Issues in Acquisitions of Defense Industry Contractors

This memorandum discuses some of the pertinent issues involved in takeovers of defense industry contractors. Part I gives a brief introduction to the topic. Part II discusses generally the Exon-Florio legislation. Part III gives a sampling of illustrative caselaw concerning the Exon-Florio legislation, illustrating decisions based on the general concept of foreign control, as well as decisions based on the later expansion of the legislation, which distinguishes between foreign control and foreign government control. Finally, Part IV discusses the relationship between the Department of Defense (DOD) and the Committee on Foreign Investment in the United States (CFIUS) in regard to Exon-Florio review. Specifically, it discusses DOD review of CFIUS cases for national security risks, DOD assessment of risk of diversion for defense-critical technologies, and the importance of obtaining and maintaining security clearances to gaining approval for a takeover under the Exon-Florio legislation.

Introduction

One of the principal bases of the defense and national security strategy of the United States is to preserve technological, rather than numerical, superiority of items used by or in conjunction with the defense industry. Preserving U.S.-based and owned industrial capabilities in sectors critical to national security has been a traditional goal and means of maintaining that superiority. As a result, the United States has implemented a legal and regulatory scheme to ensure that foreign investment does not assume forms harmful to the nation's interest.

This legal and regulatory scheme imposes specific restrictions on specific areas of concern to the U.S. defense and national security. These restrictions are aimed at protecting classified defense information from foreign access and ensuring U.S. production of vital defense goods in the event of crisis. Foreign investments into U.S. companies that perform classified defense work are monitored under the National Industrial Security Program (NISP). While this program does not permit the denial of foreign investment, it can have the effect of deterring potential investors that seek access to the classified information or in destroying the economic viability of the proposed acquisition.

The Congress enacted the Exon-Florio legislation to fill in gaps it perceived in federal antitrust, environmental and securities laws, as well as in the general power of the president to declare a national emergency, to protect companies involved in defense or national security from takeover by foreign interests. The Exon-Florio legislation grants to the president the authority to take appropriate action to suspend or prohibit foreign acquisitions, mergers and takeovers of U.S. businesses that threaten to impair national security. To exercise that authority, the president must find that

1. credible evidence exists that the foreign interest might take action that threatens to impair national security and that
2. no provisions of law, other than provisions in the International Emergency Economic Powers Act, provide adequate and appropriate authority to protect the national security.

Congress did not, however, intend for the Exon-Florio legislation to raise obstacles to foreign investment.

Exon-Florio Legislation

Overview of Legislation

The application of the Exon-Florio legislation has evolved since its enactment in 1988. In particular, as a result of the attempted takeover of a missile division of a subsidiary of LTV Corporation by Thomson-CSF, S.A., Congress strengthened Exon-Florio by imposing a distinction between foreign control and foreign government control. It also strengthened the legislation by requiring intelligence agency assessment of the risk of diversion of defense-critical technologies in situations where the U.S. company that is the subject of the takeover is engaged in the development of such technology, or is otherwise important to the defense industrial and technology base.

The review process under Exon-Florio is delegated to the Committee on Foreign Investment in the United States (CFIUS), which is a committee of representatives of 11 different agencies or offices. The Secretary of the Treasury chairs the committee and the Departments of State, Defense and Commerce are among the agencies represented. The Defense Technology Security Administration coordinates the positions of the various Department of Defense (DOD) components, and provides the final DOD position for CFIUS reviews.

Exon-Florio covers any acquisition by a foreign company of a company engaged in U.S. interstate commerce. Thus, a foreign company's acquisition of another foreign company is subject to Exon-Florio if the target company had a business engaged in interstate commerce. In addition, Exon-Florio covers more than the defense industry.

CFIUS has developed an illustrative list of criteria for determining whether a transaction raises national security implications. These criteria include:

1. impact on readiness of U.S. military forces,
2. defense procurement,
3. new technologies and
4. defense-related research and development projects.

