Defense Trade: Identifying Foreign Acquisitions Affecting National
Security Can Be Improved (Letter Report, 06/29/2000, GAO/NSIAD-00-144).

Pursuant to a congressional request, GAO reviewed the process used by
the Committee on Foreign Investment in the United States to identify
foreign acquisitions of U.S. companies, focusing on current
identification process used by the Committee and the effectiveness of
the Committee's follow-up on acquisitions identified by its member
agencies.

GAO noted that: (1) the identification process the Committee on Foreign
Investment uses does not enable it to effectively identify all foreign
acquisitions with possible effects on national security; (2) the
Committee depends on a system of voluntary reporting by the parties to
foreign acquisitions; (3) the Committee also encourages each member
agency to inform the Committee of any acquisitions that comes to the
agency's attention; (4) GAO did not attempt to identify foreign
acquisitions of U.S. companies with potential national security
implications that were not reported voluntarily; (5) however, GAO did
find that member agencies become aware of such acquisitions in the
course of their daily operations; (6) in some instances member agencies
reported foreign acquisitions to the Committee, but in other instances
agencies did not; (7) the Department of Defense the Department of the
Treasury officials informed GAO of three acquisitions that were known to
officials in these agencies but the agencies did not inform the
Committee; for example, in March 1999, a German-owned firm acquired a
U.S. manufacturer of ceramic body armor; (9) the U.S. company reported
the acquisition to the Defense Security Service and Department of
State's Office of Defense Trade Controls because the company
manufactures classified defense products and was required by law to
report the acquisition to Defense and State (but not to the Committee);
(10) the company, the Defense Security Service and the Office of Defense
Trade Controls did not inform or report this acquisition to the Defense,
State or Treasury Departments' Committee representatives because there
is no requirement to do so; (11) as a result, the Committee did not
conduct a full assessment of this acquisition; (12) the Committee does
not keep records of acquisitions referred by member agencies, does not
document all contacts made with the parties to acquisitions to encourage
voluntary reporting, and does not track whether these contacts led the
parties to report the acquisition to the Committee; (13) as a result,
Treasury officials could not tell GAO which acquisitions were identified
by member agencies but not reviewed by the Committee; (14) further, the
Committee has no process to inform all member agencies that potentially
relevant unreported acquisitions have been identified; and (15) as a
result, not all member agencies have the opportunity to review
acquisitions identified by other member agencies for potential national
security risks using relevant information available only to individual
agencies.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-00-144
     TITLE:  Defense Trade: Identifying Foreign Acquisitions Affecting
	     National Security Can Be Improved
      DATE:  06/29/2000
   SUBJECT:  Defense industry
	     Foreign investments in US
	     National defense operations
	     International economic relations
	     National policies
	     Reporting requirements
	     Corporate mergers
	     Foreign corporations

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GAO/NSIAD-00-144

Appendix I: Comments From the Department of Commerce

20

Appendix II: Comments From the Department of Defense

23

Appendix III: Comments From the Department of State

27

Appendix IV: Comments From the Department of the Treasury

28

Table 1: Foreign Acquisitions, Voluntary Reports to the Committee,
and Dispositions, 1988-99 8

National Security and
International Affairs Division

B-285111

June 29, 2000

The Honorable Chuck Hagel
United States Senate

Dear Senator Hagel:

In 1988, Congress enacted the Exon-Florio Amendment to the Defense
Production Act, authorizing the President to suspend or prohibit foreign
acquisitions, mergers, or takeovers of U.S. companies if there is credible
evidence that a foreign controlling interest might threaten national
security and if other legislation cannot adequately protect national
security. Congress passed the legislation to prevent foreign acquisitions
that would adversely affect national security with respect to the domestic
defense industry, U.S. technological leadership in national security areas,
and the sale of military equipment and technology to countries that support
terrorism or proliferate missile technology or chemical and biological
weapons.

The President delegated the authority to review foreign acquisitions of U.S.
companies to an interagency group, the Committee on Foreign Investment in
the United States. The Secretary of the Treasury chairs the Committee, which
consists of 11 departments and agencies, including the departments of State,
Commerce, and Defense.1 Companies involved in a foreign acquisition of a
U.S. company that may affect national security are encouraged to voluntarily
report the acquisition to the Committee. The Committee then passes the
report to its member agencies to determine whether the acquisition could
adversely affect national security. To supplement voluntary reporting, the
Committee's member agencies also have the authority to independently report
foreign acquisitions that may affect national security and that have not
been voluntarily reported to the Committee.

