United States: CFIUS Adopts "Pilot Program" Implementing Various Aspects Of FIRRMA; Mandatory Clearance Requirement To Take Effect

Last Updated: October 31 2018
Article by Leslie W. Kostyshak and Eric R. Markus

As we explained in our August 2018 e-alert regarding the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA), that law made a number of changes in the procedures applicable to national security reviews of foreign investments in the United States. Some of the provisions of FIRRMA were immediately effective but many provisions were the subject of future rulemaking and would not become effective until that process was complete. On October 10, 2018, the US Department of Treasury published a set of "pilot program" rules, without notice or opportunity for public comment, that implement on a temporary basis certain of the FIRRMA provisions that had required further rulemaking.1 The interim rulemaking covers four main areas: (1) an expansion of the authority of the Committee on Foreign Investment in the United States (CFIUS) for certain transactions not involving control; (2) mandatory filings with CFIUS prior to completion for certain transactions involving critical technologies; (3) a new "safe harbor" for private equity type investments; and (4) an abbreviated process for seeking CFIUS clearance.

The new pilot program rules become effective on November 10, 2018, and will be applicable to all transactions except transactions that are completed before November 10, 2018, and other transactions where any of the following has occurred before October 11, 2018: (a) the parties had executed a written, binding agreement establishing the material terms; or (b) a party had made a public offer to buy the shares of a business otherwise covered by the pilot program rules; or (c) a shareholder had solicited proxies in connection with the election of directors or the conversion of convertible securities of a business otherwise covered by the pilot program rules. The pilot program rules are "interim" and will expire on March 5, 2020, unless final rules are adopted prior to that date.

Expansion of Covered Transactions

Under the law and regulations in effect prior to FIRRMA and the pilot program, a transaction was subject to CFIUS's authority only if it could result in "control" of a US business by a foreign person. Control was defined broadly; however, the control definition carved out investments where the investor acquired less than 10 percent of the stock and did so "solely for the purpose of passive investment" (which was defined as not planning or intending exercise control).2 The official commentary included in the rules also indicated, as an example, that a foreign person acquiring a 13 percent interest in the shares of a US business and having the right to appoint one member of its seven-member board of directors and certain permitted shareholder protections would not control the business absent other facts.3 The pilot program creates a new type of transaction—called "a pilot program covered transaction"4—that is subject to CFIUS's authority. This category includes some transactions that would be "covered transactions" under the non-pilot program rules as well as some transactions that would not be subject to such rules. A pilot program covered transaction has to satisfy three criteria:

  • First, the US business involved must be producing, designing, testing, manufacturing, fabricating or developing a "critical technology."5 A critical technology is defined as: (a) defense articles or defense services controlled by the International Traffic in Arms Regulations; (b) items controlled by the Export Administration Regulations (1) pursuant to multilateral regimes relating to national security, chemical and biological weapons proliferation, nuclear nonproliferation and missile technology or (2) for reasons relating to regional stability or surreptitious listening; (c) specially designed nuclear equipment, parts and components, materials, software and technology; (d) nuclear facilities, equipment and material; (e) certain poisonous agents and toxins; and (f) emerging and foundational technologies.6
  • Second, the critical technology must be either utilized in connection with the US business's activities in one or more of 27 specifically identified "pilot program industries"7 or designed by the US business for use in one or more such industries. These industries are designated by North American Industry Classification System (NAICS) codes. With only a few exceptions, all of these targeted industries involve manufacturing, alloying or smelting of some kind. The nonmanufacturing sectors are nuclear electric power generation and research and development of nanotechnology and biotechnology. The applicable NAICS codes and the relevant descriptions are set forth on Annex A.
  • Third, the transaction must be one that could result in the foreign party's acquiring "control" of the US business under the non-pilot program rules or that constitutes a "pilot program covered investment."8 A pilot program covered investment is defined as an equity interest (contingent or otherwise) that does not amount to control but that affords the foreign party (a) access to any material nonpublic technical information9 in the possession of the US business; (b) membership or observer rights on the board of directors or equivalent governing body of the US business (or the right to nominate an individual to a position on such governing body); or (c) any involvement, other than through voting of shares, in substantive decision-making of the US business regarding the use, development, acquisition or release of critical technology.

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1 Despite being implemented without notice or opportunity for comments, comments are now being accepted on the interim rule and will be considered in the process of promulgating any final rule.

2 See 31 CFR §§ 800.204, 800.223, 800.302(b).

3 See 31 CFR § 800.204, example #5. The pilot program rules give a counter-example and reach a different conclusion where the foreign person merely has an observer on the US business's board. See 31 CFR § 801.302, example #1.

4 See 31 CFR §§ 801.210, 801.302.

5 See 31 CFR § 801.204.

6 Items (a) through (e) of this definition refer to existing lists of export-controlled items. Item (f) is new and will require further determination by various government agencies of technologies that are essential to national security under section 1758 of the John S. McCain National Defense Authorization Act for Fiscal Year 2019.

7 See 31 CFR § 801.212.

8 See 31 CFR § 801.209.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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