CNOOC’s Bid for Unocal: Now is the Time to Improve the Exon-Florio Amendment 1

On June 23rd, 2005, the Chinese state-controlled China National Offshore Oil

Corporation (CNOOC) offered an unsolicited all-cash bid of $18.5 billion to acquire the

U.S. oil company Unocal Corp.2 This signified the largest ever takeover attempt made by

a Chinese company in the United States.3 Two months earlier U.S. oil company Chevron

had made its own cash-and-stock bid for Unocal of $16.4 billion.4 By July 15th, 2005,

Unocal’s board had decided it would have to drop its recommendation of Chevron’s bid

if Chevron did not raise its offer.5 Unocal, having completed a draft merger agreement

and negotiation of “key documentation relating to the CNOOC transaction,” was ready to

accept a CNOOC takeover, but requested that CNOOC raise its offer to compensate in

part for the risk of delay in seeking regulatory approval.6 CNOOC requested in turn that

Unocal lobby congress for approval of the deal, and pay for termination costs associated

with the Chevron bid, in return for a higher bid, actions Unocal refused to take.7

Evidencing its strong desire to acquire Unocal, CNOOC subsequently offered to pay the

Chevron termination costs itself ($500 million) and even considered raising its own bid to

$20 billion.8

CNOOC had performed some due diligence as to how its bid would be received

politically. CNOOC’s independent board members originally voted against the bid, but

1 By Marc Pane, December 2005.2 David Barboza & Andrew Ross Sorkin, Chinese Oil Giant in Takeover Bid for U.S. Company, N.Y. TIMES, June 23, 2005, at A1 [hereinafter Takeover Bid].3 David Barboza, China Backs Away From Unocal Bid, INT’L HERALD TRIB., Aug. 3, 2005.4 Takeover Bid, supra note 1.5 Unocal Says it Almost Accepted China Bid, ASSOCIATED PRESS, July 25, 2005.6 Id.7 Id.8 Barboza, supra note 2.

1

this warning sign was unacceptable to CNOOC’s decision makers, including its

chairman, Fu Chengyu.9 One leading skeptic on the board, former Swiss Ambassador to

China Erwin Schurtenberger, resigned from the board six days after the ‘no’ vote, citing

health reasons.10 The remaining directors consented to vote again after hiring an

independent advisor and an energy consulting firm, who suggested that there was “some

regulatory risk,” but nothing more than “the usual noise.”11 The recent successful

purchase of IBM’s personal computer business by Chinese company Lenovo was seen as

a promising sign of U.S. political acceptance of acquisition of large U.S. concerns by

Chinese companies.12

It was not- congressional opposition came quickly and strongly. Even before the

offer was made, two congressmen, Rep. Duncan Hunter (Chairman of the House Armed

Services Committee) and Rep. Richard Pombo, had written a letter to President Bush

requesting scrutiny of the proposed deal on national security grounds.13 On June 27th,

Rep. Joe Barton (Chairman of the House Energy and Commerce Committee) and Rep.

Ralph Hall also sent a letter, expressing “deep concern” over the bid, calling it a threat to

the “energy and national security” of the U.S., stating that the proposed deal would put

vital energy resources and “a host of highly advanced technologies” into the hands of the

Chinese.14 Three days later, the House of Representatives passed a resolution by a vote

of 398 to 15, expressing the sense of the House that “a Chinese state-owned energy

company exercising control of critical United States energy infrastructure and energy

9 David Barboza & Andrew Ross Sorkin, China’s Oil Setback: The Overview; China’s Company Drops Bid to Buy U.S. Oil Concern, N.Y. TIMES, Aug. 3, 2005, at A1 [hereinafter Overview].10 Id.11 Id.12 Id.13 Id.14 WAYNE M. MORRISON, CHINA-U.S. TRADE ISSUES 14 (July 1, 2005) (Congressional Research Service Issue Brief, IB91121), http://www.fas.org/sgp/crs/row/IB91121.pdf [hereinafter TRADE ISSUES].

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production capacity could take action that would threaten to impair the national security

of the United States.”15 The same day the House also introduced an amendment to an

appropriations bill denying the Treasury funding that could be used to recommend a sale

of Unocal to CNOOC.16 On July 13th, the House Armed Services Committee held

hearings to determine the impact of the Unocal sale on U.S. national and economic

security.17 Within the month, a bill was introduced in the Senate that would flatly

prohibit the sale.18

By August 2nd, CNOOC had decided against raising its offer, and announced the

withdrawal of its bid.19 In language more frequently associated with investments

attempted by U.S. companies in foreign markets, CNOOC stated that the “political

environment has made it very difficult for us to accurately assess our chance of success…

creating a level of uncertainty that presents an unacceptable risk to our ability to secure

this transaction.”20

An advisory group to Unocal’s shareholders, Institutional Shareholder Services,

recommended Chevron’s bid over CNOOC’s for fear of U.S. political opposition to the

deal.21 On August 10th, Unocal’s shareholders voted to accept the sole remaining bid by

Chevron.22 Uncertainty as to whether or not the U.S. would permit the takeover to go

ahead once Unocal had accepted CNOOC’s bid was the direct cause of the deal’s failure.

CEO Fu believed investment in the United States was the correct avenue for the

15 H. Res. 344, 109th Cong. (2005).16 TRADE ISSUES, supra note 13, at 14-15.17 Full Committee Hearing on the National Security Implications of the Possible Merger between the China National Offshore Oil Corporations (CNOOC) and the Unocal Corporation: Hearing Before the House Armed Services Committee, 109th Cong. (2005) [hereinafter Hearing].18 S. 1412, 109th Cong. (2005).19 Overview, supra note 8.20 Id.21 Elizabeth Douglass, Chevron’s Unocal Bid Supported, L.A. TIMES, Aug. 2, 2005, at C1.22 Jad Mouawad, Foiled Bid Stirs Worry for U.S. Oil, N.Y. TIMES, Aug. 11, 2005, at C1.

