Client Alert

New CFIUS Pilot Program Expands U.S. Government Review of Tech Transactions

13 Oct 2018

The Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”), which became law on August 13, 2018, effected sweeping change to the authority and processes of the Committee on Foreign Investment in the United States (“CFIUS”). Many of FIRRMA’s most significant changes were not effective immediately, however, as they are subject to rulemaking by the Department of the Treasury. If there were any questions whether Treasury would let the regulatory process initiated by FIRRMA linger, those questions were just answered with the release of unprecedented new CFIUS regulations that include possible multi-billion dollar fines across almost 30 critical technology-related industries, and provisions that make filing certain notifications with CFIUS mandatory. 

On October 10, 2018, Treasury published two interim rules announcing new regulations implementing some of the most critical and transformational aspects of FIRRMA.[1]  Although several aspects of these rules are expected or technical updates to the existing regulations, many of the provisions – especially CFIUS’s new “pilot program” – represent a substantial broadening of CFIUS’s jurisdiction and its importance to the investment community in the United States.

In particular, one interim rule establishes new regulations (31 C.F.R. Part 801) for a CFIUS “pilot program” effective November 10, 2018.[2] Such a pilot program was explicitly authorized by FIRRMA pending issuance of implementing regulations, and it is expected to remain in effect until the final regulations are issued, probably by February 2020.

Key takeaways regarding the new pilot program include:

  • Expansion of CFIUS’s jurisdiction to conduct national security reviews of certain non-controlling investments in U.S. companies involving critical technologies;
  • Establishment of a new mandatory declaration process for covered transactions involving certain critical technology industries, transforming the previously voluntary CFIUS review process and imposing a significant burden on foreign investment in these industries;
  • Identification of 27 “pilot program industries on which these critical technology reviews will be focused, which include both “traditional” national security-related fields (e.g., the design and manufacture of aircraft, armored vehicles, missiles, and space vehicles and related equipment) and several industries in the technology sector, including computer and semiconductor manufacturing, and research and development in biotechnology and nanotechnology;
  • Imposition of civil penalties for parties to transactions that fail to meet the mandatory declaration requirements; and
  • Clarification for investment funds regarding the effect of participation in the fund by foreign limited partners on CFIUS’s jurisdiction to review transactions covered under the pilot program.

The second interim rule, which became effective October 11, 2018, updates the existing CFIUS regulations (31 C.F.R. Part 800) to incorporate provisions of FIRRMA that were immediately effective upon its enactment.

Expanded CFIUS Jurisdiction Under the Pilot Program

Prior to the implementation of FIRRMA, CFIUS’s national security review jurisdiction was limited to transactions that could result in control of a U.S. business by a foreign person. The CFIUS pilot program expands the scope of transactions reviewable by CFIUS to include certain non-controlling investments in U.S. businesses that produce, design, test, manufacture, fabricate, or develop “critical technologies” used in connection with, or designed specifically for, one or more of the 27 pilot program industries identified in the regulations. Such businesses are termed “pilot program U.S. businesses.”

Under the pre-FIRRMA CFIUS regime, a “critical technology” generally was defined as:

  1. a defense article or service controlled under the International Traffic in Arms Regulations;
  2. items controlled under the Export Administration Regulations for reasons relating to national security, nuclear and weapons proliferation, regional stability, or surreptitious listening;
  3. nuclear equipment, materials, and technology controlled under regulations pertaining to assistance to foreign atomic energy activities and the export and import of nuclear equipment and material; and
  4. select agents and toxins controlled under applicable regulations.

Due to the revisions to the CFIUS regulations effective October 11, critical technology now also includes “emerging and foundational technologies” identified and controlled under the Export Control Reform Act of 2018 enacted concurrent with FIRRMA (which was also described in our recent Client Alert).