In addition, consideration is also given to whether a particular transaction could lead to unauthorized access to U.S. classified information and/or violations of U.S. export controls by the foreign company.

The Decision To File An Exon-Florio Notice

While notification to CFIUS of an acquisition is voluntary, pre-acquisition notification and review forecloses the possibility of any future review or of any sanctions, such as forced divestiture of the U.S. entity. Given the certainty that voluntary notification gives to a purchaser, many foreign investors routinely give CFIUS notification, even where there is virtually no chance of a national security implication from a particular acquisition.

When deciding whether to file, a company should focus initially on three pertinent issues:

1. Is the transaction an "acquisition?"
2. Would it result in "control?"
3. If so, could it impair "national security?"

The term "acquisition" under Exon-Florio regulations includes any acquisition, merger or takeover, including any acquisition of an entity through purchase of its voting securities, conversion of its convertible voting securities, or acquisition of its convertible voting securities or proxies, if any of the foregoing involves acquisition of control over the U.S. entity.

Further, the term also includes the acquisition of a business, including any production or research facilities, if the technology or personnel of the business will be substantially used. The term also includes consolidations. Finally, the term can also include a joint venture, if the venture involves a foreign entity gaining control through the venture of an existing business of the U.S. entity. The term does not appear to apply to investments known as "greenfield investments," which are new ventures started from scratch.

The term "control" means the power through the ownership of a majority or a dominant minority of the total voting securities, or through proxy voting, contractual arrangements or other means, to determine, direct, or decide matters affecting an entity. Obviously, this a broad test, and there is no bright line rule.

Finally, there is no formal definition of the term "national security" but the following factors are analyzed to determine a transaction's effect on national security:

Pre-1992 Amendment Factors:

1. The domestic production needed for projected national defense requirements.
2. The capability and capacity of domestic industries to meet national defense requirements, including the availability of human resources, products, technology, materials, and other supplies and services.
3. The control of domestic industries and commercial activities by foreign citizens as it affects the capability and capacity of the U.S. to meet the requirements of national security.

1992 Amendment Additional Factors:

1. The potential effects of a transaction on U.S. international technological leadership affecting U.S. national security.
2. The potential effects of a transaction on sales of military goods, equipment, and technology to a country identified as supporting terrorism or a country of concern regarding proliferation of missiles or nuclear, chemical or biological weapons.

In addition, in defining "national security," the regulations state that it should be "broadly interpreted and without limitation to particular industries" and also that "[g]enerally speaking, transactions that involve products, services, and technologies that are important to U.S. national defense requirements will usually be deemed significant with respect to national security" and that notice should be given to CFIUS where, for example, "a company is being acquired that provides products or key technologies essential to U.S. defense requirements."

Basically, when deciding whether to file notice, a company should use the above discussion as a starting point. It should determine whether the target company provides any products, technologies or services to the military. It should also look at past CFIUS investigations (some of which are summarized below) to see if it is the same type of company that has been investigated previously. After this starting point, a commentator on the subject has suggested some additional steps a foreign investor should initially focus on:

1. Determine whether the U.S. firm has any government contracts and, if so, whether it has any security clearances either for its facilities or its personnel.
2. Examine the market share for the U.S. firm's products or services and the number and nationality of other suppliers of the same products or services.

The existence of government contracts is a key factor in CFIUS interest in reviewing a proposed acquisition. The existence or non-existence of a direct government contract is not in and of itself dispositive as many contractors manufacture components or subassemblies that are incorporated into other contractors products, which are in turn sold to the Department of Defense. CFIUS and its members normally query whether, in the case of a national emergency or armed conflict, the U.S. would still have adequate access to the relevant products or services from suppliers other than the U.S. firm, assuming foreigners control the firm.

Effect of Notification or of CFIUS Investigation

Upon notification to CFIUS of a proposed or completed acquisition, the party filing thus begins the Exon-Florio review process. CFIUS first undertakes a preliminary review of the filing, which it must complete within 30 days of the notification. In this preliminary review, CFIUS determines whether an additional 45-day investigation is necessary.

