- Mandatory declarations of certain transactions now required
- Certain changes to pre-existing regulations also announced and effective immediately
- Mandatory declaration requirement may not ease burden on parties filing with CFIUS
On October 11, the U.S. Treasury Department took the first steps to implement the significant changes introduced under the Foreign Industrial Review and Risk Modernization Act (FIRRMA). FIRRMA broadens the mandate of the Committee on Foreign Investment in the United States (CFIUS), which reviews foreign investments in the United States that could impact U.S. national security.
Most notably, the Treasury Department is establishing a pilot program that imposes new obligations on foreign parties making investments, even non-controlling investments, in U.S. businesses involved in 27 explicitly designated industries. The pilot program defines such investments as “pilot program investments.”
Under the new rules, parties to a pilot program investment must file a declaration of the transaction with CFIUS – unless the parties decide to submit a formal notice to CFIUS in accordance with the pre-existing regulations. The declaration must be filed at least 45 days prior to the closing date of the pilot program investment. Failure to make a submission to CFIUS can lead to a civil penalty of up to the value of the transaction.
The pilot program does not become effective until November 10 – the same date on which comments on the new rules are due. Comments can be viewed here.
Also on October 11, Treasury announced regulatory changes to reflect those portions of FIRRMA that became effective immediately upon enactment of the law. Among other things, these changes extend from 30 to 45 days the period during which CFIUS can review a potential transaction. (CFIUS may still initiate a further investigation of a potential transaction, for a period of up to 45 days, after the initial 45-day review period.) These regulatory changes, which also broaden the definition of what constitutes a transaction and establish a new definition of critical technology, were effective on October 11.
This post summarizes key elements of the pilot program, including the process for determining whether a transaction is covered under the pilot program.
New Definitions Establish What Constitutes a Pilot Program Covered Transaction
The first step is to determine whether a potential investment by a foreign investor involves a “pilot program U.S. business.” That term is defined as any U.S. business that produces, designs, test, manufactures, fabricates, or develops a critical technology:
- Utilized in connection with the U.S. business’s activity in one or more pilot program industries; or
- Designed by the U.S. business specifically for use in one or more pilot program industries.
The term “critical technology” covers the following:
- All defense articles and services controlled for export under the U.S. International Traffic in Arms Regulations,
- Specific items and related technologies controlled for export under the U.S. Export Administration Regulations,
- Certain nuclear equipment, facilities, software, technology, and materials controlled for export by the U.S. Department of Energy,
- Select agents and toxins deemed to pose a threat to public health and safety, including to animal and plant health, and / or
- Emerging and foundational technologies controlled under the Export Control Reform Act of 2018. (To date, no such technologies have been identified publicly.)
What constitutes a “pilot program industry”? That too is defined under the pilot program: 27 industries have been so designated.
Many industries in the defense sector are covered, but so are less obvious national security industries, such as battery production, biotechnology, and petrochemical manufacturing.
If the foreign investment is not in a pilot program U.S. business, no declaration is required. The foreign investor might nonetheless decide to file a formal notice with CFIUS in accordance with the pre-existing CFIUS regulations at 31 CFR Part 800.
Pilot Program Covered Investment Is Broadly Defined, Goes Beyond Controlling Interest
If a foreign investment is in a pilot program U.S. business, the next step is to determine whether the investment constitutes a “pilot program covered investment.” If so, the mandatory declaration requirement is triggered.
When the foreign investor obtains control of a pilot program U.S. business it is – not surprisingly – a pilot program investment.
But even when an investment does not give a foreign investor control of a pilot program U.S. business, a declaration may be required. In particular, a mandatory declaration must be made in the case of the following:
[A]n investment, direct or indirect, by a foreign person in an unaffiliated pilot program U.S. business that could not result in control by a foreign person of a pilot program U.S. business and that affords the foreign person:
(a) Access to any material nonpublic technical information in the possession of the pilot program U.S. business;
(b) Membership or observer rights on the board of directors … of the pilot program U.S. business or the right to nominate an individual to a position on the board of directors or equivalent governing body of the pilot program U.S. business; or
(c) Any involvement, other than through voting of shares, in substantive decision-making of the pilot program U.S. business regarding the use, development, acquisition, or release of critical technology.
The regulations include several examples of pilot program covered investments. One of those examples posits a scenario in which foreign corporation A seeks to acquire a four percent interest in U.S. company B, which manufactures critical technology and is thus a pilot program U.S. business. Under the investment, A would be permitted to observe B’s board meetings. Because of these observer rights, this would be a pilot program covered investment, and a mandatory declaration would be triggered.
This is a significant departure from past CFIUS practice. Historically (and under the current regulations), CFIUS review has focused on whether a foreign party was obtaining control of a U.S. business.
