On October 10, 2018, the US Treasury Department released interim regulations mandating submissions to the Committee on Foreign Investment in the United States (CFIUS) regarding planned transactions involving foreign investment in certain US businesses dealing with critical technologies.1 These regulations, issued pursuant to the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA), are of great significance for entities that may be planning transactions that will either (i) increase foreign involvement in the decisionmaking of such US businesses or (ii) provide for foreign access to certain nonpublic information held by such businesses.
As of November 10, 2018, the interim regulations temporarily enable CFIUS to examine certain transactions in which foreign persons, while not obtaining control over a US business, gain the ability to affect important decisions made by, or obtain important information from, a US business with respect to the use, development, acquisition, or release of critical technology. FIRRMA provides CFIUS permanent authority to review such transactions, but that FIRRMA provision will take effect only after CFIUS publishes detailed regulations following a notice-and-comment period under the Administrative Procedures Act. In the meantime, however, FIRRMA also allows CFIUS to undertake "pilot programs" to implement provisions that have such a delayed effective date. The interim regulations establish such a pilot program (officially called a "Pilot Program to Review Certain Transactions Involving Foreign Persons and Critical Technologies") so that CFIUS can address any national security concerns raised by such "pilot program covered transactions" almost immediately.
Specifically, the interim regulations require that, with limited exceptions, the parties to any "pilot program covered transaction" scheduled to close on or after November 10, 2018 must submit a "declaration" of approximately five pages in length regarding the transaction at least 45 days before the transaction closing date. If the parties prefer, they may submit a more lengthy "notice" containing the detailed information required under the current CFIUS rules for voluntary notifications to CFIUS. Failure to submit at least a declaration could result in a civil monetary penalty up to the value of the transaction.
The interim regulations exempt parties from this obligation if, before October 11, 2018: (i) the parties had executed a binding written agreement to undertake the transaction, (ii) a party had made a public offer to shareholders to buy shares of the target US business or (iii) a shareholder had solicited proxies in connection with an election of the board of the US business or had requested the conversion of convertible voting securities. All other "pilot program covered transactions" must be reported to CFIUS.
The interim regulations will remain in force until final regulations implementing FIRRMA are adopted, which FIRMMA specifies must be on or before March 5, 2020. To help inform its development of the final regulations, Treasury is inviting comments on the interim regulations, but only during the 30 days following their issuance, i.e., until November 10, 2018.
As discussed in our New Law Expands and Reforms CFIUS Jurisdiction and US Export Controls Advisory, FIRRMA, enacted in August 2018, amended Section 721 of the Defense Production Act of 1950 (Section 721),2 which authorizes the President, if he perceives a threat of impairment to US national security, to block or require modification of mergers, acquisitions and takeovers by or with a foreign person that could result in foreign control of a business engaged in interstate commerce in the United States. CFIUS, as the President's designee, is responsible for reviewing such transactions and recommending to the President whether to block or require modifications to the deals.
FIRRMA broadened the authorities of the President and CFIUS under Section 721 in several ways, including by expanding the scope of foreign investments subject to review to include certain investments even if they do not result in foreign control of a US business. Specifically, FIRRMA added to Section 721's "covered transactions" any "other investment" (i.e., a noncontrolling investment) by a foreign person in a US business that (i) owns, operates, manufactures, supplies, or services "critical infrastructure"; (ii) produces, designs, tests, manufactures, fabricates, or develops one or more "critical technologies"; or (iii) maintains or collects sensitive personal data of US citizens that may be exploited in a manner that threatens national security.
Although some provisions of FIRRMA became effective immediately upon the law's enactment, the provision making "other investments" a type of "covered transaction" takes effect considerably later—on the earlier of (i) 18 months after FIRRMA's enactment (i.e., February 13, 2020) or (ii) 30 days after publication in the Federal Register of a determination by the CFIUS Chair that the regulations, organizational structure, personnel, and other resources necessary to administer those new provisions are in place. Given the complexity of the required regulations, CFIUS is unlikely to have published them and reached such a determination until at least sometime in 2019.
The interim regulations partially jumpstart the effective date of the "other investments" provision by launching the pilot program to address, on an immediate basis, certain foreign investments in US businesses involved with critical technologies—i.e., "pilot program covered transactions."
Transactions Subject to the Pilot Program
As noted, the interim regulations require submission of a declaration (or, at the parties' discretion, a full notice of the nature prescribed in the current CFIUS regulations) to CFIUS of any "pilot program covered transaction," which is defined as:
- Any transaction by or with any foreign person that could result in foreign control of any "pilot program US business," including such a transaction carried out through a joint venture; or
- Any "pilot program covered investment."
