Final rule cements CFIUS’s broadened jurisdiction

Effective February 13, 2020, CFIUS’s jurisdiction to review foreign investment in the United States is as follows:

• All transactions that could result in foreign control of a U.S. business are subject to CFIUS jurisdiction.
• CFIUS also has jurisdiction to review non-controlling “covered investments” that afford a foreign person certain rights, access to information, or involvement in specified U.S. technology, infrastructure, and data (TID U.S. business), meaning a U.S. business that

(a) Produces, designs, tests, manufactures, fabricates, or develops one or more critical technologies;

(b) Performs certain functions related to critical infrastructure; or

(c) Maintains or collects – directly or indirectly – sensitive personal data of U.S. citizens.

• CFIUS also has jurisdiction to review “covered real estate transactions,” which include the purchase or lease by, or a concession to, a foreign person of certain real estate in the United States that affords the foreign person three or more of the following property rights: to physically access; to exclude; to improve or develop; or, to affix structures or objects. Covered real estate transactions focus on transactions in and around certain airports, maritime ports, military installations, and geographic areas.

Filings are mandatory for certain transactions involving foreign government interests and critical technologies, but final rule introduces exemptions

As contemplated in the proposed rule, parties are required to submit a mandatory declaration to CFIUS for a covered transaction that results in the acquisition of a “substantial interest” in a TID U.S. business by a foreign person in which the national or subnational governments of a single foreign state (other than an excepted foreign state) have a “substantial interest.” The final rule exempts investment funds from this requirement where the fund satisfies certain conditions regarding its management structure and foreign person involvement.

Mandatory declarations remain a requirement for a covered investment in, or transactions that could result in foreign control of, a TID U.S. business that produces, designs, tests, manufactures, fabricates, or develops one or more critical technologies for certain identified industries. Notably, however, the final rule exempts several transactions from the critical technology mandatory filing requirement, including investments related to foreign ownership, control, or influence-mitigated entities, certain encryption technology, and investment funds managed exclusively by, and ultimately controlled by, U.S. nationals.

CFIUS identifies Australia, Canada, and the United Kingdom as first “excepted” foreign states

 In addition to the above exemptions, as contemplated under FIRRMA and the proposed rule, the final rule creates a narrow exception from covered investments for investments by certain foreign persons defined as “excepted investors” based on their ties to certain countries identified as “excepted foreign states,” and on the foreign person’s compliance with certain laws, orders, and regulations. CFIUS has identified Australia, Canada, and the United Kingdom as the initial excepted foreign states and excepted real estate foreign states. The initial eligibility period for these states is February 13, 2020, until February 13, 2022. Following the end of the two-year delayed effectiveness period, CFIUS must make a determination as to whether those states will remain as excepted foreign states.

Foreign persons from the excepted foreign states are not afforded blanket or automatic exemptions from covered investments; rather, in order to qualify as an “excepted investor,” foreign persons must meet criteria regarding, for example, principal place of business, place of incorporation, ownership, and compliance with laws. The final rule also expands certain other criteria identified in the proposed regulations. Under the previous framework, to qualify as an “excepted investor,” all board members of the foreign investor were required to be either (1) U.S. nationals or (2) from an excepted foreign state. The final rule provides that only 75 percent of the board must satisfy this requirement. Further, the final rule increased the ownership percentage threshold at which a foreign owner must be from an excepted foreign state from 5 percent to 10 percent. The final rule also decreases the minimum excepted ownership percentage from 90 percent to 80 percent, meaning that the U.S. or excepted foreign state persons or entities must own at least 80 percent of an entity for it to maintain its excepted investor status.

This expansion reflects CFIUS’s desire to expand resources on transactions that warrant scrutiny and alleviate the burden of having to scrutinize a significant number of transactions that are benign.

Interim rule proposed, made effective for definition of principal place of business

In response to significant public comment on the proposed regulations, CFIUS has included an interim rule defining “principal place of business,” a term previously undefined. Although the definition is not yet final and is subject to a public comment period, CFIUS has made the definition effective as of February 13, 2020, in an effort to provide much-needed clarity to stakeholders. It is no surprise that many businesses, particularly investment funds, are organized outside of the United States but largely operate within the United States. The interim rule provides that an entity’s principal place of business is “the primary location where an entity’s management directs, controls, or coordinates the entity’s activities, or in the case of an investment fund, where the fund’s activities are primarily directed, controlled or coordinated by or on behalf of the general partner, managing member, or equivalent.” However, to the extent an entity has represented that its principal place of business is outside of the United States, such location will be deemed the entity’s principal place of business for CFIUS purposes until it can demonstrate otherwise.

While this may not significantly impact entities that largely operate offshore, for foreign entities that mostly operate within the United States – such as organizations that are structured offshore for tax reasons – the updated definition may mitigate CFIUS concerns as the entity potentially will not be considered “foreign” for CFIUS purposes.

Further changes are expected to filing requirements for investments in critical technologies 

The final rule integrates many of the components and the mandatory declaration requirement from the pilot program, which requires mandatory declarations for covered investments in critical technologies with a nexus to specified industries identified by North American Industry Classification System (NAICS) codes. This aspect of the pilot program has proven especially challenging and burdensome for many U.S. businesses, including in particular start-ups in critical technologies that are still in development stages and conceivably could apply their technologies to or engage with a range of industries. Moreover, as NAICS codes are largely a self-applied and subjective identification system, the requirement for declarations based upon this system, coupled with the potential for severe penalties, presents numerous flaws and questions of fairness. In response to significant public comment on this issue, the Treasury Department anticipates issuing a notice of proposed rulemaking that would revise the mandatory declaration requirement regarding critical technologies at section 800.401(c) from one based upon NAICS codes to one based upon export control licensing requirements.

Client Alert 2020-021