Navigating Board Requirements of the US National Industrial Security Program
In a world increasingly characterized by global business relationships, foreign investment in the US industrial base is steadily on the rise. When that foreign influence is present in companies with Department of Defense or other US government contracts of a classified nature, a host of security requirements become mandatory for those companies.
Among these requirements is the creation of a specialized, government-sanctioned board of directors that will serve to monitor and control the flow of information to the company's foreign owners and their affiliates. The goal is to mitigate the risk of unauthorized access to classified and export-controlled information and, in some cases, highly sensitive intellectual property. These directors shoulder a critical responsibility.
For companies with a foreign ownership interest that seek to win classified US government contracts, identifying the senior and experienced talent capable of obtaining the requisite government clearance and performing effectively as a board member is a key business priority. That said, understanding and navigating the government regulations, clearance standards and process for board members, and other specific requirements can be challenging to say the least – especially for the uninitiated.
Within ZRG's team, we possess in-depth knowledge of and experience with government-regulated foreign-owned, controlled, or influenced companies (FOCI), mitigated proxy boards, and special security agreement (SSA) boards. The firm's unparalleled expertise and resources in this area include Pete Metzger, Senior Advisor and Managing Director, who is currently a director on both a government-regulated proxy board as well as a Special Security Arrangement (SSA) board (more on this in the section “Firsthand” below). This perspective makes ZRG Partners uniquely qualified among executive search firms to partner with clients in order to identify senior leaders with the integrity, business acumen, and dedication to fulfill this vital role.
Companies under foreign ownership, control, or influence (FOCI) that seek to provide classified services to the US government must be sponsored for a US government facility security clearance by a cleared company or US government entity that intends to award a classified contract to the company. These sponsorship requests are generally submitted to the Defense Counterintelligence and Security Agency (DCSA) of the US Department of Defense. The Department of Energy also issues facility security clearances for classified contracts. Legal counsel can be a useful early step to help determine the appropriate FOCI mitigation arrangement and prevent delays in obtaining approval. DCSA will conduct an evaluation of the company's foreign influence factors and dictate the arrangement to be established prior to the company engaging in classified business with the US government.
A US company is considered to be under FOCI when a foreign interest has the power, whether direct or indirect, to make decisions affecting the management or operations of a company in a manner that may result in unauthorized access to classified information or may adversely affect the performance of classified contracts. Considerations for a FOCI determination include the country of the foreign owner's record of economic and government espionage against US targets as well as compliance with pertinent US laws, the type and sensitivity of information requiring protection, and other matters. DCSA generally requires one of three security agreements, each including a special board structure, for companies deemed to be under majority foreign control or influence.
The first two of these, proxy agreements and voting trust agreements, require the appointment of three proxy holders or voting trustees respectively who are both cleared US citizens and elected to the company's board of directors. Representatives of the parent companies (including US parents) and their affiliates are not eligible to serve on a proxy or voting trust board.
The third arrangement, the SSA, allows for a board that includes three cleared independent US citizens (outside directors), any cleared US citizen management team members who also serve as directors (officer/directors), and the representatives of the parent companies (Inside directors, who may or may not be US citizens). Under an SSA, the number of outside directors must exceed the number of inside directors.
In any of these board structures, the US citizen directors with personnel security clearances (PCLs) are typically the only members who may participate in board discussions involving national security matters, such as those pertaining to classified contracts. Within the SSA structure, however, foreign owners retain a direct board voice and representation for financial and other business management issues through the presence of inside directors on the company's board and board committees.
When operating under the proxy agreement, the cleared proxy holders (who also serve as directors) are vested with the voting rights of the foreign owners for most business matters, with specified exceptions (see section “Brass Tacks” below).
The cleared directors of proxy and SSA boards serve as the ultimate gatekeepers of the information flow between the US business and its parent companies, investors, or affiliates. The CEO of the US company or business division, as well as all senior executives, must report to the foreign owners through the proxy or SSA board.
In other ways, SSA and proxy boards function like and bear many of the same responsibilities of any other board of directors, providing business oversight and strategic input. The board typically has a chairman and a compensation committee, which is required by the SSA, and the required Government Security Committee (GSC). Nominating committees and audit committees are typically not part of the board committee structure.
In addition to attending board and committee meetings, proxy holders and outside directors should expect to attend meetings convened by DCSA for all US directors in such roles as well as annual meetings with DCSA in connection with their company's FOCI mitigation arrangement.
The Director Profile
Clearly, identifying the right individuals for a proxy or SSA board is of the utmost importance due to both the critical nature of the role for these directors and the extensive process companies must engage in to establish and maintain the government-required board. Squandering time and resources with poorly selected or ill-suited candidates is counterproductive, costly, and in some cases, difficult to rectify. Specific criteria must be satisfied in order to remove a proxy holder.
When assembling a board that will operate under a proxy agreement or an SSA, director nominees must possess or be eligible to attain the level of clearance required for the facility. For instance, a Top Secret facility would require directors with Top Secret clearance. Individuals may not personally request a clearance; rather, the sponsoring company must request the clearance if the candidate does not already possess a current PCL through DCSA, and the process can be time-consuming. Director nominees will submit a resume to DCSA, complete a questionnaire, and be the subject of an exhaustive personal background investigation. Clearance requests can be denied for a variety of reasons, including personal affairs, a history of financial difficulties, and other matters.
