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October 15, 2019

Stroock Special Bulletin

By: Chris Griner, Shannon Reaves, Gregory Jaeger, Christopher R. Brewster, Erin Bruce Iacobucci

New Report Cards: Are Your OD/PH Measuring Up?

Foreign-owned or controlled entities may not hold U.S. facility security clearances (“FCL”) unless they enter into a corporate governance agreement with the U.S. Government to mitigate “foreign ownership, control, or influence” (“FOCI”).  When a foreign interest has the power, whether or not exercised, to be represented on the board, oversight of these agreements depends, in large measure, on independent Outside Directors and Proxy Holders (“OD/PH”), who are chosen by the shareholder with the consent of the U.S. Government.

For several years, the U.S. Department of Defense (“DOD”) has been reviewing the roles and qualifications of OD/PH in the National Industrial Security Program.  In August 2018, the Defense Counterintelligence and Security Agency (“DCSA”)[1] published a white paper describing the agency’s expected OD/PH reforms[2] (the “DCSA White Paper”).  On October 1, 2019, as required by the Paperwork Reduction Act (“PRA”), DOD published its proposal for six new forms related to the nomination and evaluation of OD/PHs.[3]  Under the PRA, agencies must seek the prior approval of the Office of Management and Budget (“OMB”) before they may publish broad-based “information collection requests.”  OMB is required by law to assess the paperwork burden generated by the proposal, with the goal of ensuring that the request does not impose unnecessary burdens.  The DOD request is open to public comment for 30 days.

For at least the past decade, the DOD has required little information concerning nominees for OD/PH positions: generally, a recent copy of the candidate’s resume or biography would suffice, together with the nominee’s responses to a DOD questionnaire.  The questionnaire was brief, but required disclosure of any prior relationship between the nominee and the company seeking (or holding) an FCL, its affiliates, and the foreign owner.[4]  Once approved by DCSA and appointed to serve, OD/PH have not historically been subject to any structured, continued evaluation, although DCSA maintains oversight of the agreement.  Only recently have OD/PH been asked to complete post-appointment DCSA training programs related to their duties as directors or proxy holders.

We have reviewed the new forms that DCSA intends to use with OD/PH.  The proposed forms indicate that the nomination process will now require more than a completed questionnaire from the nominee (and, as before, a resume or biography). Now, it appears that DCSA also intends to require the nominating entity to complete a separate questionnaire concerning the nomination process and the entity’s pre-existing relationships (if any) with the nominee.  Additionally, DOD proposes to add the following evaluation forms:

  • A Peer Assessment Form to evaluate the performance of sitting OD/PH. The proposed form appears to be for completion by other company officials or, possibly, board members, but no instructions are provided with the proposed form.  It is unclear who is expected to complete the form or how frequently.
  • A Self-Assessment Form, which is presumably intended for completion by each OD/PH respecting his or her service on the board. No instructions are provided with the form, nor is there any guidance on how often these assessments are to be completed.
  • A Group Assessment Form, the purpose of which appears to be an evaluation of various “Groups” at the cleared company including, among others, the full Board, the Government Security Committee, and the Compensation Committee. There are no instructions provided with the draft form, so it is unclear if this is intended to be a self-assessment or, if not, who would be responsible for completing the form.  Also unclear is the frequency with which the form will need to be completed.
  • An OD/PH Training and Certification form, which appears to be for each OD/PH to use in order to track and report his or her completion of training programs. Nothing in the form indicates how many hours of training will be required of each OD/PH (in addition to the baseline training already required by the DCSA[5]), nor is there any indication of the intended scope of the training programs associated with the forms.

In their request, DOD states only that the forms will be required “on occasion.”  A fair reading of this statement is that DOD is trying to preserve its flexibility in deciding when and where to use these forms.  DOD also maintains that each respondent will complete three forms, and that the average response time will be 45 minutes.  All of these representations are open to comment.

The nomination questionnaires appear to be in line with the expectations for OD/PH expressed in the DCSA White Paper.  We note, however, that the questionnaire seeks information about future relationships between the OD/PH and the company and its affiliate.  We find this interesting.  After the OD/PH relationship ends, there is no inherent prohibition on an Outside Director or Proxy Holder maintaining a relationship with a cleared company or an affiliate, including a foreign shareholder, although (for example) an offer of post-service employment to an OD/PH at any time during his or her service could be perceived as undue FOCI.  The intent of the questionnaire is likely to identify whether, at the outset, a nominee has been promised a post-service relationship that could taint the candidate’s independence.

The evaluation forms, are open-ended and, as a result, are highly subjective.  As an alternative, DCSA could provide statements respecting the expectations for the OD/PH, have the responding party rank the OD/PH on a scale (e.g., 1-5), and provide a section for comments, if any.  In any event, the evaluation forms and Training and Certification form must, at minimum, be accompanied by instructions.  The failure to provide instructions at this time limits the utility of the forms and the public’s ability to comment on them.

DOD has requested that any comments on the information collection request be submitted by October 31, 2019.

_______________________________________________

For further information, including copies of the proposed forms and assistance in preparing comments, please contact any member of the Stroock National Security/CFIUS/Compliance Group:

Chris Griner

Shannon Reaves

Gregory Jaeger

Tatiana O. Sullivan

Christopher R. Brewster

Erin Bruce Iacobucci

[1] Formerly known as the Defense Security Service (DSS).

[2] See Defense Security Service, “Partnering With Outside Directors & Proxy Holders To Strengthen FOCI Boards: A White Paper,” August 2018, available at: https://www.dcsa.mil/portals/91/documents/ctp/tools/ODPH_white_paper.pdf.

[3] See Department of Defense, Submission for OMB Review; Comment Request, 84 Fed. Reg. 52,077 (Oct. 1, 2019), available at: https://www.govinfo.gov/content/pkg/FR-2019-10-01/pdf/2019-21166.pdf.

[4] The National Industrial Security Program Operating Manual (“NISPOM”) requires that OD/PHs be “completely disinterested individuals with no prior involvement with the company, the entities with which it is affiliated, or the foreign owner[,]” in addition to being resident U.S. citizens that hold or are eligible to hold personnel security clearances at the level of the company holding or in process for a facility security clearance.  See NISPOM 2-305.

[5] Available at: https://www.cdse.edu/catalog/curricula/IS175.html.

This article is for general information purposes only. It is not intended as legal advice, and you should not consider it as such.