The U.S. Department of the Treasury (Treasury) proposed a new rule today to modify the regulations of the Committee on Foreign Investment in the United States (CFIUS). Specifically, the proposed rule would modify the mandatory declaration provision for certain foreign investment transactions involving critical technologies by transferring the reference base for determining the applicability of CFIUS requirements from the North American Industry Classification System (NAICS) to existing U.S. export control regimes. The proposed rule also makes clarifying amendments to the definition of "substantial interest." Written comments are being accepted by Treasury now and must be received by June 22, 2020.
Even in non-pandemic times, transaction parties must balance timing and financial exigencies when ensuring compliance with the regulations administered by CFIUS. With CFIUS and U.S. businesses operating under difficult conditions due to COVID-19, the proposed rule issued today is intended to provide clarity to U.S. businesses when determining whether their transaction is subject to a mandatory declaration. The Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) amends section 721 of the Defense Production Act of 1950, as amended (DPA), which provides the authority for CFIUS. FIRRMA broadened the authority of CFIUS' to review and take action to address national security concerns arising from certain non-controlling investments and real estate transactions involving foreign persons. Also, FIRRMA updates CFIUS processes to enable timely and effective reviews of transactions. One way it does so is by introducing the concept of a declaration. The declaration is an abbreviated notification to CFIUS that triggers a 30-day assessment period. Filing a declaration is an alternative to a voluntary notice, which has been the traditional way to seek CFIUS review of a proposed transaction and triggers a longer CFIUS assessment period.
Purpose of the Proposed Rule
The proposed rule has two key purposes:
- Critical Technologies. While the CFIUS process permits voluntary filings, FIRRMA authorizes CFIUS to mandate through regulations the submission of a declaration for covered transactions involving certain U.S. businesses that produce, design, test, manufacture, fabricate, or develop one or more critical technologies. This is the primary goal of the proposed rule.
- Substantial Interest. FIRRMA requires declarations also for covered transactions where a foreign government has a "substantial interest" in a foreign person that will acquire a substantial interest in certain types of U.S. businesses. The proposed rule also makes clarifying amendments with respect to the definition of substantial interest.
The Proposed Changes
At the end of 2018, Treasury implemented a Pilot Program establishing mandatory declarations in defined circumstances. The focus was on non-controlling investments and transactions that could result in foreign control of a U.S. business involved in critical technologies. The Pilot Program identified 27 specific industries by referencing NAICS codes. With respect to the mandatory declarations required for critical technology transactions, Treasury's final rule—effective February 13, 2020—largely incorporated the Pilot Program's approach of referencing NAICS codes into regulation, with modifications. For instance, the final rule exempts transactions involving (1) "excepted investors," (2) entities subject to an agreement to mitigate foreign ownership, control, or influence, (3) encryption technologies, and (4) investment funds managed exclusively by, and ultimately controlled by, U.S. nationals.
The proposed rule issued today modifies the scope of the mandatory declaration. Specifically, it moves away from identifying U.S. businesses involving critical technologies by referencing NAICS codes. Instead, Treasury—after considering public comments submitted in response to the Pilot Program and noting CFIUS experience over the last year—proposes basing the declaration requirement on whether U.S. government authorization would be required to export, re-export, transfer (in country), or retransfer the critical technologies at issue.
Treasury is focusing on export control requirements for the critical technologies in an attempt to leverage established U.S. export control regimes, specifically the Export Administration Regulations administered by the Bureau of Industry and Security of the U.S. Department of Commerce. This change does not impact the role of CFIUS in identifying emerging and foundational technologies that are essential to U.S. national security and should be controlled under FIRRMA.
In addition, the proposed rule issued today seeks to clarify issues regarding paragraphs (b) and (c) of the substantial interest definition at 31 C.F.R. § 800.244—these provisions establish how to determine the percentage interest held indirectly by one entity in another. The amendment would clarify that the foreign ownership test of (b) applies to the general partner (or the equivalent) of an entity who primarily directs or controls the entity. It would also remove "voting" from (c) to clarify the calculation of determining indirect ownership.
Please let us know if you have any questions or would be interested in submitting comments on the proposed rule.