Issues Relating to Foreign Investment and Control of U.S. Airlines
Gao ID: GAO-04-34R October 30, 2003
In May 2003, the Bush Administration proposed amending the legislation that currently restricts foreign ownership of U.S. airlines, raising the allowable percentage of total foreign ownership of voting stock in U.S. airlines from 25 to 49 percent. The Department of Transportation (DOT) suggested that implementing this amendment could provide significant benefits to U.S. consumers and airlines, particularly by providing access to additional capital, which would help the financial health of the industry. DOT and the Department of State also maintain that these new limitations would bring the United States in line with current foreign ownership laws of the European Union (EU). Concerned about the effect that changes in foreign ownership and control requirements might have on the aviation industry, national interests, and consumers--and recognizing that we examined this issue in 1992 when DOT earlier proposed increasing the level of foreign ownership--the Subcommittee on Aviation, Senate Committee on Commerce, Science, and Transportation asked us to discuss two related topics: (1) current proposals to revise U.S. limits on foreign ownership and control, including information on current shareholders and past examples of efforts by foreign interests to purchase significant equity in U.S. air carriers and (2) whether key analytic issues raised in our 1992 report on foreign ownership and control remain relevant.
Foreign airlines have attempted to invest in and influence the operations of U.S. airlines several times since the late 1980s. These foreign airlines have on occasion invested significant amounts of capital into U.S. airlines, only to later disinvest due in part to U.S. policies concerning airline control. The Administration's proposal does not seek to change U.S. law regarding control of air carriers. Our 1992 report identified five key issues relating to raising the limit on foreign investment in U.S. airlines. In general, those issues covered the potential impact of foreign investment on domestic competition, national security, employment, safety, and international competition. Because the current economic environment and the state of the aviation industry are similar to that in existence at the time of the prior report, we believe that most of these issues remain relevant today.
GAO-04-34R, Issues Relating to Foreign Investment and Control of U.S. Airlines
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October 30, 2003:
The Honorable Trent Lott:
Chairman:
The Honorable John D. Rockefeller:
Ranking Minority Member:
Subcommittee on Aviation Committee on Commerce, Science, and
Transportation:
United States Senate:
Subject: Issues Relating to Foreign Investment and Control of U.S.
Airlines:
In May 2003, the Bush Administration proposed amending the legislation
that currently restricts foreign ownership of U.S. airlines, raising
the allowable percentage of total foreign ownership of voting stock in
U.S. airlines from 25 to 49 percent. The Department of Transportation
(DOT) suggested that implementing this amendment could provide
significant benefits to U.S. consumers and airlines, particularly by
providing access to additional capital, which would help the financial
health of the industry. DOT and the Department of State also maintain
that these new limitations would bring the United States in line with
current foreign ownership laws of the European Union (EU).
Concerned about the effect that changes in foreign ownership and
control requirements might have on the aviation industry, national
interests, and consumers--and recognizing that we examined this issue
in 1992 when DOT earlier proposed increasing the level of foreign
ownership--you asked us to discuss two related topics: (1) current
proposals to revise U.S. limits on foreign ownership and control,
including information on current shareholders and past examples of
efforts by foreign interests to purchase significant equity in U.S. air
carriers and (2) whether key analytic issues raised in our 1992 report
on foreign ownership and control remain relevant.[Footnote 1] This
report summarizes the information we provided to Committee staff during
our June 25, 2003, briefing pursuant to your request. The briefing
slides, which provide more details about our analysis, are attached as
enclosure I.
In summary:
Foreign airlines have attempted to invest in and influence the
operations of U.S. airlines several times since the late 1980s. These
foreign airlines have on occasion invested significant amounts of
capital into U.S. airlines, only to later disinvest due in part to U.S.
policies concerning airline control. The Administration's proposal does
not seek to change U.S. law regarding control of air carriers.
Our 1992 report identified five key issues relating to raising the
limit on foreign investment in U.S. airlines. In general, those issues
covered the potential impact of foreign investment on domestic
competition, national security, employment, safety, and international
competition. Because the current economic environment and the state of
the aviation industry are similar to that in existence at the time of
the prior report, we believe that most of these issues remain relevant
today.
