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DoD reviews foreign ownership policy.

In conjunction with the establishment of the National Industrial Security Program (NISP), the Department of Defense (DoD) is conducting an overall review of its policy relating to foreign ownership, control, and influence (FOCI) of cleared U.S. industries. Although the outcome of this review will not be promulgated for some time, it can be useful to review the current policy.

U.S. firms that are under FOCI are usually ineligible to accept classified contracts. Current policy allows for exceptions to this rule provided the U.S. firm is insulated from the effects of FOCI or the company's access to classified information is otherwise limited.

The DoD uses a variety of methods to offset the effects of foreign ownership on U.S. cleared firms. Currently, only beneficial ownership by foreign interests of 5 percent or more of a cleared firm's securities must be reported to the DoD.

Three principal insulating methods are used by the DoD to negate or reduce the risk associated with significant foreign ownership: the voting trust, the proxy agreement, and the special security agreement. The voting trust is used to transfer legal control of a company to trustees. The foreign owner retains equitable ownership rights under this arrangement; however, legal title of the foreign-owned stock is transferred to voting trustees. In a proxy agreement, the foreign shareholder transfers the voting rights of the foreign-owned stock to proxy holders. No limitations are placed on the types of classified information that can be accessed by a participating facility.

Under both the voting trust and proxy arrangements, the trustees or proxy holders must be U.S. citizens, be approved and cleared by the DoD, and be appointed as directors of the U.S. firm. Under such arrangements, the exercise of all prerogatives of ownership is unequivocally afforded to the trustees or proxy holders. They have complete freedom to act independently without consultation, interference, or influence from the foreign shareholders.

A Special Security Agreement (SSA) allows the foreign parent firm to retain control or dominance of the cleared facility's operations and management. The SSA allows the foreign shareholder to maintain representation on the board.

An SSA generally prescribes responsibilities, obligations, limitations, and other security safeguards and mechanisms concerning personal, physical, and organizational aspects deemed necessary by the DoD. It will usually provide for the appointment of outside directors who are U.S. citizens, approved by the DoD, and appropriately cleared. The outside directors must ensure that classified information is not subjected to compromise with regard to the foreign shareholder and that the cleared subsidiary's ability to perform on classified contracts is not adversely impacted.

A Defense Security Committee, comprised of outside directors and cleared management officials of the U.S. firm, will assist the outside directors in fulfilling their responsibilities and will oversee the U.S. firm's technology control program.

A firm cleared under an SSA is generally prohibited from accessing sensitive, proscribed information. However, a firm can be awarded contracts involving access to such information provided it is determined to be in the national interest.

The various instruments used to insulate foreign owners of cleared facilities may be viewed on a continuum with regard to the degree of direct control and influence that the foreign shareholder is allowed to retain and the sensitivity of classified information to which the cleared subsidiary is allowed access. At one end of the spectrum, the proxy agreement and voting trust prohibit the exertion of any direct control or influence by the foreign shareholder, yet these arrangements impose no access limitations on the subsidiary's clearance. At the other end of the spectrum, a reciprocal facility security clearance, under a foreign investor, is allowed unfettered management control and influence of the U.S. subsidiary, to the point of placing its own nationals in management positions. This approach, however, results in strict access limitations.

In the middle is the SSA. Under an SSA, a certain degree of direct control by the foreign investor is allowed, normally in the form of "inside directors" who represent the foreign shareholder on the board. Access limitations may be imposed.

None of these instruments totally insulates the U.S. cleared facility from the foreign shareholder. Even a proxy agreement or voting trust does not preclude a foreign parent from seeking to influence its cleared U.S. subsidiary; it only precludes direct influence.

John F. Donnelly is director of the Defense Investigative Service.
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Title Annotation:Pentagon Corner; Department of Defense
Author:Donnelly, John F.
Publication:Security Management
Date:Nov 1, 1993
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