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corporation’s future development.23 He had argued against investment in areas such as

Africa and the Middle East for years, on the grounds that these areas posed too great a

political risk.24 A CNOOC adviser called the failure of the Unocal bid “a pretty rude

awakening. The political risk turned out to be higher in America.”25

This paper takes no position on whether or not the success of the CNOOC bid

would have been in the best interests of the United States. Instead, this paper argues that

the outcome of CNOOC’s bid was ultimately determined by political factors where it

should have been determined by the rule of law, to the detriment of Sino-U.S. relations

and the interests of free trade. The legal framework put in place to balance the interests

of national security against the interests of free trade (the process of review mandated

under Title VII of the Defense Production Act of 1950, commonly known as the “Exon-

Florio Amendment,”26 to be discussed below) was never brought into play. In its place,

political rhetoric and the uncertain climate it creates were allowed to determine market

activity. China is being encouraged to develop the rule of law in its marketplace by

foreign investors,27 the WTO,28 and the United States,29 which all have an interest in the

constructive engagement of China as a player in the global marketplace. This interest is

not served by denying Chinese investors the benefits of a uniform set of rules within

which to conduct business in the United States while at the same time encouraging China

to provide the same for American investors.

23 Overview, supra note 8.24 Id.25 Id.26 Enacted by the Exon-Florio Amendment to the Omnibus Trade and Competitiveness Act of 1988, Pub. L. No. 100-418, §5021, 102 Stat. 1425 (1998) (codified at 50 U.S.C. app. §2170) [hereinafter “Exon-Florio Amendment,” “Exon-Florio,” or the “Amendment”].27 RANDALL PEERENBOOM, CHINA’S LONG MARCH TOWARD RULE OF LAW 476 (2002).28 See id. at 492.29 TRADE ISSUES, supra note 13.

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The first part of this paper will look at the Exon-Florio review process, its origins,

and its flaws. The second part will examine the political opposition to the CNOOC-

Unocal bid and why Exon-Florio failed to constitute a legal mechanism able to satisfy the

concerns of proponents and opponents of the bid. Throughout, it will question whether

anything can be done to improve the law so that it may provide more uniform guidance

and become more resilient to political abuse.

I. The Exon-Florio Amendment and CFIUS Review

The Exon-Florio Amendment gives the President or his designee authority to

“take such action… as the President considers appropriate to suspend or prohibit any

acquisition, merger, or takeover, of a person engaged in interstate commerce in the

United States… by or with foreign persons so that such control will not threaten to impair

the national security.”30 The President may only exercise this authority if no other law

exists to protect national security in a given matter, aside from the International

Emergency Economic Powers Act (IEEPA), which requires a finding of an “unusual and

extraordinary threat” to national security and the declaration of a state of national

emergency.31 Exon-Florio was signed into law in 1988 by President Reagan as a

response to the perceived rising threat of foreign nations acquiring goods and services

thought essential for the national defense.32

30 Exon-Florio Amendment, 50 U.S.C. app. §2170(c) (1988). 31 Christopher R. Fenton, U.S. Policy Towards Foreign Direct Investment Post-September 11: Exon-Florio in the Age of Transnational Security, 41 COLUM. J. TRANSNAT’L L. 195, 204 (2002).32 Id. at 201.

5

The foreign nation of principal concern at the time of Exon-Florio’s enactment

was Japan.33 Unparalleled growth in Japanese-originating foreign direct investment

(FDI) increased concern amongst industry leaders and Congress that certain domestic

sectors crucial to defense were “threatened with extinction.”34 FDI from Japan in the

United States had increased by an average of 32.5% each year in the first half of the

1980s and by an average of 28.4% each year for the second half, with a focus on the

electronics, metals, and transportation sectors.35

One attempted takeover in particular spurred Congress into action; an attempted

purchase of U.S. based Fairchild Semiconductor Corporation from its French owner

Schlumberger by the Japanese Fujitsu Corporation, which was announced in October of

1986.36 Fujitsu was offering $200 million for an 80% stake in Fairchild.37 Fairchild had

long been considered one of the most, if not the most, important companies in Silicon

Valley.38 Semiconductors are an integral part of most advanced defense systems.39

Industry leaders spoke of “a domino theory [where] the Japanese would take over the

industry and U.S. companies would eventually only market and distribute Japanese

products,” and found sympathetic ears in Washington.40 Secretary of Commerce

Malcolm Baldridge noted that “the country that controls semiconductors… is going to

control computers in the future.”41 Concerns did not center solely around the

33 Jose E. Alvarez, Political Protectionism and United States International Investment Obligations in Conflict: The Hazards of Exon-Florio, 30 VA. J. INT’L L. 1, 58 (1989).34 Id.35 U.S. Congress, Office of Technology Assessment, Multinationals and the National Interest: Playing by Different Rules, OTA-ITE-569, 82 (Washington, DC: U.S. Government Printing Office, September 1993) available at http://www.wws.princeton.edu/ota/disk1/1993/9334/933406.PDF.36 W. Robert Shearer, The Exon-Florio Amendment: Protectionist Legislation Susceptible to Abuse, 30 HOUS. L. REV. 1729, 1730 (1993).37 Alvarez, supra note 32 at 63.38 Id. at 57.39 Id.40 Id. at 58.41 Id. at 62.

6

monopolization of technological assets or know-how, but also focused on the anti-

competitive nature of U.S.-Japanese trade, as U.S. semiconductor companies did not have

the same amount of access to the Japanese markets as the Japanese had in the U.S.42 The

feeling that the transaction should be prevented spread from industry to Congress and

found proponents in the Departments of Commerce, State, Defense, Justice, the Treasury,

and the White House.43 Their lawyers explained to them that under existing law, little

could be done to block the sale.44 The American public was against the sale of Fairchild

to the Japanese.45 Newspaper editorialists warned their readers that Japanese

businessmen were suspected of stealing American technological secrets and passing them

on to other parties.46

Responding to pressure, the administration submitted the proposed transaction to

the interagency Committee on Foreign Investment in the United States (CFIUS) by the

end of October for review.47 CFIUS had been created by executive order under President

Ford in 1975, in order to monitor the trend of foreign investments in the United States.48

At this stage, CFIUS served only in an advisory role, with no enforcement powers.49

CFIUS returned an “inconclusive” report with no recommendations four months later,

and the debate between opponents of the sale and those who saw the opposition as a

hindrance to efforts to open the Japanese market smoldered on.50

42 Id. at 58.43 Id.44 Id. at 59.45 David A. Menard, The Flexibility of Exon-Florio Amendment and the Expansion of Telecommunications into the Global Economy, 31 PUB. CONT. L.J. 313, 319-20 (2002).46 C. S. Eliot Kang, U.S. Politics and Greater Regulation of Inward Foreign Direct Investment, 51 INTERNATIONAL ORGANIZATION, Spring 1997, at 321.47 Alvarez, supra note 32 at 60.48 Syed Anwar Karim, Foreign Acquisitions of U.S. Companies, 1995 EXECUTIVE RESEARCH PROJECT S11 (The Industrial College of the Armed Forces, National Defense University, Fort McNair, Washington D.C.) 1995 at 2-3.49 Id. at 3.50 Alvarez, supra note 32 at 59.

