Earlier than expected, the Committee on Foreign Investment in the United States (CFIUS) has announced new interim rules—effective November 10, 2018, pursuant to the recently enacted Foreign Investment Risk Reduction Modernization Act of 2018 (FIRRMA)—that: 

(1) Expand the scope of transactions subject to review by CFIUS to include certain non-controlling investments made by foreign persons in US critical technology companies; and 

(2) For the first time in its history, mandate the filing with CFIUS—at least 45 days before closing—of a short form declaration for a range of foreign investments, both controlling and non-controlling, in US critical technology companies (with parties having the option of filing a full notification in lieu thereof). 

The New Requirements Apply to a Broad Range of Transactions. As discussed below in detail, under the definitions used in the new regulations, mandatory filings will be required in a broad range of transactions involving even very small percentage investments in US firms that either: (1) are utilizing a range of technologies deemed critical (including defense, dual use, nuclear, and a range of other “emerging and foundational” technologies to be designated) in one of 27 industrial sectors specified by CFIUS; or (2) have designed such technologies specifically for use in one of these sectors. The industrial sectors include major parts of the economy, including, among others, aerospace, aluminum production, ball bearings, computers, defense, nanotechnology, nuclear, petroleum, semiconductors, wireless communications, and other specified sectors.

Thus, when contemplating investments or collaborative arrangements like joint ventures, participants in the investment community as well as firms in numerous affected high-tech industries and traditional sectors should carefully review the new rules.

The New 45 Day Rule. Moreover, because the declaration must be filed 45 days before the complete date of the transaction (effectively, the closing), its filing becomes a gating element that will affect the timing of numerous transactions.

Why Now? While FIRRMA delayed the effectiveness of certain provisions for at least 18 months, including those relating to non-controlling investments and declarations, CFIUS has announced the new changes as a “pilot program” that addresses “the need to immediately assess and address significant risks to national security posed by some foreign investments.” As such, the new rules are temporary in nature (time limited to no more than 570 days); they will be put in effect unchanged without notice and comment. 

However, CFIUS can make these regulations permanent at a later time (after public notice and comment) and it is expected that the pilot program experience will inform final regulations adopted subsequently under FIRRMA. Written comments on the interim rules can be submitted to CFIUS no later than November 10, 2018. 

What Types of Transactions Are Now Subject to Mandatory Filings? The pilot program’s requirement for short-form mandatory declarations applies to investments: (1) both investments that could result in “control,” including transactions carried out through joint ventures, and certain “other investments” that could not result in control (referred to as “Pilot Program Covered Investments” in the new rules); (2) by all foreign persons from all countries, without exception; and (3) in “Pilot Program US Businesses.” 

What is a “Pilot Program Covered Investment”? An investment (i.e., the acquisition of an equity interest, including a contingent equity interest), direct or indirect, by a foreign person in an unaffiliated Pilot Program US Business that affords the foreign person: 

• Access to any material nonpublic technical information in the possession of the Pilot Program US Business, not available in the public domain, that is necessary to design, fabricate, develop, test, produce, or manufacture critical technologies, including processes, techniques, or methods; 
• Membership or observer rights on the board of directors or equivalent governing body of the Pilot Program US Business, or the right to nominate an individual to a position on the board of directors or equivalent governing body of such business; or 
• Any involvement, other than through voting of shares, in substantive decision-making of the Pilot Program US Business regarding the use, development, acquisition, or release of critical technology. 

Is There a Minimum Level of Investment for a Transaction to be Covered? No. CFIUS has made it clear, in the examples in the regulations, that as long as the foreign person investing meets one of the three criteria noted above, even the acquisition of a small equity interest – in the range of 4% of equity – would constitute a Pilot Program Covered Investment. 
 
What is a “Pilot Program US Business”? Any US business that produces, designs, tests manufactures, fabricates, or develops a critical technology that is: (1) utilized in connection with the US business’s activity in one or more Pilot Program Industries; or (2) designed by the US business “specifically for use in” one or more Pilot Program Industries.

What are Critical Technologies? These are: (1) defense articles or services subject to the US Munitions List under the State Department’s International Traffic in Arms Regulations (ITAR); (2) certain dual-use items on the Commerce Department’s Control List under the Export Administrational Regulations; (3) certain specially designed nuclear equipment, parts and components, materials, software, and technology covered by 10 CFR 110; (4) nuclear facilities, equipment and materials covered by 10 CFR 110; (5) select agents and toxins covered by various federal rules; and (6) “emerging and foundational technologies” to be designated under the Export Control Reform Act of 2018, a companion law to FIRRMA.

While there is today no list of “emerging and foundational technologies,” such a list is expected to be developed and implemented in the coming months by the Commerce Department. A transaction related to such technology that becomes controlled after the effective date of the new rules (i.e., November 10, 2018) is still covered by the declaration requirement as long as the technology was controlled before the date upon which the written agreement establishing the material terms of the transaction was executed. 

What are Pilot Program Industries? Annex A to the new rules sets forth a list of 27 covered industries for which, according to CFIUS, “certain strategically motivated foreign investment could pose a threat to US technological superiority and national security.” The industries are defined with reference to North American Industry Classification System (NAICS) categories. 

In effect, the industry list serves as a limiting factor under the pilot program. That is, only investments in companies with critical technology utilized or designed for use in such industrial sectors is covered by the new rules and subject to the mandatory declaration requirement. For example, where a US business utilizes a defense technology on the US Munitions List in an industrial sector not on the Annex US, the acquisition of an equity interest in that business would not be considered a Pilot Program Covered Investment under the rules. 

While some specified industries are relatively narrow in scope—“other guided missile and space vehicle parts …” and “military armored vehicle, tank, and tank component manufacturing”—others are far broader in scope.

