Summary

On January 13, 2020, the Committee on Foreign Investment in the United States (CFIUS) issued final regulations to implement the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA)¹ (the “Regulations”²). The Regulations go into effect on February 13, 2020. CFIUS’s existing regulations (the “Pilot Program”) will continue to apply to transactions that close prior to February 13, 2020. Foreign investors who invest in companies or funds domiciled within the United States are most likely to be affected by the new rules.

Background

The Committee on Foreign Investment in the United States is an interagency committee chaired by the Secretary of the Treasury that assists the President in overseeing the national security risks of foreign direct investment in the U.S. economy. CFIUS was established in 1975 and operates pursuant to section 721 of the Defense Production Act of 1950, as amended (section 721) and as implemented by Executive Order 11858, as amended.³ The FIRRMA-amended review process maintains the President’s authority to block or suspend proposed or pending foreign “mergers, acquisitions, or takeovers” of U.S. entities, including through joint ventures that threaten to impair national security. In addition, a party’s failure to file a mandatory declaration, or a party’s submission of a declaration or notice with a material misstatement or omission or a false certification, may be liable for a civil penalty, not to exceed $250,000 or the value of the transaction, whichever is greater.

To exercise authority under CFIUS, the President must (1) conclude that other U.S. laws are inadequate or inappropriate to protect national security; and (2) have “credible evidence” that the foreign interest exercising control might take action that threatens to impair U.S. national security. Final determinations by the President are not subject to judicial review.⁴ However, FIRRMA provides for judicial review of CFIUS determinations by bringing a civil action before the U.S. Court of Appeals for the District of Columbia Circuit. To date, there has only been one case challenging a presidential and CFIUS determination, and the argument relied on constitutional grounds.⁵ That case was settled before a final decision on the merits could be rendered.

FIRRMA

On August 13, 2018, President Trump signed into law new rules governing foreign investment national security reviews, otherwise known as the Foreign Investment Risk Review Modernization Act of 2018. FIRRMA aims to strengthen and modernize the current CFIUS process by broadening the authorities of the President and CFIUS regarding national security concerns arising from certain foreign non-controlling investments and real estate transactions that previously fell outside CFIUS’s jurisdiction. In September 2019, CFIUS issues proposed rules to implement FIRRMA, and it has incorporated public comments into the final Regulations. Most public comments seeking to narrow the regulations were dismissed.

Key Takeaways from the Regulations

1. Expanded Jurisdiction: The Regulations broaden CFIUS's traditional jurisdiction over foreign investments that could result in control over a U.S. business by a foreign person (now called “covered control transactions”) to include two additional types of transactions: (i) certain non-controlling investments in U.S. businesses involved with “critical technologies,” “critical infrastructure,” or “sensitive personal data”; and (ii) certain transactions involving real estate. The covered real estate focuses on transactions in the proximity of specific airports, maritime ports, and military installations.
2. Mandatory Filings for Two Categories: Most filings with CFIUS will remain voluntary, but certain foreign investment transactions involving critical technology or foreign government ownership will require mandatory filings, with some exceptions. CFIUS implemented FIRRMA's mandatory filing requirement for certain critical technology investments through its Pilot Program regulations in October 2018. The Pilot Program will terminate as of February 13, 2020, but its provisions are largely included in the Regulations. In a change from the Pilot Program, the Regulations restrict the scope of critical technology transactions for which filings are required by excluding encryption items that are covered by an export control license exception.
3. Exceptions for Qualifying Investors: There are certain exceptions to CFIUS's expanded jurisdiction over certain non-controlling investments and real estate transactions for investors from “excepted foreign states” – initially Australia, Canada, and the United Kingdom – that meet certain qualifications. These exceptions are likely of limited utility as, among other things, they do not extend to covered control transactions.
4. Incremental Acquisitions: The Regulations continue to provide a safe harbor from future CFIUS review of additional investments in a U.S. business by a foreign person where CFIUS approved a prior controlling investment, albeit a non-controlling investment, by the same foreign person. This rule remains silent on transaction structures, allowing parties to structure transactions in the most appropriate manner based on the facts and circumstances at hand.
5. Investment Funds: FIRRMA clarifies that in investment funds, limited partners may qualify as passive investors when certain conditions are met, including: (i) a U.S. general partner or equivalent manages the fund and (ii) restrictions on the limited partner to impact certain investment decisions whether through the advisory board, a committee, or some other form of authority. The statute does not define “investment fund.” However, the Pilot Program defines an “investment fund” as any entity that is an “investment company” as defined in Investment Company Act §3(a), even if the entity would fall within the statutory exemptions. As such, under the Pilot Program, “investment fund” covers conventional funds engaged in the business of investing in securities or issuing face-amount certificates, as well as entities such as private equity funds, hedge funds, and government sovereign wealth funds.
6. Nerve Center Test: The proposed rule used the term “principal place of business” (PPB), but did not define it. CFIUS has proposed an interim rule defining the term using a “nerve center” test, which may serve to exclude from CFIUS's jurisdiction certain investment funds organized outside the United States, but managed by U.S. general partners. Under the new definition, a party’s PPB is the primary location where an entity’s management directs, controls, or coordinates the entity’s activities, or, in the case of an investment fund, where the fund’s activities and investments are primarily directed, controlled, or coordinated by or on behalf of the general partner, managing member, or equivalent.
7. Short-Form Declarations: Investors have the option to make a CFIUS filing using either a traditional “notice” or an abbreviated “declaration.” The use of a declaration offers the potential, but not a guarantee, of an abbreviated and streamlined review process.
8. Filing Fees: FIRRMA authorized a filing fee of 1% of the value of the transaction, not to exceed $300,000. However, CFIUS has not yet implemented the fee.
9. Reporting: FIRRMA modifies CFIUS’s annual confidential report to specified Members of Congress and nonconfidential reports to the public to provide for more information on investment transactions, including specifically those involving China.
10. Impact on Technology Sector: National security concerns about technology and data transfer to China propelled the policy debate that led to FIRRMA. These Regulations and related export control changes will have a significant impact on large segments of the U.S. technology sector that were previously unaffected by CFIUS or export control requirements.