7

In the end, it was not a reasoned consideration of the benefits and disadvantages

of the sale that caused its failure, but political uncertainty. In March of 1987, Secretary

Baldridge announced in what was described as a “’preemptive strike’ against a possible

Cabinet recommendation against intervention” that he was against the sale.51 His

opposition was based on the anti-competition argument, that the Japanese market was

unfairly restrictive of U.S. investment, but he was joined by Secretary of Defense Caspar

Weinberger who opposed the sale for national security reasons.52 Schlumberger

announced three days later that they were canceling the sale of Fairchild to Fujitsu,

stating “the rising political controversy in the United States… [has] made it unlikely that

the sale of Fairchild could be completed within a reasonable time.”53 National

Semiconductor, a U.S. based rival of Fairchild, ended up purchasing Fairchild for $122

million.54

Stating that the Fairchild sale posed a threat to national security, Senator James

Exon introduced legislation on June 4th, 1987, to rectify what was perceived by many as

a problem: the administration was legally powerless to have prevented it.55 His bill gave

the President authority to review and act upon “foreign takeovers, mergers, acquisitions,

joint ventures, and licensing agreements which threaten the national security or essential

commerce of the United States.”56 Hearings were held on June 10th.57 Critics of the bill,

including Treasury Secretary James Baker, Paul Volcker of the Federal Reserve, and

51 Id. at 62.52 Id.53 Id.54 Id. at 63.55 Id. 56 Id. (quoting Senator Exon).57 Id. at 64.

8

even Commerce Secretary Baldridge58, argued that it “would chill foreign investment to

the detriment of the U.S. economy, was unnecessary given existing laws, would increase

uncertainty for the foreign investor, undermine U.S. efforts to eliminate investment

barriers abroad, and invite retaliation against U.S. investors abroad.”59 Senator John

McCain pointed out that bill would encourage foreign companies to fill their defense

needs internally, rather than enter into agreements with U.S. defense companies, as they

would be reluctant to deal with the uncertainties and delays the bill would cause.60

Few critics challenged, however, the need of the President to protect national

security and the changes in the version eventually signed into law reflect this fact.61

Among other, lesser, changes, the “essential commerce” criterion was dropped from the

language of the Amendment,62 stricter reporting and confidentiality requirements were

incorporated,63 as well as the proviso that the President can only take action if there is

credible evidence that the foreign parties involved might take action to impair national

58 Baldridge opposed the bill on the grounds that it undercut the U.S. position on GATT and other ongoing trade negotiations. Id. at 65.59 Id. at 64.60 Id. at 68. Support has been lent to Sen. McCain’s prediction by more recent commentary:

…there has been a substantial increase in intra-European co-development and co-production weapons projects in the post-Cold War era…. Why has this shift occurred? The evidence suggests that European governments have been motivated to collaborate as a response to U.S. dominance in the defense industry in the post-Cold War era…. Political obstacles in the United States to transatlantic collaboration have added to this development. There has been a push in the U.S. for self-sufficiency and a deep reluctance to cooperate with foreign governments for much of American history… Political obstacles to transatlantic cooperation have included… restrictive regulatory processes regarding foreign investment in U.S. firms. European difficulties in penetrating the U.S. market… have encouraged greater collaboration among European defense firms.

SETH G. JONES, THE RISE OF EUROPE’S DEFENSE INDUSTRY 2-3 (The Brookings Institution, U.S.-Europe Analysis Series, May 2005).61 See Alvarez, supra note 32 at 69-78.62 Id. at 76-77.63 Id. at 77.

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security.64 President Reagan signed the Exon-Florio Amendment into law on August

23rd, 1988, as part of the Omnibus Trade and Competitiveness Act of 1988.65

CFIUS was given the role of implementing Exon-Florio.66 As mentioned, it is an

interagency body. It is chaired by the Secretary of the Treasury, and consists of

representatives from the Departments of Defense, State, Justice, and Commerce, as well

as the FBI and various intelligence agencies.67 Under President G.W. Bush, the

Department of Homeland Security was added to the list of departments which have

representation in CFIUS.68 By its own description, “CFIUS seeks to serve U.S.

investment policy through thorough reviews that protect national security while

maintaining the credibility of our open investment policy and preserving the confidence

of foreign investors here and of U.S. investors abroad that they will not be subject to

retaliatory discrimination.”69

Just how well CFIUS can balance its objectives has been called into question.

Criticism which was originally raised in the Exon-Florio Amendment’s drafting process

is still valid today, despite several opportunities to review and alter Exon-Florio. Then,

as now, critics of Exon-Florio generally make one (or both) of two arguments.70 The first

is that Exon-Florio is too broad in scope.71 The second is that Exon-Florio is susceptible

to political abuse.72 These two lines of argument are not mutually exclusive; the broad

64 Id.65 Id. at 78.66 Id. See also U.S. Treasury – Committee on Foreign Investments in the United States (CFIUS) at http://www.treas.gov/offices/international-affairs/exon-florio/ .67 James A. Lewis, New Objectives for CFIUS: Foreign Ownership, Critical Infrastructure, and Communications Interception, 57 FED. COMM. L.J. 457, 464 (2005).68 Id.69 U.S. Treasury – Committee on Foreign Investments in the United States (CFIUS) at http://www.treas.gov/offices/international-affairs/exon-florio/ (emphasis added).70 Menard, supra note 44 at 319.71 Id.72 See id.; see also Karim, supra note 47 at 17.