Viewed in total, the resulting list of Pilot Program Industries covers significant sectors of the economy. These include, among others:

Aircraft and aircraft engine manufacturing
Alumina refining and primary aluminum production
Ball and roller bearing manufacturing
Computer storage device manufacturing
Electronic computer manufacturing
Nuclear electric power generation
“Other” basic inorganic chemical manufacturing
Petrochemical manufacturing
Power distribution, and specialty transformer manufacturing
Primary battery manufacturing
Radio and television broadcast and wireless communications equipment manufacturing
R & D in nanotechnology and biotechnology
Semiconductor machinery manufacturing
Storage battery manufacturing
Telephone apparatus manufacturing 
Turbine and turbine generator manufacturing

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In sum, the new rules require the filing of either a declaration or, at the election of the parties, a full notice with respect to a wide range of foreign investments.

What Types of Transactions Are Not Covered by or Are Exempt From the New Rules?

• “Other Investments” Concerning Critical Infrastructure and Sensitive Personal Data. The new rules do not implement FIRRMA’s planned coverage of “other transactions” (i.e., non-controlling) in critical infrastructure or sensitive personal data. However, it is possible that CFIUS could establish pilot programs in these areas as well in the coming months.
• Traditional Private Equity Investments. Implementing FIRRMA, the new rules establish an exemption for indirect investments in a foreign person in a Pilot Program US Business through an “investment fund,” as defined therein by reference to the Investment Company Act of 1940, that affords the foreign person membership, as a limited partner or equivalent, on an advisory board or a committee of the fund if: (1) the fund is being managed exclusively by a general partner, a managing member, or equivalent (general partner) who is not a foreign person; (2) the advisory board or committee does not have the ability to approve, disapprove or otherwise control investment decisions of the fund or the general partner related to entities in which the fund is invested; (3) the foreign person does not otherwise have the ability to control the investment fund, including certain authorities specified in the rules; and (4) the foreign person does not have access to material nonpublic technical information as a result of its participation on the advisory board or committee. 

In effect, this exemption means that foreign investments in traditional private equity funds controlled by US general partners, where foreign investors are passive only, are exempt from the pilot program rules.

• Exemptions for Countries or Classes of Investors? Notably, while the focus of FIRRMA has been on a series of problematic Chinese practices and policies, the Pilot Program is mandatory globally—across all classes of investors from all countries. As CFIUS has stated, there is no “white list” of exempt countries or “black list” of covered countries. In justifying its comprehensive coverage, CFIUS observes that “foreign investors that may present national security risks are becoming increasingly sophisticated in structuring investments in a manner that may obfuscate those concerns, including by utilizing entities in other jurisdictions.” While CFIUS notes it will have dialogue with foreign partners about its changing policies and practices concerning the national security review of foreign investments, the mandatory reporting of transactions involving close allies may undoubtedly raise diplomatic tensions and could chill investment in these sectors.
• Do the New Rules Apply to Now Pending Transactions? The rules do not apply to: (1) any transaction completed before November 10, 2018; or (2) any transaction where any of the following occurred before October 11, 2018: (a) the parties executed a binding written agreement or other document establishing the material terms of the transaction; (b) a party made a public offering to shareholders to buy shares in a Pilot Program US Business; or (c) a shareholder has solicited proxies in connection with an election of the board of directors of a Pilot Program US Business or has requested the conversion of convertible voting securities. 

When Should Parties File the Short Form Declaration vs. the Full CFIUS Notification? As noted above, under the new rules, parties have the option of filing the mandatory declaration or a traditional full CFIUS notification. The appropriate filing to make will depend on a range of considerations—many of which are case-specific—including the nature of the transaction, the relevant countries and parties involved, and the degree of national security risks.

Process Differences. Process-related differences (timelines and information to be submitted) are also relevant to making a considered choice. 

Significantly, upon receipt of a declaration, CFIUS shall “promptly” inspect it and decide whether to accept it or determine it is incomplete and so notify the parties. Once it accepts the declaration, CFIUS then must decide, within 30 days of receipt, whether to: (1) request that the parties file a full notification; (2) initiate a unilateral review of the transaction; or (3) complete the action and clear the transaction. 

Thus, as a practical matter, the declaration timetable—if it results in a CFIUS clearance—can be significantly shorter than the full notification process, which can easily take 3 to 4 months (assuming 2 weeks for CFIUS to review and initiate a draft notification, the initial 45-day review period, and a 45-day to 60-day investigation). 

From a content standpoint, while the declaration is intended to be a short form filing, in fact the required information include much of the same information contained in the full notification. The major differences include the requirement, for a full notification, to file personal identifier information for the foreign acquirer and its parent entities and owners, transactional documents, and financial reports. Thus, while the declaration is more limited in scope, it remains to be seen whether the detailed list of 18 items required to be submitted truly can be handled in five pages. (Indeed, it took CFIUS five pages in its rules to describe the required contents of the Declaration.)

Finally, under the interim rules, parties can provide in a Declaration various stipulations, together with a supporting basis, that can potentially speed the CFIUS review process (i.e., that the transaction is a Pilot Program Covered Transaction, could result in “control” of a Pilot Program US Business by a foreign person, or is a foreign government-controlled transaction). 

The Choice. Participants in foreign investment transactions will have to decide whether to use this abbreviated process and weigh the benefits of an early decision based on a short filing versus filing a traditional and more complete notification. The dilemma is that if the parties guess wrong, and cannot get a clearance in 30 days, then they may face a yet longer process—the initial 30-day declaration stage plus the time and cost of preparing a full joint notification and participating in the full CFIUS review process.

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In sum, the new CFIUS pilot program regulations for the first time impose mandatory filing obligations with respect to a relatively wide range of transactions that investment community participants and companies need to carefully consider in planning their business activities.

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