Selling to the U.S. Department of Defense and the UK Perspective on Practical Impediments

to Transatlantic Cooperation

February 25, 2003

US-UK Defense Industry Seminar

AGENDA

• Introduction– Dave Tarbell, Senior Advisor, Vinson & Elkins

• Defense Procurement Regulatory Process– Dave Johnson, Partner, Vinson & Elkins

• Export Controls– Robert Vander Lugt, Of Counsel, Vinson & Elkins

• Industrial Security/Foreign Investment Regulations– Dave Tarbell, Senior Advisor, Vinson & Elkins

• UK Perspective– Richard Jones, Attache’, Defense Equipment Policy & Trade, UK

Embassy

U.S. Defense Market Access – Business Models

• Direct sales to U.S. suppliers

• Joint ventures/alliances with U.S. suppliers

• Mergers with or Acquisitions of U.S. suppliers

• “Greenfield” investment in the U.S.

• Direct Sales to the U.S. Department of Defense

Direct Sales to U.S. Suppliers -- Challenges

• Procurement regulations – flow-down challenges

• “Industrial base” – DoD 2nd & 3rd tier restrictions

• Export controls – offshore procurement issues

• Prime and 1st tier reluctance

• Difficulties with classified information

Joint Ventures -- Challenges

• Contracting can be more complicated– Who’s in charge? Who owns what?

• “Industrial base” restrictions – Is it British or U.S.?

• Export controls – technical data and services issues

• Difficulties with classified information

Mergers & Acquisitions -- Challenges

• Procurement regulatory issues multiply

• Foreign investment review – Can you get started?

• Export controls – Parental interaction challenges

• Classified – Parental control challenges

Greenfield -- Challenges

• Startup procurement issues – e.g., getting qualified

• Export controls – Parental interaction challenges

• Classified – Parental control challenges

Direct Sales to DoD -- Challenges

• Procurement transparency issues

• “Industrial Base” restrictions

• Export controls – selling to other markets

• Classified – very difficult

Administrative Note

• Sign-up sheet in the back to receive copies of slides presented today.

• Please leave your name and e-mail address (or mailing address if no e-mail).

Managing the “Practical Impediments”:U.S. Defense Procurement

Regulatory Process

David R. JohnsonVinson & Elkins

General Rule: Full & Open Competition

General Rule: Promote Competition• Competition in Contracting Act (“CICA”) (10 U.S.

Code 2304)– (a)(1) “… the head of an agency in conducting a

procurement for property or services –(A) shall obtain full and open competition through the use of competitive procedures . . .”

Exceptions

• Exceptions to CICA– Only one source– Urgency– Mobilization base/industrial preparedness– International agreement– National security– Required by law– Public interest

Restrictions

• Restrictions on Foreign Buys– Buy American Act (41 U.S.C. 10(a))– Appropriations Act restrictions

(e.g., Berry Amendment (10 U.S.C. 2240))– Statutory Restrictions (see Defense Federal Acquisition Regulation

Supplement 225.70 for a complete list)• 10 U.S.C. 2241 (Berry Amendment) (certain food, clothing, tooling, specialty

metals)• 10 U.S.C. 2534 (certain chemical weapons antidotes, ball bearings, naval vessel

components, etc.)– 10 U.S.C. 7309 (Byrnes-Tollefson Amendment) (shipbuilding restrictions)– R&D on certain weapons system or other military equipment if lower cost,

equally competent U.S. company– Certain contracts for ballistic missile defense RDT&E

Efforts to Remove Barriers

• Reciprocal Defense Procurement MOUs (“Qualifying Countries”)– Promote full and open competition– Promote standardization and interoperability of defense equipment

among allies– Removes discriminatory procurement policies– Waives most Buy American Act and customs duties– Exceptions: some statutory/regulatory restrictions

• Reciprocal Defense Procurement MOUs often include annexes for contract audit, quality assurance, some contract administration (some retained by DOD)