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scope of Exon-Florio gives rise to the potential for abuse.73 This abuse can come directly

from the President in the misuse of his discretion under Exon-Florio, as vague and

undefined national security standards can easily mask a decision made for retaliatory or

protectionist purposes, or it can come from Congress, where in the absence of clear

standards for foreign investors to abide by, Congressional posturing is made more

effective in frightening them off. Either way, certain results can be expected: both

domestic and foreign businesses will suffer financial loss, the credibility of America’s

open-door policy on FDI is tarnished, and the confidence of investors investing in and

investing from the United States in freedom from retaliatory discrimination is

undermined.

The Exon-Florio Amendment lists a number of factors the President can

consider towards a definition. These include: (1) 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, and (3) the

control of domestic industries and commercial activity by foreign citizens as it affects the

capability and capacity of the United States to meet the requirements of national

security.74 In 1992, two additional factors were added: (4) the potential effects of the

transaction on the sales of military goods, equipment, or technology to a country that

supports terrorism or proliferates missile technology or chemical and biological weapons;

and (5) the potential effects of the transaction on U.S. technological leadership in areas

73 Shearer, supra note 35 at 1735 (“While Exon-Florio ostensibly serves the legitimate purpose of helping to protect U.S. national security, its vague parameters and elastic provisions create a potent protectionist weapon that virtually invites abuse.”)74 50 U.S.C. app §2170(e) (1988).

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affecting U.S. national security.75 Adherence to these factors is not necessary, however,

as under the language used in the statute the President may consider them among other

factors, or alternatively not at all.76 While Exon-Florio calls for the issuance of

regulations to carry out its objectives, CFIUS refuses to define “national security” in

them, desiring not to limit the President’s authority in any given matter.77

The methods of abuse the broad language of Exon-Florio lends itself to have been

likened to a shield and a sword.78 If national security were defined broadly to include

economic and technological interests, the Amendment could be used as a shield

protecting domestic industry from foreign competition by denying foreign competitors

access to the domestic market on national security grounds.79 Congress might also be

lobbied by private parties to raise the specter of Exon-Florio in order to secure a better

deal for themselves.80

This seemed the case after British Tire and Rubber PLC (BTR) made a hostile

$75 per share bid for Norton Co. of Massachusetts, in 1990.81 Norton was a manufacturer

(among other things) of weapons components on contract with the Department of

Defense.82 119 members of Congress lobbied President Bush to subject the proposed

transaction to Exon-Florio review, stating in a letter that “Norton is at its leading edge in

the development of technology critical to the future of U.S. weaponry and advanced

electronics. Frankly we do not believe that any takeover of Norton would be in our

75 National Defense Authorization Act for Fiscal Year 1993, sec. 837, § 2170(b)(3), 106 Stat. 2315, 2463-4 (1992).76 Shearer, supra note 35 at 1740.77 Id. at 1739-40.78 Fenton, supra note 30 at 211-12.79 Id.80 Id. See also Alvarez, supra note 32 at 80-81, n.436.81 Karim, supra note 47 at 15.82 Id.

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economic security or national security interest.”83 Norton argued before Congress that its

technological skills “should not pass into foreign hands.”84 A white knight, the French

Compagnie de Saint-Gobain, then entered the scene, offering an appreciably higher bid of

$90 per share.85 Shareholder and Congressional opposition to the deal fell silent, and

Norton was sold to Compagnie de Saint-Gobain before the end of the year.86 With a

higher bid on the table, the fact that France, like Britain, was a foreign country seemed to

be of considerably less concern.87

Another method of Exon-Florio misuse is as a “sword in the arsenal of trade

policy,” where foreign transactions are denied on the grounds that the home country of

the foreign investor has denied similar access by U.S. investors to its own market.88 The

“sword” could even be used as far as to retaliate for political events unrelated to trade.

This was the perception in at least one notable instance, the CATIC-MAMCO sale.89

In 1989, China National Aero-Technology Import and Export Corporation

(CATIC), owned by China’s Ministry of Aerospace Industry, offered to purchase Seattle-

based MAMCO Manufacturing, Inc, a manufacturer of aircraft components.90 MAMCO

notified CFIUS of the pending transaction under the voluntary notification policy CFIUS

maintains.91 The acquisition occurred before CFIUS returned a recommendation.92

When CFIUS finished its review, it recommended against the acquisition.93 President

Bush, following the recommendation, ordered CATIC to divest itself of its newly

83 Id.84 Id. at 16.85 Id.86 Id. at 16-17.87 Id.88 Fenton, supra note 30 at 212.89 Menard, supra note 44 at 320.90 Alvarez, supra note 32 at 96.91 Id. at 96-7.92 Id.93 Shearer, supra note 35 at 1757.

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acquired interest in MAMCO on February 1st, 1990, stating that “CATIC’s continued

control of MAMCO might threaten to impair the national security.”94 He further claimed

to have “credible confidential information” to support his finding.95 The secrecy of

CFIUS review exacerbates the problems inherent to Exon-Florio’s broad national security

definition. Because CFIUS review is performed in secret, the reasons for CFIUS’s

decision have been called into question. MAMCO did not possess any sensitive

information as a result of its DOD contracts, neither did it manufacture parts of special

military use or prohibited by CFIUS.96 Some observers have suggested that the true

reason for CFIUS’s recommendation was political: President Bush felt pressure at home

to send a message to China over the recent Tiannenmen Square incident following his

refusal to offer the Chinese students protection in America.97

An empirical look at Exon-Florio implementation suggests considerable prudence

by the government. While CFIUS posts no official tallies of its reviews, one source

reports that out of 1,500 notifications received, 25 full investigations were performed, of

which thirteen transactions were withdrawn during the review process.98 Of the

remaining twelve, only one was blocked, the CATIC-MAMCO sale.99 The suggestion of

prudence, however, is no substitute for guidelines in the eyes of a foreign would-be

investor. Without guidelines, Congress is able to introduce a much higher degree of

94 Id.95 Menard, supra note 44 at 321.96 Alvarez, supra note 32 at 97-8.97 Menard, supra note 44 at 321; see also Cecelia M. Waldeck, Proposals for Limiting Foreign Investment Risk Under the Exon-Florio Amendment, 42 HASTINGS L.J. 1175, 1220-21 (1991) (“Critics of the divestiture order called it ‘a politically motivated use of a law intended to safeguard national security.’”).98 JAMES K. JACKSON, THE EXON-FLORIO NATIONAL SECURITY TEST FOR FOREIGN INVESTMENT 4 (July 15, 2005) (Congressional Research Service, RS22197).99 Id.