If necessary, CFIUS completes the 45-day investigation and relates to the President both its findings and its recommendation in regard to the transaction. The President then determines whether there is a risk to U.S. national security. If CFIUS determines not to conduct the 45-day investigation, or the president ultimately determines that the transaction poses no risk to national security, then the Exon-Florio review is complete.

In contrast, where there is no voluntary notification, there is a continual threat of divestiture of the entity, and thus uncertainty in the transaction. Thus, an Exon-Florio filing is usually a prudent move, because of the potentially severe consequences, as well as the uncertainty caused by not filing, where the foreign investment even arguably falls within the parameters of Exon-Florio.

Pursuant to Exon-Florio's enactment, there have been 1,150 filings, 15 investigations (45-day), and only one order prohibiting the investment. The foregoing statistics do not include, however, voluntary withdrawals of acquisitions after initial negative reaction by CFIUS. Part III sets forth a sampling of cases reviewed by CFIUS, as well as some illustrative or inferred teachings gleaned from the public record.

Caselaw Re: Exon-Florio Legislation

Decisions Based On Foreign Control Concept - Pre-1992 Amendment Decisions

1. Luxembourg (But South African Controlled) Holding Company's Takeover of British Firm (Owning 49.3% of U.S. Mining Company)

This case involved an unsolicited tender offer by a South African controlled mining company, for a British mining company that, in turn, owned 49.3% of a U.S.-based mining company. The issue was whether the acquisition would endanger U.S. national security through the strategic concentration of certain minerals and metals in a South African controlled company. As a defensive measure, the British company wrote the President of the United States alleging that the unsolicited bid would endanger U.S. national security for the above cited reasons.

CFIUS agreed with the bidder's position that the transaction was purely foreign and, thus, would not cause a direct change of control. Accordingly, the transaction was held to be outside Exon-Florio's intended coverage. CFIUS also concluded that U.S. access to strategic minerals would not have been impaired significantly even if sales to the U.S. were terminated after the acquisition. Had CFIUS concluded that U.S. access to strategic materials would be impaired, it would have been unlikely that CFIUS would have so easily dismissed the transaction as purely foreign.

2. German Company's Acquisition of 12.25% of U.S. Company

In this case, a German company notified CFIUS of its intention to acquire 12.25% of the common stock of a U.S. company. The U.S. parent company controlled the remaining 51% of the common stock, and three European companies controlled the remaining 49%. The proposed investment would have redistributed the stock among the foreign owners and left the majority ownership in the U.S. company. The U.S. company had classified DOD and other U.S. government contracts that were protected by facility security clearances.

CFIUS determined that the purchase of the 12.25% interest, although merely a redistribution of the foreign ownership, constituted foreign control because of several minority veto rights. These rights included veto power over certain decisions, such as the adoption of a strategic plan, and any departures from that plan in regard to product development strategies, as well as the determination of the annual budget. CFIUS reviewed the filing and proceeded with a 45-day investigation. While undergoing the investigation, however, CFIUS addressed issues relating to the DOD's ability to mitigate foreign control and influence over the company under the existing security agreement and thus, ultimately concluded against blocking the acquisition.

3. German Company's Acquisition of U.S. Company Which Produced Critical Technology

In this case, CFIUS investigated the acquisition because the U.S. company was the sole supplier of this type of critical technology and there were concerns that the resultant foreign control pursuant to the acquisition could lead to a loss of U.S. capacity to develop new generations of products. However, despite lobbying by many members of Congress, including then-Rep. James Florio, the acquiror's willingness and effectiveness in working with CFIUS to alleviate any security concerns forestalled any adverse decision.

