Foreign investors in U.S. businesses take note: If your transaction is scheduled to close any time after November 10, 2018, new U.S. national security rules could result in delays or penalties for non-compliance.

Transactions involving a foreign party’s acquisition of all or part of a U.S. business often are subject to review by the Committee on Foreign Investment in the United States (CFIUS). CFIUS is an interagency committee, chaired by the U.S. Department of the Treasury (Treasury), that reviews foreign investments in U.S. businesses to identify and address U.S. national security concerns. Until now, all CFIUS notifications were voluntary. But recent changes following the enactment of CFIUS reform legislation have changed the rules, and parties to M&A deals that close after November 10, 2018, need to evaluate those transactions for compliance with the new regulations.

On October 10, 2018, Treasury implemented a pilot program requiring mandatory notification of foreign investment in U.S. businesses engaged in certain “critical technologies.” Following the enactment of the Foreign Investment Risk Review Modernization Act (FIRRMA) in August, this program marks the first time that CFIUS has imposed mandatory filing requirements for certain transactions. The pilot program regulations go into effect on November 10, 2018, and apply to transactions completed after that date. 

What do Foreign Buyers Need to Know?

In addition to transactions that result in foreign ownership and control over a U.S. business, the Pilot Program implemented under FIRRMA also covers additional types of foreign direct investment in the United States, including for the first time “access/decision-making transactions.” Specifically, the pilot program covers investments that give a foreign investor in a U.S. company any of the following:

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

Notably, the pilot program is not limited to foreign investments originating from particular countries (e.g., China or Russia), or to transactions involving foreign government-controlled parties. It does not exempt purchasers from any particular country either.

What do U.S. Businesses Need to Know?

The new program focuses on 27 designated Pilot Program Industries, listed in the table below. These industries closely align with those that have been subject to heightened CFIUS scrutiny in recent years.

To fall within the scope of the new rules, the U.S. business involved must be a Pilot Program U.S. Business, meaning it produces, designs, tests, manufactures, fabricates, or develops a critical technology that is (i) used in connection with the company’s activity in one or more of the Pilot Program Industries or (ii) designed by the U.S. business specifically for use in one or more Pilot Program Industries.

The pilot program’s definition of “critical technologies” is identical to FIRRMA’s, which includes:

1. Defense articles or military technologies subject to the International Traffic in Arms Regulations,
2. Certain categories of civilian/military dual-use technologies subject to the Export Administration Regulations,
3. Nuclear technologies, select agents and toxins, and emerging and foundational technologies controlled pursuant to the Export Control Reform Act of 2018.

Importantly, the definition of “Pilot Program U.S. Business” only includes companies involved in various stages of development of relevant critical technologies. It does not extend to companies in Pilot Program Industries that merely use those critical technologies.

Are Passive Foreign Investments Covered?

No, not all foreign investments in Pilot Program U.S. Businesses will be subject to the pilot program. Although FIRRMA expands CFIUS’ jurisdiction to new types of foreign control, it also provides an exemption from jurisdiction for certain foreign investments in U.S.-managed investment funds, including those with advisory boards or similar investor committees. This exemption extends to the pilot program under the interim regulations. As a result, a foreign party may invest indirectly in a Pilot Program U.S. Business via a U.S.-managed investment fund and participate as a member of the fund’s advisory board, provided that:

1. neither the foreign investor nor the advisory board is able to approve, disapprove, or otherwise control the fund’s investment decisions or decisions of the fund manager relating to the fund’s portfolio companies;
2. the foreign investor may not unilaterally dismiss, prevent the dismissal of, select or determine the compensation of the fund manager; and
3. participation on the advisory board or committee does not afford the foreign investor access to material nonpublic technical information of the Pilot Program U.S. Business.

What are the Next Steps?

Foreign transactions that either constitute non-controlling investments covered by the pilot program or could result in control by a foreign person of a Pilot Program U.S. Business will be subject to a new mandatory short-form declarations process.

These mandatory declarations are designed to be abbreviated CFIUS Notices, generally no more than five pages, containing certain details about the parties, the nature of the transaction, whether the transaction will result in foreign control, the nature of the access or membership to be acquired by the foreign person, and other relevant details. Under the new rules, Notices must be filed at least 45 days before a transaction is expected to close. For transactions that will be completed between the interim regulations’ effective dates of November 10, 2018, and December 25, 2018, parties must file on or promptly after the effective date. Any party failing to submit a mandatory declaration may be liable for a civil penalty in an amount not to exceed the value of the transaction.

Once filed, CFIUS has 30 days to take one of the following actions:

1. asking the parties to file a complete (i.e., non-abbreviated) CFIUS Notice;
2. informing the parties that CFIUS cannot take action on the basis of the declaration alone and that they may file a complete Notice (which would initiate a full CFIUS review of the noticed transaction);
3. initiating a review of the transaction; or
4. notifying the parties that CFIUS has completed all action.

The pilot program is temporary and will ultimately be superseded by the final regulations necessary to implement all of the FIRRMA revisions. Those regulations have not yet been proposed but are to be completed and final by March 5, 2020, following notice and an opportunity for the public to provide comments. The pilot program does not apply to transactions for which parties signed a binding agreement or other document establishing the material terms before October 11, 2018, or to transactions completed prior to November 11, 2018. Parties to any transaction may still elect to file a voluntary Notice using CFIUS's prior procedures.

What are Pilot Program Industries?

The pilot program applies to businesses in 27 enumerated Pilot Program Industries, defined by their North American Industry Classification System (NAICS) codes as follows: