The President's Decision to Order a Chinese Company's Divestiture of a Recently Acquired U.S. Aircraft Parts Manufacturer

Published by the Government Accountability Office on 1990-03-19.

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

                      -United   States General .4ccounting    Office

For Reiease    on        The Presiden:      's Lecision       To 3rder    a
Delivery   Expected      Chinese    Company's     Divestiture       of a
at 9:3C a.m. EST         Recently     Acquired    U.S. Aircraft        Parts
Monday                   Manufacturer
March 19, 199C

                         Statement           of
                         Allan     I.       Mendelcwitz
                         Director,           International   Trade,    Energy,      and
                            Finance          Issues

                         Before     the
                         Subcommittee    on Commerce,     ConslJmer
                            Frotecticn   and Competitiveness
                         House Committee    on Energy     and Commerce
                         House cf Representatives

GAO/T-NSIAD-90-21                       /                                        GAO Form 160 (12/87)
Mr.     Chairman               and Members of the                          Subcommittee:

I am pleased                   to testify              today         before             this    Subcommittee.                    At your
request,           we examined               certain             issues             regarding           the     President's
February           1, 1990,             decision              to order              a firm       of the         People's               Republic
of China,               the     China      National              Aero-Technology                      Import         and Export
Corp.       (CATIC),             to divest              its      recently                acquired          control         of the             U.S.
firm,      MAW0 Manufacturing,                                Inc.              The issues           relate       to      (1)         the
interagency                  process        for        reviewing                 national-security                   related                foreign
investments,                   (2)     existing          means for                  safeguarding               information
possessed               by MAMCO, and                  (3)     sources              of     information            needed              in
investigating                   the     national              security              implications               of the           investment.
These       issues             arose      because             CATIC proceeded                    to complete               its
acquisition                   of MAMCO before                  the         government            had finished                   its         review
of the        investment,                 as provided                     for     under        the    1988 Exon-Florio
Amendment to the                       Defense          Production                  Act.

CATIC is           an export-import                       company controlled                          by    the      Chinese
Ministry           of Aerospace                   Industry.                     MAMCOwas a small,                    privately-
owned firm,                   which     produces              metal             parts      and assemblies                 for         aircraft.
Some     of       its         machinery           is    subject                 to U.S.        export         controls.                MAMCO
had not           previously              exported             its         products,            and so had not                   had to
apply       for         export         licenses.

As you know,                   the     Exon-Florio               Amendment gave the                           President               new
authority               to     investigate              and,         if         appropriate,            block        or suspend

foreign       mergers,          acquisitions,               or takeovers              that      may threaten                    to
impair      national           security.              The President               delegated           his      authority               to
review      foreign        investment               transactions             to    the     interagency                Committee
on Foreign          Investment             in the         United      States,         known as CFIUS and
chaired       by the       Treasury            Department.             The Exon-Florio                      Amendment does
not     specifically            require         foreign        investors            to notify               CFIUS of their
investments            in national-security                       related         firms.           However,           the
consequences            of not       notifying             CFIUS may be severe,                        because            the
President        may later            order         divestiture             of    specific            investments,                as
was done in the                CATIC-MAMCO case.                    This         is the      first          investment
since      enactment           of the         Exon-Florio           Amendment to be disallowed                                   by
the     President.

Our ability            to discuss             publicly        the     details            of this        case         is     limited
both      by the       confidential              nature       of much of the                 available
information            and by the             law's       provision          of    confidentiality                    for
information            filed      with        the     President        by the            parties        involved.


The Exon-Florio                Amendment provides                    specific            maximum timeframes                          for
reviewing          foreign        investments.                The review             process           is     permitted               to
take      a maximum of 90 days,                       including         a 30-day            initial           review            period
to determine            whether          to    initiate           an investigation,                    then         45 days to
complete        such an investigation,                        and a final                15 days        for     the
President          to act.         According              to proposed             regulations,                the     30-day

review          period        begins        on the         first          calendar             day following                     receipt         of
notification              either        from        one of the              investment                    parties          or from          a
CFIUS member agency.                          The CFIUS staff                    chairman                  retains         the      right        to
reject          voluntary           notices         that      do not            comply           with        the      information
needs       specified           in the         proposed             regulations.

