This is the fourth in our multipart series of alerts addressing proposed regulations published in the Federal Register on September 24, 2019, for the Committee on Foreign Investment in the United States (CFIUS) to implement the Foreign Investment Risk Review Modernization Act (FIRRMA).

One of the most anticipated changes in FIRRMA is the concept of a “white list” of investors exempted from certain aspects of CFIUS’s foreign investment review jurisdiction. Another prominent feature of FIRRMA is the heightened CFIUS scrutiny on foreign government-owned investors, which left many wondering what this will mean for the viability of future investments in which a foreign government has an interest. The proposed regulations address both of these concepts and provide some initial answers, while raising several new questions for investors and U.S. businesses about which deals will get a green light in 2020, and which will need to hit the brakes.

The key takeaways regarding how different investors will be treated under the proposed regulations are:

  • A Narrow Exception for Foreign Investors: The “excepted foreign investor” provisions of the proposed regulations are narrow and complex. The exception exempts certain investors from CFIUS’s expanded jurisdiction to review non-controlling investments in “TID U.S. businesses” – business involving critical technologies, critical infrastructure, or sensitive personal data – and in certain covered real estate.
  • Mandatory Filings for Transactions Involving Government-Owned Investors: The only new mandatory CFIUS filing requirement included in the proposed regulations is for transactions where an investor in which a foreign government has a “substantial interest” will obtain a “substantial interest” in a TID U.S. business. Because all parties to a transaction are responsible for complying with these mandatory filing requirements, this will require increased diligence on the part of both the investor and the U.S. business.
  • Additional Clarification for Investment Funds: The proposed regulations extend to all investments in TID U.S. businesses the “clarification” for investment funds that was included in the critical technologies pilot program regulations. Under this clarification, an indirect investment by a foreign person as a limited partner in an investment fund will not be considered a “covered investment” under the new regulations as long as certain additional requirements are satisfied with respect to the management of the fund and limitations on its foreign limited partners’ access to portfolio companies.
  • Expanded Scope of the “U.S. Business” Definition: The current CFIUS definition of a “U.S. business” is an entity engaged in U.S. interstate commerce – but “only to the extent” of its activities in U.S. interstate commerce. In practice, this “only to the extent” caveat has done little to restrict the potential for CFIUS reviews to have an extraterritorial impact. As directed by FIRRMA, the proposed regulations remove this caveat altogether, so that, going forward, a U.S. business for CFIUS purposes will include any entity engaged in U.S. interstate commerce, regardless of its place of organization or the nationality of its owners.

The “White List”: Excepted Investors Under the Proposed Regulations

As discussed in Part 3 of this series, the proposed regulations address CFIUS’s expanded jurisdiction under FIRRMA to review certain “covered investments” – foreign investments that do not result in “control” of the target U.S. business, but afford the foreign investor certain rights with respect to U.S. businesses involving critical technologies, critical infrastructure, and sensitive personal data (so-called “TID U.S. businesses”). However, FIRRMA also included a key counterbalance to this expanded jurisdiction: a requirement that CFIUS also prescribe regulations that limit this covered investment jurisdiction to investments by certain categories of foreign persons.

The proposed regulations address this mandate through a list of “excepted foreign states” identified by the CFIUS Chairperson with the agreement of two-thirds of the voting members of CFIUS.[1] The final regulations are expected to include an initial list of such excepted foreign states, which will be updated from time to time. Starting two years after the effective date of the new regulations, the CFIUS Chairperson, with agreement of two-thirds of the voting CFIUS members, must also determine that foreign states on this list have established and are effectively using a “robust process to analyze foreign investments for national security risks and to facilitate coordination with the United States on matters relating to investment security.” CFIUS can rescind such a determination at any time. In other words, to stay on this excepted list, foreign states must demonstrate that they will be reliable partners with CFIUS and the U.S. government when it comes to both national security and international trade policy goals.