The first category includes transactions that have been "covered transactions" under the CFIUS regulations for years—i.e., transactions in which a foreign person (including a US entity that is controlled by a foreign person or entity) will gain "control" over important decisions of a US business. The second category, however, includes transactions that have not been "covered transactions" under the current CFIUS regulations. FIRRMA refers to these transactions as "other investments." Specifically, a "pilot program covered investment" is an investment, direct or indirect, by a foreign person in an unaffiliated "pilot program US business" that does not result in control by a foreign person of a "pilot program US business" but does afford the foreign person:
- Access to any material nonpublic technical information in the possession of the US business;
- 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 the board of directors or equivalent governing body of the US business; or
- Any involvement, other than through voting of shares, in substantive decisionmaking of the US business regarding the use, development, acquisition, or release of critical technology. 3
For both categories of "pilot program covered transaction," a threshold element is the involvement of a "pilot program US business," which the interim regulations define as any US business that produces, designs, tests, manufactures, fabricates, or develops a "critical technology" that is either (i) used in connection with the US business's activity in one or more "pilot program industries" or (ii) designed by the US business specifically for use in one or more "pilot program industries."
Thus, a transaction will not be subject to the mandate for a submission to CFIUS unless it involves a US business producing, testing or developing one or more "critical technologies" that are used or designed to be used in at least one "pilot program industry."
Critical technologies are technologies subject to certain specified regulations relating to national security, as follows:
- Defense articles or defense services included on the United States Munitions List set forth in the International Traffic in Arms Regulations (ITAR) (22 C.F.R. parts 120-130).
- Items included on the Commerce Control List set forth in
Supplement No. 1 to part 774 of the Export Administration
Regulations (EAR) (15 CF.R. parts 730-774) and controlled:
- Pursuant to multilateral regimes, including for reasons relating to national security, chemical and biological weapons proliferation, nuclear nonproliferation, or missile technology; or
- For reasons relating to regional stability or surreptitious listening.
- Specially designed and prepared nuclear equipment, parts and components, materials, software, and technology covered by 10 C.F.R. part 810 (relating to assistance to foreign atomic energy activities).
- Nuclear facilities, equipment, and material covered by 10 C.F.R. part 110 (relating to export and import of nuclear equipment and material).
- Select agents and toxins covered by 7 C.F.R. part 331, 9 C.F.R. part 121, or 42 C.F.R. part 73.
- Emerging and foundational technologies controlled pursuant to Section 1758 of the Export Control Reform Act of 2018.
Pilot program industries are defined by reference to North American Industry Classification System (NAICS) Codes, and include manufacturing of airplanes, airplane parts, missiles, space vehicles, armored vehicles, computers and computer storage devices, semiconductors, ball bearings, chemicals and petrochemicals, and telecommunications equipment, as well as nuclear power generation and television and radio broadcasting. (The full list of Pilot Program Industries is attached in the appendix to this Advisory.) Notably, the list includes industries not typically referred to as national security-related, such as: Optical Instrument and Lens Manufacturing (NAICS Code: 333314), Other Basic Inorganic Chemical Manufacturing (NAICS Code: 325180) and Research and Development in Biotechnology (except Nanobiotechnology) (NAICS Code: 541714).4
Exemption for Certain Investment Fund Investments
Paralleling FIRRMA, the new interim regulations recognize that certain investment funds may include foreign investors whose interest and involvement in a target US business may be sufficiently limited to refute the possibility of a national security risk arising from the foreign investment. Thus, under the new regulations, there is an exemption from the definition of "pilot program covered transaction" for certain indirect investments in "pilot program industries" by a foreign person through an investment fund even if the foreign person sits on an advisory board or committee of the fund. Specifically, such an indirect investment is not a "pilot program covered investment" with respect to the foreign person if:
- The fund is managed exclusively by a general partner, a managing member or an equivalent and that manager is not the foreign person;
- The advisory board or committee does not have the ability to
approve, disapprove or otherwise control:
- Investment decisions of the investment fund; or
- Decisions made by the general partner, managing member or equivalent related to entities in which the investment fund is invested;
- The foreign person does not otherwise have the ability to
control the investment fund, including the authority:
- To approve, disapprove, or otherwise control investment decisions of the investment fund;
- To approve, disapprove, or otherwise control decisions made by the general partner, managing member or equivalent related to entities in which the investment fund is invested; or
- To unilaterally dismiss, prevent the dismissal of, select, or determine the compensation of the general partner, managing member, or equivalent; and
- The foreign person does not have access to material nonpublic technical information as a result of its participation on the advisory board or committee.
