Congress Enacts CFIUS Reform in Effort to Strengthen Foreign Investment Rules

President Trump signed into law the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) on August 13, 2018, which was included as part of the annual National Defense Authorization Act (NDAA). FIRRMA significantly reforms the Committee on Foreign Investment in the United States (CFIUS or the Committee), and makes related changes to the country’s export control regime. 

Congress considered myriad proposals over the past year as it attempted to balance national security interests against the policy of encouraging foreign investment in the United States. The new law settled on an approach focused on areas lawmakers believe are most under threat from certain countries. FIRRMA makes several substantial changes to the CFIUS process, including by: 

• Expanding the scope of CFIUS jurisdiction to permit review of a wider range of transactions; 
• Adopting a new declaration process to notify the Committee about potentially covered transactions; 
• Extending the time period for CFIUS to conduct its review; 
• Strengthening the Committee’s authority to restrict transactions that threaten U.S. national security; and 
• Making other changes that impact non-U.S. investors and their U.S. targets. 

Some of these changes took effect immediately, while others will not take effect until the earlier of 18 months after enactment or after the CFIUS chairperson formally determines that CFIUS has the necessary resources to administer the updated program. The U.S. Treasury Department recently released a list of FIRRMA FAQs (FAQs), which provides some information about the status of FIRRMA’s implementation and enforcement, including limited details about which provisions it is currently enforcing. CFIUS might also choose to conduct pilot programs to test certain program elements prior to full implementation of all changes.

Expanded CFIUS Jurisdiction 

CFIUS has jurisdiction over all “covered transactions,” which, under the previous law, included mergers, acquisitions and takeovers that could result in a non-U.S entity’s control over a U.S. business. FIRRMA adds four additional categories of cross-border deals to its definition of covered transactions, including: investments in certain real estate; investments in entities involved in critical infrastructure, critical technology or sensitive information; certain changes in a non-U.S. entity’s rights with respect to a U.S. business; and transactions that are intended to evade CFIUS review. 

• Real Estate Investments: CFIUS has reviewed, and in some cases, rejected, transactions involving the acquisition by foreign persons of real estate located in close proximity to U.S. military facilities and sensitive government facilities (so-called “persistent co-location” concerns). FIRRMA broadens CFIUS’ jurisdiction further by allowing the Committee to review a purchase or lease by, or a concession offered to, a non-U.S. person (including foreign governments) of a public or private piece of U.S. real estate that: (i) is located within, or will function as part of, an air or maritime installation; (ii) is in close proximity to a U.S. military installation or other national security facility; (iii) could offer a non-U.S. person the ability to collect information about the facility; or (iv) could otherwise put national security activities at risk of foreign surveillance. FIRRMA provides an exception to these reviews for the lease or purchase of a single housing unit or certain real estate located in urbanized areas. 
  
  
• Critical Infrastructure, Critical Technology and Sensitive Personal Data Investments: FIRRMA places particular focus on U.S. technologies and industries where the competitive advantage of the United States is perceived to be under threat from other countries. To that end, FIRRMA authorizes the Committee to review investments that relate to “critical infrastructure,” “critical technology” or sensitive personal information about U.S. persons, even when such an investment does not result in control by a non-U.S. person. If a non-U.S. investor will acquire certain rights – such as access to material non-public technical information (other than financial information), membership or observer rights on a board, or certain other decision making authority – investments in these types of entities are subject to review. The Committee’s interpretation of what constitutes “critical infrastructure” and “critical technology” will be significant as FIRRMA provides fairly broad definitions in this regard: 
  • Critical infrastructure: “Systems and assets whether physical or virtual, so vital to the U.S. that the incapacity or destruction of [them] would have a debilitating impact on national security.” 
  • Critical technology: Defense items on the U.S. Munitions List, certain items on the Commerce Control List, specified items related to the nuclear energy industry, select agents and toxins, and “emerging and foundational technologies” (discussed below).
    
    Private equity exemption: FIRRMA also narrows CFIUS’ jurisdiction in this category by exempting certain investments by funds. An indirect investment through an investment fund that affords a non-U.S. investor membership as a limited partner is not a covered transaction as long as certain requirements are met, including that: (i) the fund is managed by a U.S. general partner (or equivalent), (ii) the fund board or committee on which the non-U.S. limited partner sits does not have control over the U.S. fund’s management or investment decisions, and (iii) the non-U.S. limited partner does not have access to material non-public technical information of the target company, and other potential requirements. 
    
    
• Changes in Investor Rights: FIRRMA gives CFIUS jurisdiction over any action that results in any change in the rights of a non-U.S. person that could result in either foreign control of the U.S. business or in an investment in a company involved in critical technology or critical infrastructure activities or that maintains sensitive personal data (as described above). This new authority allows the Committee to assert jurisdiction based solely on a change in rights, even when no formal merger, acquisition, or other transaction has occurred. 
  