While business knowledge and acumen are essential for this role, there is, understandably, less emphasis placed on acquiring extensive business credentials through the selection of such a director. Instead, greater emphasis is placed on identifying a leader with relevant insight into governmental processes and concerns, as well as the related contact network. Obviously, these leaders will be individuals who will bring the highest level of integrity, dedication, and soundness of judgment to the board position.
Often the best candidates for proxy or SSA board roles are leaders from the Defense and Intelligence communities, either from a uniformed or a corporate background. For that reason, many of these leaders will be found outside the ready-contact list of most executive search firms.
For companies seeking to establish a government-sanctioned board operating under a proxy agreement or SSA, tapping ZRG's executive and board search expertise to identify and attract qualified director candidates can bring a disciplined approach to this critical endeavor – not to mention superior results. ZRG Partners possesses a unique understanding of, and access to, this population of leaders. The firm combines decades of search experience with the important insights gained from its singular position among proxy and SSA board leaders.
Companies under foreign ownership or influence that aspire to contract with the US government for classified services should view board formation as a vital first step. ZRG Partners is well-prepared to serve as an ally in this process.
Getting down to brass tacks, here is a thumbnail comparison of some key requirements for boards operating under proxy or voting trust agreements versus SSAs. DCSA will determine which agreement applies on a case-by-case basis.
Similarities: Under all three structures, the board will include three US citizens who have obtained clearance appropriate to the level of the facility. These three directors, and any company officers with personnel security clearances who also serve as directors, will be the only board members to participate in discussions related to classified information and national security matters.
Differences: A proxy or voting trust board is composed solely of the three US directors and any cleared US company officers who are also elected as directors. An SSA board includes three independent cleared US citizen directors (outside directors), the cleared company officers who have been elected as directors (officer/directors), as well as US citizen or non-US citizen directors who represent the parent companies (inside directors).
Under a proxy or voting trust agreement, the prerogatives of ownership are surrendered by the ultimate foreign investor to the US proxy holders or trustees. Exceptions to this surrender of rights include: for the sale of assets, reorganization, bankruptcy filing, dissolution of the US company, and other specified matters. Under an SSA, the prerogatives of ownership are generally retained by the ultimate foreign investor through the investor's representation on the board, with the outside directors serving as stewards to ensure that the US business is managed and directed by the SSA Chief Executive Officer (CEO), the CEO's management group, and the SSA board. This arrangement permits the ultimate foreign investor a direct voice in business matters not related to national security through the company's board and board committees.
There's no better guide through the intricacies of the US National Industrial Security Program than somebody with firsthand experience. Pete Metzger, Managing Director at ZRG Partners, is currently a proxy board director for a prime classified contractor to the intelligence community and other US government customers. The business is a government IT solutions subsidiary of a large, foreign-owned company whose largest shareholder is a foreign government. Therefore, a proxy board is required by the US Department of Defense. Additionally, Pete is also an outside director for a foreign-owned business operating under an SSA that provides mission-critical engineering solutions to US special operations forces.
Pete Metzger has the distinction of being the only consultant in the search industry serving as a proxy holder and outside director for companies operating under both a Department of Defense proxy as well as an SSA agreement. Prior to his executive search career, Pete served as a US Marine officer, worked in the CIA, and served as Marine Military Assistant to President Ronald Reagan. Pete is a graduate of the US Department of State's Foreign Service Institute and the Inter-American Defense College of the Organization of American States.
As a proxy holder, Pete chairs the Compensation Committee, which leads all US division executive compensation decisions; he also serves as Secretary of the Government Security Committee. While the board functions much like any other company board in many respects, the overriding responsibility of a proxy holder is to protect and insulate classified information and export-controlled information not authorized for release to an organization's parent companies and their affiliates. In Pete's words, “You become the trusted holder of the intellectual property of the business, and that is a serious matter.”
Teaming with Pete since 2012 is Charles H. (Chuck) King, leader of ZRG Partners' Global Board Practice. In that role, he is responsible for board of director assignments, governance consulting, and CEO recruiting. Prior to ZRG, Chuck served as Vice Chairman of the CEO & Board Services Practice at CTPartners, and earlier, as Managing Director of the Board Practice at Korn Ferry International. He has recruited over 600 directors for many of the top companies in the world, in industries that include manufacturing, oil and gas, retail, consumer packaged goods, technology, financial services, and more. He has also built numerous boards from scratch for IPOs, spinoffs, and other situations.
Chuck retired from the US Coast Guard following a two-decade career which included a variety of command and staff assignments both afloat and ashore, including a one-year special assignment to the Office of the US Secretary of Transportation. He is a graduate of the US Coast Guard Academy and holds an MBA degree from the Yale School of Management. Additionally, Chuck has been named to the Directorship 100 list of the Most Influential Individuals in Corporate Governance.
We would be delighted to provide further information or a pro bono consult if you are considering creating and seating a FOCI-mitigated board. Please feel free to contact us below.