Treasury Department Imposes Mandatory Filing Requirement on Parties to Certain Foreign Investments in U.S. Critical Technology Companies

On Wednesday, October 10, 2018, the Department of the Treasury exercised its authority under the recently passed Foreign Investment Risk Review Modernization Act (FIRRMA) to implement a Pilot Program that expands the jurisdiction of the Committee on Foreign Investment in the United States (CFIUS) and imposes mandatory filing requirements on certain transactions in the U.S. technology sector. The Pilot Program regulations are available here.

The Pilot Program requires parties to file a declaration with CFIUS at least 45 days in advance of certain foreign-person investments in U.S. businesses that are involved with critical technologies used in specified industry sectors.  Parties failing to file a required declaration may be subject to a civil penalty up to the amount of the transaction value.  Although future CFIUS regulations may exempt certain foreign countries and/or investors from the requirement, the Pilot Program applies to all foreign persons irrespective of nationality.  

The Pilot Program will impact many foreign investments across 27 U.S. industry sectors, including computer storage and semiconductor manufacturing, military hardware, research and development in biotechnology and nanotechnology, optical instrument and lens manufacturing, wireless communications, petrochemicals, energy storage and distribution, and others.   

The Pilot Program will end no later than March 5, 2020, although some form of mandatory filing requirement is expected to endure beyond that date.  

Mandatory Declaration Requirement

The Pilot Program requires the filing of a declaration with CFIUS at least 45 days in advance of certain investments by a foreign person in an “unaffiliated” U.S. business that produces, designs, tests, manufactures, fabricates, or develops one or more “critical technologies” that the U.S. business either utilizes in connection with its activities in, or designs specifically for use in, a “Pilot Program Industry.” 

Definitions relevant to the Pilot Program: 

• “Unaffiliated” means the foreign person does not already own a majority interest in nor appoint a majority of the board of directors of the U.S. business.  Thus, a foreign investor could increase its investment in an affiliated U.S. business without implicating the Pilot Program.
• “Critical technologies” means: 
  • Defense articles and defense services regulated by the International Traffic in Arms Regulations (ITAR).
  • Items on the Commerce Control List of the Export Administration Regulations (EAR) that are controlled for reasons relating to national security, chemical and biological weapons, nuclear proliferation, missile technology, regional stability, or surreptitious listening.  Such items do not include Export Control Classification Number “EAR99” items nor items controlled exclusively for anti-terrorism reasons.
  • Certain nuclear facilities, equipment, material, parts, components, and software.
  • Select agents and toxins.
  • “Emerging and foundational technologies” soon to be controlled pursuant to a separate, interagency process underway and expected to target technologies not currently subject to ITAR or EAR controls, possibly including technologies relating to artificial intelligence, robotics, cybersecurity, advanced materials, telecommunications, and biomedicine, among others.
• “Pilot Program Industry” means one of 27 industries identified by their North American Industry Classification (NAICS) Code and set forth in Appendix A to this alert.

Investments meeting the criteria above are nevertheless not subject to the declaration filing requirement if the investment would afford the foreign person:

• No “control” of the U.S. business by the foreign person, under the pre-FIRRMA, low-threshold, multifactored criteria that CFIUS has traditionally applied to that determination;
• No access to material nonpublic technical information that is necessary to design, fabricate, develop, test, produce, or manufacture critical technologies, including processes, techniques, and methods;
• No membership or observer rights on the U.S. business’s board of directors or equivalent, or the right to nominate such a person; or 
• No involvement, other than voting their non-“control” shares, in the substantive decision-making of the U.S. business regarding the use, development, acquisition, or release of “critical technology.”

Parties to a transaction otherwise subject to the Pilot Program that wish not to implicate the mandatory filing requirement and consequent CFIUS review should complete their transactions prior to the effective date (November 10, 2018); ensure that their transactions do not confer any of the foregoing rights upon the foreign investor; or confirm eligibility under the exemption for certain investment funds, discussed immediately below.

Exemption for Certain Investment Funds

As promised in FIRRMA, the Pilot Program exempts from the mandatory filing certain indirect foreign investments made through an investment fund.  An indirect investment by a foreign person in a Pilot Program U.S. business that affords membership as limited partner (or equivalent) on an advisory board or committee of the fund is not subject to the mandatory filing requirement if all of the following are true:

• The fund is managed exclusively by a general partner (or similar); 
• The foreign person is not the general partner (or similar);
• The advisory board or committee cannot approve, disapprove, or control:
  • investment decisions of the investment fund; or 
  • decisions of the general partner (or similar) related to the U.S. businesses in which the fund is invested.
• The foreign person cannot otherwise control the investment fund, including by:
  • approving, disapproving, or otherwise controlling investment decisions of the fund or of the general partner (or similar) regarding entities in which fund is invested; or
  • unilaterally dismissing, preventing the dismissal of, selecting, or determining the compensation of the general partner (or similar).
• The foreign person does not have access to material nonpublic technical information that is necessary to design, fabricate, develop, test, produce, or manufacture critical technologies, including processes, techniques, and methods.