  
• Transactions Meant to Evade CFIUS Review: The Committee now has the ability to review any transaction, transfer, agreement or arrangement if its structure is designed or intended to evade or circumvent CFIUS review. This provision may result in a broad expansion of CFIUS jurisdiction because it applies to any transaction, regardless of control or the type of industry. CFIUS regulations will provide more detail on what constitutes “evasion,” but parties to cross-border transactions should be aware of this broad new power of the Committee. 

Optional and Mandatory Declarations 

FIRRMA provides parties to a transaction the opportunity to file a “declaration” – an abbreviated notification that should not exceed five page in length – instead of a formal written notice. Within 30 days, CFIUS must respond to a declaration in one of four ways: (i) requesting parties to submit a full notice; (ii) informing parties that CFIUS is not able to complete action based on the declaration and that the parties can submit a full notice to seek confirmation that the Committee has no further action; (iii) opting to initiate a unilateral review of the transaction; or (iv) informing the parties that it does not intend to review the transaction (effectively clearing the transaction). While parties may always submit a full notice if they so choose, declarations provide an opportunity for parties to seek relatively quick determinations about whether their transaction is considered a covered transaction. 

Prior to FIRRMA’s passage, the CFIUS notification process was voluntary, though CFIUS could initiate its own review if parties to a transaction did not voluntarily submit a notification to the Committee. Under FIRRMA however, certain transactions, including many that involve foreign governments, require parties to submit a declaration. When a non-U.S. person acquires a “substantial interest” in a U.S. business that involves critical infrastructure, critical technology or the maintenance of sensitive personal information, parties must submit a mandatory declaration if a foreign government (including state-owned enterprises) holds a “substantial interest” in the foreign person. An investment by a foreign person that does not result in any foreign governmental interest does not require a declaration. 

CFIUS will develop through regulations what constitutes a “substantial interest.” FIRRMA specifies, however, that an investment of less than a 10 percent voting interest is not substantial. Moreover, CFIUS may choose to waive the declaration requirement if it determines that the non-U.S. person’s investment is “not directed by a foreign government” and the non-U.S. person has a “history of cooperation” with CFIUS. In addition, investments in investment funds may fall under an exception to the declaration requirement if certain requirements are met (including that the general partner or equivalent is a U.S. person). CFIUS may also provide for additional categories of investment that require mandatory declarations. 

Timing and Fees 

Under the previous law, CFIUS conducted an initial 30-day review after parties to a transaction file their notice and may conduct an additional 45-day investigation under certain circumstances. Under FIRRMA, CFIUS has 45 days to conduct its initial review but still has only 45 additional days to continue evaluating the transaction if it decides a second stage investigation is necessary (unchanged from the existing process). FIRRMA does, however, allow a potential 15-day extension following the investigation in “extraordinary circumstances.”¹ If CFIUS decides to refer the case to the President following its review, the President still has 15 days to decide whether to block, restrict or unwind the transaction. Accordingly, the longest potential review under the revised process is a total of 120 days compared to the previous maximum review period of 90 days (though under the previous CFIUS regime, many reviews extended well beyond 90 days as parties were requested to withdraw and refile notifications in order to address concerns raised by CFIUS without running beyond regulatory deadlines). This longer timeline provides CFIUS more time to review filings and negotiate with parties to a transaction, if necessary. The extended time period may also result in fewer instances where parties are forced to withdraw their notice and re-file before the review deadline expires. 

FIRRMA also requires CFIUS to provide comments on a draft or formal notice or accept a formal notice within 10 business days after submission. This is a departure from the Committee’s prior practice of waiting to start the 30 day review “clock” when parties first submit a notice. The change will likely provide more timing certainty to parties contemplating a covered transaction. 

Because FIRRMA significantly expands CFIUS’ jurisdiction, the Committee will hire additional staff to handle the increased caseload. FIRRMA authorizes up to US$20 million per year to fund the Committee, and allows CFIUS to assess filing fees for covered transactions up to the lesser of US$300,000 or 1% of the value of the transaction.² CFIUS is also authorized to consider offering submitting parties the option of an additional “prioritization fee.” Under the previous law, the CFIUS process did not involve any fees. 

Other CFIUS Powers 

CFIUS often negotiates mitigation agreements with parties to assuage potential concerns the Committee might have about a transaction’s impact on national security. FIRRMA further empowers CFIUS to take specific actions when a transaction creates a potential threat to national security. Under FIRRMA, CFIUS may suspend a proposed or pending covered transaction or enforce an interim risk agreement to a completed transaction for the length of CFIUS’ review or investigation. If parties choose to abandon a proposed transaction, CFIUS also may require the parties to agree to certain conditions governing how the deal will be abandoned. 

FIRRMA also gives CFIUS discretion to scrutinize investments differently based on an investor’s nationality. The legislation allows CFIUS to consider “certain categories of foreign persons” when determining whether to limit its own jurisdiction to review transactions involving real estate, critical infrastructure, critical technology or sensitive personal information of U.S. persons. While regulations are necessary to shed light on how CFIUS will use country-specific considerations, it is likely that transactions involving investors from countries that are U.S. allies, from countries whose governments share information with the Committee, and/or from countries that have national security review processes similar to CFIUS could face less scrutiny than investors from elsewhere. 