As described above, the pilot program goes further.
Mandatory Declaration of Any Pilot Program Covered Investment
The parties to a pilot program covered investment are required to file a mandatory disclosure with CFIUS. Failure to do so can lead to civil penalties of up to the value of the transaction.
In announcing the pilot program, the Treasury Department emphasized that mandatory declarations, in accordance with the language of FIRRMA, should “not generally exceed 5 pages in length.” This may be hard to accomplish given the volume of information that a mandatory declaration must include. We will not be surprised if information volume is a focus of comments the proposed new rules.
Once the declaration is submitted (electronically), CFIUS will “promptly inspect” the declaration and “promptly notify” the parties as to whether the declaration is complete. This is a potentially expedited version of the current process for submissions to CFIUS, since the existing regulations do not explicitly require CFIUS to act “promptly.” It is therefore common under the existing regulations that CFIUS will not deem a filing complete until a week or more after the filing is submitted. This is notable as CFIUS does not begin official review of a transaction until the filing is deemed complete.
Under the pilot program, CFIUS has 30 days to review and render a decision as to a mandatory declaration. During this period, CFIUS may pose questions to the submitting parties, and the parties have two business days to respond. This differs from CFIUS rules with respect to formal notices, as the parties have three business days to respond to CFIUS inquiries related to notices.
With respect to a mandatory declaration, by the end of the 30-day review period, CFIUS must take one of four steps:
- Request the parties to file a formal notice, including with additional information required under the new rules;
- Inform the parties that CFIUS cannot conclude its review on the basis of the declaration alone, and inform the parties that they may file a formal notice so CFIUS can conduct a formal review;
- Initiate unilateral review of the transaction if so requested by a member of CFIUS; or
- Notify the parties in writing that CFIUS has concluded its review of the transaction, e., that the transaction may proceed.
New Formal Notice Requirements Established Under Pilot Program
As noted above, in response to a submission of a mandatory declaration, CFIUS can require the parties to submit a formal notice that both (1) meets the informational requirements of the existing regulations and (2) includes additional information required under the pilot program. (A formal notice made to CFIUS in connection with a non- “pilot program covered transaction” does not need to include the additional information specified under the pilot program.)
Under the new regulations, the additional required information includes:
- A statement as to whether the transaction is a pilot program covered transaction;
- A statement as to whether to the foreign investor will be acquiring:
- Access to non-public technical information in the possession of the pilot program U.S. business,
- Membership, observer rights, or nomination rights in the pilot program U.S. business, or
- Involvement in substantive decision-making in the U.S. business’s work related to critical technology; and
- Details of the critical technology of the U.S. pilot program business.
At the same time, the formal notice does not have to include this information if the parties stipulate that the transaction is covered under the existing CFIUS regulations. The rationale appears to be that if CFIUS has authority to review the transaction under the existing regulations because the transaction is covered under those regulations, details as to whether the transaction is a pilot program covered transaction are not relevant.
Mandatory Declaration Not Sure to Ease Filing Process
In theory, the mandatory declaration provision could make the filing burden easier for some parties. A declaration is considerably shorter than a formal filing, which means less time will be needed to prepare the declaration. CFIUS also has only 30 days to complete its review of a mandatory declaration – as opposed to the 45 days CFIUS now has under FIRRMA to conduct its review of a formal filing. These factors could make it more likely that CFIUS gets through its review of more transactions more quickly.
At the same time, given the breadth of transactions that seemingly will trigger a mandatory declaration, CFIUS may see such a substantial number of mandatory declarations that those submissions outstrip CFIUS’s ability to review them in a timely fashion. This could lead to CFIUS reaching the conclusion of a 30-day review of a mandatory declaration and recommending to the parties that they file a formal notice. That would re-start the clock on CFIUS’s review and add months to the overall review process.
In the context of deals notified to CFIUS, completion of CFIUS review can be the last hurdle to the deal closing. Any delay in CFIUS review is unwelcome.
There may therefore be some benefit for parties to forego the mandatory declaration process and simply file a notice in accordance with existing CFIUS regulations (as updated by the revised regulations issued on October 11). It will almost invariably take longer to prepare a notice than to prepare a mandatory declaration. The notice also is subject to a 45-day review period as opposed to the 30-day review period in the case of a mandatory declaration.
But submission of a notice may bring some certainty for parties not sure of how the mandatory declaration process will work. Importantly, CFIUS cannot really know how that process will work either, because it is brand new. It is easy to envision CFIUS erring on the side of caution, especially in the initial months of the pilot program, and thus imposing on parties to make a formal filing at the end of the mandatory declaration review process.