4. Singaporean Company's Acquisition of 22.8% of the Voting Interest of a Group Formed to Acquire 100% of a U.S. Company (Majority Owned by U.S. entities)

In this case, 99% of the Singaporean company was ultimately owned by the Singapore Ministry of Finance. Due to the existence of classified contracts and classified information, a security agreement existed which covered those concerns. CFIUS concluded that the foreign party did not have control, in part, due to the foreign party's willingness to enter into a proxy agreement under industrial security regulations that would give the foreign company's voting rights to two U.S. citizens. Also, the requirement that approval by two-thirds of the shareholders was necessary for certain decisions also acted as a factor contributing to CFIUS' conclusion. In this case, the foreign company later entered into a security agreement that allowed the foreign company to gain board membership.

5. Israeli Companies' Acquisition of a total of 35.6% of Stock of U.S. Company

In this case, one Israeli company increased its ownership of stock in a U.S. company from 10.5% to 17.4%, while the other Israeli company acquired 18.2% of the U.S. company's stock. The Israeli companies disclosed in their CFIUS application that they may enter into a shareholders' agreement under which they agree to vote their stock in concert. Subsequently, CFIUS learned that the shareholders' agreement was never reached. CFIUS concluded that there was no foreign control because the two firms were not acting in concert. Thus, because CFIUS held that there was no foreign control, it did not further review the transaction for national security concerns.

6. Japanese Soda Company's Proposed Acquisition of U.S. Ceramic Company

In this case, a Japanese based soda company sought to acquire a U.S. ceramics company. The U.S. company produced ceramic beryllium components used in the manufacture of nuclear armaments. The U.S. company also held a classified contract as the sole supplier of these components for a particular U.S. weapons plant. Because of this contract, CFIUS would have recommended prohibition of the transaction to the President. It then filed a new notification in which it provided assurances that the Japanese company would not obtain any confidential information relating to the classified contract with the weapons plant. This new notification was approved by CFIUS and the President. However, the Japanese company withdrew its notification and developed in cooperation with the Energy Department acceptable precautionary measures.

7. Joint Venture Between Swiss-Swedish Electrical Engineering Company and U.S. Electric Company

In this case, the Swiss-Swedish company proposed a joint venture between the two companies to manufacture, distribute, sell and service high-voltage electrical transmission and distribution equipment in the U.S. Under the terms of the joint venture agreement, the Swiss-Swedish company would own a 45% interest in the venture with an option to purchase the remaining 55% interest from the U.S. company.

The Defense and Commerce Departments expressed concerns that if the Swiss-Swedish company exercised its option, this could lower the availability of high-powered electrical transmission equipment in the U.S. In response to these concerns, the Swiss-Swedish company notified CFIUS of its intention to continue to manufacture, service, repair, research and design the transmission equipment in the U.S. upon acquisition of the U.S. company's interest. CFIUS and the president subsequently approved the joint venture.

8. Chinese (Government Owned) Aero-Technology Company's Proposed Acquisition of U.S. Manufacturer of Metal Components for U.S. Commercial Aircraft

In this case, a Chinese aero-technology import and export company, owned by China's Ministry of Aerospace Industry, acquired a U.S. company which designed metal components exclusively for U.S. commercial aircraft. During CFIUS' 30-day review, it determined that some of the U.S. company's manufactured products would require individual validated licenses if exported. Then, after its 45-day investigation, the president followed CFIUS' recommendation and ordered the Chinese company to divest itself of its new acquisition.

Commentators suggest that the president's decision was based, at least in part, on the goal of expressing U.S. disdain at the Tiananmen Square incident. The President stated, however, that the transaction was prohibited based on concerns that the Chinese company's control of the U.S. company might threaten to impair the national security of the U.S.

9. French Company's Acquisition of U.S. Aerospace Company

In this case, a French conglomerate, engaged in, among other things, the development of aerospace and weapons systems technologies, sought to acquire from a U.S. company three of the company's divisions which produced spacecraft and aerospace system software and hardware. These divisions were engaged in classified defense contract work for the U.S. government. CFIUS investigated the transaction based on a Commerce Department request.

