On October 10, 2018, the US Department of the Treasury issued interim regulations for the Committee on Foreign Investment in the United States (CFIUS) to conduct a pilot program, as authorized by the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA).

The pilot program is intended to regulate the conduct of foreign persons seeking to acquire certain interests in US businesses involved in critical technologies related to specific industries. The pilot program covers critical technologies in 27 industries (including aviation, defense, semiconductors, telecommunications and biotechnology) that the US government identified because certain strategically motivated foreign investment in those industries could pose a threat to US technological superiority and national security.

The following three factors created the urgent and compelling circumstances for the pilot program:

  1. the pace of technological change in certain critical technology industries
  2. the significant growth in foreign investment in certain industries relevant to national security and
  3. the current inability of CFIUS to examine certain non-controlling transactions in a US business that produces, designs, tests, manufactures, fabricates or develops one or more critical technologies.

The pilot program will become effective on November 10, 2018 – 30 days following publication of the regulations in the Federal Register. The pilot program does not apply to transactions for which the completion date; is prior to the pilot program's effective date (November 10, 2018). The pilot program also does not apply to transactions where the following occurred before October 11, 2018: (1) the parties executed a binding written agreement or other document establishing the material terms of the transaction; (2) a party made a public offer to shareholders to buy shares of a pilot program US business; or, (3) a shareholder solicited proxies in connection with an election of the board of directors of a pilot program US business or requested the conversion of convertible voting securities.

Pilot program covered transactions

The pilot program expands the scope of transactions subject to review by CFIUS to include certain non-controlling investments (referred to in FIRRMA as "other investments") made by foreign persons in US businesses that produce, design, test, manufacture, fabricate, or develop one or more critical technologies2 related to specific industries (ie, pilot program US businesses). These pilot program industries are identified by their respective North American Industry Classification System (NAICS) codes and are listed here. In order for a US business to be covered, the critical technology must be used in connection with the business' activity in a pilot program industry, or designed by the US business specifically for use in a pilot program industry. If the US business operates in a pilot program industry but does not produce, design, test, manufacture, fabricate, or develop any critical technology, then it would not be subject to the pilot program.

More specifically, a pilot program covered transaction includes an investment, direct or indirect, by a foreign person in a pilot program US business that would not result in control by a foreign person of the US business but that (no matter the percentage of voting interest acquired) affords the foreign person:

  1. Access to any material nonpublic technical information in the possession of the pilot program US business
  2. Membership or observer rights on the board of directors or equivalent governing body of the pilot program US business or the right to nominate an individual to a position on the board of directors or equivalent governing body of the pilot program US business or
  3. Any involvement, other than through voting of shares, in substantive decision-making of the pilot program US business regarding the use, development, acquisition or release of critical technology.

For example, if a foreign person proposes to acquire a 4 percent non-controlling equity interest in a US business that manufactures a critical technology as part of its business in a pilot program industry, and a designee of the foreign person will have the right to observe the US company's board of directors meetings, the proposed transaction is a pilot program covered investment. Consequently, both startup companies and investors in the venture capital ecosystem should consider these regulations because many investments by foreign venture capital firms may be covered under the pilot program.

Certain incremental investments may also be covered by the pilot program. If the parties to a transaction that is approved by CFIUS under the pilot program engage in a follow-on investment that involves the acquisition of new access or rights (as described in a - c above), that subsequent transaction is also covered under the pilot program.

Additionally, if the critical technology of a US business becomes controlled as an "emerging or foundational technology" after November 10, 2018, then an investment as described above in that US business is covered under the pilot program unless the parties executed a binding written agreement or other document establishing the material terms3of the transaction before the critical technology became controlled.

Finally, an investment by a foreign person in a pilot program US business resulting in control is covered by the pilot program.