Background:
Congress first enacted citizenship requirements for U.S. airlines with
the Air Commerce Act of 1926. That act required that U.S. citizens own
at least 51 percent of any individual aircraft in order for it to be
registered in the United States. Under the Civil Aeronautics Act of
1938, Congress required that U.S. citizens own or control at least 75
percent of the voting interests of U.S. airlines. This standard has
remained the same since then.[Footnote 2]
Under current U.S. law, in order to operate as a U.S. airline, an
entity must obtain a certificate of public convenience and necessity or
an exemption from the certification requirement from DOT. A
prerequisite for obtaining such authority is U.S. "citizenship."
Current U.S. law defines a "citizen of the United States" as an
individual U.S. citizen, a partnership whose members are U.S. citizens,
or a corporation or association organized under U.S. law where at least
75 percent of the voting interest is owned and controlled by U.S.
citizens.[Footnote 3] The law also specifies that the President, as
well as at least two-thirds of the Board of Directors of the
corporation, must be U.S. citizens. In practice, DOT has interpreted
control to mean that day-to-day management decisions must be made by
U.S. citizens, even if there is substantial foreign investment in the
airlines. That is, the law has been construed as requiring actual
control of the enterprise to rest with U.S. citizens.
In addition to DOT's initial citizenship evaluation of an airline when
it first applies for certification, DOT again reviews the airline's
citizenship status following any substantial change in an airline's
ownership, management or operations.[Footnote 4] This is done on a
case-by-case basis. In a March 2003 review of DOT's citizenship
evaluation process, the DOT Inspector General found that no single
document defines the process or criteria to be applied for the review
and that DOT examines several factors when determining the issue of
control.[Footnote 5] These factors include any significant contracts
between the airline seeking citizenship and its business partners,
voting rights held by U.S. and non-U.S. citizens, and the terms of any
debt instruments or bankruptcy agreements. During its analysis, DOT
determines whether a foreign entity's influence over any of these
factors shifts the actual, day-to-day control of the airline from U.S.
citizens to foreign citizens.
DOT has previously proposed easing the restrictions on foreign
investment in U.S. airlines. In 1991, the Secretary of Transportation
proposed allowing foreign investors to own up to 49 percent of a U.S.
airline's voting stock, although no legislative proposal was submitted
to the Congress. According to DOT officials, the proposal was made in
response to heavy losses suffered by U.S. airlines in 1990 and 1991,
and experience gained in structuring foreign investments to maintain
U.S. citizen control by working with two major U.S. airlines (Northwest
Airlines (NW) and Continental Airlines) and their foreign investors.
Congress did not adopt these proposals.
Proposed Legislation Would Affect Ownership and Control of U.S.
Airlines:
The latest efforts to change U.S. foreign investment and control
restrictions were submitted as two separate amendments to the Federal
Aviation Administration (FAA) reauthorization bill (H.R. 2115 and S.
824).
The Administration proposed an amendment that would relax the
restrictions on foreign-owned voting stock of U.S. airlines from 25 to
49 percent, while not changing the policy that U.S. citizens control
U.S. airlines. DOT suggested that increasing allowable foreign
ownership limits would provide access to additional capital, which
would provide several benefits that would help the financial health of
the industry. This includes encouraging more efficient market-driven
networks, creating opportunities for new airlines to enter the market,
and bringing U.S. ownership limitations in line with European laws. DOT
also sought to find additional tools for the airline industry to
respond to unforeseen economic conditions, such as the recent effects
of the Iraqi War or the Sudden Acute Respiratory Syndrome outbreak in
Asia.
A separate but related amendment addressed the issue of control of U.S.
airlines. The House and Senate conference agreement on the FAA
reauthorization bill includes a section that would revise the
definition of "control."[Footnote 6] The bill would amend Section
40102(a)(15)(C) of title 49 to include in the criteria for meeting the
citizenship requirement as "(airlines) which (are) under the actual
control of citizens of the United States." In effect, this language
would codify DOT's existing practice.
