A Summary and a Business Decision-Maker's Chart for the Path Forward
On January 13, 2020, the U.S. Department of the Treasury issued final rules fully implementing the new powers granted to the Committee on Foreign Investment in the United States (CFIUS or the Committee). Congress provided these new powers via the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA), which significantly enhances the Committee's ability to conduct national security reviews of inbound investments.
For the last 15 months, CFIUS has operated a temporary "pilot program," which implemented only a few pieces of FIRRMA. Now that the new rules have been released, on February 13, 2020 (the effective date), the Committee will start to exercise its expanded jurisdiction to review the national security implications of more foreign investments and acquisitions. FIRRMA specifically instructs CFIUS to focus on companies with novel or advanced technologies, access to other sensitive U.S. businesses, or sensitive personal data of U.S. citizens; the new rules implement that mandate.
Arguably the three most important features of the new rules are that they i) give CFIUS jurisdiction over many small minority equity investments (even 1 percent or less) in a broad swath of technology, infrastructure, and data businesses; ii) generally maintain (from the pilot program) requirements to make filings for certain investments involving "critical technologies"; and iii) add filing requirements for certain investments involving foreign government stakeholders. Other material changes include a new set of rules giving CFIUS jurisdiction over real estate transactions in certain geographies and an "excepted investor" provision that removes qualifying investors from CFIUS' jurisdiction for some transactions. Both of these changes are referenced briefly in this advisory but, because they likely will have less significant impact on technology companies and investors, the advisory does not discuss them in detail.
The new rules may have far-reaching implications for businesses in a wide array sectors ranging from biotechnology to autonomous navigation to cybersecurity services to consumer-facing apps, and for investors of almost all foreign nationalities that invest in those businesses—including investments made via many U.S. private equity and venture funds.
Below we summarize the current state of the CFIUS rules and their collective impact on U.S. companies and foreign investors. We address key questions that business decision-makers may have, noting in responses some important changes between the new rules and the proposed rules that were published in September 2019 (see here for our summary of those proposals), as well as the effects of those changes. We also further highlight the importance of risk allocation and structuring decisions, and we then close by noting some rules that are still pending and that will affect CFIUS considerations. In an appendix, we provide a chart that addresses five key questions that transaction parties often will need to answer because of the new rules.
Stay tuned for invitations to two further events: In February, the Wilson Sonsini CFIUS team will host the "CFIUS Lounge"—a phone-based office hour—to answer questions clients and others may have about basic aspects of the proposed rules. In March, the team will provide an in-person briefing in Palo Alto that will be simulcast as a webinar.
The Bottom Line Up Front: For any investment (even a small minority investment) or acquisition involving a U.S. business and a foreign person, parties should assess CFIUS considerations as early as possible.
Simple, no? Unfortunately, the new CFIUS rules mean the risk assessment can become complex quickly, but addressing that risk early will help pave the path forward.
Q: What constitutes a "U.S. business" subject to potential CFIUS review?
A U.S. business includes any business that engages in commerce in the U.S., including a foreign business that operates in the U.S., whether or not via a separate subsidiary. The new rules implement a FIRRMA-mandated change giving CFIUS broader jurisdiction over foreign companies with U.S. operations if those foreign companies take investment from outside the U.S.
Q: What is a "foreign person" for CFIUS purposes?
A foreign person is any foreign government, person, or entity, and includes any U.S. entity controlled by a foreign person. Even some U.S. funds with foreign general or limited partners (depending on the GPs' and LPs' rights) may be foreign for CFIUS purposes.
Q: What types of investments are subject to CFIUS review under the new rules?
- Those in which a foreign person will obtain "control" over any U.S. business (control may be found if there is more than a 10 percent voting stake or significant veto authority); and
- Those in which a foreign person will make an investment in, and obtain 'triggering rights' in, a "TID U.S. business," whether the investment is controlling or not:
- Triggering rights are the following:
- A board or observer seat, or nomination rights; or
- Access to material non-public technical information; or
- Involvement in company decision-making.
