CFIUS Reform – What Investors Need to Know

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As a result of recent changes in U.S. law, foreign companies contemplating investments in the United States may be confronted with new administrative hurdles and the potential need to restructure certain transactions.  This article summarizes the recent changes and suggests steps to avoid delays caused by the newly imposed obligations.

I. Foreign Investment Risk Review Modernization Act – FIRRMA

On August 13, 2018, President Trump signed the Foreign Investment Risk Review Modernization Act (“FIRRMA” or the “Act”) into law.  FIRRMA provides the first legislative reform to the Committee on Foreign Investment in the United States (“CFIUS” or the “Committee”) in over a decade.  CFIUS is an inter-agency U.S. Government committee, headed by the Secretary of the Treasury.  Its members include, among others, representatives from the Defense Department, the Justice Department, the State Department and the Commerce Department.

CFIUS has extensive authority to review and reject foreign investment in the United States from a “national security” perspective.  CFIUS conducts its mandatory national security reviews of transactions in a number of sectors, including manufacturing, finance, technology, information services, mining, utilities, construction, wholesale, retail and transportation.  The Committee’s authority is intentionally broad in order to provide CFIUS with the latitude to bring a wide range of transactions under its purview.  CFIUS reviews transactions in a comprehensive manner by considering factors such as the potential effects on projected national defense requirements, whether a foreign person will control an industry that is vital to national security, and the protection of U.S. critical technologies, resources and infrastructure.  Following its review and investigation of a transaction, CFIUS can implement certain restrictions in order to mitigate risks, including reducing non-U.S. ownership or control or restricting access to critical assets, before providing its approval.  If certain security concerns persist, CFIUS can recommend to the U.S. President that he administratively block the transaction.

CFIUS jurisdiction extends only to “covered transactions,” previously defined as mergers, acquisitions, and takeovers by or with any foreign entity that could result in foreign control of a U.S. business.  The primary legal change caused by FIRRMA is that it provides for an expanded scope of what should be considered a “covered transaction,” thereby codifying prior practice.  Moreover, FIRRMA broadens CFIUS’s jurisdiction to cover current U.S. Government concerns regarding recent actions of foreign actors.  FIRRMA is vague regarding the specifics of how the Committee will judge these new factors in its analyses.  As a result, the ultimate impact of many of FIRRMA’s changes will not be known until CFIUS determines and sets forth new regulations, as required by the Act.  As discussed below, the first of such regulations is the new “Pilot Program,” which CFIUS unveiled in October.

FIRRMA significantly expands CFIUS’ jurisdiction by no longer conditioning its scope to a foreign party that will “control” a U.S. business following a transaction.  Non-controlling investments can now trigger Committee review as well.  These reviews will occur only if a foreign party seeks to make an investment in a U.S. business that involves critical technologies, critical infrastructures, or bulk sensitive personal information of U.S. citizens.  This expansion to non-controlling investments, however, will apply only to investors from countries explicitly named in CFIUS regulations.

In the real estate context, CFIUS historically evaluated the risk of a foreign party purchasing properties that are near sensitive areas, such as a military base or where the building houses CFIUS-covered businesses.   FIRRMA now additionally provides CFIUS the jurisdiction to review the purchase of all U.S. business owned real estate and other real estate transactions like leases, grants and concessions for concerns.

In a limitation of the scope of CFIUS, FIRRMA permits foreign investors to get involved in private equity investment funds as “passive investors” if they meet certain requirements.  To qualify, a foreign investor must be a limited investor in a fund that is managed exclusively by a general partner that is not a foreign person.  Also under FIRRMA, a foreign investor may serve on an advisory board of the fund, but (i) that board cannot have the power to approve, disapprove or otherwise control investment decisions of the fund; and (ii) the foreign investor cannot have access to material, non-public technical information as a result of its participation on the board.

