Section 721 of the Defense Production Act of 1950 (50 U.S.C. § 4565) (the “DPA”) sets forth the authority and power of the President of the United States and the Committee on Foreign Investment in the United States (the “Committee” or “CFIUS”) to take such action to protect the national security with regard to any transaction in which a foreign person could obtain control of a U.S. business (a “Covered Transaction”). The DPA was amended in 2008 by the Foreign Investment and National Security Act (“FINSA”) and, while the subject of periodic discussion, has not been amended since. Since the enactment of FINSA, practitioners generally believe that CFIUS has and wields broad and effective authority to protect the national security of the United States. However, Senator John Cornyn (R-Texas) and key figures within the Administration apparently do not share that view.1
Specifically, on November 8, 2017, Senator Cornyn and a bipartisan group of co-sponsors introduced the Foreign Investment Risk Review Modernization Act of 2017 to amend the DPA (the “Amendment”) in the Senate.2 If enacted, the Amendment will significantly expand the authority of CFIUS by broadening the types of transactions that CFIUS is able to review, requiring certain transactions to be notified to the Committee, and, among other things, lengthening the list of factors that CFIUS is to take into account when assessing the impact of a transaction on the national security of the United States, which could dramatically increase the number of filings to CFIUS far beyond the total number of filings in 2017, which will be a record year.
In particular, the Amendment focuses attention on acquisitions of U.S. entities that are developing otherwise benign dual-use technologies that could be exploited for defense and/or intelligence purposes. Senator Cornyn’s rationale for reform, as expressed in a press release, is that “gaps in the current process have allowed foreign adversaries to weaponize their investment in U.S. companies and transfer sensitive dual-use U.S. technologies, many of which have potential military applications. These investment-driven technology transfers have jeopardized the United States’ ability to maintain our historical military advantage and have, in turn, weakened our defense industrial base.” The Amendment will also extend CFIUS’ authority to review emerging technologies.
The key changes contemplated by the Amendment are summarized below.
Expansion of Types of Transactions Subject to Review
Currently, the authority of the President and CFIUS is limited to so-called Covered Transactions. The Amendment expands the authority of the President and CFIUS in two key ways: (i) it expands the definition of a Covered Transaction; and (ii) narrows the Passive Investment Exemption.
Expanded Definition of Covered Transaction
The Amendment expands the definition of Covered Transaction to go beyond typical asset acquisitions and acquisitions of equity interests. The Amendment would also include in the definition of Covered Transactions:
(1) acquisitions or leases of real property in close proximity to a U.S. military instillation or to a sensitive U.S. Government facility;
(2) any investment in a critical technology or critical infrastructure company; and
(3) contributions of intellectual property and support to a foreign person by a U.S. critical technology company through “any type of arrangement, such as a joint venture.”
The addition of transactions covered in (1) above appears to reflect a concern that the U.S. military is not aware of and does not have the authority to track the holdings of foreign persons near military and sensitive instillations. We believe some CFIUS reviews and mitigation agreements have been designed to mitigate this issue.
The changes in (2) include a broad array of investments, including non-controlling investments and limited partner investments in critical technology and critical infrastructure. We believe this change is proposed because CFIUS has not been able to review transactions in which foreign persons invest in critical technology or infrastructure companies through limited partnerships and because the U.S. export control laws may not be sufficient to restrict technical data transfers associated with existing and emerging commercial technologies that may ultimately be used in defense and/or intelligence applications. Indeed, the Amendment includes the following as part of the definition of critical technology: “Other emerging technologies that could be essential for maintaining or increasing the technological advantage of the United States over countries of special concern3 with respect to national defense, intelligence, or other areas of national security, or gaining such an advantage over such countries in areas where such an advantage may not currently exist.” The Amendment is designed, in part, to allow CFIUS to review foreign investment in technologies that could ultimately prove critical to the U.S. military.
Transactions covered in (3) include a wide array of transactions and covers technology transfers, possibly technology licenses and other technology ventures involving a U.S. business in the critical technology sector.
Narrowed Exemption for Passive Investments
CFIUS has concluded that a passive investment of 10 percent or less is not subject to its review. The Amendment narrows the passive investment exemption to exclude from the exemption any transaction in which the foreign person:
(1) obtains access to any nonpublic technical information of the U.S. business;
(2) obtains access to any nontechnical information in the possession of the U.S. business that is not available to all investors; and
(3) obtains membership or observer rights on the board of the U.S. business (including any right to nominate a director).
The passive investment exemption would also not be available to companies with a “parallel strategic partnership or other material financial relationship.” This provision appears focused on transaction structures that may be viewed by Congress and CFIUS as intended to avoid CFIUS review.