There are differing levels of support by various aviation stakeholders
for altering current foreign ownership and control statutes. Several
key aviation stakeholders generally support the proposal of raising the
allowable level of foreign ownership in U.S. airlines. Most major U.S.
airlines favor increasing their access to foreign capital, and some
have called for removing all restrictions regarding foreign ownership.
The Air Transport Association issued its support in June 2003, citing
the potential to create greater access to global capital for U.S.
airlines, while also bringing U.S. foreign ownership laws into line
with those of other countries.[Footnote 7] Certain international
aviation organizations also support removing barriers to international
investment and open markets. Both the International Civil Aviation
Association and the International Air Transport Association support the
liberalization of ownership and control. Other stakeholders, especially
various labor groups, oppose increasing foreign ownership levels. For
example, the Association of Flight Attendants has a preference that
foreign ownership be handled on a case-by-case basis and not just as a
blanket lifting of the limitations. They also support control of U.S.
airlines by U.S. citizens. The AFL-CIO's Transport Trade Department
also strongly opposes any relaxation of the rules on foreign control of
domestic airlines, citing both national security and the economic
welfare of U.S. workers among their concerns.
Current Status of Foreign Investment in U.S. Airlines:
As of July 2003, the amount of foreign investment in U.S. airlines
remained limited. According to a major international investment bank,
as of May 2003 no major stockholders--U.S. or foreign--owned more than
20 percent of any major U.S. network carrier.[Footnote 8] American
Airlines and Delta Air Lines both had significant blocks of stock owned
by single shareholders, but these were U.S. financial service firms.
Both NW (18 percent), and Continental (13 percent) have shares held by
Axa Financial, a U.S. subsidiary of the French-based Axa
Group.[Footnote 9]
Past Examples Show Control Has Been the Central Issue:
Foreign airlines have attempted to invest in and influence the
operations of U.S. airlines several times since the late 1980s. These
foreign airlines have on occasion invested significant amounts of
capital into U.S. airlines, only to later disinvest due in part to U.S.
policies concerning airline control.
In 1989, NW announced that it would be acquired in a leveraged buyout
by Wings Acquisition, Inc. (Wings). KLM Royal Dutch Airlines (KLM)
provided about 57 percent of the total equity in Wings and owned 5
percent of the voting shares of Wings. KLM also proposed to gain the
right to appoint one member of Wings' 12-member Board of Directors and
to form a financial advisory committee to advise Wings on the
management of NW.[Footnote 10] In its review of the proposed
transaction, DOT objected to the proposed deal's structure and issued a
consent order, with NW and Wings agreeing to (1) place KLM's interest
above 25 percent of the total equity in a voting trust, (2) terminate
KLM's right to appoint a financial advisory committee, and (3)
disqualify KLM's board member from participating in all decisions on
competitive and international aviation matters. NW petitioned for
reconsideration in 1991. DOT then permitted KLM to own 49 percent of
the total equity investment in Wings and allowed increased
representation on Wings' board, since the United States and the
Netherlands had an open skies bilateral aviation agreement.[Footnote
11] DOT ordered modifications to the original investments and attached
conditions to its approval to ensure that NW retained its decision-
making independence from its foreign airline investor. In 1997, KLM
decided to disinvest from NW and instead focused on building up an
alliance without direct financial investment. KLM and NW formed the
first international code-sharing alliance granted antitrust immunity in
1993.[Footnote 12]
In 1992, British Airways (BA) proposed investing $750 million in USAir
in an arrangement that would have created the world's largest airline
alliance.[Footnote 13] In the original proposal, BA's investment would
include about 44 percent of USAir's total equity, 21 percent of USAir's
voting stock and representation on USAir's Board of Directors.[Footnote
14] BA included some important conditions to its investment, including
one that it would have significant influence over major investment and
financing decisions by USAir. DOT initiated a review of the proposal.
BA withdrew its proposal before DOT issued a formal decision, in part
because of changes being sought in the bilateral aviation agreement
between the United States and the United Kingdom. BA later revised its
proposal and invested $300 million, with an option to invest an
additional $450 million in the future, and eliminated the governance
condition. The alliance never functioned as the two airlines had hoped,
according to court motions filed by USAir in 1996, and the BA-USAir
alliance ended in 1997.