Because of concerns that the current process may not identify all foreign
acquisitions of U.S. companies that could affect our national security, you
asked us to review the process used by the Committee on Foreign Investment
to identify foreign acquisitions of U.S. companies. Specifically, we
evaluated the current identification process used by the Committee and the
effectiveness of the Committee's follow-up on acquisitions identified by its
member agencies.

The identification process the Committee on Foreign Investment currently
uses does not enable it to effectively identify all foreign acquisitions
with possible effects on national security. The Committee depends on a
system of voluntary reporting by the parties to foreign acquisitions. The
Committee also encourages each member agency to inform the Committee of any
acquisitions that comes to the agency's attention. We did not attempt to
identify foreign acquisitions of U.S. companies with potential national
security implications that were not reported voluntarily. However, we did
find that member agencies become aware of such acquisitions in the course of
their daily operations. In some instances member agencies reported foreign
acquisitions to the Committee, but in other instances agencies did not.
Defense and Treasury Department officials informed us of three acquisitions
that were known to officials in these agencies but the agencies did not
inform the Committee. For example, in March 1999, a German-owned firm
acquired a U.S. manufacturer of ceramic body armor. The U.S. company
reported the acquisition to the Defense Security Service and the State
Department's Office of Defense Trade Controls because the company
manufactures classified defense products and was required by law to report
the acquisition to the Defense and State Departments (but not to the
Committee). The company, the Defense Security Service and the Office of
Defense Trade Controls did not inform or report this acquisition to the
Defense, State, or Treasury Departments' Committee representatives because
there is no requirement to do so. As a result, the Committee did not conduct
a full assessment of this acquisition.

The Committee does not keep records of acquisitions referred by member
agencies, does not document all contacts made with the parties to
acquisitions to encourage voluntary reporting, and does not track whether
these contacts led the parties to report the acquisition to the Committee.
As a result, Treasury officials could not tell us which acquisitions were
identified by member agencies but not reviewed by the Committee. Further,
the Committee has no process to inform all member agencies that potentially
relevant unreported acquisitions have been identified. As a result, not all
member agencies have the opportunity to review acquisitions identified by
other member agencies for potential national security risks using relevant
information available only to individual agencies.

We are making recommendations aimed at improving (1) the current process
used by the Committee on Foreign Investment to identify foreign acquisitions
of U.S. companies with national security implications and
(2) the Committee's use of available information about acquisitions that may
have potential implications for national security to determine whether the
acquisitions warrant further review. In commenting on a draft of this
report, the Commerce, Defense, and Treasury Departments agreed with our
recommendations. The State Department said that they would take our
recommendations under advisement.

The President established the Committee on Foreign Investment in the United
States in 1975 to monitor foreign investment.2 The Treasury Department's
Office of International Investment coordinates the Committee's activities
and has the dual responsibility of monitoring foreign investment in the
United States and advocating U.S. policy on open investment--that is, U.S.
policy of advocating free trade and world markets open to foreign
investment.

Voluntary reporting of a foreign acquisition requires the U.S. company or
the foreign company to submit detailed information to the Committee
concerning the organization, background, assets, and products of each
company and how these areas relate to national security. Since legal fees
associated with a submission can be a burden to a company, and because
reviewing all acquisitions could create a large workload for the Committee's
member agencies, the Committee does not require reporting of acquisitions
that do not involve national security issues. Committee officials told us,
however, that it is in the interest of the foreign investor to voluntarily
report because the President retains the authority to force divestiture for
acquisitions that are not reviewed by the Committee. Committee member
agencies also have the authority to report any foreign

acquisition that comes to their attention and that may adversely affect
national security.3

Once companies involved in an acquisition provide the required information,
the Treasury Department distributes the companies' reports to its member
agencies for an initial 30-day review. If the Committee decides during this
30-day review that there could be credible evidence to support the belief
that the foreign entity may take action that threatens to impair national
security, it can initiate a 45-day investigation. After it completes the
investigation, the Committee submits a report and a recommendation to the
President. The President has 15 days to decide whether to allow the
acquisition to proceed or suspend or prohibit it. The Committee retains the
right to review at any time any acquisition that is not reported to the
Committee. Such a subsequent review could result in an order to divest.