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uncertainty regarding the acceptability of a transaction to CFIUS or the President then it

would otherwise.

At least one commentator has suggested that Exon-Florio codifies a new foreign

trade policy equilibrium between the legislative and executive branches of government.100

The White House is given an incentive to interpret national security provisions broadly,

or risk Congressional anger which might lead to new, more restrictive legislation being

passed regarding foreign investment.101 Exon-Florio does not just expressly give the

President broad discretion over foreign investment. Its mere existence, so long as it

remains vaguely defined, effectively gives Congress an almost equal power.102 In the

interests of the status quo, neither branch has an incentive to narrow Exon-Florio’s

scope.103 This is to the detriment of trade policy: without clear CFIUS guidance, the

“new equilibrium” translates into political risk for foreign investors.

II. CNOOC-Unocal

The enactment of Exon-Florio in 1988, and the resultant powers of review granted

to CFIUS, has been likened to a high-water mark in the struggle between Congress and

the Executive for control over FDI policy: “The strengthened CFIUS represented the

point at which the renewed policy struggle ended just as the flow of [inward FDI] began

to ebb.”104 Eighteen years later, with the tide of FDI in the United States once again

rising, the high-water mark might have to be redrawn. If China is the coming storm

100 Kang, supra note 45 at 329.101 Id.102 Id.103 Id.104 Id.

15

Japan once seemed, CFIUS will (again) have to be made stronger, or risk becoming a

greater hindrance to successful economic engagement than it is a tool for national

protection. Not through granting it more powers, as was the case in 1988, but by granting

it resiliency to abuse through transparency and reliability. The challenges a rising China

presents to Exon-Florio review today could not be made more clear by the CNOOC-

Unocal bid and the sequence of events leading to its failure. As a sign of things to come

in the near future, policymakers would be wise to treat it as the Fujitsu-Fairchild of today

and make serious reforms to the CFIUS process. Sadly, reform does not seem to be

forthcoming, despite an atmosphere of public, industrial, and congressional alarm

regarding China that rivals that caused by Japan two decades ago.105

China’s program of market liberalization combined with central planning begun

in 1979 produced striking economic results. While growth, particularly agricultural and

industrial output, was considerable in the 1980s, Deng Xiaoping’s renewed push to create

a “socialist market economy” in the 1990s was even more impressive.106 Throughout that

decade China’s economy had the world’s fastest growth rate, with an average 10%

increase each year.107 China is currently the world’s third largest trading nation, with

growth rates of 9.1% and 9.5% in 2003 and 2004 respectively.108 Unsurprisingly, China’s

importance to the United States has grown as well. According to the Department of

State:

Total two-way trade between China and the U.S. grew from $33

billion in 1992 to over $230 billion in 2004. The United States is China’s

105 See e.g. Pavel Molchanov, US Revives Japan Inc Fears Over China's Buying Spree, NAT. BUS. REV., Aug. 12, 2005.106 U.S. Department of State Bureau of East Asian and Pacific Affairs, Background Note: China (2005), <http://www.state.gov/r/pa/ei/bgn/18902.htm> [hereinafter Background Note].107 Id.108 Id.

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second-largest trading partner, and China is now the third-largest trading

partner for the United States (after Canada and Mexico). U.S. exports to

China have been growing more rapidly than to any other market (up

28.4% in 2003 and 20% in 2004). U.S. imports from China grew 29%,

with the U.S. trade deficit with China exceeding $162 billion in 2004.109

As a result of this growth, China attracted considerable foreign investment.110 Between

2000 and 2005, China’s foreign exchange reserves have soared from approximately $250

billion to over $800 billion.111 China, like Japan in the late 1980s, is now looking

overseas to invest this money.112 The value of proposed transactions involving a Chinese

buyer and a multinational target has increased from an average $2.5 billion in the

previous two years to a record $23 billion in 2005 (of which CNOOC-Unocal accounted

for $18.5 billion).113

The nature of the new expansion has been debated. Some analysts believe

China’s government coordinates a policy of overseas expansion-through-acquisition in

order to acquire proprietary secrets and technologies, valuable resources, and global

brand-name recognition.114 Others argue that Chinese government is too fragmented to

be able to coordinate such a policy, despite obvious political backing for some of China’s

private companies.115

Regardless of motivation, China’s expansion has caused great concern in the

United States. Economic growth is not the only reason, although the trade disputes which

109 Id.110 See Don Lee, Unocal Bid Tests U.S.’ China Ties, L.A. TIMES, July 11, 2005 at C1.111 Asian Squirrels, THE ECONOMIST, Sep. 15, 2005 (chart, “Stashing it Away”).112 See Edmund L. Andrews, China’s Oil Setback: The Politics; Shouted Down, N.Y. TIMES, Aug. 3, 2005, at C1; The Dragon Tucks In, THE ECONOMIST, June 30, 2005.113 The Dragon Tucks In, THE ECONOMIST, June 30, 2005.114 TRADE ISSUES, supra note 13 at 14.115 The Dragon Tucks In, supra note 111.

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have accompanied increasing trade ties with China have done much to sour the

atmosphere.116 China’s military strength has also risen significantly in the last decade.117

In this regard China is perceived as a greater threat than Japan was, as China has the

potential to become a military as well as an economic rival to the United States.118

Three concerns in particular drove Congressional opposition to selling Unocal.

First, China’s increasing need for energy to fuel its economic expansion might threaten

America’s own oil supply as China diverts oil from the global market for domestic

purposes, particularly in a climate where policymakers see oil as a strategic resource and

China as a “strategic competitor.”119 Second, China’s practice of providing heavy

subsidization for CNOOC, among other companies, and prohibition of foreign investment

in its own energy sector suggest an unfair advantage to Chinese companies over their

American rivals. Finally, Unocal’s sensitive technologies might threaten national

security interests if they end up in foreign hands.