Changes in the ownership, management, and operations of DHL Airways
illustrate that it is sometimes difficult to determine the control of
an airline. DHL Airways (now ASTAR Air Cargo) holds a certificate of
public convenience and necessity from DOT, and thus was found to meet
U.S. citizenship requirements. In the fall of 2000, DHL Airways
reported to DOT that it had undergone a substantial change in
ownership, involving Deutsche Post, the German postal monopoly. DOT
conducted an informal review of its citizenship, as is standard
practice, and in May 2002, informed DHL Airways that it met U.S.
citizenship requirements. However, Federal Express and United Parcel
Service petitioned for a public review, alleging that DHL no longer met
the citizenship requirement. DOT initiated a public proceeding to
examine the issue.
In April 2003, P.L. 108-11 directed that DOT use an Administrative Law
Judge to assist in resolving this issue. The Administrative Law Judge
is to issue a recommended decision by December 1, 2003. DOT will then
review that decision.
Prior GAO Report Identified Five Key Issues Relating to Changes in
Foreign Investment Laws:
In 1992, we reported on the potential impact of changing U.S. airline
foreign investment and control laws and evaluated DOT's 1991 proposal
to allow for increased foreign investment in U.S. airlines.[Footnote
15] We found that the five key issues identified in the prior report
are still relevant today. This proposal, according to DOT officials,
was in response to the heavy losses suffered by U.S. airlines in 1990
and 1991, who were hurt by the generally weak economy. The report noted
that six large U.S. airlines had declared bankruptcy and three of them
had ceased operations. The report concluded that fewer airlines could
mean less competition and higher fares. The report addressed five key
areas that may be affected by changing ownership and control laws:
Domestic competition - Allowing greater potential access to foreign
capital could give U.S airlines, particularly those in financial
difficulty, additional capital which would allow them to enhance their
domestic competitive position.[Footnote 16]
National security - U.S airlines, through their voluntary participation
in the Civil Reserve Air Fleet (CRAF) program, provide the Department
of Defense (DOD) with supplemental airlift capacity in
emergencies.[Footnote 17] DOD was concerned that foreign investors
might discourage continued participation in CRAF.
Employment - Increased foreign investment could put jobs at risk--for
example, those of U.S. pilots and crew on international routes; but it
could also help stabilize U.S. airline employment by strengthening
financially weak airlines.
Safety - Increased foreign investment could place additional burdens on
the Federal Aviation Administration's safety oversight
responsibilities if foreign aircraft are transferred to U.S. registry.
International competition - The impact of increased foreign investment
on international competition depends, in part, on existing bilateral
aviation agreements. These agreements set the conditions under which
U.S. and foreign airlines operate and compete, and can restrict
competition by limiting the service that can be offered. There may be
opportunities for relaxing operating restrictions in some bilateral
agreements in exchange for relaxing restrictions on foreign investment
in U.S. airlines. Eligibility to invest in U.S. airlines could be
restricted to airlines from nations that allow greater access to their
aviation markets or do not subsidize their airlines.
Issues Identified in Prior GAO Report Still Relevant Because Current
Aviation Environment Is Similar to 1992:
Although 11 years have passed since we reported on the potential effect
of changing foreign investment and control limits on U.S. airlines,
most of the issues that we identified still appear to be relevant. As
in the early 1990s, the U.S. commercial airline industry in 2003 faces
a weak economy, relatively high fuel prices, and military action in the
Middle East. These conditions, as in the past, have contributed to weak
passenger demand, decreased airlines revenues, and some airline
bankruptcies. The airlines have likewise used some of the same basic
strategies to control operating costs. For example, major airlines
responded to the 1992 economic downturn by implementing cost-cutting
programs, laying off employees, canceling or delaying aircraft
deliveries and refocusing service. These same strategies have been
implemented again since 2001 by major airlines. For example, United and
American have made huge employee cutbacks, and Continental Airlines
announced in July, 2003 that it plans to defer prior orders for
additional Boeing planes until the domestic economy recovers. Some
airlines also are again expressing interest in acquiring capital
through foreign investment. Therefore, general issues identified in our
prior report appear to be still relevant to U.S. interests.