The amendment allows                        the     review          process              to    be expedited,                 and would
allow       the       President         to        suspend          completion                 of a foreign                 investment
earlier          in the        go-day         period,          but        only      if        the     President             can make
the      required          findings,              applicable              to all          his        actions          under         the
amendment,             that

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

 (2)     provisions            of     law,        other      than         the     Exon-Florio                     Amendment and the
          International               Emergency            Economic              Powers             Act,      do not,            in the
         President's                judgment,           provide           adequate              and appropriate
         authority            for     the     President              to protect                 the        national          security.

The decision                by CATIC and MAMCOto                            complete                the     investment
transaction               was made before                  the       initial             30-day            CFIUS review               process
was completed,                 an action             not     prohibited                  by     the        law.       According             to
CFIUS,          the      30-day       process           began        on Monday,                 November             6,    1989,          when
the       CFIUS staff               chairman         accepted             the     notificat                ion     voluntari          lY

provided            by    MAMCOon November                        3,        1989.          CFIUS considered                  the     30-day
process         as due to end on December                                    5, 1989.              The transaction                  was
completed             on November                 30,     1989,         when CATIC purchased                         all     the     voting
securities               of MAMCO. CFIUS was not                                notified            that      the        transaction
would       be completed                  before          the     end of the                30-day         period.

During        this        initial          30-day           review,           CFIUS staff              followed             the
standard            practice           of notifying                 CFIUS member agencies                            of the
proposed            CATIC investment                      and providing                    them with          copies         of the
notification                 letter        and documents.                       CFIUS member                 agencies             then
notify        their        appropriate                   internal            offices             to assist          in     reviewing
the       investments.                 For example,                 in       the      Commerce         Department,                 the
initial         CFIUS contact                     was the         Office             of Trade         and Investment
Analysis            within          the     International                    Trade         Administration.                   This
office        asked          certain         other          parts           of Commerce to                 review          aspects        of
the       transaction.                 One of these                 was the               Bureau      of Export
Administration,                     which         checked         its        files         for     evidence          or allegations
of    export          control          violations.

Commerce staff                  were notified                   of the          proposed             CATIC-MAMCO investment
on November               6, 1989,           and by November                         17,    1989,      the     Bureau             of Export
Administration                  had developed                   information                 indicating              potential
issues         warranting              further            investigation.                         Questions          were developed
to    clarify            whether          MAMCO's products,                          or    its     factory          machinery,
would        fall        under        existing            export            controls,             because      MAMCO had not
previously               exported           its         products.              These types             of questions                 were

faxed       to    MAMCO on November,                       27,     1989,         requesting              the        company's
response          by November              29,      1989,         in anticipation                  of a CFIUS meeting
on this          case on November                   30,     1989.          MAMCOprovided                      its         response        to
these       questions          by fax         on November                 29,      1989,        but did             not      mention       to
CFIUS that           the      takeover            would       be completed                 the     next         day.          CFIUS
members met on that                    day,         November             30,     1989,       but did            not        yet    know
that       the     takeover         had already               been completed.

We did       not     find      evidence             that      CFIUS had informed                         MAMCO of its
potential           concerns          about         the     investment.                  CFIUS staff                  told       us that
it     is not       their      practice             to     provide             such information                     before        their
initial           review      is    completed.                   In this         case,       their         potential
concerns           were based          on confidential                         information              concerning               CATIC.
CFIUS staff            also        noted      the         law's        clear       authority             to      require
divestiture            and that             investors             proceeding             with      their            transactions
are       aware     of the         risk.