The expanded CFIUS pilot program jurisdiction applies if the investment is in a pilot program U.S. business and does not result in control of the U.S. business, but will afford a foreign person:

  • Access to any material nonpublic technical information in the possession of the U.S. business (i.e., nonpublic information necessary to design, fabricate, develop, test, produce, or manufacture critical technologies, but not including financial information regarding the performance of an entity);
  • Membership or observer rights on the board of directors or equivalent governing body of the U.S. business, or the right to nominate an individual to a position on the board of directors or equivalent governing body of the U.S. business; or
  • Any involvement, other than through voting of shares, in substantive decision-making of the U.S. business regarding the use, development, acquisition, or release of critical technology.

Notably, an investment meeting the above requirements (i.e., a “pilot program covered investment”) is covered under the CFIUS pilot program regardless of the percentage of voting interest acquired, whether CFIUS reviewed a previous investment by the same foreign person in the same U.S. business, and whether the relevant critical technology became controlled under the Export Control Reform Act after the effective date of the pilot program. Pilot program covered investments also include the acquisition of a “contingent equity interest,” or a financial instrument that is convertible into an equity interest with voting rights.

Clarification for Investment Fund Investments Involving Foreign Limited Partners: The pilot program also incorporates FIRRMA’s clarification regarding treatment of the participation by foreign persons as limited partners or equivalents in investment fund investments for the purposes of CFIUS’s jurisdiction over non-controlling investments. Specifically, an indirect investment by a foreign person as a limited partner in an investment fund will not be considered a covered transaction under the CFIUS pilot program if all of the following requirements are met:

  • The fund is managed exclusively by a general partner, a managing member, or an equivalent;
  • The foreign person is not the general partner, managing member, or equivalent;
  • The advisory board or committee on which the foreign person is a member does not have the ability to approve, disapprove, or otherwise control (1) investment decisions of the investment fund or (2) 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 (1) to approve, disapprove, or otherwise control investment decisions of the investment fund, (2) 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 (3) to unilaterally dismiss, prevent the dismissal of, select, or determine the compensation of the general partner, managing member, or equivalent;
  • The foreign person does not have access to material nonpublic technical information (as defined above); and
  • The investment is not otherwise a pilot program covered transaction.

Expanded CFIUS Notice Requirements for Pilot Program Covered Transactions: In addition to the content requirements for notifications to CFIUS under the existing regulations, the CFIUS pilot program requires additional information for notices relating to “pilot program covered transactions.” Pilot program covered transactions include the pilot program covered investments described above, as well as covered transactions under the existing CFIUS regulations (i.e., acquisitions or controlling investments by foreign persons) involving critical technologies in one or more of the pilot program industries. These expanded notice content requirements generally include statements from the parties as to whether the transaction qualifies as a pilot program covered transaction and if so, descriptions of the critical technologies at issue.

Applicability to Completed and Pending Transactions: The new pilot program regulations do not apply to transactions completed before the pilot program effective date (November 10, 2018). They also do not apply to transactions for which, prior to October 11, 2018, (1) the parties have executed a binding written agreement or other document establishing the material terms of the transaction, (2) a party has made a public offer to shareholders to buy shares of a U.S. business, or (3) a shareholder has solicited proxies in connection with the election of the board of directors or has requested the conversion of convertible voting securities.

Mandatory Declarations for Pilot Program Covered Transactions

With the implementation of the new CFIUS pilot program regulations, parties to a pilot program covered transaction must submit to CFIUS either (1) an abbreviated “declaration” describing the transaction and the parties; or (2) a full written notice pursuant to the existing CFIUS regulations. If the parties decide to submit a declaration in lieu of a full written notice, it must be submitted at least 45 days before the completion date of the transaction (or promptly after November 10, 2018 if the completion date is on or before December 25, 2018). Any party that fails to comply with the mandatory declaration requirements may be liable to the U.S. government for a civil penalty not to exceed the value of the pilot program covered transaction. The requirement of a mandatory filing is a significant change from pre-FIRRMA rules, under which filing of a CFIUS notice was optional.

