The most pressing question around the new FIRRMA regulations is "Will my transaction be covered?" To provide a bit of guidance on that point, we present an illustration from our upcoming Second Edition of The CFIUS Book due out in March of this year.
With that question answered, we will examine the small changes between the proposed and final FIRRMA regulations.
On February 13, 2020 (just in time for Valentine's Day), the biggest change to U.S. foreign investment review since its inception goes into effect. Like a Valentine card from the the Committee on Foreign Investment in the United States, an enormous (presumably heart-shaped) message:
Putting foreign money into the United States will be a lot harder.
P.S. Be careful with those tech investments. We're really gonna be watching those, especially the emerging and foundational technologies.
Nevertheless, like all Valentine's hopefuls, your investment in the U.S. economy still has a chance.
The Valentine's Day Card
On January 13, 2020, CFIUS published its final rules implementing most of the changes created by the Foreign Investment Risk Review Modernization Act (FIRRMA). Those rules are largely similar to the proposed rules published on September 17, 2019. For background, our report on the investment regulation changes in those rules is available here, our report on the propsed real estate regulations is available here, and our report on Excepted Foreign States and Excepted Investors is available here. Finally, our report on the FIRRMA Pilot Program can be found here.
Building on those reports, this article provides a summary of the major points of the final regulations. We highlight where they differ from the proposed regulations:
I. The Heartbreak of Mandatory Filing
FIRRMA's most significant change to foreign investment review was introducing a penalty – up to and including the value of an investment – for failure to file a declaration or notice for an investment that triggers a mandatory filing. Simply by failing to tick an administrative box, a company getting in on a seed or early series investment could be subject to millions of dollars in penalties. Under the FIRRMA regulations, two types of investments will trigger mandatory filings:
1. Investments in Critical Technology Businesses
Where a foreign person makes an investment in a U.S. business that produces, designs, tests, manufactures, fabricates, or develops critical technology for use in certain designated industries, the transaction parties must file a declaration or notice with CFIUS. At this point, the coverage of the Critical Technology mandatory filing will be largely similar to that under the Pilot Program.
However, the new regulations will expand significantly because they reference emerging and foundational technologies. Continuing to play with our hearts, the U.S. Commerce Department has not yet issued those lists of technologies. As soon as Commerce releases those lists, investment in large swaths of U.S. innovation and know how will be swept not only into CFIUS jurisdiction, but into the broadening expanse of mandatory CFIUS filings.
Interestingly, the final FIRRMA regulations except investments in critical technology that would be eligible for export pursuant to License Exception ENC. That may be a reach for those of you who are not export nerds, but it essentially means that the basic encryption technology that would be common in software being developed by companies looking for investment would not trigger the mandatory filing requirements.
2. Investments by Foreign Governments
If an entity in which a foreign government holds 49% of voting interest, directly or indirectly, obtains 25% or greater voting interest, directly or indirectly, in a U.S. Technology, Infrastructure, or Data (TID) business, the parties must file a declaration or notice with CFIUS (for more on the TID businesses, check back to our article on these regulations as initially proposed). Much to the relief of many investment funds, this mandatory filing is only triggered if a foreign government holds a 49% interest in the general partner of a fund, whereas the proposed rule had covered foreign government interests in funds' limited partners.
II. More to love: Expanded CFIUS Jurisdiction
We note that all TID investments areas, though they do not quite have the sweetheart status of investments in critical technology or by foreign governments, have caught CFIUS' eye.
The final rules provide for CFIUS jurisdiction over a non-controlling investments in a TID U.S. business by which a foreign person acquires any of the following in the target:
1. Board representation or board observer rights;
2. Access to non-public technical information; or
3. A right to participate in substantive decision-making regarding the U.S. company's critical technology, infrastructure, or data.
We note that, in a tweak from the proposed rules, the final rules exclude from the "sensitive personal data" definition data that was derived from U.S. government databases as those data are broadly used in medical research.
III. CFIUS' Crushes: Excepted Foreign States and Excepted Foreign Investors
As we discussed in our article on excepted foreign states, investors from certain countries will not be subject to the mandatory filing requirements or to CFIUS jurisdiction over non-controlling investments. For those companies, the investment review world will look a lot like CFIUS before the advent of FIRRMA. The initial countries selected are Australia, Canada, and the United Kingdom.
The regulations provide means to add other countries to the list, but we would not expect CFIUS to be handing out these passes freely . . . if at all. Further, the three initial countries on the Excepted Foreign State list will be subject to a review in two years. If their investment review regimes do not satisfy U.S. regulators, their Excepted Foreign State Status could be revoked.
Don't forget, these are still just crushes. Only persons who meet the following qualifications can be an Excepted Foreign Investor:
1. You are organized under the laws of an Excepted Foreign State or the United States;
2. You have your principal place of business in an Excepted Foreign State or the United States;
3. 75% of your board members or observers must be nationals of an Excepted Foreign State or the United States;
4. Any individual or group of foreign persons that holds more than 10% of your voting interests must be nationals of an Excepted Foreign State or the United States; and
5. At least 80% of your voting interest must be held by nationals of an Excepted Foreign State or the United States.
IV. Location, Location, Location
The new regulations show CFIUS may be a bit enamored with real estate. The regulations make clear that CFIUS' jurisdiction over real estate is not limited to transactions where a foreign person invests in a U.S. business where that business has close proximity to airports, ports, military installations, or other sensitive U.S. government facilities.
CFIUS will continue to review those transactions to determine national security vulnerabilities are exposed. But now CFIUS is taking full advantage that FIRRMA expanded CFIUS' jurisdiction from transactions involving U.S. businesses to any purchases, leases, or concessions of real estate (including Real Estate Investment Trusts (REITs)) by foreign persons regardless (!) of whether a U.S. business is involved in that transaction. However, like all good relationships, there are some boundaries. CFIUS may only review those transactions that provide a foreign person with three of the four following property rights:
1. Physical access to the property
2. Exclusion of others from physically accessing the property
3. Improvement or development of the property
4. Affix structures or objects to the property
Thus, CFIUS' love affair with real estate continues.
V. Private Equity: Not Yet Smitten
CFIUS' love letter is not all final. While CFIUS is not exactly smitten with private equity, it is showing some affection by providing a few proposed definitions for some much-needed clarification.
CFIUS proposes the following:
1. Principal place of business is fully defined as the primary location where an entity's management directs, controls, or coordinates the entity's activities; or in the case of an investment fund, where the fund's activities are primarily directed, controlled or coordinated by or on behalf of the general partner, managing member, or equivalent.
2. Parent is defined to include the general partner, managing member, or equivalent.
3. Limited partners are explicitly exempted in the following circumstances from critical technology and foreign government mandatory filings: Where the foreign person is a limited partner on the advisory board or committee of an investment fund, and that board or committee does not have the ability to approve or control investment decisions or decisions made by general partners, managing members, or the equivalent; and the foreign person does not otherwise have the ability to control the investment fund.
Note, however, that some of these definitions may now explicitly include more investors within CFIUS' reach where before the regulations, there was some ambiguity.
While we could write an entire book on this (and we have!), we will leave you with our Valentine's analogies and metaphors until the 13th. At that point, we invite you to revisit this blog for reference as these regulations will be in full effect.
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.