Before the Exon-Florio Amendment,4 a foreign acquisition could not be
stopped unless the President declared a national emergency or regulators
invoked federal antitrust, environmental, or securities laws. To take action
under Exon-Florio, the President must find that (1) credible evidence exists
that the foreign interest might take action that threatens to impair
national security and (2) provisions of law, other than this legislation and
the International Emergency Economic Powers Act,5 do not provide adequate
and appropriate authority to protect national security.

The Committee does not know the extent of foreign acquisitions of U.S.
companies that have effects on national security. To ensure that national
security-related acquisitions are reviewed, Treasury depends on voluntary
reporting by the companies involved, and Treasury officials encourage the
Committee's member agencies to inform the Committee of any national
security-related foreign acquisitions they identify in the course of their
work.

Voluntary reporting results in some acquisitions not being reported by the
companies. For example, in November 1999, the Commerce Department informed
the Committee of a January 1999 acquisition of a U.S. ultra-precision
machine tools manufacturer by a Swiss-owned company. The Commerce Department
became aware of the acquisition when the Swiss-owned company applied for a
Commerce Department license to sell products to a Chinese manufacturer of
jet engine turbine blades. Treasury contacted the company, which agreed to
voluntarily report the acquisition to the Committee. However, the Committee
does not keep records of acquisitions identified by member agencies and does
not document all contacts made with the parties to these acquisitions to
encourage voluntary reporting.

Some national security-related foreign acquisitions are reported to
individual agencies on the basis of other laws and regulations, but no
requirement exists to inform the Committee of these acquisitions. For
example, companies that manufacture certain controlled items are required to
report their acquisition by a foreign entity to the State Department's
Office of Defense Trade Controls. The Office of Defense Trade Controls is
required to report these acquisitions to the U.S. Customs Service but is not
required to inform Committee representatives at either the State or Treasury
Departments of these acquisitions. As a result, agencies do not always
inform the Committee of foreign acquisitions and diverse agency perspectives
on national security may not be considered.

Since the Exon-Florio legislation was enacted in 1988, nearly 1,300 foreign
acquisitions have been reported voluntarily to the Committee. These
acquisitions represent about 17 percent of the nearly 7,400 foreign
acquisitions of U.S. companies that have been reported to the Commerce
Department's Bureau of Economic Analysis over the same period.6 However,
many of these acquisitions had no effect on U.S. national security. In
December 1995, we reported that although many companies voluntarily reported
proposed foreign acquisitions to the Committee, nearly 600 foreign
acquisitions in the high-technology industry were not reported between
October 1988 and May 1994.7 However, we did not gauge to what extent these
foreign acquisitions may have had an effect on national security.

Table 1 shows foreign acquisitions annually reported by the Commerce
Department, acquisitions reported voluntarily to the Committee, and
dispositions of the acquisitions voluntarily reported. Committee officials
attribute the large drop in reports after 1990 to companies and their legal
representatives obtaining a better understanding of the criteria for
reporting foreign acquisitions "affecting national security," after the
Committee had several years of experience in conducting reviews.

 Year  Foreign        Reports to         Reports       Offers    Blocked by
       acquisitions   Committee          investigated  withdrawn President
 1988  869            a14                1             0         0
 1989  837            200                5             2         1
 1990  839            295                6             2         0
 1991  561            152                1             0         0
 1992  463            106                2             1         0
 1993  554            82                 0             0         0
 1994  605            69                 0             0         0
 1995  644            81                 0             0         0
 1996  686            55                 0             0         0
 1997  640            62                 0             0         0
 1998  b673           63                 2             2         0
 1999  Not available  79                 0             0         0
 Total 7,371          1,258              17            7         1

aFilings began in September 1988.

b1998 data is not complete.

Sources: Committee, Department of Commerce Bureau of Economic Analysis.

In 7 of the 17 investigations, the companies voluntarily withdrew their
investment offers and terminated the foreign acquisitions. The President
decided not to intervene in 9 of the 10 remaining acquisitions. In one case,
the President ordered divestiture of a Chinese company's interest in a U.S.
aircraft parts company because the technology used by the U.S. company was
under export controls, the Chinese company had close ties to the People's
Liberation Army, and the acquisition would have given the Chinese company
unique access to U.S. aerospace companies.