Declarations under the pilot program are required to contain much of the same information as full CFIUS notices, but are intended to be no more than five pages in length. The declaration generally must (1) identify the parties; (2) describe the transaction and interests the investor will acquire; (3) state whether the transaction is a pilot program transaction and/or a foreign government-controlled transaction; (4) describe the U.S. business’s activities, locations, and relevant critical technologies; (5) identify the U.S. business’s contracts with U.S. government agencies and/or funding received from U.S. government sources; (6) describe the foreign person’s business, organizational structure, and parent entities; (7) identify whether any party has been a party to another transaction notified to CFIUS; and (8) state whether the parties, their parents, or their subsidiaries have been convicted of a crime in any jurisdiction.

CFIUS will have 30 days to review the declaration and take one of the following four actions in response:

  • Request that the parties to the transaction file a full written notice;
  • Inform the parties that CFIUS is not able to complete action (i.e., “clear” the transaction) based on the declaration, and that the parties may file a written notice to seek such CFIUS clearance;
  • Initiate a unilateral review of the transaction; or
  • Notify the parties that CFIUS has cleared the transaction.

Notably, unlike CFIUS reviews of full written notices, CFIUS may not reset the 30-day review timeline by requesting or recommending that the parties withdraw and refile a declaration, except to permit parties to correct material errors or omissions.

Revisions to the Existing CFIUS Regulations Based on FIRRMA

Effective October 11, the existing CFIUS regulations in 31 C.F.R. Part 800 were also revised to reflect certain provisions of FIRRMA that were immediately effective upon enactment. These revised regulations only apply, however, to CFIUS reviews initiated on or after the effective date of the changes (October 11, 2018). Key changes to the existing regulations include:

  • Definition of Covered Transaction: This definition was revised slightly to cover transactions “by or with any foreign person that could result in foreign control of any U.S. business, including such a transaction carried out through a joint venture.”
  • New Types of Covered Transactions: The definition of “transaction” was revised to include (1) any change in rights that a person has with respect to an entity in which that person has an existing investment that will result in a covered transaction and (2) any transaction or other device designed or intended to evade or circumvent CFIUS jurisdiction.
  • 45-Day Review Period: Various sections of the regulations were updated to reflect FIRRMA’s change to an initial 45-day (versus 30-day) CFIUS review period, followed as needed by a 45-day investigation period.
  • Possible Extension of the Investigation Period: Provisions were added to allow the CFIUS Staff Chairperson, in “extraordinary circumstances” and upon a written request signed by the head of a CFIUS lead agency, to extend the 45-day investigation period for one 15-day period. Extraordinary circumstances are “circumstances for which extending an investigation is necessary and the appropriate course of action due to a force majeure event or to protect the national security of the United States.” The latter allowance would seemingly provide CFIUS broad discretion to extend the investigation.
  • Changes to Applicable Penalties: Under the previous regulations, parties were only liable for misstatements or omissions in a notice, false certifications, and/or violations of a CFIUS mitigation agreement if such violations were made “intentionally or through gross negligence.” This qualifier was removed from the regulations such that parties potentially are subject to a civil penalty for all misstatements, omissions, false certifications, and/or material violations of mitigation agreements. The applicable penalty was also revised to not exceed $250,000 per violation or the value of the transaction, whichever is greater.

 


[1] The impact of FIRRMA on foreign investors and U.S. companies was the subject of a previous Client Alert.

[2] Both interim rules cite “urgent and compelling circumstances” to support the effectiveness of the regulations prior to the end of the 30-day public comment period called for under the Defense Production Act (“DPA”). However, the interim rules allow for written comments to be submitted by November 10, 2018, and state that any such comments will be taken into consideration before the final rules are issued.


CFIUS PILOT PROGRAM INDUSTRIES
Defined by North American Industry Classification System (“NAICS”) Code

No.

Pilot Program Industries

NAICS Code

Industry Description

1.

Aircraft Manufacturing

336411

Establishments primarily engaged in one or more of the following: (1) manufacturing or assembling complete aircraft; (2) developing and making aircraft prototypes; (3) aircraft conversion (i.e., major modifications to systems); and (4) complete aircraft overhaul and rebuilding (i.e., periodic restoration of aircraft to original design specifications).

2.