It is beyond the scope of this paper to judge which of these concerns are valid and

which not- indeed, it is likely that the most conclusive way to answer these questions

would be to subject them to CFIUS review. However, without clearly defined standards

of review, the advantage granted to parties wielding the threat of review remains,

notwithstanding that those parties may have motives which are protectionist, retaliatory,

or otherwise unconcerned with national security. Moreover, any review would be

inconclusive so long as CFIUS’s findings in investigating cases remain entirely

116 See TRADE ISSUES, supra note 13; Molchanov, supra note 104.117 Elizabeth Douglass, Familiar Trade Fears, But Bigger Risks, L.A. TIMES, July 18, 2005 at C1.118 Id.119 Molchanov, supra note 104 (“The Bush administration characterizes China as a ‘strategic competitor,’ in contrast to the Clinton administration's preference for ‘strategic partner.’).

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confidential. This does not prevent an examination of the questions raised by each

concern as they relate to motivation, Exon-Florio, and future engagement with China.

Concern about the diversion of natural energy resources by a Chinese oil firm

away from the United States motivates what could be the most significant potential

transgression of Exon-Florio’s original purpose to date. Never before has CFIUS review

focused on a natural resource company.120 The CNOOC-Unocal bid thrust upon

policymakers the question of whether or not “energy security” should be included within

the scope of national security.121 As mentioned earlier, the idea of economic security

concerns being included in Exon-Florio’s national security definition is not new.122

Neither is the idea of oil being a strategic concern. However, U.S. policymakers have not

had to deal with the more subtle (yet consequential) question of whether or not control

over a globally traded commodity concerns national security as defined by Exon-Florio,

and neither the Amendment itself nor CFIUS’s broad regulations provide any guidance as

to whether or not it should.

While production of and trade in oil is certainly part of U.S. “essential

commerce,” this language was rejected in the final version of Exon-Florio as being overly

protectionist.123 Exon-Florio’s own guidelines for consideration are of little help either.

These guidelines are concerned with the ability to be self-sufficient with a given product

or service considered vital to national security.124 Many opponents of the CNOOC bid

cite the need for U.S. “energy independence.”125

120 Jim Wolf, Secretive Panel Could Block China’s Unocal Bid, REUTERS, June 24, 2005.121 Steve Lohr, Unocal Bid Opens Up New Issues of Security, N.Y. TIMES, July 13, 2005, at C1.122 See supra notes 57 and 61 and accompanying text.123 See id.124 See supra notes 73-4 and accompanying text.125 See TRADE ISSUES, supra note 13 at 14.

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It is unclear, though, if reliable supply of oil and other forms of natural energy is

dependant on actual physical control of those resources, given that they are highly

fungible globally-traded commodities.126 Some analysts have argued that the CNOOC

deal would not pose a threat to energy security by pointing out that if China diverted oil

from Unocal (a small player in global oil markets to begin with)127 for its own use, this

would simply displace oil China is already purchasing from other suppliers, who would

have to reintroduce their product into the global marketplace as a result.128 As a net oil

importer, China would have no interest in cutting back on production, suggesting fears of

any use by China of its reserves as an “oil weapon” are unfounded.129 Such unique

considerations make “energy security” a matter different and apart from national security

as the latter has been defined for Exon-Florio purposes (i.e., where national security is

best served by maintaining national control over production capacity or technological

capability).

The CNOOC-Unocal bid was also opposed on the grounds that China provided

heavy subsidization for CNOOC’s bid, which might suggest that the transaction was

“non-commercial” in nature.130 At the House Armed Services Committee hearings, Sen.

D’Amato pointed out that:

126 Jerry Taylor, CNOOC Bid for Unocal No Threat to Energy Security, 19 FREE TRADE BULL., July 19, 2005.127 As of the first quarter of 2005, Unocal was responsible for 0.23% of global oil production. Id. Further, most of Unocal’s oil reserves are located in Asia, and are sold to the Asian market. Alexei Barrioneuvo, Foreign Suitors Nothing New in U.S. Oil Patch, N.Y. TIMES, July 1, 2005, at C1.128 Id.129 Id. While not directly refuting this argument, Sen. Richard D’Amato, Chairman of the U.S.-China Economic and Security Review Commission has stated that China is willing to pay above marketplace premiums for oil and gas, thus harming “efforts… to develop fungible, transparent, and efficient oil and gas markets.” Hearing, supra note 16 (statement of Hon. C. Richard D’Amato).130 Hearing, supra note 16 (statement of Hon. C. Richard D’Amato); see also Andrews, supra note 114 (quoting Sen. Byron Dorgan, “When a Chinese government-controlled company tries to buy an American oil company, is it a free-market transaction? The answer is no.”).

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…the loan package for the acquisition is heavily subsidized. Seven

billion dollars came from CNOOC's parent, China National Offshore Oil.

Of that amount, $2.5 billion dollars is interest free, and the rest is a 30-

year loan at 3 percent….Six billion more dollars came from a State-owned

bank, an exceptionally large figure. Without this generous state-guided

credit, CNOOC, a company worth $22 billion, could not possibly offer

$18.5 billion for an acquisition of this type.131

Others pointed to the fact that while Chinese companies are free (in theory) to buy a U.S.

energy company, a U.S. company could not acquire a Chinese energy company due to

Chinese investment restrictions.132 Regardless of whether such concerns are valid, Exon-

Florio is not the appropriate instrument with which to alleviate them. Doing so would

constitute a “sword”-type usage of Exon-Florio, an attempt to deny Chinese investment

based on dissatisfaction with Chinese trade policy rather than on national security

grounds. Yet because CFIUS review is perceived as the sole process available for

rejecting CNOOC’s proposed transaction,133 they are raised by Congress not just as trade

policy issues unto themselves, but to cast doubt on CNOOC’s motivations for wishing to

acquire Unocal. One could question whether concerns about CNOOC’s “non-

commercial” motivations are in fact behind such attempts, or whether those dissatisfied

with China’s protectionist investment policies are attempting to fashion their concerns

into a form acceptable to CFIUS. Suggesting a double-standard, there was little

opposition to prior acquisitions of more extensive U.S. oil assets by nations with 131 Hearing, supra note 16 (statement of Hon. C. Richard D’Amato).132 See e.g. id.; Mouawad, supra note 21. This argument has also been criticized. Id. (“[M]any…point out that it’s less an issue of fairness than what the respective laws of the two nations permit. The U.S. allows such an acquisition, whereas China doesn't. ‘To say, ‘You can buy us, but we can't buy you’ ignores the overall context in which these companies operate,’” quoting Steve Chu of Strategic Impact Group in Shanghai).133 Hearing, supra note 16 (statement of Hon. C. Richard D’Amato) (“The CFIUS process appears to be the sole means for the U.S. government to consider and act on this transaction, and reject it if necessary.”)