To be an “excepted investor,” a foreign investor must be either (1) a foreign national of an excepted foreign state, and not also a national of a non-excepted foreign state, (2) a foreign government of an excepted foreign state, or (3) an entity that is organized under the laws of and has its principal place of business in an excepted foreign state or the United States, and meets several additional conditions relating to its governance, ownership, and control with respect to other persons and entities from an excepted foreign state or the United States.

Among the conditions that an “excepted investor” entity must meet is a “minimum excepted ownership.” The rules vary depending on whether the investor is publicly traded on an exchange in the United States or a foreign excepted state. However, this generally means that a majority (or 90%, in the case of entities not publicly traded on such exchanges) of the investor’s voting interest, the right to a majority of its profits, and the right in the event of a dissolution to a majority of its assets must be held, individually or in the aggregate, by persons who are (i) not a foreign person, (ii) nationals of an excepted foreign state, and not also nationals of a non‑excepted foreign state, (iii) a foreign government of an excepted foreign state, or (iv) entities organized under the laws of an excepted foreign state with their principal places of business in an excepted foreign state or the United States.

The excepted investor provisions in the new regulations should provide some relief to foreign investors that qualify, but they will also require careful consideration when the initial list of excepted foreign states is released. For investment funds or similar entities in which multiple foreign investors are involved, the excepted investor provisions will also be a key factor to consider when structuring both the transaction and the fund itself.

The Other Side of the Coin: Mandatory Filing Requirement for Certain Transactions Involving Foreign Government-Controlled Investors

Prior to the release of the proposed regulations, there was much concern about the potential for mandatory CFIUS filing requirements in addition to those already included in the critical technologies pilot program. In fact, the proposed regulations only include one additional category of transactions that will be subject to a mandatory filing requirement: investments by certain foreign government-controlled investors in TID U.S. businesses. However, this requirement promises to have a significant impact on certain types of investments going forward, particularly because it will require careful analysis on the part of both the investor and the U.S. business to determine whether they will be subject to these new rules.

The new mandatory filing requirement applies to all CFIUS covered transactions that would result in the acquisition of a “substantial interest” in a TID U.S. business by a foreign person in which a foreign government has a “substantial interest.” This requirement is particularly complex because the threshold for “substantial interest” is different in various contexts. In terms of an interest in a U.S. business by a foreign person, a substantial interest means a voting interest, direct or indirect, or 25% or more. In terms of an interest by a foreign government in a foreign person, a substantial interest means a voting interest, direct or indirect, of 49% or more.

To meet this mandatory filing requirement, the parties must, at a minimum, submit a declaration (a short-form notice now available only under the critical technologies pilot program, but which will be available for all transactions) to CFIUS at least 30 days before closing the transaction. The proposed regulations include an important clarification that, notwithstanding this 30-day requirement, the parties may close a transaction subject to the mandatory declaration requirement at any time after having been informed by CFIUS that it has either cleared the transaction or is not able to complete action on the basis of the declaration alone. As with the pilot program, parties subject to this mandatory filing requirement may submit a full written notice to CFIUS instead of a declaration. Parties that fail to meet these mandatory filing requirements may be liable for a civil penalty not to exceed $250,000 per violation or the value of the transaction, whichever is greater.

This new mandatory filing requirement makes it even more important for parties to a transaction to know the investor(s) involved and all of the entities in their ownership chains, including their relationships with foreign governments. At the same time, these new rules also require a close examination of the target U.S. business to determine whether or not it qualifies as a TID U.S. business, and, if so, whether the circumstances of the transaction cause it to be either a covered control transaction or a covered investment under the new CFIUS regulations. One area of ambiguity is the extent to which CFIUS will presume government ownership in cases where the foreign investment is from countries like China, where there is no consensus on the lines between state-owned and private enterprises. Now, more than ever, investors and companies will benefit from the advice of experienced CFIUS counsel to help them navigate these challenging issues.