- A TID U.S. business is a business involved with
- Critical Technologies; or
- Critical Infrastructure; or
- Sensitive personal Data.
Q: What are "critical technologies," "critical infrastructure," and "sensitive personal data," and what are some types of companies that might fall under this new "TID business" definition?
- "Critical technologies" are defined by reference to several U.S. government lists, collectively hundreds of pages, most prominently the U.S. export control lists; the complete scope remains under development as the U.S. government prepares to add "emerging and foundational" technologies.
- EXAMPLE: Biotech companies working with certain pathogens.
- EXAMPLE: Robotics companies using sensors of a certain quality.
- EXAMPLE: Certain commercial software providers that use encryption. Under the new rules, many encryption items have been exempted from the list of critical technologies for which filings are mandatory; such businesses still may be TID businesses over which CFIUS may exercise jurisdiction, but their filing obligations have been curtailed.
- "Critical infrastructure" is defined by reference to an appendix in the rules that cross-references a litany of other lists, and includes entities that own, operate, and in some cases provide services to utilities, telecommunications companies, financial services providers, and similar entities.
- EXAMPLE: Companies that provide cybersecurity services to sensitive U.S. businesses.
- EXAMPLE: Any internet exchange point that supports public peering.
- EXAMPLE: Certain electric energy bulk power systems.
- "Sensitive personal data" is data that facilitates identification and that falls into any one of many distinct categories—e.g., geolocation data, health data, or financial data—if the business holds or intends to hold more than a million such records or targets government customers.
- EXAMPLE: Advertising data brokers with extensive records on more than one million U.S. consumers.
- EXAMPLE: A scooter company that tracks customer location information and seeks eventually to serve more than one million U.S. customers.
- EXAMPLE: Biotechnology companies with access to identifiable genetic testing results. Under the proposed rules, genetic information in any amount—even a single record—also qualified. However, the final rules set a higher bar for genetic information, which now must include identifiable genetic testing data to be considered sensitive personal data.
Q: Do the new rules make it significantly harder for foreign investors to invest in TID businesses?
The risk of CFIUS review may be higher for TID businesses. That risk will be exacerbated, and a filing may be required, if either of the following are present:
- The U.S. business is involved with critical technologies (a subset of TID U.S. businesses); or
- The foreign investor will obtain a 25 percent or greater stake (direct or indirect) in a TID U.S. business and a foreign government has a 49 percent or greater stake (direct or indirect) in the investor (both 25 percent and 49 percent stakes sometimes referenced individually or in the aggregate as a "substantial interest" test).
On the other hand, most CFIUS reviews result in clearance. Accordingly, CFIUS risk assessment and filings may create delays for TID businesses seeking foreign investment, but for many foreign investors there may be little or no impact on the likelihood of completing that investment.
Q: Can there be a legal requirement to file with CFIUS?
Yes, and the new rules expand the circumstances in which a filing is required. An investment involving i) critical technology or ii) a TID business with a foreign government stakeholder may create a mandatory CFIUS filing obligation, subject to penalties up to the value of the transaction if the parties fail to make the filing. Accordingly, conducting an assessment to determine whether those factors are present is of utmost importance.
Helpfully, the new rules eliminate the legal requirement to file for some types of technologies that were required to file under the pilot program—e.g., encryption items subject to license exception ENC—and for certain foreign entities, known as "excepted investors."
Q: Are the rules on required filings now permanently finalized?
Unfortunately, no. CFIUS has previewed that a forthcoming rulemaking will consider revising the current "critical technology" filing obligation to remove one key piece of the mandatory filing test—i.e., whether the technology is used in one of a particular set of 27 industries. Until that change occurs, an investment in which a foreign person obtains a triggering right in a critical technology company will not require a mandatory filing unless that critical technology is also used in one of the 27 industries. Elimination of that industry prong could substantially expand the scope of mandatory filing obligations. CFIUS has suggested, however, that the industry prong will be replaced by export control licensing considerations—i.e., that the availability of an export license will narrow mandatory filing requirements for critical technologies. These mechanics apparently will be the subject of proposed rules with an opportunity for public comment.