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protectionist investment policies (such as Russia, Saudi Arabia and Venezuela) even

where these oil assets posed a greater risk to disruption of American oil supply and

national security.134

Finally, opposition centered around a third concern, that of the transfer of

proprietary, dual-use, or otherwise sensitive technologies in Unocal’s possession to

China.135 Concerns of this type are routine (and appropriate) for CFIUS review.136

Indeed, unlike the objections based on energy security and incongruity in investment

policies, CNOOC was expecting such objections and expressed its willingness to divest

itself of any such technologies should CFIUS have indicated that they have national

security implications.137

As mentioned, these three fears, in the context of a greater, more general fear

regarding a rising China, led to such Congressional and public outcry that the bid was

eventually withdrawn. No CFIUS review was ever performed. Despite a request by

CNOOC to do so, the Bush administration, hoping to avoid another point of conflict with

China, declined from initiating a review until such would have been automatically

triggered by CNOOC’s bid being accepted by Unocal.138

The consequences of CNOOC’s “rude awakening” are difficult to predict, but will

almost certainly not be to America’s benefit. America has long been trying to open the

134 See Barrioneuvo, supra note 87.135 Wolf, supra note 119 (“[A]ny CFIUS review would have to look at whether any Unocal oil-drilling and oil-prospecting technologies could help China test nuclear weapons or mask such tests,” quoting Congressman Michael Wessel.); Lohr, supra note 120 (“[A]nalysts said that Unocal had underwater terrain-mapping technology used for offshore oil exploration that might also be useful in navigation for the Chinese military's growing fleet of submarines.”); see also Hearing, supra note 16.136 Lohr, supra note 120.137 Dark Clouds on the Horizon: The CNOOC-Unocal Controversy and Rising U.S.-China Frictions, Carnegie Endowment for International Peace (July 14, 2005) (Transcript of speaker Albert Keidel, Senior Associate for the Carnegie Endowment for International Peace).138 Lohr, supra note 120. CNOOC considered unwillingness to initiate CFIUS review a factor working in Chevron’s favor. Id.

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energy markets of China and other nations with similarly protectionist regulation.139 Such

countries can now point to what appears as hypocrisy when American firms continue

their attempts.140 “What this misguided policy did was to say the United States will not

advocate fair trade when it comes to American assets,” said a former Assistant Secretary

of Energy.141 Lee R. Raymond, CEO of the U.S. energy corporation Exxon-Mobil,

summated fears amongst industry leaders and analysts by stating that it would be a “‘big

mistake’ for Congress to interfere with the CNOOC bid because it might backfire on

American companies seeking to do business abroad.”142

China’s official response to date has been subdued. The foreign ministry issued a

brief statement on August 4th, after CNOOC withdrew its bid, which simply stated:

“Economic and trade cooperation between companies from China and the United States

are to the benefit of both sides… CNOOC’s bid to merge with Unocal was a normal

commercial activity between companies.”143 It has been suggested that China might be

unwilling to make an issue of the failed transaction in order not to upset other trade ties

with the U.S.144 However, the bid was highly prominent in Chinese media, being

portrayed as a point of pride, a transaction showcasing China’s new prosperity- as a

result, Chinese public opinion regarding the United States has sunk.145

Observers fear that China might yet take any of several courses of action. One

would be a form of direct retaliation. China might, for example, have a state-owned

airline company place an order with Airbus instead of Boeing, or grant an oil concession

139 Fareed Zakaria, Mishandling the China Challenge, NEWSWEEK, Aug. 15, 2005.140 See id.; Giving China A Bloody Nose, THE ECONOMIST, Aug. 6, 2005.141 Mouawad, supra note 21 (quoting David L. Goldwyn of the Clinton administration).142 Id.143 Keith Bradsher, China Plays Down Bid’s Failure, N.Y. TIMES, Aug. 5, 2005, at C4.144 Id.145 Keith Bradsher, China’s Oil Setback: The Fallout; China Retreats Now, But It Will Be Back, N.Y. TIMES, Aug. 3, 2005, at C1.

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to BP or Shell, in some future transaction.146 The other, perhaps both more likely and

potentially damaging, would be for China to change strategies for future energy

expansion.147 Having been thwarted from acquiring a U.S. energy company, China might

decide to slate its needs for oil and gas by increasing investment in other more amenable

countries such as Iran, Myanmar, and the Sudan.148 Not only would this be at the expense

of U.S. shareholders, it might have more far reaching consequences, as China is rumored

to sometimes trade armaments for oil and gas rights in such countries.149 In a broader

context, continued refusal to engage China in a price-based system for securing energy

resources might eventually force China to adopt non-price-based systems for doing so

(including military intervention), with potentially severe national (and global) security

repercussions.150 The appearance of protectionism by the United States plays into the

hands of Chinese hardliners, further isolating China and giving it fewer incentives to

improve its human-rights record or make concessions regarding the status of Taiwan, and

supports the positions of opponents to China’s market liberalization programs.151

What does this all mean for Exon-Florio? Almost since its enactment, numerous

critics have raised the need, in one way or another, to narrow the scope of CFIUS review

and to make it more transparent and accessible to concerned parties.152 One student of

