Issues Relating to Foreign Investment and Control of U.S.
Airlines (30-OCT-03, GAO-04-34R).
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.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-04-34R
ACCNO: A08824
TITLE: Issues Relating to Foreign Investment and Control of U.S.
Airlines
DATE: 10/30/2003
SUBJECT: Airline industry
Airline regulation
Commercial aviation
Competition
Employment
Foreign investments in US
International economic relations
National preparedness
Proposed legislation
Stocks (securities)
Transportation safety
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GAO-04-34R
United States General Accounting Office Washington, DC 20548
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.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.
1U.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).
In summary:
o 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.
o 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
2
the same since then.
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.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
2The 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).
349 U.S.C. 40102.
substantial change in an airline's ownership, management or operations.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.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."6 The bill would amend Section 40102(a)(15)(C) of title 49 to
include in the criteria for meeting the citizenship
414 C.F.R. 204.5.
5Department 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.
6Section 807 of the conference report on H.R. 2115.
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.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. 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.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.
7The Air Transport Association is the principal trade organization for
large U.S. airlines.
8Section 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.
9We omitted information on ownership for United Airlines and US Airways
due to their respective ongoing and recent emergence from bankruptcy.
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' 12member Board of Directors and to form a financial
advisory committee to advise Wings on the management of NW.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.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 1993.12
In 1992, British Airways (BA) proposed investing $750 million in USAir in
an
13
arrangement that would have created the world's largest airline alliance.
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.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
10In 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.
11DOT 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.
13USAir officially changed its name to the current US Airways on February
27, 1997.
14In 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).
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.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:
15U.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).
o 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.16
o 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. 17 DOD was concerned that foreign investors might discourage
continued participation in CRAF.
o 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.
o 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.
o 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
16The 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.
17Under 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.
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.
o 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.18
o 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.
o 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.
o 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.19 As the United States and EU
start negotiations
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.
19The "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.
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.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.
20DOT has noted that any U.S.-EU agreement, which includes provisions on
foreign investment would require implementing legislation.
For further information on this report, please contract JayEtta Hecker at
(202) 5122834. Individuals making key contributions to this report
included Steve Martin, Emily Pickrell, Tim Schindler, and Matt Zisman.
JayEtta Z. Hecker
Director, Physical Infrastructure Issues
Enclosure
Carrier Largest holder (%)a Total holders above 5% share
U.S. Foreign
American Lord Abbett (18.3%) 3 0
Continental Axa Financial (12.6%) 3 1
Delta Primecap Management 3 0
(12.5%)
Northwest Axa Financial (17.8%) 5 1
1990-1992 2001-2002
Jobs losses at majors airlines 19,000 (3.6%)
Industry profit(loss) - In 2002 ($13.2 billion) 86,000 (14.7%)
constant dollars Number of 27 ($19.7 billion) 6
airline bankruptcies
(544062) Page 30 GAO-04-34R Foreign Investment in U.S. Airlines
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