Deals can be derailed by security concerns.

AuthorKaplan, Michael L.
PositionETHICS CORNER

* Given the weak U.S. dollar and historically low valuations of defense contractors, commentators expect even greater mergers-and-acquisitions activity from foreign buyers in the U.S. defense industry. Defense companies considering a transaction that could result in a foreign person acquiring control of the business should prepare for close regulatory scrutiny.

The U.S. president has authority to review and uhimately prevent any transaction that could result in control of a U.S. business by a foreign person if it threatens national security under the socalled Exon-Florio Amendment. The Committee on Foreign Investment in the United States (CFIUS), an inter-agency committee chaired by the secretary of Treasury, is charged with administering Exon-Florio.

As enticing as an acquisition proposal with a lofty valuation may be, CFIUS implications mandate that U.S. defense contractors thoroughly analyze the structure, source, motives of foreign investment and nature of the business to determine whether CFIUS review is needed. The analysis will turn on three key questions: Will the transaction transfer control of a U.S. business to a foreign person? Does the transaction involve a foreign national or any entity controlled by a foreign national, foreign government or foreign entity? Does the transaction raise national security concerns?

On the question of control, the seller should conduct due diligence on the buyer early, including evaluating the structure and ownership of the buyer and the extent of all foreign government interests in the buyer. The regulatory definition of a "foreign person" turns not on where the company does business but on whether it is controlled by a foreign interest. CFIUS review may apply to the acquisition of a U.S. company by the U.S. subsidiary of a foreign company. Thus, determining that a potential purchaser is domiciled in the U.S. does not complete the CFIUS analysis. The seller must investigate the buyer and its affiliates.

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As for transactions, those that implicate CFIUS scrutiny include ones that result, or could result, in foreign control of a U.S. business. Transactions less obvious than mergers and acquisitions, such as joint ventures with a foreign-controlled entity and minority equity investments by foreign entities, potentially implicate CFIUS as well. Transactions resulting in the conversion of non-voting securities into voting securities, or the acquisition of voting proxies, may also...

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