Under FIRRMA, CFIUS’ authority is subject to judicial review. Parties may challenge CFIUS’ actions or findings via a civil law suit, though legal challenges remain limited. All actions are heard in the U.S. Court of Appeals for the District of Columbia Circuit. 

Export Control Reform 

While prior drafts of FIRRMA would have expanded CFIUS’ jurisdiction to include certain joint ventures and other arrangements that could result in the transfer of U.S. intellectual property, the final version does not include this authority. Instead, it establishes an export control process that covers “emerging” and “foundational” technologies and provides the Commerce Department more authority to regulate outbound investment. 

FIRRMA contemplates the creation of an interagency process through which the Secretaries of Commerce, Defense, Energy, and State and the heads of other federal agencies will work to identify emerging and foundational technologies “that are essential to the national security of the United States.” 

FIRRMA tasks the Secretary of Commerce with establishing appropriate export controls and licensing requirements under the Export Administration Regulations for emerging and foundational technologies identified through this new interagency process. FIRRMA further requires the Secretary of Commerce, in collaboration with other federal agency heads, to submit reports to both CFIUS and Congress regarding these new export controls at least every 180 days. Complementing this interagency process is a new directive to the Commerce Department’s Emerging Technology and Research Advisory Committee (the Advisory Committee) to similarly target the identification of emerging and foundational technologies. The bill calls for the Advisory Committee to meet at least every 120 days and to include its findings in the Commerce Secretary’s annual report to Congress. 

This process seems to draw upon the Trump Administration’s National Security Strategy (NSS), which was published in December 2017 and emphasizes the Administration’s intention to “Promote and Protect the U.S. National Security Innovation Base.” While the NSS envisioned a role for CFIUS in protecting emerging technologies, FIRRMA shifts this responsibility to an interagency group and to the country's export controls regime. However, FIRRMA requires the Commerce Department to issue a report every two years on foreign direct investment in the United States from China including an analysis of patterns of Chinese investment, the extent to which those patterns align with the Made in China 2025 plan, a list of U.S. companies purchased through Chinese government investment, and identification of any limitations in identifying comprehensive information on Chinese investment.

Impact on U.S. Companies and Non-U.S. Investors 

An expansion of CFIUS’ authority and the current political climate could have a number of effects on the United States’ ability to attract foreign investment, especially from countries of concern. More aggressive CFIUS reviews could constrain foreign investment in industries most closely targeted by FIRRMA and from countries the U.S. Government views skeptically. Indeed, FIRRMA requires CFIUS to specify criteria to limit its review of certain investments and transactions to “certain categories of foreign persons,” suggesting that the level of scrutiny of transactions might differ depending on the country of the non-U.S. investor. Even if non-U.S. investors show a continued willingness to invest in the United States, U.S. companies may be less willing to accept investments from non-U.S. investors – or at least some non-U.S. investors – because of the uncertainty a thorough CFIUS review poses to a transaction. In addition, U.S. funds might be less willing to accept capital from non-U.S. investors due to concerns that the funds’ investments might be subject to greater scrutiny depending on their (non-U.S.) sources of capital (though FIRRMA provides exceptions for investment funds, subject to certain requirements, as noted above). Investors from countries like China, whom CFIUS has scrutinized closely in recent years, may continue to face difficulty securing clearance for investments in certain sectors of the U.S. economy. 

While FIRRMA may make regulatory compliance more complicated for certain transactions, there also may be market opportunities associated with these changes. For example, investors from countries under relatively less scrutiny may have an easier time securing CFIUS clearance. And investors from countries of relatively greater concern might find that, while investments in industries associated with critical technology and critical infrastructure might become (even) more challenging, opportunities remain with respect to targets operating in other sectors of the U.S. economy. 

How Dechert Can Help 

As FIRRMA implementation continues, a proactive CFIUS strategy is essential for a broader universe of foreign investments in the United States. Parties to transactions involving foreign investments in U.S. businesses involved in critical technology, critical infrastructure, or the maintenance of sensitive personal information or the acquisition of certain U.S. real estate are being impacted most significantly by CFIUS reform. Dechert has represented many clients through CFIUS reviews, including major players in the energy, telecommunications, high technology, defense and infrastructure industries. Dechert regularly advises U.S. and non-U.S. entities (“buyers” and “sellers,” as well as other interested third parties) through the CFIUS review process, helping them to: determine whether or not to bring a transaction before the Committee, assemble the required information and materials for a voluntary filing and then (as necessary) negotiate national security agreements with CFIUS in a manner that minimizes both delay and the imposition of conditions that might threaten the transaction. The firm also gives counsel on strategies for identifying and addressing political and policy considerations that may arise. 

Footnotes

_{1) As of this writing, CFIUS has already adopted the new review period, giving the Committee 45 days instead of the previous 30 for an initial review. However, CFIUS has not yet implemented 15 day investigation extensions.
2) As of this writing, CFIUS is not yet requiring a filing fee.}

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