Other Issues Affecting U.K. Contractors

• Unique features of U.S. Procurement Regulations Affecting Performance – cost accounting standards, – Socioeconomic clauses & record-keeping requirements– disputes resolution (bid protests, claims, ADR)– termination rights

• Foreign Corrupt Practices Act/Other Anti-Bribery Statutes• Prohibition Against “Step Up” of Assets in Acquisition• Assignment/Novation Issues

Variable Impact Depending on Business Model

• Direct Sales to the U.S. Department of Defense

• Direct sales to U.S. suppliers (as subcontractor)

• Joint ventures/alliances with U.S. suppliers

• Mergers with or Acquisitions of U.S. Suppliers

• “Greenfield” investment in the U.S.

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Managing the “Practical Impediments”:Overview of U.S. Export Controls

Robert D. Vander LugtVinson & Elkins

Arms Export Control Act

• International Traffic in Arms Regulations, 22 C.F.R. 120-130

• Office of Defense Trade Controls• Defense Articles, Defense Services, Related Technical

Data

• Export of equipment and technology• Reexport of U.S. origin equipment and

technology• Export of foreign origin equipment incorporating

U.S. origin parts and components• Export of foreign origin equipment based on U.S.

technology

Export (§ 120.17)

• Sending or taking a defense article out of the United States

• Disclosing or transferring technical data to a foreign person whether in the United States or abroad

• Performing a defense service on behalf of or for the benefit of a foreign person whether in the United States or abroad

Foreign Person (§ 120.16)

• An individual who is neither a U.S. citizen nor a permanent U.S. resident

• Foreign corporation, partnership, trust, society or other entity that is not incorporated or organized to do business in the US

Proscribed Destinations (§ 126.1)

• Afghanistan, Angola, Belarus, Burma, Cuba, Democratic Republic of the Congo (formerly Zaire), Haiti, Indonesia (presumption of denial), Iran, Iraq, Liberia, Libya, North Korea, People’s Republic of China, Rwanda, Somalia, Sudan, Syria, Vietnam, Yemen (presumption of denial)

Scope of U.S. Controls

• Defense Articles• Technical Data• Defense Services

Scope of U.S. Controls Broader

Major Difference Between U.S. Export Controls and European Controls:

• European countries generally control technical data only in tangible form

• European countries generally do not control defense services

• European countries generally do not claim extraterritorial jurisdiction or attempt to control retransfers

Defense Article (§§ 120.3, 120.6)

• General Policy: – Specifically designed, developed, configured, adapted or

modified for military application; and– No predominant civil applications and no performance

equivalent to civil applications• Catch-All Category: Item that has significant

military or intelligence applicability• Intended use after export is irrelevant

Defense Services (§ 120.9)

• Furnishing of assistance, including training, to foreign persons in the design, development, engineering, manufacture, production, assembly, testing, repair, maintenance, modification, operation, demilitarization, destruction, processing or use of defense articles

• Military training and advice• Technical data need not pass

Technical Data (§ 120.10)

• Information which is required for the design development, production, manufacture, assembly, operation, repair, testing, maintenance or modification of defense articles.

• Includes information in the form of blueprints, drawings, photographs, plans, instructions and documentation.

• Key Point: “A piece of the puzzle”

Excluded from Tech Data Controls

• Public Domain: information that is published and generally accessible or available to the public, e.g.– “fundamental” science or engineering research, ordinarily published and not

proprietary

– general scientific, mathematical or engineering principles commonly taught in schools, colleges or universities

• Basic marketing information on function or purpose or general system descriptions– What it does– Not how it operates

• Additional Controls Administered by The Office of Foreign Assets Control (“OFAC”) of the Department of Treasury

• Additional Controls Administered by The Office of Foreign Assets Control (“OFAC”) of the Department of Treasury• Administers various sanctions programs

• OFAC controls are for more extensive than export controls. They include:– Exports– Reexports– Financial Transactions– Contracting or doing business with a sanctioned entity– Dealing in property interests

• Controls vary according to country

• Primary Sanctioned Countries:– Cuba– Iran– Iraq– Libya– Sudan

• Effect on You?– Mergers with U.S. companies– Acquisitions of U.S. companies– Acquisition by U.S. companies– Joint ventures or other teaming arrangements– Technology sharing arrangements with U.S. companies– Doing business with U.S. Government or U.S. companies– Doing business in U.S.