Aircraft Engine and Engine Parts Manufacturing

336412

Establishments primarily engaged in one or more of the following: (1) manufacturing aircraft engines and engine parts; (2) developing and making prototypes of aircraft engines and engine parts; (3) aircraft propulsion system conversion (i.e., major modifications to systems); and (4) aircraft propulsion systems overhaul and rebuilding (i.e., periodic restoration of aircraft propulsion system to original design specifications).

3.

Alumina Refining and Primary Aluminum Production

331313

Establishments primarily engaged in one or more of the following: (1) refining alumina (i.e., aluminum oxide) generally from bauxite; (2) making aluminum from alumina; and/or (3) making aluminum from alumina and rolling, drawing, extruding, or casting the aluminum they make into primary forms. Establishments in this industry may make primary aluminum or aluminum-based alloys from alumina.

4.

Ball and Roller Bearing Manufacturing

332991

Establishments primarily engaged in manufacturing ball and roller bearings of all materials.

5.

Computer Storage Device Manufacturing

334112

Establishments primarily engaged in manufacturing computer storage devices that allow the storage and retrieval of data from a phase change, magnetic, optical, or magnetic/optical media. Examples of products made by these establishments are CD-ROM drives, floppy disk drives, hard disk drives, and tape storage and backup units.

6.

Electronic Computer Manufacturing

334111

Establishments primarily engaged in manufacturing and/or assembling electronic computers, such as mainframes, personal computers, workstations, laptops, and computer servers. Computers can be analog, digital, or hybrid. Digital computers, the most common type, are devices that do all of the following: (1) store the processing program or programs and the data immediately necessary for the execution of the program; (2) can be freely programmed in accordance with the requirements of the user; (3) perform arithmetical computations specified by the user; and (4) execute, without human intervention, a processing program that requires the computer to modify its execution by logical decision during the processing run. Analog computers are capable of simulating mathematical models and contain at least analog, control, and programming elements. The manufacture of computers includes the assembly or integration of processors, coprocessors, memory, storage, and input/output devices into a user-programmable final product.

7.

Guided Missile and Space Vehicle Manufacturing

336414

Establishments primarily engaged in (1) manufacturing complete guided missiles and space vehicles and/or (2) developing and making prototypes of guided missiles or space vehicles.

8.

Guided Missile and Space Vehicle Propulsion Unit and Propulsion Unit Parts Manufacturing

336415

Establishments primarily engaged in (1) manufacturing guided missile and/or space vehicle propulsion units and propulsion unit parts and/or (2) developing and making prototypes of guided missile and space vehicle propulsion units and propulsion unit parts.

9.

Military Armored Vehicle, Tank, and Tank Component Manufacturing

336992

Establishments primarily engaged in manufacturing complete military armored vehicles, combat tanks, specialized components for combat tanks, and self-propelled weapons.

10.

Nuclear Electric Power Generation

221113

Establishments primarily engaged in operating nuclear electric power generation facilities. These facilities use nuclear power to produce electric energy. The electric energy produced in these establishments is provided to electric power transmission systems or to electric power distribution systems.

11.

Optical Instrument and Lens Manufacturing

333314

Establishments primarily engaged in one or more of the following: (1) manufacturing optical instruments and lenses, such as binoculars, microscopes (except electron, proton), telescopes, prisms, and lenses (except ophthalmic); (2) coating or polishing lenses (except ophthalmic); and (3) mounting lenses (except ophthalmic).

12.

Other Basic Inorganic Chemical Manufacturing

325180

Establishments primarily engaged in manufacturing basic inorganic chemicals (except industrial gases and synthetic dyes and pigments).

13.

Other Guided Missile and Space Vehicle Parts and Auxiliary Equipment Manufacturing

336419

Establishments primarily engaged in (1) manufacturing guided missile and space vehicle parts and auxiliary equipment (except guided missile and space vehicle propulsion units and propulsion unit parts) and/or (2) developing and making prototypes of guided missile and space vehicle parts and auxiliary equipment.

14.

Petrochemical Manufacturing

325110

Establishments primarily engaged in (1) manufacturing acyclic (i.e., aliphatic) hydrocarbons such as ethylene, propylene, and butylene made from refined petroleum or liquid hydrocarbons and/or (2) manufacturing cyclic aromatic hydrocarbons such as benzene, toluene, styrene, xylene, ethyl benzene, and cumene made from refined petroleum or liquid hydrocarbons.

