Headlines show that foreign governments, particularly China, have used clandestine methods to obtain, copy and use intellectual property developed and owned by American businesses. These methods originally included criminal acts such as bribery, commercial spying and outright theft of property. Criminal indictments have been obtained against numerous foreign nationals and American citizens working conspiratorially with them, for outright stealing of intellectual property with military and national security implications, as well as improper purchase and shipping of protected military and national security assets.
With the advent of prosperity, aided in part by these thefts, and being welcomed into international commerce, there is a newer and more insidious threat to American intellectual property and to our worldwide commercial and military influence and might: foreign interests simply (and legally) buying access to and even control over strategic American business and military assets. This is an “invasion” that is real, that has happened and is a continuing threat.
FIRRMA Changes to the CFIUS Regime Begin to Take Effect
Seeking to curtail the uncompensated taking of American intellectual property and business secrets, the U.S. Treasury has begun the process of implementing the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA). The law, which President Donald Trump signed this summer, significantly changes the procedures used to conduct national security reviews of foreign investments in the United States.
Review of Foreign Investments
Prior to FIRRMA, section 721 of the Defense Production Act of 1950 (DPA) authorized the Committee on Foreign Investment in the United States (CFIUS) to review mergers, acquisitions, and takeovers by or with any foreign person which could result in foreign control of any person engaged in interstate commerce in the United States. The reviews are conducted to determine the effects of such transactions on the country’s national security.
FIRRMA modified and broadened the authorities of the President and CFIUS under section 721 to expand the scope of foreign investments in the United States subject to national security review pursuant to section 721. While several FIRRMA provisions took effect immediately, others require implementing regulations. FIRRMA also authorizes the U.S. Department of the Treasury, as chair of CFIUS, to conduct pilot programs to implement provisions in the legislation that did not become effective immediately upon enactment.
FIRMMA Pilot Program
As set forth in the U.S. Treasury’s Pilot Program Interim Rule, the pilot program expands the scope of transactions subject to CFIUS review to include certain non-controlling investments in U.S. businesses involved in critical technologies related to specific industries. As detailed in the rulemaking, “the purpose of implementing a pilot program addressing these areas is to confront the rapid changes in certain critical technology industries, the significant growth of certain types of foreign investment in those industries, and the current inability of CFIUS to review non-controlling transactions, which creates an unacceptable risk of undermining U.S. technological superiority in industries with national security implications.” The pilot program also makes effective FIRRMA’s mandatory declarations provision for transactions that fall within the scope of the pilot program. Below are several key aspects of the regulations:
- Covered Investments: For an investment to be covered under the pilot program, it would have to give the foreign investor: Access to any material nonpublic technical information in the possession of the target U.S. business; 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 a position on the board of directors or equivalent governing body of the U.S. business; or 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 critical technology.
- Covered U.S. Businesses: The pilot program covers any U.S. business that produces, designs, tests, manufactures, fabricates, or develops a critical technology that is: (1) utilized in connection with the U.S. business’s activity in one or more Pilot Program Industries; or (2) designed by the U.S. business specifically for use in one or more Pilot Program Industries (Pilot Program U.S. Businesses).
- Covered Critical Technologies: The pilot program covers critical technologies, which are defined as: (a) defense articles or defense services controlled by the International Traffic in Arms Regulations; (b) items controlled by the Export Administration Regulations (1) pursuant to multilateral regimes relating to national security, chemical and biological weapons proliferation, nuclear nonproliferation and missile technology or (2) for reasons relating to regional stability or surreptitious listening; (c) specially designed nuclear equipment, parts and components, materials, software and technology; (d) nuclear facilities, equipment and material; (e) certain poisonous agents and toxins; and (f) emerging and foundational technologies.
- Covered Industries: The pilot program covers 27 industries, identified by their respective North American Industry Classification System (NAICS) code (Pilot Program Industries). The list of Pilot Program Industries includes those in which certain strategically motivated foreign investments could pose a threat to U.S. technological superiority and national security. Examples include manufacturing, alloying, nuclear electric power generation, and nanotechnology.
- Mandatory declarations: The pilot program establishes mandatory declarations (i.e., abbreviated notices that generally should not exceed five pages in length) for foreign transactions involving Pilot Program U.S. Businesses that are within the purview of CFIUS (i.e., both controlling investments and “other investments”). Declarations must be filed at least 45 days prior to a transaction’s expected completion date. The Committee will have 30 days to take action. Parties may choose to file a notice under CFIUS’s standard procedures rather than a declaration. Parties that are required to file with CFIUS and do not do so can be assessed a civil monetary penalty up to the value of the transaction.
- Safe Harbor for Private Equity: The rules include a safe harbor under which an indirect investment by a foreign person in a U.S. business via an investment fund where the foreign person serves on an advisory board or committee will not be considered a covered investment under the pilot program, so long as the following are satisfied: (1) The fund is managed exclusively by a general partner, a managing member, or an equivalent who is not a foreign person; (2) The advisory board or committee does not have the ability to approve, disapprove, or otherwise control investment decisions of the investment fund or decisions made by the general partner, managing member, or equivalent related to entities in which the investment fund is invested; (3) The foreign person does not otherwise have the ability to control the investment fund, including the authority to approve, disapprove, or otherwise control investment decisions of the investment fund; to approve, disapprove, or otherwise control decisions made by the general partner, managing member, or equivalent related to entities in which the investment fund is invested; or to unilaterally dismiss, prevent the dismissal of, select, or determine the compensation of the general partner, managing member, or equivalent; and (4) The foreign person does not have access to material nonpublic technical information as a result of its participation on the advisory board or committee.
The pilot program started on November 10, 2018. It will end no later than the date on which the final FIRRMA regulations are fully implemented, which is no later than February 2020. Given the breadth and significance of the changes, we encourage private equity funds and other businesses that may now fall under the purview of CFIUS to contact an experienced business attorney.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work at 201-806-3364.