The Department of Commerce wanted CFIUS to investigate the French company's proposed plan for acting in compliance with the U.S. export control laws. Based on CFIUS' investigation of the French company's comprehensive export control development system, which it developed in part through consultation with the Department of Commerce, the president did not prohibit the transaction, because he concluded that because of the export control management system, sensitive technologies were sufficiently protected from unauthorized transfer outside of the U.S.

10. Joint Venture Between U.S. Metals Company and Japanese Sponge Company

In this case, a metals company agreed tentatively with a Japanese sponge company to sell sophisticated sponge to U.S. aerospace and commercial firms. The agreement provided that the Japanese company would contribute seventy million dollars in technological, engineering and financial support to aid in construction of a U.S. sponge plant. In return, the Japanese company was given an option to acquire 25% of the U.S. company.

The U.S. company is the West's largest supplier of Titanium. Titanium is an ideal component of numerous aerospace applications, including aircraft, missiles, engines and submarine parts, and is considered a critical metal by DOD. CFIUS investigated the venture in response to concerns expressed by several congressmen. It concluded, however, that the venture would not impair U.S. national security, due in part to such laws as the Defense Production Act of 1988. These laws would ensure that the U.S. company would continue to supply titanium for U.S. strategic stockpiles and for U.S. manufacturers. This conclusion was controversial, and was criticized by several representatives in Congress.

11. Indian Government Owned Computer Software Company's Proposed Acquisition of London-Based Software Consulting Firm Including U.S. Subsidiary

In this case, a computer software and support company owned by the Indian government proposed to acquire a London software consulting firm. The U.S. subsidiary of this firm designs customized applications for a sophisticated computer program used both in military and commercial applications. Specifically, this program uses a digital encryption standard to encode data for transmission. This standard was regulated by U.S. munitions controls, thus prompting an Exon-Florio investigation. An additional concern arose because the firm consulted for firms which manufactured classified military products.

CFIUS, however, determined in its investigation that sufficient protection through controls existed to protect the encoded standard from export. The president followed CFIUS' conclusion and did not prohibit the acquisition.

12. French Company's Proposed Acquisition of U.S. Manufacturer

In this case, a French company sought to acquire a U.S. company which manufactured abrasive products and engineering materials, including advanced ceramics, and researched and developed advanced ceramics and diamond films. The U.S. company had several classified contracts with the U.S. government, including with the Defense and Energy Departments. The president decided not to intervene in the transaction based on CFIUS' investigation.

13. Swiss and South African Companies' Proposed Acquisition of Communications Division of U.S. Company

In this case, a Swiss company proposed to acquire 51%, with a South African company acquiring the other 49%, of a communications division of a U.S. company. The division designs, manufactures and services communications networks. In a speedy decision on the proposal, the president declined to intervene in the transaction, based on CFIUS' investigation's conclusion that no credible evidence existed to conclude that the foreign acquirors would take any action that might threaten national security.

Decisions Based Upon Foreign Government Control Concept - Post-1992 Amendment Decisions Holding Foreign Government Control, But Insufficient National Security Concerns

After the attempted 1992 takeover of LTV Corporation's Missile Division by Thomson-CSF, S.A., Exon-Florio was amended and strengthened to make a distinction between foreign control and foreign government control. The amended law also mandates a 45-day investigation where the acquiring company is controlled by or acting on behalf of a foreign government and the acquisition could result in foreign government control that could affect the national security. The amended law also adds the requirement of intelligence agency assessment of the risk of diversion of a defense-critical technology in situations where a company is engaged in the development of such a technology or is otherwise important to the defense industrial and technology base.

A sampling of 18 cases where CFIUS found foreign government control disclosed no cases in which CFIUS commenced a 45-day investigation. The decision not to proceed with 45-day investigations in those cases was based upon CFIUS' view that national security concerns were not sufficient to warrant further review. Thus, although the legislative language appears to mandate investigations where there is foreign government control that could affect national security, CFIUS has in effect tempered this language by requiring that a credible threat to national security exist before it would conduct a 45-day investigation.