Acquisitions

To ensure that foreign acquisitions with national security implications are
reported, the Committee relies on U.S. and foreign companies to voluntarily
report foreign acquisitions and on the Committee's member agencies to inform
the Committee of foreign acquisitions. According to Treasury officials,
there is no requirement for member agencies to inform the Committee when
they identify a potential national security-related foreign acquisition.
Although the Committee's member agencies have informed Treasury officials of
acquisitions, agencies have never initiated the process that would require
companies involved in an acquisition to provide information to the Committee
as described in the regulations.8 Instead, Treasury officials generally
encourage agencies to bring foreign acquisitions to their attention
informally so that the officials may contact the companies involved and
encourage them to report the acquisition voluntarily.

Treasury officials told us that Committee member agencies obtain information
about acquisitions that may be of concern by reviewing business media
sources. The Committee also relies on each agency to inform it of
acquisitions as it carries out its responsibilities in areas such as
government contracting, export controls, and industry analysis. In response
to our 1995 report, Treasury officials provided guidance reminding agencies
to bring to the Committee's attention acquisitions that have not been
reported voluntarily. However, our latest review showed inconsistent
compliance with this guidance:

ï¿½ According to an official at the Defense Threat Reduction Agency, which
coordinates the Committee's work for the Department of Defense, the agency
does not regularly search for foreign acquisitions of U.S. companies,
although agency staff have on occasion searched the Internet and other
sources to identify proposed acquisitions involving U.S. companies and
foreign investors. The official noted that the Department of Defense has to
prioritize its work on the basis of what is required by statute and
regulation. Other tasks such as identifying non-reporting acquisitions are
done as time and resources allow. The official also stated that his office
has no additional resources to regularly devote to identification efforts.

ï¿½ State Department officials told us that they do not search for foreign
acquisitions and have not informed the Committee of any acquisitions.

ï¿½ Commerce Department officials told us that they have occasionally informed
the Committee of acquisitions.

ï¿½ According to the Justice Department's Committee representative, the
Department considers Exon-Florio as it reviews mergers and acquisitions,
including acquisitions notified under the Hart-Scott-Rodino Antitrust
Improvement Act of 1976.9 Using various sources, the Justice Department has
identified several foreign acquisitions to the Committee for review since
1988.

ï¿½ The Treasury Department's Office of International Investments has an
informal method for identifying foreign acquisitions: an official in the
Office reads various trade publications and advises the Committee's staff
chairperson of pending acquisitions.

ï¿½ Other officials from Committee member agencies we spoke with, including
those from the Council of Economic Advisors, the U.S. Trade Representative,
and the Office of Science and Technology Policy, do not attempt to identify
acquisitions for the Committee.

In the course of our work, we identified three acquisitions of U.S.
companies that had been identified by the departments of Defense, State, and
Treasury as having potential implications for national security but that had
not been reported voluntarily to the Committee. The Committee was not aware
of the acquisitions because it was informed neither by the agencies involved
nor by the parties to the acquisitions. As we did not set out to identify
such acquisitions, we do not know whether there may be other similar
unreported acquisitions. The three acquisitions are the following.

U.S. company acquired by a German firm. In March 1999, a German-owned firm
acquired a U.S. manufacturer of ceramic body armor and a nuclear-related
material. The U.S. company manufactures and exports items on the State
Department's U.S. Munitions List and is the sole source supplier of ceramic
body armor to the Defense Department. It also has several classified
contracts with the Army. The company reported the acquisition to the Defense
Security Service and the State Department's Office of Defense Trade
Controls.10 However, the company did not report the acquisition to the
Committee. Defense Security Service officials told us that they advised
company officials of the Committee's reporting process. A company official
stated that the board of directors believed the company's obligation was met
when it reported to the Defense Security Service. The Defense Security
Service did not inform Defense Department Committee representatives of this
acquisition because it was not required to do so. The Office of Defense
Trade Controls, while notified of the acquisition, did not refer the
acquisition to the Committee because it has no process for informing the
Committee of foreign acquisitions. The Defense Security Service, the U.S.
manufacturer, and the German firm signed a Special Security Agreement11 to
guard against unauthorized disclosure of classified information. However,
other national security issues, such as the company's status as a sole
source supplier of ceramic body armor, were not considered because a general
review by the Committee did not occur. In March 2000, we informed Committee
representatives of this acquisition. They subsequently contacted the
company, and company representatives agreed to report the acquisition to the
Committee.

