On Aug. 1, officials from the powerful Committee on Foreign Investment in the United States (CFIUS) told representatives of Japan's biggest steelmaker and its U.S. target that the committee had identified a potential national security risk, two sources familiar with the negotiations told Reuters.

CFIUS was concerned that the deal could reduce U.S. steel production capacity, disrupting critical industries like transportation and infrastructure, the officials told the executives in the call, which has not previously been reported.

The warning from the U.S. committee - which has the power to block foreign acquisitions on national security grounds - should have rung alarm bells at Nippon Steel, which was already fighting criticism from a labour union and U.S. politicians ahead of Nov. 5 elections.

Yet, the Japanese steelmaker hoped it could still win approval for the deal by patiently explaining its business merits, according to Reuters' interviews with two sources with knowledge of the discussions, one company source and a top Nippon Steel executive.

In an Aug. 19 follow-up meeting to the Aug. 1 call held at the Treasury Department according to one of the sources, the companies' representatives stressed to CFIUS the economic importance of Nippon Steel's investments given U.S. Steel's struggling business. They left feeling their case had been heard, the two sources close to the talks told Reuters.

And in an interview on Aug. 28 with Reuters, Nippon Steel's chief negotiator Takahiro Mori expressed confidence the deal was on track. He said he wanted to build a constructive long-term relationship with the unions and that he had met around 1,000 people, including many workers, during five U.S. visits since the offer was announced in December to explain its economic benefits.

"The political power of the union will weaken. That's true now and of course after the election", he told Reuters, adding that talks with CFIUS and other U.S. regulators were "progressing". A day later, Nippon Steel publicly vowed to invest $1.3 billion to refurbish U.S. Steel's aging facilities.

But on Aug. 31, CFIUS sent the two merging partners a 17-page letter detailing its concerns and giving them just one business day to respond. Reuters and other media reported last week that President Joe Biden was poised to kill the deal.

U.S. Steel, Nippon Steel and CFIUS did not comment on the details of process as laid out by Reuters.

"We do not believe this transaction creates any national security concerns," Nippon Steel said in a statement, without elaborating on the negotiations.

U.S. Steel said in a separate statement that there was "no scenario" in which it could make necessary investments without the Japanese company: "A transaction with Nippon Steel is the best avenue to ensure that U.S. Steel will be able to thrive well into the future."

POLITICAL HOT POTATO

Nippon Steel had tried to approach the politically-connected United Steelworkers union (USW) before it announced it had agreed to purchase U.S. Steel, a company based in the pivotal swing state of Pennsylvania during an election year.

On Nov. 20, the Japanese steelmaker requested a meeting with USW, according to U.S. Steel filings in January. But lawyers for the American firm denied the request, saying the union had aligned with another suitor and talks would risk breaking the confidentiality of a competitive bidding process, the filings said.

The approach backfired.

When Nippon Steel's deal was made public on Dec. 18, USW head David McCall slammed the companies for keeping unions in the dark. In a statement the same day, the union leader accused U.S. Steel of ignoring workers' concerns while "selling out" to a foreign company.

He urged the U.S. government to scrutinise the deal to see if it served workers and national security interests.

Just three days after McCall's appeal, Biden's national economic advisor Lael Brainard said the takeover appeared to deserve "serious scrutiny".

USW declined to comment on the merger process.

"In hindsight it was obvious (Nippon Steel) needed to get the union on board but I don't think they expected the union, and in particular the leader of the union, to get as upset as he did," said Nick Wall, an M&A partner at Allen & Overy, who was not involved in the negotiations.

In the weeks after the deal announcement, both Biden and his Republican rival Donald Trump voiced opposition to the merger.

When Japanese Prime Minister Fumio Kishida headed to Washington DC in April - the first state visit by a Japanese leader in nine years - Nippon Steel's acquisition was the elephant in the room.

McCall and his wife joined VIP guests such as Amazon founder Jeff Bezos and actor Robert De Niro at a lavish dinner Biden arranged for Kishida, listening to live music by singer Paul Simon. U.S. Steel and Nippon Steel top executives were not on the list of more than 200 guests released by the White House.

'LISTEN ONLY MODE'

As the political noise around the deal grew louder, Nippon Steel still believed there was a path forward and that the union was simply trying to extract better terms, two sources close to the company told Reuters, requesting anonymity due to the sensitivity of the discussions.

In May, chief negotiator Mori told Reuters he believed that, once the election was over, the president would assess the economic merits of the deal. Blocking it could upset one of America's closest allies and it seemed unlikely any administration would want to do that, he added.

But that logic went out of the window on August 31, when the CFIUS letter landed.

The letter argued the transaction posed a risk without offering any discussion of ways to assuage officials' concerns and gave the parties until Sept. 4 to respond, according to the two sources familiar with the discussions.

In a call on Sept. 1, attorneys working on the deal pressed CFIUS officials about why they had been given so little time, the sources said.

"We have been instructed to be in listen only mode," a CFIUS official replied, an ominous sign as sources inside the Biden administration were telling the two companies the White House was about to block the takeover, the people said.

The companies began frantically drafting a response, correcting what they perceived as factual inaccuracies, proposing mitigation and arguing to save the deal in a 100-page letter delivered on Sept. 3.

The letter, reviewed by Reuters, said they expected USW to be more "forward-leaning" in talks with the companies.

The next day, however, news broke that the White House was close to announcing Biden was preparing to block the deal.

"In the future, this deal will probably be considered as a textbook case of how a business failed to understand politics," said David Boling, a former U.S. trade official now at Eurasia Group.