1. Subsidiary of German Company's Proposed Acquisition of U.S. Manufacturer of Large Machine Tools

In this case, the U.S. company had unclassified contracts with DOD, and its products were subject to export controls which applied to dual-use products. The products did not possess unique capabilities, and the company's technology was not considered critical. Approximately one-third of the German company was indirectly owned by one German state government and two German city governments.

Under German law, this gave the German governments the power to block certain decisions, such as the acquisition or closing down of businesses. The government-owned entities offered to abstain on shareholder decisions affecting the U.S. company. CFIUS concluded that there was foreign government control despite the offer to abstain, however, it also concluded that the insufficiency of national security concerns precluded further investigation.

2. Subsidiary of French Company's Proposed Acquisition of U.S. Developer of Software Tools

In this case, the U.S. company had unclassified contracts with DOD and other U.S. government entities, but the technology involved in the transaction was not military sensitive. The ultimate parent of the acquiring company was 100% owned by the French government, and CFIUS, therefore, concluded foreign government control would occur. However, CFIUS again concluded that there were insufficient national security concerns to warrant any further investigation.

Decisions based upon Foreign Government Control Concept - Post-1992 Amendment Decisions Holding No Foreign Government Control

In four other cases that were reviewed, CFIUS determined that there was no foreign government control. The first two are discussed below for illustrative purposes. CFIUS found there was no foreign government control in the other two cases because either multiple intervening layers of ownership diluted government control or the foreign government could not appoint board members.

1. South Korean Company's Proposed Acquisition of U.S. Manufacturer of Semiconductor Devices

In this case, the U.S. defense subcontractor was engaged in a defense-critical, but not state-of-the-art, technology. The South Korean company proposed to transfer that technology to South Korea and establish a plant there. The South Korean company's financing arrangements were with a South Korean government-owned bank. However, CFIUS determined that the amount of capital provided by the government-owned banks was insufficient to constitute foreign government control. In addition, although CFIUS concluded that there was foreign control, it also determined that there were insufficient national security concerns.

2. British Company's Proposed Acquisition of 20% of U.S. Company

In this case, the U.S. company had classified contracts and provided a critical U.S. government emergency service. Although the British government owned only 1.5% of the stock of the acquiring company, the government retained special veto powers and the right to elect two directors. CFIUS decided that there was no foreign government control because the government owned only a small amount of stock, had not recently exercised its right to appoint two directors and had no significant consent rights over the acquiring company. While CFIUS conducted a 30-day review, it determined that there were insufficient national security concerns to warrant a 45-day investigation.

The Role of DOD and its Relationship to CFIUS in Regard to Exon- Florio Review

DOD Review of CFIUS Cases for National Security Risks

DOD has assumed, though informally, the role of CFIUS member that reviews transactions for national security concerns when a CFIUS case is presented. When reviewing transactions, the DOD considers, among other things, the following factors:

1. The critical nature of the technologies and products involved in relation to national security concerns.
2. Whether the firm being acquired is the sole source supplier to the DOD.
3. The existence of classified contracts between the U.S. company and the U.S. government.

DOD also reviews and analyzes information provided by the intelligence community regarding the foreign buyer's past record of compliance with export controls, proliferation of sensitive weapons-related technologies, and other matters.

In some cases, where intelligence information existed which showed that the acquiring company or its government's practices violated U.N. sanctions or transferred U.S. technology to proscribed countries, DOD has not recommended a 45-day investigation. According to Defense Technology Security Administration officials, this information did not, in and of itself, provide sufficient grounds to warrant investigation in light of the limited value of the technology or the lack of corroboration or age of the noted violations.

