S Industrial Security Program.

The one investment that the President ordered blocked was the acquisi-
tion of a small, privately owned U.S. aircraft parts producer by a Chi-
nese company controlled by the Chinese aerospaceministry. This
investment was different from these other c~lt~scases,in the sensethat
(1) the foreign investor was controlled by the government of a non-allied
country, and (2) a past record of the investor’s objectionable activities
could be documented, based on classified intelligence reporting, to sat-
isfy the “credible evidence” requirement.




P8ge 22                                     GAO-           Foreign hmmtment
Chapter 5

Broader Policy QuestionsPersist


               The vast majority of casesconsidered by CFTJS, and of foreign takeovers
               of U.S. firms in general, have been friendly, not hostile. In someof these
               takeovers, the U.S. firm had initially sought a domestic buyer, but with-
               out success.In the semiconductor sector, it appears that the foreign
               investing firms were interested in acquiring the U.S. firms becausethey
               would fit into their more comprehensive product structure and would
               also enhance their U.S. market position. Someof the U.S. firms selling
               out were discontinuing their efforts in the industry segment as a result
               of low profitability, market uncertainties, or corporate realignments,
               and the foreign purchaser did assure continued U.S.-basedproduction.
               Businessconsiderations, understandably, are of primary concern to
               managers of U.S. firms.

               National security questions about specific investments are raised,
               rather, by government policymakers who try to view the investment
               from the larger perspective of the country’s defense needs.Sometimes
               these questions are raised only after a sensitive foreign investment is
               publicly proposed and CFIUSbegins a review of it or after a large seg-
               ment of the industry has already been acquired by foreign firms.

               CFXJS’ reactive, case-bycase approach does bring out certain investment
               issues,but it is focused on developing information to meet the law’s spe-
               cific requirements. The President’s recent decision to block an invest-
               ment illustrates that these requirements can be met for certain
               investments.

               But CFIUSis not presently set up to examine other larger questions, such
               as (1) which industry sectors, technologies, or types of firms to preserve
               for U.S. ownership, (2) how to evaluate the importance of a U.S. firm’s
               commercial strength to its defense role, (3) why U.S. companies have
               found it desirable to discontinue operations in certain sensitive sectors,
               (4) why foreign investors place more value than U.S. firms do on devel-
               oping predominance in certain high technology sectors, and (5) what
               parts of the US. defense industrial base are being “hollowed out,” as
               foreign investors acquire U.S. firms which are lower-tier suppliers to
               DOD.

               For example, the concerns raised with us by semiconductor industry
               representatives and industry analysts, as noted below, are not the types
               of questions on which the CFVJS   processhas focused. They are not
               focused strictly on the firms’ relationships with DOD. Rather, they reflect
               concerns about preserving long-term U.S. commercial competitiveness
               - in the face of foreign firms’ competitive businesstactics - in order,


               Page 24                                     GAO/NSID-SO-94   Foreign Investment
over the longer run, to preserve a U.S. production base available for
defense needs.

These industry representatives and analysts expressedthe following
concerns about foreign competitors’ practices. They also raised ques-
tions about what, if anything, could be done, since the practices are not
specifically prohibited under U.S. laws.
Foreign investors in U.S. semiconductor firms, particularly the Japa-
nese,tend to substitute their own suppliers for U.S. suppliers once the
firm is bought. U.S. equipment manufacturers are typically small, but
their products are high in value, and so the loss of even one customer is
considered important.
U.S. computer fm’ increasing dependenceon component parts sup
plied by their more vertically integrated Japanesecompetitors raises
questions about whether the most advanced design components would
be supplied in a timely manner to the U.S. firms.
Foreign investors have bought U.S. firms not only to enhancetheir own
position and acquire technology but also to deny their U.S. competitors
accessto this technology.
The relatively high cost of capital in the United States, together with the
increasingly capital-intensive nature of the semiconductor industry, has
led U.S. start-up companiesto seek foreign funding or businessalliances
that may entail the transfer of commercially valuable technology.
It is difficult to track systematically the extent to which research and
development efforts of high-tech firms are continued, once a U.S. firm is
acquired.

Semiconductor industry concernsremain unanswered, however, about
how foreign investments may contribute to the continued erosion of the
U.S. semiconductor infrastructure. One recent, proposed Japaneseacqui-
sition of a U.S. supplier of critical semiconductor materials illustrates
that the current CFIWprocessdoes not resolve commercial concerns.

