U.S. Court to Decide Whether National Security Trumps Foreign Investment and Due Process

Wednesday, July 10, 2013

InfosecIsland News

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In the global economy, one of the great prizes is the capital and boost to a country's economy provided by Chinese foreign investment.  The importance of  Chinese direct investment to the U.S. is evident from the over 30,000 American jobs produced by Chinese firms at the end of 2012, as chronicled by the  Rhodium Group's China Investment Monitor.  Additionally, Rhodium reports that direct investment from China into the U.S. since 2007 is up as high as 1,300%,  and that there are over $2.3 billion in deals in the U.S. pipeline from China in 1Q 2013 alone, the highest ever reported.  

However, in spite of the obvious benefits, there is an uneasy tension with respect to Chinese investment in the U.S., given serious concerns about espionage, theft of intellectual property and cyber-security. Last week, for instance, a federal grand jury indicted Sinovel Wind Group Co. of Beijing on charges of stealing technology from American Superconductor Corp. of Devens.  Earlier, Congress and domestic business leaders were loud in condemning Chinese practices after the private security firm Mandiant in February released a report that indicated systematic cyber-attacks originating from a military address in Shanghai. 

Of course, the recent announced takeover of US pork producer Smithfield by China's Shuanghui has also stirred public concern that Chinese ownership might somehow affect food safety in the U.S.  Politicians on both sides are concerned about the business climate, as witnessed by  the recent California Sunnyland summit between President Obama and China's President Xi Jinping.  Many experts such as Thilo Hanemann and Dan Rosen of the Rhodium Group worry that foreign investment review in the U.S. may become politicized by the rhetoric  emanating from Congress.  (the Hill's Congress Blog, June 8, 2013).

It is within this backdrop, that a little noticed lawsuit has significant implications to the way that the U.S. will review national security concerns for proposed foreign purchases of U.S. businesses.  In an unprecedented lawsuit, a DC federal court will hear arguments on Thursday, July 11, about whether the Committee on Foreign Investment in the United States (CFIUS) (the U.S. gatekeeper for foreign investment) owes some type of due process to Ralls (an affiliated company of the Sany Group, a Chinese construction equipment manufacturer). Ralls acquired wind farm sites in Oregon last year, which were near a U.S. Naval installation and flight testing zone. No party has ever challenged in a lawsuit the extremely broad discretion of CFIUS and the President to make a formal finding of a national security threat.

"In every instance prior to Ralls, these issues have been settled without a lawsuit, with the foreign company agreeing not to acquire the American business or divesting its ownership," according to Chris Simkins, a CFIUS specialist in Washington DC.  Indeed, The President's order to divest the wind farm assets was the first to be issued in over 22 years.  The Ralls case and the rough treatment given Ralls by CFIUS raises issues of whether the American review process is fair and whether Chinese companies, given the current background, are more likely to viewed as national security risks.  According to court papers, after the CFIUS investigation began, Ralls proposed selling the wind farm interests to an American group to cure the concern. No reason was ever provided by CFIUS as to why Ralls' offer to voluntarily divest its ownership of the site to Americans with the improvements would not have been sufficient.

Instead, CFIUS's orders, later adopted by the President, directed that Ralls could not divest ownership without CFIUS approval and ordered Ralls, in sequence, to destroy first all construction and the expensive concrete foundations on the site, and then required that ownership of the site be transferred to an approved buyer. Because Ralls did not notify CFIUS in advance of closing its purchase and constructed the concrete foundations on the site without approval, CFIUS  seemingly showed Ralls no mercy. 

"CFIUS appears to have taken some pretty drastic action by not only unwinding the deal, but requiring Ralls to essentially leave no trace after its exit, and then to restrict even which U.S. company could buy the asset from Ralls," added Simkins.  "That's unprecedented and many would argue is overreaching by CFIUS, especially because Ralls could turn around and sell its equipment and services to the wind farm after divestment without CFIUS having any authority to stop it."

After considering Rall's lawsuit in February, the DC U.S. District Court dismissed most of Ralls' claims of violations, holding that the President's broad authority to make national security findings permitted the actions taken against Ralls (including CFIUS's order to destroy the construction on the site), since no permission was sought in advance. However, the court allowed Ralls to proceed to the next hearing on Thursday with the novel claim that the President's divestiture requirements were unconstitutional because they were not done through due process of law - essentially that  Ralls  may have been denied its constitutional rights to have an opportunity to review, respond to, and rebut any evidence that  takes away private property. The Judge was careful to state that she was not ruling that such a right existed or that due process might already have been satisfied in these circumstances, but simply that Ralls was not precluded from making that claim under the statute.

If the Court finds that Ralls has some form of due process rights, it could significantly change how CFIUS conducts its review of foreign investors wishing to acquire American businesses. Roel Campos, a former SEC Commissioner who oversaw international matters and whose law firm represents Chinese companies, points out that due process rights would require CFIUS to establish procedures providing notice of a potential taking of private property and to offer the foreign investor the opportunity to present evidence that no threats exist.

In a legal note, Dan Pickard, a CFIUS expert in DC, observed that, even if due process rights exist, such due process rights may not be very meaningful, since the facts underlying the finding of a national security threat are classified and cannot be disclosed to Ralls or other parties in that situation.  However, Campos points out that, even if the chances of prevailing with CFIUS are small, due process is an extremely valuable right to any foreign investor and is one of the hallmarks of the universally admired American Rule of law.

For example, with due process rights, Campos explained, Ralls might be able to challenge the CFIUS's taking of the improvements it constructed (e.g., the concrete foundations build by American contractors) and argue that transferring the site and improvements to an American owner could not possibly impact national security.  Ralls could present other evidence – e.g., that the concrete foundations in fact had nothing in them other than concrete and therefore as a factual matter posed no plausible threats to military installations.  "If the equipment and concrete were examined at the time of divestment and shown to be 'clean,' then transfer of control to a U.S. owner should have dispelled national security concerns," stated Simkins.  "Thereafter, it's a matter of enforcement of the various espionage statutes to make sure there is no post-divestment national security threat emanating from the wind farm."

After making a record that evidence presented by the foreign investor was considered, CFIUS would make its finding as before, without explaining or revealing classified information. In that due process context, Campos points out, CFIUS's decision regarding national security would remain - essentially unassailable and immune from any court review, as the DC Court already held.

However, due process rights are never meaningless. Even in the face of low odds, having the right to be heard and to present evidence provides an important sense of justice to the proponent, Campos notes. Importantly, he contends, accommodating due process in the CFIUS review would not compromise the national security analysis which could still be done efficiently, without disclosing classified information. "Imposing due process procedures upon CFIUS ultimately would show the strength and fairness of our system to all foreign investors and would help continue to attract capital into the U.S."

After hearing oral argument this Thursday, the eventual decision of the Court is not expected for several months.  If the Court's ruling ultimately requires due process, CFIUS's procedures may change substantially to provide foreign investors notice and to permit evidence to be presented.  Chinese companies, as well as other foreign investors, will be watching with great interest.

SOURCE: Roel Campos

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