Q: Might my foreign investment vehicle be an "excepted investor"?
Possibly, but the test is complicated, and excepted investors are only partially exempted from CFIUS jurisdiction. First, the investing entity must be from an "excepted foreign state"—initially, only Canada, the UK, and Australia qualify. Seventy-five percent of the entity's board members and observers and all of its 10 percent or greater shareholders must also be a U.S. person or from an excepted foreign state, and it must satisfy additional criteria as well. Even if the entity can satisfy all of the tests, it can be removed from excepted investor status for violating any of several U.S. laws or regulations. Importantly, if an entity loses its status—e.g., by taking on a new foreign board member—it can retroactively lose its immunity for the filing of transactions entered into over the past three years. Moreover, qualifying as an excepted investor only grants an investor a reprieve from CFIUS's new (FIRRMA-created) extended jurisdiction and from mandatory filing obligations—such investors remain subject to CFIUS review for traditional "controlling" investments.
Q: Are "TID business" status, "critical technology" status, and "substantial interest" from a foreign government the only relevant considerations at CFIUS?
No. CFIUS may review any transaction over which it has jurisdiction (again, covering any control transaction and any investment with a triggering right into a TID business). A U.S. business engaged in sensitive activities, whether or not categorized as a TID business, or an investor linked to a country of concern to CFIUS (particularly China or Russia), may exacerbate CFIUS risk even if there is no mandatory filing.
Q: When will it make sense to consider filing with CFIUS even when the mandatory filing factors are not present?
For TID businesses and matters in which other risk factors are present, it may be sensible to make a filing voluntarily with CFIUS to clear the deal in advance and obtain safe harbor against post-closing adverse action by CFIUS. For example, a European 5 percent investment (with observer seat) into a TID business that lacks critical technology may be sensible to file, depending on the potential sensitivity of the technology (notwithstanding that it is outside the "critical technology" category), and depending further on details about the investor.
Q: Can a foreign investment be structured in a manner that eliminates CFIUS risk?
If neither control rights nor triggering rights are granted, CFIUS will have no jurisdiction over the transaction.
Q: If a foreign investor wants to maintain its rights, can its investment be structured in a manner that reduces CFIUS risk without needing to wait for a filing?
CFIUS risk can be, and often is, reallocated through transaction documents. For example, the parties may decide to specify what should happen if CFIUS were to intervene and require a foreign investor to agree to certain conditions in order to retain its investment. The foreign investor may not want to be obligated to agree in advance to burdensome conditions and may want to specify the lack of any such obligation. The U.S. company, on the other hand, may want some assurance that if CFIUS forces divestment by the investor, that investor cannot make a claim for losses against the company. To allocate CFIUS risk and structure the transaction in light of that risk requires a clear understanding of the CFIUS risks that inhere in the transaction.
Q: How likely is it that a transaction that falls outside of the set of pre-defined "mandatory" filing transactions will be requested or required by CFIUS to file?
CFIUS had minimal enforcement resources prior to FIRRMA's enactment in 2018; since FIRRMA, however, CFIUS has begun to build enforcement staff and related resources. The use of those resources will help determine the effect of the CFIUS rules: how frequently CFIUS compels filings for transactions, the nature of those transactions (e.g., mostly China- and Russia-related, or involving investors from many countries), the nature of final enforcement actions (e.g., monetary penalties, divestment, etc.), as well as CFIUS' interpretive positions in these matters—all of this will significantly shape the CFIUS environment. Answers to whether to file, when and how to allocate CFIUS risk, and other CFIUS questions will be adjusted as CFIUS enforcement practices emerge. CFIUS enforcement practices will be a significant factor guiding the private sector, and these enforcement practices may take many months or years to ascertain.