15.

Powder Metallurgy Part Manufacturing

332117

Establishments primarily engaged in manufacturing powder metallurgy products using any of the various powder metallurgy processing techniques, such as pressing and sintering or metal injection molding. Establishments in this industry generally make a wide range of parts on a job or order basis.

16.

Power, Distribution, and Specialty Transformer Manufacturing

335311

Establishments primarily engaged in manufacturing power, distribution, and specialty transformers (except electronic components). Industrial-type and consumer-type transformers in this industry vary (e.g., step up or step down) voltage but do not convert alternating to direct or direct to alternating current.

17.

Primary Battery Manufacturing

335912

Establishments primarily engaged in manufacturing wet or dry primary batteries.

18.

Radio and Television Broadcasting and Wireless Communications Equipment Manufacturing

334220

Establishments primarily engaged in manufacturing radio and television broadcast and wireless communications equipment. Examples of products made by these establishments are transmitting and receiving antennas, cable television equipment, GPS equipment, pagers, cellular phones, mobile communications equipment, and radio and television studio and broadcasting equipment.

19.

Research and Development in Nanotechnology

541713

Establishments primarily engaged in conducting nanotechnology research and experimental development. Nanotechnology research and experimental development involves the study of matter at the nanoscale (i.e., a scale of about 1 to 100 nanometers). This research and development in nanotechnology may result in development of new nanotechnology processes or in prototypes of new or altered materials and/or products that may be reproduced, utilized, or implemented by various industries.

20.

Research and Development in Biotechnology (except Nanobiotechnology)

541714

Establishments primarily engaged in conducting biotechnology (except nanobiotechnology) research and experimental development. Biotechnology (except nanobiotechnology) research and experimental development involves the study of the use of microorganisms and cellular and biomolecular processes to develop or alter living or non-living materials. This research and development in biotechnology (except nanobiotechnology) may result in development of new biotechnology (except nanobiotechnology) processes or in prototypes of new or genetically-altered products that may be reproduced, utilized, or implemented by various industries.

21.

Secondary Smelting and Alloying of Aluminum

331314

Establishments primarily engaged in (1) recovering aluminum and aluminum alloys from scrap and/or dross (i.e., secondary smelting) and making billet or ingot (except by rolling) and/or (2) manufacturing alloys, powder, paste, or flake from purchased aluminum.

22.

Search, Detection, Navigation, Guidance, Aeronautical, and Nautical System and Instrument Manufacturing

334511

Establishments primarily engaged in manufacturing search, detection, navigation, guidance, aeronautical, and nautical systems and instruments. Examples of products made by these establishments are aircraft instruments (except engine), flight recorders, navigational instruments and systems, radar systems and equipment, and sonar systems and equipment.

23.

Semiconductor and Related Device Manufacturing

334413

Establishments primarily engaged in manufacturing semiconductors and related solid-state devices. Examples of products made by these establishments are integrated circuits, memory chips, microprocessors, diodes, transistors, solar cells and other optoelectronic devices.

24.

Semiconductor Machinery Manufacturing

333242

Establishments primarily engaged in manufacturing wafer processing equipment, semiconductor assembly and packaging equipment, and other semiconductor making machinery.

25.

Storage Battery Manufacturing

335911

Establishments primarily engaged in manufacturing storage batteries.

26.

Telephone Apparatus Manufacturing

334210

Establishments primarily engaged in manufacturing wire telephone and data communications equipment. These products may be stand-alone or board-level components of a larger system. Examples of products made by these establishments are central office switching equipment, cordless and wire telephones (except cellular), PBX equipment, telephone answering machines, LAN modems, multi-user modems, and other data communications equipment, such as bridges, routers, and gateways.

27.

Turbine and Turbine Generator Set Units Manufacturing

333611

Establishments primarily engaged in manufacturing turbines (except aircraft); and complete turbine generator set units, such as steam, hydraulic, gas, and wind.

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