U.S. company acquired by a French firm. In August 1998, a French-owned firm
acquired a U.S. manufacturer of laser systems. The U.S. manufacturer had
several classified Army contracts to maintain equipment and also makes
lasers used in rocket launches. The U.S. manufacturer contacted the Defense
Security Service shortly after the acquisition occurred. The manufacturer
chose not to enter into a Special Security Agreement with the Defense
Security Service and canceled its classified contracts. Defense Security
Service officials told us that they advised company officials of the
Committee's reporting process. A company official told us that most of its
business had been in the defense sector but was now primarily in the
commercial sector and that as a result, the company did not believe it
needed to report the acquisition to the Committee. However, the company
manufactures some sensitive products that require Commerce Department
approval for export. Defense Security Service officials did not inform
Committee representatives at the Department of Defense or the Committee
itself of the acquisition because they were not required to do so. As a
result, the Committee did not have the opportunity to determine whether the
acquisition would adversely affect national security. In March 2000, we
informed Committee representatives of this acquisition. They subsequently
contacted the company, and company representatives agreed to send a letter
to the Committee explaining why they do not intend to report.

U.S. company acquired by a Hong Kong firm. In December 1995, a Hong Kong
firm purchased a U.S. bearing manufacturer. The U.S. company has various
contracts and purchase orders with the Department of Defense and the
National Aeronautics and Space Administration. The company's bearings are
used in military aircraft, submarines, satellites, and vehicles. A major
U.S. business trade publication had featured the acquisition in August 1996
and reported on the Hong Kong investor's connection with the People's
Republic of China. The article noted the planned transfer of sensitive
technology. Records show that a Treasury Department Committee representative
had transmitted a copy of the publication to a Defense Department Committee
representative. Yet neither Treasury nor Defense officials informed the
Committee of the acquisition. Defense Department officials could not
recollect why they took no action to refer the acquisition for review when
they saw the publication.

During the acquisition, the parties involved were not aware of the
Committee's reporting process and did not report the acquisition to the
Committee until November 1997, nearly 2 years after the acquisition.
Committee representatives explained that a new legal counsel at the company
identified the need to report to the Committee. During the 30-day review,
the Committee discovered that the company had not properly registered as a
manufacturer of controlled items with the State Department as required by
the International Traffic in Arms Regulations. In December 1997, the
Committee permitted the company to withdraw its voluntary report to avoid a
Committee 45-day investigation and gave the company time to address the
Committee's concerns.

In September 1998, the company resubmitted its acquisition notification to
the Committee. The Committee conducted a full investigation and determined
that the company had not met its obligations to classify its technology or
bearings for licensing purposes and to identify whether there had been any
illegal exports. According to the Committee's investigation documents, the
foreign buyer's reason for the acquisition was to transfer the company's
technology to China to upgrade a bearing factory there. The investigation
concluded that continued ownership and control of the U.S. company by the
Hong Kong firm posed a threat to national security because it risked
unauthorized transfer of products and technology and that existing laws
would not be effective in preventing the transfer of specific technology.
The company agreed to withdraw its report of the acquisition to avoid the
possibility of a divestiture order from the President. As part of the
agreement, the Hong Kong company is divesting its interest and has appointed
a U.S. citizen as an interim trustee to oversee operations of the U.S.
manufacturer until divestiture is complete.

Treasury officials believe that using informal agency referrals allows them
to remain aware of foreign acquisitions with potential national security
implications and that this informal process precludes the need for formal
agency reports to the Committee. Treasury Department officials gave us
several recent examples in which a member agency informed them of unreported
acquisitions and followed up by encouraging the parties to the acquisitions
to voluntarily report. The officials said that they contact companies
several times a year to encourage voluntary reporting. However, Treasury
does not maintain records of these contacts and officials there were unable
to provide data on the results of these informal referrals.

Committee member agencies maintain information that could help identify
sensitive foreign acquisitions with potential effects on national security.
However, the Committee does not have a process in place to inform all member
agencies when it becomes aware of an acquisition that has not been
voluntarily reported. If they do not know about such foreign acquisitions,
agencies cannot determine whether acquisitions have national security
implications. Below are examples of some government and commercial
information sources that are currently available and that, had they been
used to share information about foreign acquisitions among all Committee
agencies, could have helped identify the national security implications of
the three foreign acquisitions we found:

Office of the Deputy Under Secretary of Defense for Industrial Affairs and
Installations. The Office of the Deputy Under Secretary of Defense for
Industrial Affairs and Installations reviews filings under the
Hart-Scott-Rodino Antitrust Improvement Act of 1976 to address mergers
within the defense industry. The office subscribes to a private database
service that provides access to over a dozen commercial databases, including
one that provides extensive information on defense-related mergers,
acquisitions, buyouts, and joint ventures. According to officials in the
Office of Industrial Affairs, analysts in the office notify the Defense
Threat Reduction Agency, which coordinates Defense Department Committee
activities, of 5-10 foreign acquisitions identified by their information
sources annually. However, the officials could not provide documents on
these acquisitions and could not recollect the specifics of these
acquisitions or whether the companies ultimately reported to the Committee.