Q: What should we expect from CFIUS going forward?
Although the new rules fully implement FIRRMA in the sense of discharging all of CFIUS' statutory obligations, there are still additional relevant rules pending.
Perhaps of most significance, the anticipated designation of "emerging" and "foundational" technologies, which are subcategories of "critical technologies," will help further define the set of mandatory CFIUS filings. These designations will be made by the Department of Commerce, but the timing is unclear, and designations of "emerging technologies" may be made in perpetuity (since new technologies are always emerging).
In addition, the new CFIUS rules state that other proposed changes to the mandatory filing rules are forthcoming, particularly changing one of the prerequisites for a mandatory CFIUS filing (see further discussion above, "Are the rules on required filings now permanently finalized?"). CFIUS also has authority to charge a filing fee of $300,000 or 1 percent of the transaction value, whichever is less. Treasury representatives have indicated that there soon will be a proposal to utilize this authority. For now, however, CFIUS charges no fees for filings.
Appendix A: A CFIUS Guide for the Business Decision-Maker
Below is a chart summarizing five questions that parties often need to answer in order to understand the CFIUS implications of their transaction—two each that address the sensitivity of the U.S. business and the foreign investor, and one on the set of rights granted.
Where the process of answering these questions has changed from what parties have come to expect under the pre-existing CFIUS rules, we've indicated a couple of key changes in italics.
--> Scroll to see full table data
--> Scroll to see full table data
||What it means
||Why it's important
||How to determine the answer
|1. Is the target of the investment a sensitive "TID Business"?
||Companies that have critical Technologies, that own or have certain kinds of access to sensitive Infrastructure, or that hold sensitive personal Data have now been defined under the CFIUS regulations as "TID Businesses." Many U.S. businesses have already performed the analysis needed to determine whether they have critical technologies. Now those businesses may need to consider whether they own, operate, or protect critical infrastructure or hold sensitive data.
||Investments into some TID Businesses—i.e., those that work with "critical technologies" in selected industries or those that take investments from certain state-backed investors, as discussed below—will be required to file with the Committee. All investments into TID Businesses (if they involve control or triggering rights) will be subject to increased CFIUS scrutiny—i.e., the Committee will be able to electively intervene to request a filing—or post-closing, unwind an investment—even in non-controlling investments into those businesses.
||Critical technology status remains the most important part of the determination and can in large part be evaluated through an export controls review. In one notable change, many pieces of commercial encryption software that were critical technologies subject to mandatory filing under the pilot program have been removed from mandatory filing coverage under the new final rules. Meanwhile, access to critical infrastructure and sensitive personal data are more fact-specific questions requiring legal analysis of a company's customers, data holdings, and future intentions. Under the new rules, many start-up companies will hold sensitive data if they a) maintain or have a plan to maintain data on a million U.S. consumers or b) hold certain kinds of identifiable genetic testing information.
|2. Is the target sensitive under other historical CFIUS criteria—e.g., U.S. government relationships or proximity?
||Outside of the "TID Business" space, CFIUS is likely to maintain its historical interest in companies that work with the U.S. government, that have sensitive technology (e.g., AI) that does not meet the "critical technology" definition, or that are sensitive for other reasons.
||CFIUS retains its historical right to elect to intervene in any transaction in which a foreign investor obtains "control" over a U.S. business; historically, the sensitivity of the U.S. business has played a major part in CFIUS choosing to request more information on a given transaction.
||Relationships with the U.S. government include both direct and indirect supply relationships. Assessing sensitive technology, meanwhile, may warrant a discussion with counsel familiar with CFIUS's past interventions and areas of interest. The new rules for the first time define specific criteria for facilities whose proximity to U.S. government facilities may become an issue—i.e., within 99 miles of certain highly sensitive facilities and within one mile of many others.
|3. Is the investor foreign?