Domestic competition - U.S. airlines have made significant reductions
in service, but continue to have more capacity than passenger demand.
Airlines are seeking additional capital to provide operating funds to
survive the reduced passenger traffic and revenues and avoid
bankruptcy. The effect that airline bankruptcies might have on domestic
competition is uncertain. Since most U.S. "legacy" airlines' balance
sheets are considerably weaker than in 1992, DOT believes that the
ability to access international capital markets is even more valuable
to the airlines in the current economic environment.[Footnote 18]
National security - While DOD has traditionally been concerned about
increasing foreign ownership due to the belief that any foreign control
of U.S. airlines would negatively affect CRAF, it presently has no
official comment on the administration's latest proposal. Questions
already exist regarding the effectiveness of DOD's program incentives,
and it is unclear if these incentives will be affected by changes in
foreign ownership restrictions.
Employment - The impact of increased foreign investment on employment
remains unclear. There are differing views on how changes in foreign
investment restrictions could affect employment--would additional
investment stimulate domestic aviation, thus domestic aviation
employment, or would foreign investment lead to jobs being transferred
to foreign workforces? DOT indicated that there is no evidence to
suggest that increased foreign investment in U.S. airlines would have
any effect on labor. DOT commented that, due to existing collective
bargaining agreements and other regulatory requirements governing U.S.
airlines and their employees, the administration's proposal would not
affect the rights of labor or the obligation of airlines with respect
to labor.
International competition - While bilateral "open skies" agreements
between the United State and many EU member states have improved the
access, level of integration, and volume of travel across the Atlantic,
other aviation agreements, such as the Bermuda II Accord, continue to
limit airline integration and efficiencies.[Footnote 19] As the United
States and EU start negotiations for a new aviation agreement, one of
the primary negotiations points for EU officials will be the relaxing
of current U.S. foreign investment and control restrictions.[Footnote
20] The effect that recent legislative proposals codifying control
standards could have is unclear. DOT has stated that since 1992, many
U.S. airlines have formed international alliances. These alliances may
find mutual investments more desirable, either to sustain a valuable
alliance partner experiencing financial difficulties or to solidify
commercial relationships.
At this time, we do not believe that the FAA safety workload issue
raised in the 1992 report continues to be a significant relevant
concern in the current environment. In addition to any legal obstacles
to transferring foreign aircraft to U.S. registry, it is not clear what
incentives exist that would encourage a foreign investor to do so. U.S.
carriers have grounded a significant number of aircraft and have been
operating less frequency with existing fleets over the past 2 years as
a result of the downturn in demand. Also, even if such a change were to
occur, it is unlikely that aircraft would be added in such numbers so
as to materially increase FAA's safety oversight responsibilities over
and above its current workload.
Scope and Methodology:
To address the administration's current proposal and discuss the
potential affect on domestic competition, national security, airline
employment, airline safety, and international competition, we conducted
interviews with key stakeholders and industry experts. This included
representatives from DOT, the European Union, various member states,
and U.S. airlines. In addition, we reviewed the literature regarding
foreign ownership regulations and implications, studied transcripts of
speeches by key U.S. government personnel, and reviewed financial
regulations and materials. Finally, we examined documents filed with
DOT regarding citizenship of airlines.
Agency Comments:
We provided a draft report with briefing slides to DOT for review and
formal comment. DOT provided technical comments, which we have
incorporated into this report as appropriate.
As agreed with your office, unless you publicly announce the contents
of this report earlier, we plan no further distribution until 30 days
from its date. At that time we will send copies to the Secretary of
Transportation and other interested parties. We will also send copies
to others upon request. In addition, this report will be available at
no charge on our Web site at http://www.gao.gov.
For further information on this report, please contract JayEtta Hecker
at (202) 512-2834. Individuals making key contributions to this report
included Steve Martin, Emily Pickrell, Tim Schindler, and Matt Zisman.
JayEtta Z. Hecker:
Director, Physical Infrastructure Issues:
Signed by JayEtta Z. Hecker:
Enclosure:
Enclosure I:
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FOOTNOTES
[1] U.S. General Accounting Office, Airline Competition: Impact of
Change Foreign Investment and Control Limits on U.S. Airlines, GAO/
RCED-93-7 (Washington, D.C.: December, 1992).