146 No Way to Treat a Dragon, INT’L HERALD TRIB., Aug. 5, 2005; Bradsher, supra note 143.147 See Linus Chua, Rejection of CNOOC Bid May Hurt U.S., Singapore’s Lee Says, BLOOMBERG, Sept. 16, 2005.148 Bradsher, supra note 144.149 No Way to Treat a Dragon, supra note 145.150 See Stephanie Ho, American Public Hostile to Chinese Bid for Unocal, NEWSVOA.COM, July 14, 2005 at http://www.voanews.com/english/archive/2005-07/2005-07-14-voa75.cfm?CFID=5376037&CFTOKEN=71843593.151 James A. Dorn, U.S.-China Relations in the Wake of CNOOC, POL’Y ANALYSIS (Cato Institute), Nov. 2, 2005 at 9, at http://www.cato.org/pubs/pas/pa553.pdf.152 See, e.g., Alvarez, supra note 32 at 160-65; Shearer supra note 35 at 1768-69 (“[B]ecause the ‘national security’ standard is susceptible to various interpretations, foreign investors face many uncertainties when structuring acquisitions… As a direct consequence, foreign direct investment into the United States will decrease and foreign countries are likely to retaliate by increasing the barriers to U.S. companies seeking to invest abroad.”)

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Exon-Florio recently suggested that CFIUS define “national security” by explicitly

specifying, among other things, exempt industries and protected technologies.153 Sixteen

years earlier, another had argued that “more detailed criteria in the regulations on the

meaning of ‘national security’ and sample hypotheticals illustrative of ‘threats’ to

national security, could help guide investors.”154

Confusion about the definition of national security is not limited to parties

outside the black-box of CFIUS. A Government Accounting Office (GAO) report

released in September of 2005 indicates that there is disagreement within CFIUS itself.155

The Department of the Treasury takes a “narrow” definition, considering “a U.S.

company’s possession of export controlled technologies or items, classified contracts, and

critical technology; or specific derogatory intelligence on the foreign company.”156 The

Departments of Defense, Justice, and Homeland Security, on the other hand, take a

broader view, examining such factors as the effects of foreign control on “critical

infrastructure” and a decrease in the number of domestic businesses engaged in defense-

critical industries.157 The report suggests that the possible negative impact of Exon-Florio

review on trade policy is a greater factor in Treasury considerations than it is for the other

mentioned departments.158 In its conclusions, the report states that “In light of the

differing views within [CFIUS] regarding the extent of authority provided by Exon-

Florio, the Congress should consider amending Exon-Florio by more clearly emphasizing

the factors that should be considered in determining potential harm to national

153 Waldeck, supra note 96 at 1178.154 Alvarez, supra note 32 at 161-62.155 ENHANCEMENTS TO THE IMPLEMENTATION OF EXON-FLORIO COULD STRENGTHEN THE LAW’S EFFECTIVENESS, GAO-05-686 (Sept. 2005).156 Id. at 12.157 Id.158 Id. at 12-13.

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security.”159 Possibly recognizing that it is a function of Congress, not the GAO, to make

any amendments, the report does not comment on the form they should take.160

CNOOC-Unocal might offer some guidance. The traditional view of national

security as dependant on domestic control of technologies and resources alone seems

increasingly anachronistic. Exon-Florio should be updated to reflect a world where

security threats may arise from a failure to properly integrate national interests with the

global economy. To that end, any definition of national security should incorporate a

definition of “energy security,” and do so in a form that clearly indicates what degree of

national control over production, distribution, and physical energy reserves is necessary

or desirable (taking into account that any policy which seeks to isolate the United States

and other global players from global energy markets might result in a greater risk of

supply disruption).161

Transparency for CFIUS review is another imperative. It is at once an irony of

the CNOOC-Unocal affair and a reflection of the inadequacies of Exon-Florio that almost

all concerned (Congressional opponents,162 proponents,163 and even CNOOC itself164 )

159 Id. at 21.160 See id. The report does suggest that to achieve greater transparency,

…the Congress could require an annual report on all transactions that occurred during the preceding year. Such a report could provide the Congress with information on the nature of each acquisition; the national security concerns raised by Committee member agencies, if any; how the concerns were mitigated; and whether each acquisition was concluded or abandoned, in addition to any presidential decisions required under the statute.

Id.161 See Taylor supra note 125.162 See, e.g., Hearing, supra note 16 (statement of Hon. C. Richard D’Amato) (“[T]he [U.S.-China Economic Security and Review] Commission has pointed out that there are serious flaws in the CFIUS statute. The statute was written without due consideration for transparency of the activities of CFIUS, and did not give itself appropriate oversight powers, requiring reports of its decisions and underlying rationales for those decisions, to the appropriate Committees of the Congress - including, this Committee. Such oversight is clearly overdue.”).163 Dorn, supra note 150 at 5 (“A judicious use of CFIUS is warranted. The committee’s lack of transparency poses problems for a country whose allegiance is to the rule of law.”).164 Lohr, supra note 120.

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wanted not just CFIUS review, but increased transparency for the process. This would

have been the best way to balance the competing interests of national security and free

trade. CNOOC would have received early indication of the political acceptability of its

bid and what steps, if any, it would have to take to make its bid more suitable from a

national security perspective. Congressional opponents, faced with the results of such a

review, would either be satisfied that such concerns were being dealt with appropriately

by the Executive or, if not, would at least find themselves forced to contend with the

public results, reducing their ability to frighten off would-be foreign investors like

CNOOC by raising fears without the backing of CFIUS’ constituent agencies and

departments. Proponents of free trade and engagement with China within a rule-of-law

and market-based framework would be satisfied that it was indeed the rule of law and not

political agendas that governed international transactions.

It is unsurprising that legislation crafted in an environment of fear and reaction

should find itself in need of change eighteen years later. While legislators cannot be

expected to foresee every possible consequence of a given law, they do have the

opportunity to change the law to make it more capable when its shortcomings are

exposed. CNOOC’s bid for Unocal exposes the shortcomings of Exon-Florio more

dramatically than any challenge that law has faced since its inception. The United States

cannot afford to leave the important task of balancing engagement with a rising China

against the interests of national security to the winds of political sentiment. Exon-Florio

needs to be updated quickly, so that the law can provide effective guidance for politicians

and investors alike in time to meet the challenges to come.

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