(Note that the foreign person’s right to waive certain potential conflicts of interest, allocation limitations, or similar activities are not considered “control” except in extraordinary circumstances determined by the Committee.)

Timing considerations

The Pilot Program and its mandatory filing requirement do not apply to investments that are completed by November 10, 2018; or where, by October 11, 2018, the parties have executed a binding written agreement; a party has made a public offer to shareholders to buy shares of a Pilot Program U.S. business; or a shareholder has solicited proxies in connection with an election of the board of directors of a Pilot Program U.S. business or has requested the conversion of convertible voting securities.

If a transaction is subject to the mandatory filing requirement, parties must prepare and submit the requisite declaration — an electronic filing requiring significant information about the U.S. business, the foreign person, and the investment terms — no later than:

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

Once a declaration is accepted as completed, CFIUS has 30 days in which to review the declaration and (a) request that the parties prepare and file a formal CFIUS (long-form) notice, subject to the review time periods governing that process; (b) inform the parties that CFIUS cannot conclude action on the basis of the declaration, leaving to the parties the decision whether to file a notice (i.e., allow the parties to decide whether they want the certainty of CFIUS clearance of the transaction); (c) initiate a unilateral review of the transaction (presumably in rare cases); or (d) clear the transaction on the basis of the declaration by announcing that CFIUS has concluded all action in respect of the transaction.  

As an alternative, the parties could elect to file the formal CFIUS (long-form) notice to satisfy a mandatory filing requirement — an option that may be attractive if the parties anticipate CFIUS would not likely be satisfied with the declaration or abbreviated time for review and may request that the parties file a notice in any event.  

Penalty for failure to file mandatory declaration  

CFIUS may issue a civil penalty not to exceed the value of the subject transaction.

APPENDIX A

• Aircraft Manufacturing, NAICS Code: 336411
• Aircraft Engine and Engine Parts Manufacturing, NAICS Code: 336412
• Alumina Refining and Primary Aluminum Production, NAICS Code: 331313
• Ball and Roller Bearing Manufacturing, NAICS Code: 332991
• Computer Storage Device Manufacturing, NAICS Code: 334112
• Electronic Computer Manufacturing, NAICS Code: 334111
• Guided Missile and Space Vehicle Manufacturing, NAICS Code: 336414
• Guided Missile and Space Vehicle Propulsion Unit and Propulsion Unit Parts Manufacturing, NAICS Code: 336415
• Military Armored Vehicle, Tank, and Tank Component Manufacturing, NAICS Code: 336992
• Nuclear Electric Power Generation, NAICS Code: 221113
• Optical Instrument and Lens Manufacturing, NAICS Code: 333314
• Other Basic Inorganic Chemical Manufacturing, NAICS Code: 325180
• Other Guided Missile and Space Vehicle Parts and Auxiliary Equipment Manufacturing, NAICS Code: 336419
• Petrochemical Manufacturing, NAICS Code: 325110
• Powder Metallurgy Part Manufacturing, NAICS Code: 332117
• Power, Distribution, and Specialty Transformer Manufacturing, NAICS Code: 335311
• Primary Battery Manufacturing, NAICS Code: 335912
• Radio and Television Broadcasting and Wireless Communications Equipment Manufacturing, NAICS Code: 334220
• Research and Development in Nanotechnology, NAICS Code: 541713
• Research and Development in Biotechnology (except Nanobiotechnology), NAICS Code: 541714
• Secondary Smelting and Alloying of Aluminum, NAICS Code: 331314
• Search, Detection, Navigation, Guidance, Aeronautical, and Nautical System and Instrument Manufacturing, NAICS Code: 334511
• Semiconductor and Related Device Manufacturing, NAICS Code: 334413
• Semiconductor Machinery Manufacturing, NAICS Code: 333242
• Storage Battery Manufacturing, NAICS Code: 335911
• Telephone Apparatus Manufacturing, NAICS Code: 334210
• Turbine and Turbine Generator Set Units Manufacturing, NAICS Code: 333611