[2] The United States has restricted ownership and control of U.S.
airlines for four primary reasons: (1) protection of the then-fledgling
U.S. airline industry, (2) regulation of international air service
through bilateral agreements, (3) concern about allowing foreign
aircraft access to U.S. airspace, and (4) military reliance on civilian
airlines to supplement airlift capacity. See U.S. General Accounting
Office, Airline Competition: Impact of Changing Foreign Investment and
Control Limits on U.S. Airlines, GAO/RCED-93-7 (Washington, D.C.: Dec.
9, 1992.).
[3] 49 U.S.C. 40102.
[4] 14 C.F.R. 204.5.
[5] Department of Transportation, Office of Inspector General, Letter
to the Honorable Don Young, Chairman, Committee on Transportation and
Infrastructure, U.S. House of Representatives, March 4, 2003.
[6] Section 807 of the conference report on H.R. 2115.
[7] The Air Transport Association is the principal trade organization
for large U.S. airlines.
[8] Section 13(d) of the Securities Exchange Act of 1934, as amended,
requires that any person who obtains beneficial ownership of 5 percent
or more of any equity security must provide notice to the issuer of the
security, to each exchange where the security is traded, and to the
Securities and Exchange Commission (SEC). The notice must include
detailed information on citizenship, the number of shares purchased,
and other related business arrangements.
[9] We omitted information on ownership for United Airlines and US
Airways due to their respective ongoing and recent emergence from
bankruptcy.
[10] In addition, other foreign investors held about 15 percent of
Wings' voting common stock, bringing the total voting stock held by
foreign investors to about 20 percent of Wings' voting stock.
[11] DOT allowed expansion of KLM's representation on Wings' board when
the number of directors was increased and continued the
disqualification provision regards decision on competitive and
international issues. However, the order stated that appointment of
foreign representatives to key positions on Wings' board, especially
the position of chairman, would be "cause for us to review the
citizenship of the affected air carrier."
[12] "Code sharing" refers to the practice of airlines applying their
names--and selling tickets via reservation systems--to flights operated
by other carriers.
[13] USAir officially changed its name to the current US Airways on
February 27, 1997.
[14] In 1992, we reported that the proposed investment included a
number of potential benefits for the two airlines planning to integrate
their services. It would have provided BA a secure partnership that
could feed U.S. passengers to its international flights and allow USAir
to better compete with U.S. airlines that have expanded their
international routes systems by purchasing international route
authority from struggling U.S. airlines. See U.S. General Accounting
Office, Airline Competition: Impact of Changing Foreign Investment and
Control Limits on U.S. Airlines, GAO/RCED-93-7 (Washington, D.C.: Dec.
9, 1992.)
[15] U.S. General Accounting Office, Airline Competition: Impact of
Changing Foreign Investment and Control Limits on U.S. Airlines, GAO/
RCED-93-7) (Washington, D.C: December, 1992).
[16] The 1992 GAO report (GAO/RCED-93-7) noted that while foreign
investment had potential benefits for U.S. airlines, it was not a
panacea for preserving domestic competition, because other factors--
such as airline control over gates and other facilities at major U.S.
airports--also affect airline competition.
[17] Under the CRAF program, U.S. airlines commit and put under
contract aircraft and crew for DOD's use during emergencies. The
commercial airlines receive no compensation for their participation in
the program unless they are activated, but they are given an incentive
to participate by being made eligible to bid for DOD's peacetime
airlift business and General Services Administration's city pair
program. Airlines are paid for missions they fly at predetermined rates
based on a weighted average of their costs plus a return on investment.
[18] "Legacy" airlines generally refer to major U.S. airlines that
operate network service, including both domestic and international
operations, such as United, American, and Delta.
[19] The "Bermuda II Accord" is the 1977 agreement between the United
Kingdom and the United States that restricts UK and U.S. flights
serving London Heathrow Airport to two airlines from each countries.
[20] DOT has noted that any U.S.-EU agreement, which includes
provisions on foreign investment would require implementing
legislation.