Defense Security Service. Under the National Industrial Security Program,
U.S. companies that have classified defense contracts are required to notify
the Service when they are acquired by a foreign entity so that the Service
can ensure that unauthorized disclosure of classified information to the
foreign buyer does not occur. These companies must also report any material
change concerning foreign ownership, control, or influence and update their
ownership status every 5 years. Defense Security Service officials told us
that whenever a change of ownership involves a foreign buyer, they advise
the parties to file with the Committee. However, the Defense Security
Service does not consistently inform the Committee when it is aware of
acquisitions involving foreign buyers and does not follow up to ensure that
companies report to the Committee because there is no requirement to do so.

Department of State. The Department's Office of Defense Trade Controls
maintains a database of companies that manufacture or export defense
articles or furnish defense services controlled under the International
Trade in Arms Regulations. All companies that manufacture covered defense
articles or furnish defense services are required to register with the
Office even if they do not export these defense articles or services. An
Office of Defense Trade Controls official told us that the Office's
databases can identify companies that manufacture controlled defense
articles. Additionally, registered companies must notify the Office of an
intended sale or transfer of ownership to a foreign entity. The Office
provides this information to the U.S. Customs Service but not to Committee
representatives at the State and Treasury Department because there is no
requirement to do so.

Department of Commerce. The Bureau of Export Administration has a list of
companies that have been granted licenses to export controlled commodities,
as well as information on the status of applications for export licenses and
violations of Export Administration Regulations. This list could be used to
identify potential national security implications of foreign acquisitions.

Department of Justice. The Department's Antitrust Division reviews filings
reported under the Hart-Scott-Rodino Antitrust Improvement Act of 1976. The
Department maintains a database of reported acquisitions. However, the
database includes only acquisitions valued at $10 million or more and does
not specifically isolate foreign acquisitions of industries with links to
national security. Using various sources, the Justice Department Committee
representative has notified Committee staff at the Treasury Department
several times of acquisitions involving foreign buyers.

Defense Intelligence Agency. The Agency assesses the risk of diversion of
critical defense technology for each acquisition that is voluntarily
reported. Among the tools the agency uses to assess this risk are commercial
databases containing information on thousands of high-technology companies.
Agency officials told us that their databases could identify acquisitions
with national security implications if the Committee provided the names of
the parties to these acquisitions.

Private sector databases. A number of private sector companies develop and
maintain financial management information databases, many of which are
accessible by subscription on the Internet. One company has several on-line
databases, including one covering worldwide mergers and acquisitions.
Another company conducts research into and provides information on private
investment activities. Still another company maintains a comprehensive
database covering thousands of international journals, books, and other
publications.

In an era of increasing global markets that are open to foreign investment
and rapid technological innovation, understanding the impact that foreign
acquisitions of U.S. companies have on national security is increasingly
important. The Committee's member agencies do not always inform the
Committee of known foreign acquisitions with national security implications.
These unreported acquisitions may be reviewed from only one perspective, for
example, from the viewpoint of protection of classified material, while
other important national security concerns, such as technology transfers,
weapon technology proliferation, or foreign sources of supply, may not be
considered.

Committee member agencies maintain information that could help identify
sensitive foreign acquisitions that could have an impact on U.S. national
security. However, the Committee does not have a process in place to inform
all member agencies when it becomes aware of an acquisition that has not
been voluntarily reported. If they do not know about foreign acquisitions,
agencies cannot use their resources to determine whether acquisitions have
national security implications. If agencies had been informed that another
member agency was aware of foreign acquisitions, existing agency resources
could have been used to identify the three acquisitions we found during the
course of our review.

To improve the Committee's process for identifying foreign acquisitions with
potential national security implications, we recommend that the Secretaries
of Commerce, Defense, Treasury, and State establish procedures requiring
agency officials to submit all known foreign acquisitions of companies with
potential national security implications to the Committee on Foreign
Investment.

We further recommend that the Secretary of the Treasury, in his role as
Chair of the Committee on Foreign Investment in the United States, establish
a process for sharing information on all foreign acquisitions submitted by
one member agency with all of the Committee's member agencies, so that
agencies can check their databases to determine whether any potential
national security implications exist.