Sample Transactions Blocked by President

Although CFIUS does not officially provide reasons for its decisions, foreign investors or domestic companies that seek to attract foreign capital may look to the following examples for guidance on whether a proposed transaction may ultimately be blocked by the President. The outcome of the 2020 United States presidential election should also bear on the analysis.

• 1990: Acquisition of Mamco Manufacturing (Mamco), a Seattle aerospace supplier, by China National Aero-Technology Import and Export Corporation (Catic). Former President Bush ordered Catic to divest itself of Mamco, saying Catic's continued control of the airplane parts maker “might threaten the national security of the United States.
• 2012: Acquisition of Oregon wind farm project by Ralls Corporation (Ralls), owned by Chinese company Sany Group. Former President Obama ordered Ralls to divest its interests in the wind farm project. Underlying his decision, President Obama said that, “there is credible evidence that leads me to believe that Ralls Corp…might take action that threatens to impair the national security of the United States.” According to the Obama administration, Ralls had four wind farm projects that are within or in the vicinity of restricted air space at a naval weapons systems training facility.
• 2016: Acquisition of Aixtron, a German-based semiconductor firm with U.S. assets, by Chinese firm Fujian Grand Chip Investment Fund. Former President Obama’s action appeared to be based on concerns about China gaining access to the secrets of producing a material called gallium nitride used in military equipment. The Treasury Department said that “[t]he national security risk posed by the transaction relates, among other things, to the military applications of the overall technical body of knowledge and experience of Aixtron, a producer and innovator of semiconductor manufacturing equipment and technology.” Gallium nitride, a powdery yellow compound used in LEDs, radar, antennas and lasers, is grown using Aixtron-manufactured technology, which has in the past been sold to U.S. military equipment makers.
• 2017: Acquisition of Lattice Semiconductor Corp. (Lattice) by Canyon Bridge Capital Partners, a Chinese investment fund (Canyon Bridge). Although President Trump’s order blocking the transaction used rationale similar to President Obama’s 2012 reasoning, Treasury Secretary Steven Mnuchin issued a press release highlighting four national security concerns: (1) the potential transfer of Lattice’s intellectual property to Canyon Bridge; (2) the role of the Chinese government in the transaction; (3) the importance of the semiconductor supply chain to the U.S. government; and (4) the U.S. government’s use of Lattice products.
• 2018: Acquisition of semiconductor chip maker Qualcomm by Singapore-based Broadcom. While Broadcom is based in Singapore, China was the main concern that drove President Trump’s decision over the Qualcomm deal, because allowing an American technology company to be acquired would surrender its dominance in the semiconductor and wireless industry. In a letter from CFIUS to Broadcom, the agency cited concerns that if the deal were to go through, Huawei and other Chinese telecommunications companies could displace Qualcomm as leaders in developing the forthcoming 5G standard for faster, higher-capacity wireless networks.

Conclusion

While FIRRMA attempts to modernize CFIUS’s review process to adapt to today’s global economic landscape, it still leaves several questions unanswered. We do not know how Congress will evaluate the performance of the amended review process in its attempt to protect U.S. national security. We have yet to see whether the expanded review process balances the traditionally open U.S. investment climate with the need to protect national security. It is also unclear to what extent FIRRMA will facilitate greater information sharing to advance national security. Nevertheless, the law is in effect and the final Regulations will soon be as well.

Subject to certain exceptions, any investment fund with a foreign limited partner, foreign investors, foreign advisory body members, offshore entity, or foreign funding that is investing in the U.S. should now include a CFIUS compliance analysis as part of its investment process.

¹H. R. 5841, 115th Cong. 2d. (2018)

³Exec. Order No. 11858, 3 C.F.R. (1971-75) Comp., pp.990-992.

⁴See the Exon-Florio Amendment, 50 U.S.C. app. 2170.

⁵Ralls Corp. v. Comm. on Foreign Investment in the U.S., 758 F.3d 296 (D.C. Cir. 2014).