The interim regulations also provide, for purposes of the decisionmaking referred to in paragraphs (2) and (3) above, that a waiver of a potential conflict of interest, a waiver of an allocation limitation or a similar activity (as applicable to a transaction pursuant to the terms of an agreement governing an investment fund) will not be considered to constitute control of investment decisions of the investment fund or decisions relating to entities in which the investment fund is invested. However, the regulations also provide that CFIUS may, in "extraordinary circumstances," consider such a waiver to constitute control of such decisions. It therefore would pose risk to rest a decision not to file a declaration on the understanding that such a waiver will not constitute such control.
Declaration Procedures and Consequences
Declarations must contain specific information on the parties to the covered transaction (somewhat less than is required for a traditional notice to CFIUS), and are to be submitted to CFIUS electronically. As with notices, all declarations will be treated as confidential—subject to the FRRMA-specified exceptions—and not subject to disclosure under the Freedom of Information Act. Unlike notices, however, declarations may be submitted without any fee (fees for notices will be prescribed under the forthcoming, more detailed FIRRMA implementing regulations). Upon receiving a complete declaration, CFIUS will commence a review, which is statutorily limited to 30 days (whereas review of a notice now may take up to 45 days).
Upon reviewing any declaration, CFIUS has the discretion to:
- Request that the parties to the transaction file a formal written notice;
- Inform the parties to the transaction that CFIUS is not able to complete action under Section 721 with respect to the transaction on the basis of the declaration and that the parties may file a formal written notice to seek written confirmation that CFIUS has concluded all action under Section 721 with respect to the transaction;
- Initiate a unilateral review of the transaction based on CFIUS's authority to self-initiate reviews; or
- Notify the parties in writing that CFIUS has concluded all action under Section 721 with respect to the transaction.
The new interim rules represent a major turning point in the 30-year history of CFIUS's scrutiny of foreign investment in the United States. For the first time, parties to a subset of transactions that may be "covered transactions" do not have discretion to decide whether or not to notify CFIUS of the transaction absent a specific request from CFIUS. Under the new regulations, in any case involving a transaction that may constitute a "pilot program covered transaction," the parties may no longer simply weigh the risks of not notifying CFIUS against financial and other factors that might counsel in favor of proceeding without such notification. Parties face serious penalties if they fail to recognize that their transaction is a "pilot program covered transaction" and fail to file a declaration.
Given the significance of the interim regulations and the Treasury Department's plan to take into account comments submitted on them when promulgating permanent regulations, any entities that may be affected by the FIRRMA regulations may wish to consider filing comments. As noted, comments are due by November 10, 2018.
APPENDIX: Pilot Program US Industries
|Aircraft Engine and Engine Parts Manufacturing||
|Alumina Refining and Primary Aluminum Production||
|Ball and Roller Bearing Manufacturing||
Computer Storage Device Manufacturing
|Electronic Computer Manufacturing||
|Guided Missile and Space Vehicle Manufacturing||
|Guided Missile and Space Vehicle Propulsion Unit and Propulsion Unit Parts Manufacturing||
|Military Armored Vehicle, Tank, and Tank Component Manufacturing||
|Nuclear Electric Power Generation||
|Optical Instrument and Lens Manufacturing||
|Other Basic Inorganic Chemical Manufacturing||
|Other Guided Missile and Space Vehicle Parts and Auxiliary Equipment Manufacturing||
|Powder Metallurgy Part Manufacturing||
|Power, Distribution, and Specialty Transformer Manufacturing||
|Primary Battery Manufacturing||
|Radio and Television Broadcasting and Wireless Communications Equipment Manufacturing||
|Research and Development in Nanotechnology||
|Research and Development in Biotechnology (except Nanobiotechnology)||
|Secondary Smelting and Alloying of Aluminum||
|Search, Detection, Navigation, Guidance, Aeronautical, and Nautical System and Instrument Manufacturing||
|Semiconductor and Related Device Manufacturing||
|Semiconductor Machinery Manufacturing||
|Storage Battery Manufacturing||
|Telephone Apparatus Manufacturing||
|Turbine and Turbine Generator Set Units Manufacturing||
© Arnold & Porter Kaye Scholer LLP 2018 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.
1 The Secretary of the Treasury is the Chair of CFIUS. The regulations are published at 83 Fed. Reg. 51,322 (Oct. 11, 2018).
2 Section 721 is codified at 50 USC § 4565.
3 "Other investments" under FIRMMA also include noncontrolling investments that give the foreign person involvement in substantive decisionmaking regarding sensitive personal data of US citizens or critical infrastructure, but the pilot program does not cover these types of "other investments."
4 Nanotechnology is also a "pilot program industry," but is covered under a separate NAICS Code (541713).
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.