We received written comments on a draft of this report from the Departments
of Commerce, Defense, State, and Treasury and have included them as
appendixes I to IV. Commerce, Defense, and Treasury agreed with the report
and recommendations, and provided information on the ways they plan to
address them. The three agencies also provided technical comments that we
have incorporated as appropriate. The Department of State, while not
expressing a view on our recommendations, commented that it would take our
recommendations under advisement and would discuss them with the other
interested federal agencies. Since the State Department collects information
from U.S. companies that identify foreign acquisitions of U.S. weapon
manufacturers, we believe the Department should share this information with
Committee representatives because it is an important body of information
that can be used to identify acquisitions that should be reviewed.

While agreeing with our recommendations, Treasury questioned our finding
concerning the adequacy of the Committee's procedures for ensuring that
relevant foreign acquisitions are reported. Treasury commented that our
report does not emphasize the safeguards the Committee uses to help ensure
that acquisitions that affect national security are reported. Treasury
stated that there is a procedure in the Exon-Florio regulations that allows
member agencies to notify the Committee of a foreign acquisition. While we
agree that this provision exists, our report points out that it has never
been used. Since we are aware of acquisitions that have not been reported to
the Committee, the provision alone does not appear to ensure reporting of
foreign acquisitions. Further, our report describes in great detail the
Committee's processes for identifying and reporting foreign acquisitions and
shows that the system for identifying and reporting unreported acquisitions
is flawed. Our recommendations are intended to help correct these flaws.

To evaluate the current identification process, we spoke with officials and
collected data from the Committee's member agencies, including the
Departments of Commerce, Defense, Justice, State, and Treasury; the Council
of Economic Advisors; the U.S. Trade Representative; and the Office of
Science and Technology Policy. The objective of these discussions was to
determine what processes member agencies use to identify foreign
acquisitions. As for agencies that attempt to identify foreign acquisitions,
we queried them on their processes and collected documents on the unreported
acquisitions they have identified. We also spoke with officials at two
companies to understand their rationale for not reporting acquisitions. We
did not set out to identify the extent of national security-related foreign
acquisitions that are not reported to the Committee. Instead, we relied on
officials from member agencies to identify foreign acquisitions, mergers,
and takeovers that were not reported to the Committee. Therefore, we do not
know to what extent, if any, there are other national security-related
acquisitions that were not reported to the Committee.

We relied on the Treasury and the Commerce Departments' data to break down
the number of acquisitions that were reported by the companies and
investigated by the Committee. To describe the universe of foreign
acquisitions in the United States, we used data collected by the Commerce
Department's Bureau of Economic Analysis. Because Committee agencies do not
maintain information on all foreign acquisitions, we were unable to quantify
the number of national security-related foreign acquisitions.

To evaluate how the Committee follows up on agency identifications, we met
with officials at member agencies to understand the Committee's follow-up
process. We discussed with officials at Treasury and other member agencies
how they track identified foreign acquisitions. We also queried member
agencies and private sector sources to determine what data they currently
use to identify acquisitions and what other data they have that would be
helpful in identifying the national security implications of foreign
acquisitions.

We conducted our work from November 1999 through April 2000 in accordance
with generally accepted government auditing standards.

We are sending copies of this report to Senator Phil Gramm and Senator Paul
Sarbanes in their capacities as Chairman and Ranking Minority Member,
respectively, of the Senate Committee on Banking, Housing and Urban Affairs,
and to Representative James A. Leach and Representative John J. LaFalce in
their capacities as Chairman and Ranking Minority Member, respectively, of
the House Committee on Banking and Financial Services. We are also sending
copies to the Honorable William M. Daley, Secretary of Commerce; the
Honorable William S. Cohen, Secretary of Defense; the Honorable Madeleine K.
Albright, Secretary of State; the Honorable Lawrence H. Summers, Secretary
of the Treasury; and the Honorable Jacob J. Lew, Director, Office of
Management and Budget. We will also make copies available to others on
request.

Please contact me on (202) 512-4841 if you or your staff have any questions
concerning this report. Major contributors to this report were
Blake Ainsworth, Raymond H. Denmark, Jr., and Thomas J. Denomme.

Sincerely yours,

Katherine V. Schinasi
Associate Director
Defense Acquisitions Issues

Comments From the Department of Commerce

The following are GAO's comments that address the Department of Commerce's
suggested changes to our report.

