What If a Chinese SOE Offer to Buy a US Company Again?

For many years, China was ranked the number one destination for foreign domestic investment. Now the cash flow could reverse from an inward bound journey to an outward bound one. Take for example; the state-owned Aluminum Corporation of China joining Alcoa in a surprised 12 percent purchase of Rio Tinto. China is concerned that the combining Rio Tinto and BHP Billiton would create a monopoly and could cause a disruptive interference with China’s iron ore needs.

Robert M. Kimmitt, Deputy Secretary of the U.S. Department of the Treasury, has outlined the following three "triggers for policy reviews." The first is whether the transaction will perpetuate ""undesirable underlying macroeconomic and financial policies." In other words, wouldl the transaction operate as "within the framework of sound domestic fiscal, monetary and exchange-rate policies." The second trigger would be whether the transaction would have an impact on "financial stability." The third possible trigger for policy intervention would occur when the transaction would take active control of a private firm, especially if the firm is involved with national security. Even if there are no national security concerns, the third trigger could be invoked if the buyer seeks board seats or unusual voting rights. The "acid test" is whether the transaction would be classified as a "passive" or an "active" transaction.

There are several review portals that may have to be crossed. First is the Committee on Foreign Investment in the United States (CFIUS), an inter-agency committee that would be alarmed if there were national security implication.  This committee is chaired by the Secretary of the Treasury, Mr. Henry Paulson. If a buyer does not notify this committee of its intent, CFIUS has 30 days to permit or begin an investigation. If it chooses the latter option, it has 45 days to issue an order to divest.

The headlines have focused on the high-profile controversies, such as the Chinese National Oil Company's (CNOOC) 2005 attempt to buy Unocal. This bid provoked the U.S. House of Representatives to refer the matter to President George W. Bush on national security ground. CNOOC soon therefore withdrew its bid and Unocal merged with Chevron for $17 billion in stock and cash. This event demonstrates the power of public opinion in the press and television. Another high-profile case which was blocked was Dubai Ports World’s attempted takeover of operations at U.S. Ports. On the other side of these headlines, there are many transactions which go through.  The most recent annual figures show that there have been approximately 10,000 mergers and acquisitions in the U.S., of which 1,730 were foreign in score. Of these only 6.5 percent were reviewed by CFIUS and none were blocked. The CNOOC transaction in 2007 was not formally blocked by CFIUS but was block in the realm of public opinion…mainly television and newspapers.

Another portal would be the Securities and Exchange Commission (SEC). This group would be greatly interested if the transaction would violate some corporate governance. Would the transaction compromise the integrity of the accounting statements and forward-looking statements? Would the transaction lead to possible violation of U.S. securities laws? A Chinese SOE would not be immune from The Foreign Sovereign Immunities Act (FSIA) of 1976. While the SOE may argue that it is not a foreign sovereign, the burden of proof would be to prove that the investors do not represent the authority of a foreign state. This would be unlikely. As recently as December, 2007, Mr. Christopher Cox, Chairman of the Securities and Exchange Commission in a presentation to the American Enterprise Institute Legal Center for the Public Interest, discussed Petrochina in this context. He argued that even though 12% of its shares were offered to the Chinese public, the balance of the share is owned by the Chinese government.

One of the theoretical arguments that would be in the mind of the SEC would concern control. For example, if a foreign private issuer is accused of violating U.S. securities laws, then the SEC would expect cooperation from the foreign government of the foreign private issuer. However, if the government is the controlling entity, then a conflict of interest would erupt and fair play would be jeopardized. In other words, how can a foreign government be both referee and player?

A final issue that would greatly concern the SEC would be transparency. In the U.S., shareholders can inquire, criticize and form joint action committees against the affairs of public companies. However, if inquiry, criticism and joint action are constrained by government policies, then the SEC would question the ability and willingness of SOE’s to be forthcoming with investors. Due the legislation that formed the SEC in the 1930’s after the Great Depression, some say was caused by the 1929 Wall Street crash; the most important mission statement of the SEC is to protect the investor. If transparency and confidence in information are not solid, the SEC will assuredly be the public defender in any court or committee proceeding.

Former U.S. Treasury Secretary Larry Summers argued in London’s Financial Times�Economists�Forum during the summer of 2007 that "The logic of the capitalist system depends on shareholders causing companies to act so as to maximize the value of their shares. It is far from obvious that this will over time be the only motivation of governments as shareholders."

While the above cited arguments could be used in court or in an administration proceeding, it behooves SOEs to remember how Napoleon once mused�The pen is greater than the sword. The power of the press and television in the U.S. could be the most decisive factor in any rejection of a SOE’s attempt  to merge or acquire a U.S. corporation.

 (Thomas H. Wilkins is the Chief Executive Manager of Joseph Jekyll Advisors LLC  in Athens, Georgia, USA and a  Chartered Financial Analyst.  He holds a Master of Arts degree in Economics from the University of Georgia. )