Expansion of National Security Factors to Consider
The DPA does not define national security. Instead, it contains a list of national security factors CFIUS must consider when assessing the threat, vulnerability and consequences of any transaction. While the Amendment does not define national security, it adds a significant number of factors that the Committee must consider. These include:
(1) The potential effects of the covered transaction on international technological and industry leadership of the United States relating to national security, including the loss or reduction of any U.S. advantage to a “country of special concern”;
(2) The effect of the covered transaction on transportation assets;
(3) The “degree to which the covered transaction is likely to increase the cost to the [U.S.] Government of acquiring or maintaining the equipment and systems that are necessary for defense, intelligence, or other national security functions;”
(4) “the potential national security-related effects of the cumulative market share of any type of infrastructure, energy asset, critical material, or critical technology by foreign persons;”
(5) “whether any foreign person that would acquire an interest in a [U.S.] business or its assets as a result of the covered transaction has a history of: (A) complying with [U.S.] laws and regulations, including laws and regulations pertaining to exports, the protection of intellectual property, and immigration; and (B) adhering to contracts or other agreements with entities of the [U.S.] Government;”
(6) “the extent to which the covered transaction is likely to expose, either directly or indirectly, personally identifiable information, genetic information, or other sensitive data of United States citizens to access by a foreign government or foreign person that may exploit that information in a manner that threatens national security;”
(7) “whether the covered transaction is likely to result in a foreign government gaining a significant new capability to engage in malicious cyber-enabled activities against the United States, including such activities designed to affect the outcome of any election for Federal office;”
(8) “whether the covered transaction involves a country of special concern that has a demonstrated or declared strategic goal of acquiring a type of critical technology that a United States business that is a party to the transaction possesses;”
(9) “whether the covered transaction is likely to facilitate criminal or fraudulent activity affecting the national security of the United States;” and
(10) “whether the covered transaction is likely to expose any information regarding sensitive national security matters or sensitive procedures or operations of a Federal law enforcement agency with national security responsibilities to a foreign person not authorized to receive that information.”
CFIUS officials have repeatedly indicated that the CFIUS review does not target any specific country. Notably, the Amendment now requires CFIUS to consider a “country of special concern.” No such countries are specifically identified, but likely would include China and Russia. Indeed, in public statements, Senator Cornyn specifically identified issues relating to Chinese investment and catching up with U.S. technological leadership.
Expansion/Clarification of CFIUS Authority
CFIUS has taken the view that it has the authority to take such action to protect the national security pending a decision by the President. The assertion of this authority is not without controversy. The Amendment ends the controversy by granting CFIUS the authority to “suspend a proposed or pending covered transaction that may pose a risk to the national security of the United States for such time as the covered transaction is under review or investigation under this subsection.”
Mandatory Declarations for Certain Transactions
The DPA does not mandate that parties to a transaction submit to CFIUS review. The DPA permits parties to a Covered Transaction to submit a joint voluntary notice (“JVN”). While the Amendment does not go so far as to require the submission of a JVN, it does mandate that certain transactions be notified to CFIUS using a “declaration.” In particular, the Amendment requires foreign persons with 25 percent or more of its voting securities owned by a foreign government to submit a declaration for transactions if that person acquires a 25 percent interest in a U.S. business. The Amendment authorizes CFIUS to promulgate regulations requiring mandatory declarations depending on the technology, industry, sector of the U.S. business, the difficulty of remedying harm to national security if a transaction is closed without review and the difficulty of obtaining information on particular types of Covered Transactions. The declaration must be submitted 45 days before closing the transaction. The Amendment provides that in lieu of a declaration, parties may submit a JVN, not to be submitted less than 90 days from closing.
The Amendment authorizes CFIUS to impose a civil penalty (unspecified) for failing to comply with a mandatory filing requirement. Parties may submit a voluntary declaration under the Amendment. While it is not entirely clear what needs to be contained in a declaration, it appears to be focused on the basics of the parties and transaction. If a declaration is submitted, CFIUS will “endeavor to take action” within 30 days of the submission and may: (1) request the parties to submit a JVN; (2) open a review; or (3) notify the parties to the declaration it plans to take no action.
Exemptions for Certain Transactions
The Amendment authorizes CFIUS to exempt transactions involving certain countries from the CFIUS review process, including based on criteria such as whether the country has a mutual defense trade treaty in place with the United States.
The DPA currently provides for an initial 30-day review, a secondary 45-day investigation in the event there are unresolved national security concerns at the conclusion of the initial review period, and a 15-day period for presidential review. CFIUS routinely requires parties to withdraw their filing and re-start the entire process. The Amendment provides that the review period will be extended from 30 to 45 days and CFIUS may extend an investigation by “one 30-day period” in extraordinary circumstances. What is unclear is what it is to be extraordinary and whether that provides CFIUS license to take what is already a de facto 75-day process and extend it to 105 days. Further, the Amendment does not limit the ability of CFIUS to “ask” parties to withdraw and refile their joint voluntary notice.
The Amendment provides that parties to a notified transaction will pay the lesser of 1% of the value of the transaction or $300,000 (adjusted annually). These fees are used to fund the operations of CFIUS. Currently, there are no fees associated with initiating and participating in the CFIUS process.
FINSA provided that the findings and actions of the president were not subject to judicial review. CFIUS had taken the position that its findings and actions were beyond judicial review. The Amendment makes clear that the findings and actions of the president and CFIUS are not subject to judicial review. However, the Amendment permits parties to petition within 60 days of an action being taken for a determination that the action by the “Committee is contrary to a constitutional right, power, privilege, or immunity.” A presidential action or decision is not reviewable.
The Amendment contains indications on the sense of Congress. One notable point is that the sense of Congress is that the United States should encourage and support other countries to create similar national security regimes and “to develop a new, stronger multilateral export control regime, aimed to address the unprecedented industrial policies of certain countries of special concern, including aggressive efforts to acquire United States technology, and the blending of civil and military programs.”
Notwithstanding these sweeping changes, the Amendment makes clear that it continues to be the policy of the United States that the nation “enthusiastically” welcomes and supports foreign investment in the United States, consistent with the protection of national security.