At the        November         30,         1989,     CFIUS meeting,                   a sufficient                    number of
agencies           requested          that         an investigation                   be conducted                    of the
CATIC-MAMCO investment                           on the          general         grounds          that         important
questions           remained          unanswered                 about     the      investment.                     On December                4,
1989,       the     29th      day of the                 review        period,        CFIUS made a determination
to     undertake            a formal         investigation,                     in order          to     assess            MAMCO's
present           and potential              production                and technological                       capabilities,
and CFIUS informed                    CATIC and MAMCO of this                              decision.                  At this
point,           MAMCOand CATIC had clear                              indications               that      the

Administration                  had potential              security            concerns        about        the
investment.               Yet there              is no indication                that       the     parties         informed
CFIUS that              the     transaction             had been completed.

The Administration,                       however,         had not         completed           the        investigative
efforts          that     would          have formed           the      basis        for    the      President's
required          findings             regarding         credible          evidence           of intent            to    impair
the     national              security          and inadequacy             of    other        laws        to protect          the
national          security.               These        findings         were made after                   (1) a visit          to
MAMCO in mid-December                           1989 by officials                of the           Commerce and Defense
Departments              representing                 CFIUS,      (2)     further          government             development
of     confidential               information             regarding            CATIC's        past        activities,          and
(3)     evaluation              by the          Commerce Department                   of the         adequacy           of the
Export          Administration                  Act    in covering             the    circumstances                of this

We did          not     examine          the     CFIUS review             process          in detail           beyond      the
point          at which         the      transaction           was completed,                 except         to determine
that      it     followed             standard         CFIUS processes.


We believe              that      the     circumstances                of this         case       raise      general
questions             about       the     adequacy         of existing               means of safeguarding
controlled              technical              data    when a foreign                investment            transaction              is
being          considered             or is      completed            before     the       Exon-Florio             national

security         review           process            is     completed.                 In this         case,       for     example,
it   appears           that       CFIUS staff                   did      not    become aware                of the
transaction's                   completion            until            several         days      later.

Under        export        control            regulations,                    an export          license          is     required                  if
controlled             technical              data         is     to be discussed                 or otherwise                     released
during        visits            by a foreign                national.                This      access        or release                  could
occur        during        visits          to discuss                  or negotiate              the      investment
transaction,               as well            as other                activities            once the         transaction                      is
completed.              The administration,                              of    course,         has the          authority                to
deny an export                   license        for         such         releases.

We note        that        it     is    difficult                 to detect            illegal         technology
transfers.              Administering                      the        export        control       laws       requires               reliance
on good faith                   compliance            by U.S.              companies           with       the     rules            on
technical           data         exports.             If         foreign           nationals          are    to visit               U.S.
facilities             and gain            access           to controlled                   technical           data,         it        is
incumbent           on U.S.            companies                to     be aware         of and comply                  with         U.S.
export        control            requirements.                        Without        good faith             compliance,                  it
would        be difficult               for     the         U.S.         government            to be aware               of visits                      by
foreign         nationals              that      could               result        in the      transfer           of controlled
technical           data.           In cases               where there               may be reason                to doubt               a
prospective              foreign           purchaser's                   good faith            compliance              with         the
rules,        the      U.S.       export         control               process         should         not    be expected                      to
serve        as adequate               protection                 against           technology            loss.

With      regard     to your        questions          about    the     sources      of the
Administration's               information        on this        investment,             much of the
information          came from        confidential             sources.          The official
government         statistics         on foreign          investment,            maintained         by the
Commerce Department's                 Bureau      of Economic             Analysis        (BEA),     do not
appear      to have been relevant                 to the        investigation,             and in any case
are     considered       proprietary            data     generally         protected        from     release
outside       of BEA.           Information       on CATIC's            other     subsidiaries          in the
United      States      was obtained            through        other,      confidential            information

Mr.     Chairman,       this      concludes       my statement.                 I will     be happy to try
to     answer      any questions         you may have.