Finally, FIRRMA also significantly modifies the administrative procedures relating to the CFIUS review process:

1. FIRRMA expands the statutory time frame in which CFIUS must complete its investigations.
2. FIRRMA grants CFIUS the ability to impose a new filing fee that cannot exceed the lesser of one percent of the transaction or $300,000 (adjusted annually for inflation).
3. FIRRMA makes CFIUS’s review more transparent by requiring it to submit an annual report to Congress; this change could provide precedents for the Committee’s handling of similar transactions.
4. FIRRMA provides a short form declaration for those dealmakers who believe their transactions are likely less sensitive, but nonetheless would like the benefit of CFIUS’s administrative safe harbor.

II. Pilot Program

In October 2018, CFIUS started to provide greater clarity on how FIRRMA will ultimately affect foreign investors investing in the United States through the publishing of the Commission’s first new regulations associated with the Act.  Those regulations created an interim rule for a pilot program (the “Pilot Program”), which will require certain foreign investments in specific U.S. businesses to be subject to a mandatory short-form declaration before the closing of a proposed transaction.

This new required disclosure system applies only to foreign investments in those U.S. businesses operating in one or more of the 27 “Pilot Program Industries” designated by the Treasury Department.  These industries consist primarily of critical technologies that support the U.S. defense industrial base, such as the manufacturing of aircrafts, guided missiles, petrochemicals, and nanotechnology.

A transaction can be covered by the Pilot Program whether or not the investment by a foreign person results in the control of a CFIUS-covered business.  In order for a non-controlling investment to be subject to the Pilot Program, however, the transaction must additionally grant the foreign person (i) access to “material nonpublic technical information” of the critical technology, (ii) membership or observer rights on the board of directors of the U.S. business, or (iii) substantial decision-making power over the critical technology.

The Pilot Program demonstrates a true expansion of CFIUS’s impact on inbound foreign investment as a result of FIRRMA because, before the Act, such disclosures were voluntary rather than obligatory.  In addition to its previous powers to reduce or reject a transaction, the new regulations authorize CFIUS to impose a civil monetary penalty up to the value of the transaction on any person who fails to comply with the Pilot Program’s requirements.  As an effect of these mandatory declarations, the Pilot Program will effectively prevent simultaneous signing and closing of transactions of covered transactions because declarations must be filed at least 45 days in advance of a transaction’s expected completion date.

Finally, the Treasury Department has made clear that these Pilot Program regulations are only the beginning of new CFIUS regulations following the implementation of FIRRMA.  Accordingly, it is expected that additional regulations and pilot programs covering other types of investments and industries are to come in the future.

III. Additional Consideration

At the end of December 2018 and well into 2019, the U.S. federal government went into a partial shutdown because of a failure to legislatively pass a federal budget.  Among countless other federal government agencies and programs, CFIUS was greatly affected by the shutdown as it nearly completely paused all transaction reviews during this operation closure.  As a result, many transactions filed with CFIUS before, during and after the shutdown had their reviews occur well after the new FIRRMA deadlines. Accordingly, dealmakers should also always be mindful that their cross-border transactions are not immune to the machinations of politics.

Conclusion

In light of these changes, foreign companies contemplating investments in the U.S. should appreciate the following important considerations:

• When considering U.S. counterparties to transact with, conduct a complete due diligence which would involve considering everything that a U.S. business produces, designs, tests, manufactures, fabricates, and develops, and determining whether anything falls within the expanded sectors reviewed by CFIUS.
• Understand that a foreign party no longer needs to control a U.S. business following an investment to fall within the jurisdiction of a required review by CFIUS.
• Appreciate that the new statutory deadlines will likely delay deal closings. Moreover, additional political factors, such as the federal government shutdown late 2018/early 2019 can compound timing issues.
• If a proposed transaction does not necessarily fall within the jurisdiction of CFIUS review, determine whether the parties should still voluntarily submit to a short form declaration in order to gain the benefit of CFIUS’s safe harbor.
• Obtain advice from experienced legal counsel early in the process to avoid penalties and to minimize the potential for wasted time and energy resulting from the denial of a transaction.