Exemptions for investment funds and air carriers

The pilot program creates an exemption for passive, indirect investments made through an investment fund by a foreign person in a pilot program US business that afford the foreign person membership as a limited partner or equivalent on an advisory board or a committee of the fund.4This exemption only applies if:

  1. The fund is managed exclusively by a general partner, managing member or equivalent (the "fund manager," who cannot be the foreign person)
  2. Neither the advisory board nor the foreign person is able to approve, disapprove or otherwise control the fund's investment decisions or decisions related to the fund's portfolio
  3. The foreign person does not have the authority to unilaterally dismiss, prevent the dismissal of, select or determine the compensation of the fund manager and
  4. The foreign person does not have access to material nonpublic technical information as a result of its participation on the advisory board committee.

The pilot program also exempts investments involving US air carriers.

Mandatory declarations for pilot program covered transactions

If a transaction is covered under the pilot program, parties are required to submit a mandatory declaration to CFIUS. The regulations note that, since foreign investors are becoming increasingly sophisticated and sometimes utilizing entities in other jurisdictions, no country is exempt from the mandatory declaration requirement. Additionally, the requirement is not limited to transactions involving foreign government-controlled parties. CFIUS is developing a web template for parties to use for filing a declaration, which is expected to guide parties in providing information and facilitate filings.

If a transaction is subject to the mandatory declarations requirement, parties may alternatively file a written notice (as described in further detail below). This approach may be advisable if parties determine that CFIUS is unlikely to approve the transaction in 30 days due to the nature of the transaction or parties involved.

A declaration or written notice must be submitted no later than:

  • November 10, 2018, or promptly thereafter, if the completion date of the transaction is between November 10, 2018 and December 25, 2018 or
  • 45 days before the completion date of the transaction, if the completion date is after December 25, 2018.

Any party that fails to comply with this requirement may be liable for a civil penalty no greater than the value of the transaction.

Upon receipt of a declaration, the CFIUS Staff Chairperson must "promptly" notify the parties that the declaration has been accepted and circulated to the Committee, which triggers CFIUS' 30-day assessment period. During that period, CFIUS must evaluate whether (1) the transaction constitutes a pilot program covered transaction and could result in foreign government control; (2) there is credible evidence to support a belief that a foreign person might take action that threatens to impair US national security; and (3) there is adequate authority to protect US national security with respect to that risk. If the Committee determines that the transaction is not a pilot program covered transaction, it will notify the parties accordingly. The Committee may also reject or allow parties to withdraw during its 30-day assessment under limited circumstances.

A declaration is intended to be an abbreviated way of informing CFIUS of a transaction and generally should not exceed five pages in length. The following basic information about a pilot program covered transaction must be provided in a declaration:

  • A brief description of the transaction and its structure, the voting interest acquired, the economic interest acquired, the total transaction value, the expected closing date and all sources of financing for the transaction
  • A stipulation as to whether the transaction (1) is a pilot program covered transaction and (2) could result in control of a pilot program US business by a foreign person, or is a foreign government-controlled transaction5
  • An explanation of what access or rights the foreign person will acquire with respect to the pilot program US business
  • Business information and activity related to the pilot program US business (including geographic coordinates and US government contracts, grants and funding)
  • A statement as to which critical technologies are involved, including whether they are controlled under the EAR or ITAR
  • Information related to the foreign person's parent companies
  • Whether the parties have been party to another notified transaction
  • Whether the parties to the transaction (or the foreign parent or subsidiaries) have been convicted of a crime in the last ten years

If parties elect to file a notice instead of a mandatory declaration, the following information must be provided (in addition to the content required for a notice under the existing CFIUS regulations):6

  • A stipulation as to whether the transaction is a pilot program covered transaction
  • An explanation of what access or rights the foreign person will acquire with respect to the pilot program US business
  • A statement as to which critical technologies are involved, including whether they are controlled under the EAR or ITAR

At the end of its 30-day assessment, the Committee may (1) request that the parties file a written notice (either under the interim regulations or the existing CFIUS regulations); (2) initiate a unilateral review of the transaction if the parties are uncooperative; or (3) notify the parties that it has concluded all action.

See the list of pilot program industries.