This acquisition, involving a mJor U.S. supplier of certain semiconduc-
tor materials, underwent the standard 30day initial CFIUSreview, but no
CFIUSmember requested that it move to the 46day investigation phase.
The U.S. firm was not a direct contractor to Don,although it was a sub
contractor on unclassified work. Alternative foreign or domestic suppli-
ers were available, and there was no evidence the specific buyer would
threaten national security. The US. firm neededcapital to redesign
equipment to remain competitive and continue research, and no other
U.S. firms had shown interest in acquiring it. One m participant


Page 26                                      oAo/NsuMnrer   PondgIl lnvelltme!nt
             Chapter 5
             Broader Policy Questions Pembt




             noted that, in his view, the casepresented a choice between two undesir-
             able alternatives: (1) foreign ownership, which could mean that funda-
             mental scienceand technology would shift offshore; or (2) continued
             businessdifficulties for the U.S. firm, which would prevent it from
             aggressively pursuing the next generation of processingequipment.
             Although such specific casesmay not individually present a threat to
             national security, the overall decline of U.S. commercial competitiveness
             in some semiconductor subsectorsdoes generate broader concernsabout
             preserving the U.S.-owned production base.

             To some analysts, the commercial health of high-technology sectors is at
             the heart of the national security issue. The 1987 DefenseScienceBoard
             study on semiconductors emphasizedthe importance of U.S. leadership
             in semiconductor technology to the electronic systems underpinning U.S.
             military systems. The board noted that leadership in semiconductor
             technology depends on high-volume commercial production becauseof
             the need for commercially derived profits to fund continued research
             and development and new investments. It also noted that high-volume
             commercial production itself dependson maintaining US. and world
             market shares. Yet neither Defensenor any other U.S. government
             agency has responsibility for assuring the commercial viability of the
             U.S. semiconductor industry. As the board concluded,

             “... the principal factor affecting the relative shift in strength of the U.S. and Japa-
             nese semiconductor industries is the fact the Japanese established a strategic (long
             term) goal and effectively brought together all the resources from government,
             industry and academia, needed to pursue that goal. The U.S., at its own discretion,
             elected not to pursue such an organized focus and structure, and as a result is find-
             ing that it is unable to compete in the marketplace as it has been defined by the
             Japanese.”



Conclusion   A strong US. economic baseoverall, and particularly in high technology,
             is widely viewed as important to national security and to the military
             defense structure. Congresshas taken steps to promote U.S. high tech-
             nology leadership, such as helping to fund the research and develop
             ment activities of Sematechand funding DOD research contracts in high
             technology fields.

             Concern persists about foreign investment, however, becauseforeign
             purchases (1) tend to confirm the existing perception that foreign firms
             value these high-technology sectors more highly than U.S. firms do, and



              Page 20                                             GAO/N3LW-W94 Foreign Investment
    (2) tend to raise larger questions about the adequacy of U.S. government
    policy in addressing the variety of factors affecting US. commercial
    competitiveness in sectors critical to national security.

    In essence,concern about the national security effects of foreign invest-
    ment is part of the ongoing public policy debate on the need to preserve
    US. commercial competitiveness in certain sectors. The link between
    national security and commercial competitiveness concernsis evident if
    it is recognizedthat

    the defense industrial base does include industries whose viability
    dependson commercial successin U.S. and world markets,
    systemic factors-such as the target&, national development strategies
    of U.S. competitors, the vertically integmted structure of Japanesesemi-
    conductor conglomerates,and differences in costs of capital between
    countries-in addition to specific trade practices, can affect the com-
    mercial competitiveness of U.S. firms, and
.   U.S. government agenciescovering trade and investment matters are
    oriented to protecting against certain unfair trade practices or specific
    investments clearly threatening national security, but they do not have
    any directive to maintain the commercial viability of an industry sector.

    In this sense,preventing the erosion of defense technology leadership is
    more than a matter of reviewing foreign investments.

    CFIUSis carrying out its foreign investment reviews as provided for by
    the Exon-Florio Amendment, but it cannot be expected to provide
    answers to the types of questions about preserving commercial competi-
    tiveness that need to be addressedat higher policy-making levels.




    P8lgC27                                     GAO/NSMDWM Fodga lnveatmeat
Appendix 1

Major Contributors to This Report


                                      bow, Assistant Director
National Security and   ~~~~*~~~Lm-2,arvps\‘u
                                phe9      *.u.uLU~‘*
                                           Prninet   Manatinr


International Affairs
Division, Washington,
DC.

San Francisco           Evelyn E. Aquino, Evaluator
Regional Office         Robert R. Tomcho. Evaluator


Seattle Regional Office ThommL.
                             Ktiti, EVtiuatir
                        David L. Hilliard, Evaluator




                         PIOC 28                                GAOflW   Foreign Investment