1. We revised the text to include a statement that the Committee does not
track whether or not agency referrals of foreign acquisitions led the
parties to report to the Committee.

2. We added a sentence to the text stating that we did not gauge the extent
that foreign acquisitions may have had an effect on national security.

Comments From the Department of Defense

The following are GAO's comments that address the Department of Defense's
suggested changes to our report.

1. We revised the text to include a statement in the report that there is no
requirement to report known foreign acquisitions with national security
implications to the Committee on Foreign Investment in the United States.

2. We clarified this sentence, which now states that companies must also
report any material change concerning foreign ownership, controls or
influence and update their ownership status every 5 years.

Comments From the Department of State

Comments From the Department of the Treasury

The following GAO comment addresses the Department of the Treasury's
comments on our report.

1. Treasury states that there are only a relatively small number of foreign
acquisitions with national security implications and noted that our report
could lead to the conclusion that there are a significant number of foreign
acquisitions of U.S. companies with implications for national security. We
added language to the report explaining that we did not gauge the extent of
unreported foreign acquisitions with national security implications.

However, since the Committee does not know the extent of foreign
acquisitions with national security implications that are not reported,
there is no documented basis for the Treasury Department's statement that
the number of foreign acquisitions with national security implications are
relatively small. Further, according to a February 2000 address by the
Deputy Secretary of Defense, the Department plans to depend more heavily on
commercial firms to meet military requirements, and is pursuing a number of
initiatives to encourage cross-border defense industry cooperation and
teaming, which may include increased opportunities for acquisitions of U.S.
companies by foreign firms. Therefore, an effective Committee process will
become increasingly important as the number of foreign acquisitions grow.

(707466)

Table 1: Foreign Acquisitions, Voluntary Reports to the Committee,
and Dispositions, 1988-99 8
  

1. Other member agencies include the Department of Justice, the Office of
Management and Budget, the Council of Economic Advisers, the United States
Trade Representative, the Office of Science and Technology Policy, the
National Economic Council, and the National Security Council. The Department
of Energy participates in the review of certain acquisitions, but is not a
member of the Committee.

2. Executive Order 11858 (May 9, 1975) as amended by Executive Order 12661
(Dec. 27, 1988) and Executive Order 12860 (Sept. 3, 1993).

3. 31 C.F.R. Section 800.401.

4. The amendment is a provision of the Omnibus Trade and Competitiveness Act
of 1988 and part of the Defense Production Act of 1950, 50 U.S.C. app. 2170,
which has been extended until the end of fiscal year 2000 by Section 1063 of
the National Defense Authorization Act of Fiscal Year 2000.

5. The International Emergency Economic Powers Act gives the President broad
powers to deal with any "unusual and extraordinary threat" to the national
security, foreign policy, or economy of the United States (50 U.S.C. 1701).
To exercise this authority, however, the President must declare a national
emergency to deal with any such threat. Under this legislation, the
President has the authority to investigate, regulate, and, if necessary,
block any foreign interests' acquisition of U.S. companies (50 U.S.C.
1702(a)(1)(B)).

6. Data reported by the Bureau includes only foreign acquisitions of U.S.
companies that had total assets of more than $1 million. Beginning in 1998,
the threshold was raised to
$3 million. Exon-Florio regulations do not specify a minimum investment or
asset value for notification.

7. See Foreign Investment: Implementation of Exon-Florio and Related
Amendments (GAO/NSIAD-96-12, Dec. 21, 1995).

8. 31 C.F.R. Sections 800.401-404.

9. The act (15 U.S.C. 18a) requires parties to a merger or acquisition to
notify the Department of Justice and the Federal Trade Commission of the
proposed merger or acquisition in order for them to assess whether the
acquisition violates antitrust laws.

10. Companies with defense contracts that entail the use of classified
national security information are required to report acquisition by a
foreign entity to the Defense Security Service. Companies that manufacture
items on the Munitions List (22 C.F.R. Part 121) are required to report
acquisition by a foreign entity to the State Department. The Munitions List
consists of defense articles, services, and related technical data that are
controlled.

11. Industrial Security Regulations require that a company obtain a facility
clearance before working on a classified Department of Defense Contract. To
obtain clearance, a U.S. defense contractor that is majority-owned by a
foreign company must first accept a voting trust, proxy agreement, or
Special Security Agreement to insulate it from its foreign owners.
*** End of document. ***