||CFIUS has retained broad discretion over determinations of foreignness in the new rules, meaning that not only non-U.S. persons and non-U.S. businesses are foreign, but also that many U.S. companies and private equity funds may potentially be considered foreign as well.
||An investor that is foreign may not be aware of its status under the regulations; the companies it acquires or invests in even less so. For example, if a U.S. venture fund has one or more foreign general partners or limited partners, then depending on the rights granted to those parties with respect to the fund and its portfolio companies, that fund may be foreign for CFIUS purposes.
||On the target side of a transaction, request a "non-foreign" representation from the investor. If the investor can provide a representation on point, no filing will be required. On the investor side, meanwhile, a determination of foreignness requires an assessment of decision-makers and investors, including limited partners, and the rights they have to control the investing entity. Despite requests from multiple parties, CFIUS did not in the final rules create clearer guidelines for determining foreign control in multinational general partnerships or for structuring funds to insulate limited partners from control. CFIUS did, however, clarify that a fund chartered outside the U.S. may be deemed to have its principal place of business in the U.S.—and therefore might not be deemed foreign—if it is managed from the U.S.
|4. Does the investor have a "substantial interest" from a foreign government or is the investor an "excepted investor"?
||A foreign government has a "substantial interest" when it holds a 49 percent or greater interest (direct or indirect) in a foreign investor—or, if the investor is a fund, then it is the government interest in the GP that counts. A foreign entity may be an "excepted investor" if it comes from one of three specified nations—Canada, the UK, and Australia—and satisfies several criteria related to its formation, ownership, directors, and past behavior in the U.S. If the entity is led, managed, and owned largely or entirely by U.S. persons or those from an excepted foreign state, it may qualify.
||Once an investor is determined to be foreign, the new rules set up more subtle gradations within the set of foreign investors. For example, the new rules require a mandatory filing if any investor in which a foreign government holds a "substantial interest" acquires a 25 percent or greater interest (direct or indirect) in a U.S. TID business. An excepted investor, meanwhile, is exempt from both CFIUS's extended jurisdiction (i.e., jurisdiction over non-controlling investments in TID businesses) and from all mandatory filing requirements. However, no investors, even excepted foreign investors, are exempt from CFIUS's elective "control" jurisdiction.
||The substantial interest test is relatively straightforward, bearing on foreign government equity and voting interests and overall control over the investing entity.
By contrast, the excepted investor test is highly complex. CFIUS has relaxed some of the criteria for qualification in the final rules—e.g., requiring only 75 percent of directors to come from the U.S. or excepted foreign states, rather than the 100 percent in the proposed rules. However, the new rules also re-emphasize that the director and ownership tests apply not only to the investing entity but to its parents all the way up the chain. This may complicate qualification for, e.g., funds operating under intricate corporate structures.
|5. Will the investor obtain "triggering rights" over the U.S. business?
||Will the investor obtain i) "control," i.e., an investment, usually of 10 percent or more, that allows the investor to influence key corporate decisions, ii) a board seat, observer seat or nomination rights, iii) access to "material non-public technical information," or iv) involvement in substantive decision-making about the business's sensitive operations.
||A foreign investor that obtains control over a U.S. business may always be subject to a potential CFIUS review. If that business is a TID Business, the non-controlling rights in (ii)-(iv) may also subject the investor to CFIUS intervention, and in some cases may give rise to a mandatory CFIUS filing.
||CFIUS retains broad discretion over the determination of whether a transaction grants "control." As a result, the most reliable way to avoid triggering rights is to adhere closely to the CFIUS regulatory definition of a passive transaction—i.e., one in which an investor stays below 10 percent and obtains only a few circumscribed rights. Beyond that point, the question of whether triggering rights have been granted is fact-specific. CFIUS has included a number of clarifying examples in the new regulations that address previous unclear questions such as the scope of material non-public technical information (e.g., publications that merely indicate technical milestones are not included).