CFIUS Proposal May Disproportionately Hit Certain Countries
Since late 2018, certain foreign investments in US companies involved in the production of so-called critical technologies for use in particular industries have been subject to a mandatory review by the Committee on Foreign Investment in the United States, or CFIUS.
Failure to submit the proposed investment to CFIUS in a declaration subjects the parties involved in these investments to potential penalties up to the value of the transaction.
On May 21, the US Department of the Treasury, as chair of CFIUS, published a proposed rule to modify the trigger for a mandatory filing to base it more heavily on export control standards.
Under the proposed rule, the current focus on the industries in which critical technologies are used would be abandoned. Under the current regulations, a declaration is mandated with respect to certain foreign investments in a US business that produces, designs, tests, manufactures, fabricates or develops one or more critical technologies for use in certain industries (identified by reference to the North American Industry Classification System, or NAICS, codes).
The proposed rule, however, eliminates the industry component and instead makes it mandatory to submit a declaration only if a US export license or authorization would be needed to transfer the relevant critical technology to any of the foreign parties involved in the investment transaction. If adopted, the proposed rule may reduce the overall number of mandatory declarations that are required for some parties.
While US businesses in any industry will now potentially be subject to the filing requirement, given that many types of critical technologies may be exported to many countries without an export license, we expect the net impact of the proposed rule will be a decrease in filings for investors from many countries, but a potential increase in the mandatory filing requirement for investors from certain countries, including China.1
The proposed rule is open for public comment through June 22. This provides only a short window of time to weigh in on whether the proposed change is a net positive or negative for affected investors and/or target US companies.
CFIUS is an interagency committee authorized to review certain transactions involving foreign investment in the US in order to determine whether such transactions would harm the national security of the US CFIUS operates pursuant to Section 721 of the Defense Production Act of 1950, as amended, and the Treasury's implementing regulations.
Traditionally, CFIUS' authority to review private transactions was limited to transactions pursuant to which a foreign person would obtain control over a US business. However, Section 721 was significantly amended in 2018 by the Foreign Investment Risk Review Modernization Act, or FIRRMA.
Among other things, FIRRMA granted CFIUS new authority to review and recommend presidential interference, including by unwinding, with transactions involving what are now termed TID US businesses—businesses involved with certain technology, infrastructure or personal data.
Specifically, FIRRMA added to Section 721's definition of covered transactions any other investment by a foreign person—i.e., a noncontrolling investment that affords the foreign investor some access or influence over the target investment—in a US business that (1) owns, operates, manufactures, supplies or services critical infrastructure; (2) produces, designs, tests, manufactures, fabricates or develops one or more critical technologies; or (3) maintains or collects sensitive personal data of US citizens that may be exploited in a manner that threatens national security.
FIRRMA also mandated preclosing filings for some foreign investments, whereas CFIUS has historically operated on a voluntary review basis — with the risk that failing to file would result in a post-closing presidential order that the transaction be unwound.
Shortly after FIRRMA was passed, CFIUS implemented a pilot program, mandating filings for certain investments in US businesses involved in the production of a critical technology for use in any of 27 industries, based on NAICS codes.
On Jan. 17 the Treasury Department published a final rule — commonly known as the Part 800 rule — that made permanent the mandatory declaration requirement for such investments, listing the specified 27 industries in Appendix B of the Part 800 rule.
As noted, the proposed rule removes the industry group element from the trigger for a mandatory filing with CFIUS, and instead makes the trigger depend on whether the critical technologies that the US business produces, designs, tests, manufactures, fabricates or develops are subject to certain US export control regulations.
The Proposed Rule
Specifically, under the proposed rule, a mandatory declaration is required for certain critical technology transactions only when the transaction involves US businesses that produce, design, test, manufacture, fabricate, or develop one or more technologies that would require US regulatory authorization to otherwise export, reexport, transfer (in-country), or retransfer such technology to any foreign party related to the transaction if any such foreign party:
- Could directly control the target US business;
- Is directly acquiring an interest that is a covered investment in the target US business;
- Has a direct investment in the target US business and the change in rights of that foreign person could result in a covered control transaction or a covered investment;
- Is a party to a transaction or other arrangement that is designed or intended to evade or circumvent FIRRMA; or
- Individually holds, or is part of a group of foreign persons that in the aggregate holds an applicable voting interest, which is defined as "a voting interest, direct or indirect, of [25%] or more."