Managing the “Practical Impediments”: Foreign Investment Reviews

& Industrial Security

Dave TarbellSenior Advisor – Vinson & Elkins

Overview

• Merging with or Acquiring a U.S. Defense Company– Committee on Foreign Investment in the US (CFIUS)– Special Pentagon Antitrust Reviews

• Access to U.S. Classified Information & Contracts– Eligibility vs Access– Industrial Security Agreements and “FOCI”– Access to Information/National Disclosure Policy

Defense M&A Regulatory Review

• Exon-Florio Statute– President may suspend or prohibit any acquisition, merger,

or takeover of a U.S. company by or with a non-U.S. company to ensure that foreign control will not threaten U.S. national security

– Rigorous review process with established criteria and timeframes

– Decision reserved to the President after making specific findings

Committee on Foreign Investment in the U.S. (CFIUS)

• Exon-Florio statute is implemented by CFIUS• Chaired by the Treasury Department• Significant Members:

– Defense, State, Commerce, Justice Departments• Other Members:

– U.S. Trade Representative, Council of Economic Advisors, Office of Management and Budget, Office of Science and Technology Policy, Assistant to President for National Security Affairs (NSC), Assistant to President for Economic Policy (NEC)

CFIUS/Exon-Florio Review Process

Companies Submit “Voluntary” Notification To CFIUS

CFIUS Review (w/in 30 days)

Investigation?

CFIUS Investigation (w/in 45 days)

Report to President

President Decides & Reports to Congress (w/in 15 days)

YesNo

CompanyMay Proceed

** With USG permission, parties maywithdraw notifications to resolve issueswithout being “on the clock.”Withdrawals are normally granted.

CFIUS Review Criteria

• Foreign Control means the power, direct or indirect, whether or not exercised, and whether or not exercised or exercisable through the ownership of a majority or a dominant minority of the total outstanding voting securities of an issuer, or by proxy voting, contractual arrangements, or other means, to determine, direct, or decide matters affecting an entity.

CFIUS Review Criteria (cont’d)

• Key issues considered by CFIUS:– Extent and nature of foreign government ownership or control (if gov’t

control, law requires a mandatory investigation)– Involved in research, development or manufacturing of critical

defense technology– Sole source supplier of critical technology or goods for U.S. defense

requirements– Plans to move production or R&D outside the U.S.– Risk of diversion of goods or technology to countries or entities of

U.S. security concern– History of export control compliance– Cooperation with law enforcement

Necessary Findings for Presidential Action

• The President may only exercise the authority to suspend or prohibit a transaction if :– There is credible evidence that leads the President to

believe that the non-U.S. interest exercising control mighttake action that threatens to impair U.S. national security, AND

– There are no other provisions of law (except the International Emergency Economic Powers Act) that would provide adequate and appropriate authority to protect the national security.

History of CFIUS Reviews

• Almost 2000 Notifications reviewed since 1986

• Greater than 98 percent approved without further investigation (within 30 days)

• Handful of transactions (e.g., Thomson-LTV) withdrawn prior to Presidential action

• Less than 1 percent to President for decision

• Only 1 Presidential action – Chinese divestiture because there was no notification prior to the sale closing

Access to U.S. Classified Information & Contracts

• Many important programs require work with U.S. and foreign classified information

• Key Issues to be Discussed:– “Eligibility” versus Actual Access– Foreign Ownership, Control and Influence (FOCI)– National Disclosure Policy Process