DOD Risk of Diversion Assessments for Defense-Critical Technologies

DOD is also required to assess the risk of diversion when the Secretary of Defense determines that a takeover may involve a firm engaged in the development of a defense-critical technology or is otherwise important to the defense industrial and technology base. These assessments, which are mandated under the 1992 amendments, are shared with each CFIUS member. The responsible DOD official has noted though that the legislation only requires assessment risk of diversion when the company is involved in development of critical technology, not in the application of that technology. The determination of whether a particular technology is being developed is based upon the Key Technologies Plan.

Relationship Between Security Clearances And Exon-Florio Approval

When a foreign company acquires a U.S. defense contractor, the ability of that contractor to maintain its security clearances may be a critical consideration in an Exon-Florio review of the proposed acquisition. Security clearances are required for a defense contractor to gain access to classified information, which may be necessary to perform the contractor's obligations under certain defense contracts. Therefore, the economic viability of the acquisition also may depend upon retention of these security clearances.

The Department of Defense Industrial Security Regulation provides that when a foreign entity acquires a majority interest in a company holding a security clearance, that security clearance shall be invalidated. The regulation also provides that the company has 30 days to submit an acceptable plan to eliminate the risk to the security of classified information posed by the foreign ownership. Should the company not submit an acceptable plan within 30 days, or should the company fail to adhere to that plan, then the facility security clearance would be revoked.

The Industrial Security Regulation provides five methods that a company may use in a plan to eliminate the risk to the security of classified information posed by foreign ownership. These methods are:

• a board resolution
• a voting trust agreement;
• a proxy agreement;
• foreign government assurances pursuant to a reciprocal industrial security agreement; and
• a special security agreement.

A board resolution is only acceptable when the foreign interest is not the largest single shareholder, U.S. interests own a majority of the stock, and the chairman and chief executive officer of the U.S. firm are U.S. citizens. The Industrial Security Regulation further requires that:

The resolution shall identify the foreign shareholders and their representatives, if any, and note the extent of foreign ownership, including a certification that the foreign shareholders and their representatives will not require, will not have, and can be effectively excluded from access to all classified information in the possession of the cleared facility, and will not be permitted to occupy positions that may enable them to influence the organization's policies and practices in the performance of classified contracts.

Voting Trusts and Proxy Agreements

Voting trust and proxy agreements, however, may be used when the foreign entity owns the majority of the stock of the U.S. company. Under a voting trust agreement the foreign owner transfers title to the shares to trustees who are U.S. citizens and who have personal security clearances. The trustees must exercise all prerogatives of ownership, except that the foreign shareholder may retain a right to approve sales of the company's assets, encumbrances on the capital stock, mergers, corporate dissolution, bankruptcy, and similar transactions.

A proxy agreement has the same requirements as a voting trust agreement, except that legal title to the stock remains with the foreign shareholder and the voting rights are conveyed to the proxy holder pursuant to an irrevocable proxy agreement.

The United States and France entered into an agreement for the exchange and protection of classified information with an effective date of September 7, 1977. That agreement provided that technical arrangements, including an Industrial Security Arrangement, were to be developed by the relevant agencies of the two governments.

We assume from this agreement, but are still attempting to confirm, that the DOD has also entered into a reciprocal industrial security agreement with France. Should such an agreement be in effect, when a French company acquires a U.S. holder of a security clearance, with certain limitations, a French security clearance for the new owner would serve as an acceptable plan of action allowing the recently acquired U.S. company to retain its U.S. facility security clearance.

Special Security Agreements and Beyond

A special security agreement may also be used when the foreign entity owns a majority of the voting stock of the U.S. company. However, this arrangement can only be accepted when:

1. the relevant agency and the Office of the Secretary of Defense determine that a facility security clearance for the particular company is in the national interest;
2. the ownership stems from countries with which the United States has a formal reciprocal security agreement; and
3. all personnel required to be cleared in connection with the facility security clearance are U.S. citizens.

Special security agreements are negotiated on a case-by-case basis and must be designed "to reasonably and effectively preclude the unauthorized disclosure of classified information to foreign interests."