The term "US regulatory authorization" is defined as a license or other approval from the US Department of State under the International Traffic in Arms Regulations, or ITAR; a license from the US Department of Commerce under the Export Administration Regulations, or EAR; an authorization from the US Department of Energy under Title 10, Part 810 of the Code of Federal Regulations (other then the general authorization described in Title 10, Section 810.6(a)); or a specific license from the US Nuclear Regulatory Commission under Title 10, Part 110 of the Code of Federal Regulations.
The proposed rule provides that for purposes of determining whether such a US regulatory authorization is required, a foreign person's nationality will be determined based on an entity's principal place of business or an individual's nationality or nationalities.Furthermore, the determination of whether US regulatory authorization is required would not take into account license exemptions under the ITAR or license exceptions under the EAR.
In other words, generally, whether the transaction would require a CFIUS filing would be a function of how the critical technology is classified under the relevant export regulations and the corresponding licensing requirements for the nationalities of the foreign parties referenced above, without regard for whether a license exception or exemption could be used to facilitate a transfer without obtaining an authorization from the government.
However, certain EAR exceptions would be taken into account in this analysis and may significantly reduce the number of required filings. In particular, in determining whether an authorization is required, parties can take account of EAR exceptions related to the transfer of broadly available technology (License Exception TSU), encryption items (License Exception ENC), and higher controlled items and technology authorized to be transferred to close allies without a specific US government approval (License Exception STA).
Thus, under the proposed rule, the determination of whether a covered investment requires a mandatory declaration is based on whether a US government authorization would be required to export, reexport, transfer (in country), or retransfer the relevant critical technology or technologies produced, designed, tested, manufactured, fabricated or developed by the US business to foreign parties to the transaction.
According to the Department of the Treasury, this approach "leverages the national security foundations of the established export control regimes" by incorporating risk-based controls based, in particular, on the specific technology or item involved, the end user, and foreign country. The likely result is that for many investors from countries that are close allies of the US, fewer mandatory CFIUS filings will be required, but for investors from other countries, more filings will be required.
For example, a French investor in a US manufacturer of certain electronic devices may no longer be subject to a mandatory filing requirement because the electronic devices could be exported to France under one of the EAR license exceptions that applies under the rule.
On the other hand, a Chinese investor in a US manufacturer of advanced computer numerical controlled manufacturing equipment, which is a business that may be in an industry not covered by the existing rule, may now be required to file with CFIUS prior to closing such investment because many computer numerical controlled machines are controlled for export to China.
The proposed rule also clarifies the definition of "substantial interest"—which establishes how to determine the percentage interest held indirectly by one entity in another—to apply only where a general partner, managing member, or equivalent primarily directs, controls, or coordinates the activities of the subject entity. Likewise, the proposed rule clarifies how to calculate an indirect ownership interest.
By aligning CFIUS's critical technology mandatory-declaration requirements for covered investments in critical technologies with existing export control regulations, the proposed rule aligns this aspect of CFIUS' consideration of national security risks with evolving US export control policies.
This will help facilitate foreign investment from countries that are treated favorably under existing US export controls, while potentially discouraging or at least requiring CFIUS review of investment from others.
In short, and when taken together with CFIUS's new excepted-investor provisions for investors from certain favored countries,2 the proposed rule suggests a further bifurcation of the level of scrutiny CFIUS gives to foreign investors based on their nationality.
The proposed rule does not impact other mandatory CFIUS filing requirements, such as investments in which a foreign government would be involved in certain kinds of US businesses.
See Arnold & Porter Advisory, "CFIUS Finalizes Rules Implementing Its Expanded Jurisdiction to Review Foreign Investment In US Businesses" (Jan. 17, 2020).