“Eligibility” vs Authorization for Actual Access

• Eligibility for Access – Must be a cleared U.S. citizen (individuals or corporations), or– A foreign government or their cleared contractors who have been

deemed eligible pursuant to a bilateral government-to-government agreement (generally titled a General Security of Military Information Agreement – GSOMIA), or

– A U.S. entity under Foreign Ownership, Control or Influence withan approved U.S. government mitigation plan (more later)

– Is NOT sufficient for actual access and transfer of information

Access to Classified Information

• Access by foreign entities requires both a Disclosure and Export Authorization from the U.S. government– U.S. Government Authorized Disclosure Official and

Owner of the classified information authorize its disclosure

– An actual export/transfer authorization is provided by the relevant authorities through a license (State Department) or use of a license exemption

Foreign Ownership, Control, or Influence (FOCI)

• FOCI is relevant when either:– Acquiring or merging with a U.S. company performing

contracts requiring access to U.S. classified information, or– Setting up a U.S. subsidiary to perform such contracts

• Choices:– Discontinue classified contract performance, or– Establish security arrangements approved by the U.S.

Government to mitigate the foreign control and influence

What is FOCI?

• The relevant USG agency may find FOCI if:– A foreign interest has the power, direct or indirect, whether or not

exercised, and whether or not exercisable through the ownership of the U.S. company's securities, by contractual arrangements or other means, to direct or decide matters affecting the management or operations of that company in a manner which may result in unauthorized access to classified information or may affect adversely the performance of classified contracts.

• A U.S. company under FOCI is generally ineligible for a facility clearance and access to classified information unless the USG authorizes an exception, usually pursuant to an approved FOCI mitigation plan.

Mitigation Measures

• FOCI exceptions permitting a continuation of a facility clearance are usually only granted if mitigation measures are implemented with USG approval.

• The severity of the measures depends on the nature and extent of the foreign control, the level of classified information and types of contracts involved, and the importance of continued performance of the contracts to DoD.

Mitigation Measures (cont’d)

• Required mitigation measures can include the following (in order of severity):– Voting Trust or Proxy Agreement– Special Security Agreement (SSA)– Security Control Agreement (SCA)– Board Resolution– Limited Facility Clearance

• Foreign owners provided an initial recommendation on the appropriate mitigation measures, but the USG makes the final decision in consultation with contract program managers

Illustrative Features of FOCI Mitigation Measures

• U.S. Citizen Governance under Proxy or Trustee Arrangements • Hybrid Governance Arrangements (SSA):

– Outside Directors (U.S. citizens)– Inside Directors– U.S. citizen subsidiary officers/directors– Government Security Committee

• Various Board Resolutions (SSA, SCA, Limited clearance)• Technology Control Plans• Legally-binding agreements• Government-approved compliance programs including foreign

visitation procedures

Foreign Access to U.S. Classified Information

• Foreign entities can participate in U.S. classified contracts under certain conditions

• Prerequisite: GSOMIA between the U.S. and foreign government with following conditions:– Will not transfer title or possession without U.S.

government consent– Will not use or permit the use for other purposes without

U.S. government consent– Will provide substantially the same degree of protection as

the U.S.

Foreign Access to Classified (cont’d)

• GSOMIA’s generally include industrial security agreements providing for specific measures that foreign contractors must implement to be eligible to handle U.S. classified information

• NATO governments and most other major European governments have GSOMIA’s with the U.S.

• U.S. classified information is transferred either through official government channels or through specific channels approved by the relevant governments

National Disclosure Policy Committee

• Process for Transfer of Classified Information to Foreign Entities:– Disclosure decision by USG Disclosure Authority

pursuant to National Disclosure Policy– Certain disclosures reserved for decision by the National

Disclosure Policy Committee (DoD, State); termed “Exceptions to National Disclosure Policy”

– Export license or other authorization– Govt-to-govt or Govt-approved transfer channels

Comments by Richard Jones