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On November 10, 2018, interim regulations adopted by the US Department of Treasury under the newly enacted Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”) go into effect. These interim regulations act as a pilot program while formal FIRRMA regulations are formulated and go into effect on the sooner of February 20, 2020 or the finalization of the regulations. The new rules change the landscape of US review of transactions involving foreign companies or persons acquiring an interest in US companies presenting national security concerns.
Private equity investment funds with foreign investors (whether foreign persons or companies, or US companies controlled by such entities) may be particularly susceptible to the new filing requirements. It is not unusual for late-stage investors to provide substantial cash infusions into start-ups in exchange for board seats. If the start-up falls within one of the enumerated business segments, then a FIRRMA filing would be required. The issue of access to “nonpublic technical information” in the hands of the US target, currently an expected occurrence by substantial investors, could also be problematic.
The Committee on Foreign Investment in the United States (“CFIUS”) was organized under the auspices of the Defense Production Act of 1950 and it reviews for potential national security issues transactions involving the acquisition of control of US companies by foreign government controlled companies or persons. The Committee consists of nine members, with the chair being the Secretary of the Treasury, and the remaining seats being occupied by the Departments of Justice, Homeland Security, Commerce, Defense, State, and Energy, the Office of the US Trade Representative and the Office of Science and Technology.
Currently if the parties to a transaction believe that it potentially involves national security risk, they can submit a draft joint voluntary notice which informs CFIUS of the nature of the transaction and the reasons why the transaction does not present security concerns. CFIUS reviews the notice, provides comments to the parties and decides whether to initiate an investigation. CFIUS can also initiate an investigation of a transaction where no filing has been made. While approximately 70% of CFIUS notices resulted in investigations through 2017, only five transactions were blocked by the President, including the 2018 proposed acquisition of Qualcomm by Broadcom, a semiconductor company located in Singapore.
The interim regulations turn this process on its head. Now if the target US company is engaged in one of the following businesses, then a declaration is required to be filed with CFIUS, the failure of which could result in a fine up to the value of the transaction:
Aircraft engine and parts manufacturing
Alumina refining and production
Ball and roller bearing manufacturing
Computer storage device manufacturing
Guided missile and space vehicle manufacturing
Guided missile and space vehicle propulsion unit and parts manufacturing
Military armored vehicle, tank and tank component manufacturing
Nuclear electric power generation
Optical Instrument and lens manufacturing
Other basic inorganic chemical manufacturing
Other guided missile and space vehicle parts and auxiliary manufacturing
Powder metallurgy parts manufacturing
Power, distribution, and specialty transformer manufacturing
Primary battery manufacturing
Radio and television broadcasting and wireless communications equipment manufacturing
Research and development in nanotechnology
Research and Development in biotechnology (except nanotechnology)
Secondary smelting and alloying of aluminum
Search, detection, navigation, guidance, aeronautical, and nautical system and instrument manufacturing
Semiconductor and related device manufacturer
Semiconductor machinery manufacturing
Storage battery manufacturing
Telephone apparatus manufacturing, and
Turbine and turbine generator set units manufacturing
There are certain exceptions to the mandatory filing requirement, but given the magnitude of the penalty for non-filing, due care must be exercised in making the filing decision. The fact that the acquisition does not result in control of the US company does not have preclusive effect. The filing obligation arises from two basic scenarios. First, the traditional CFIUS filing requirement for foreign government control of a US company in a “covered transaction.” Second, the new interim regulation filing requirement arises in transactions involving the acquisition of less than control by a foreign person (or a US entity that is controlled by a foreign person or entity) in one of the business segments enumerated above (including the testing and developing of such segments). In addition, the foreign person must assess the following: 1) access to material nonpublic information in possession of the US target; 2) membership or observer rights on the board of directors of the US target or the right to nominate board members; or 3) any involvement in substantive decision-making of the US target in regard to the referenced business segments. These three criteria form the bases for deciding whether the transaction is not subject to the new interim rule filing requirement.
While the interim regulations appeared to be dealing with problematic investments by China or other countries posing national security risks, there is no such limitation in the interim FIRRMA regulations. Any and all foreign investment in US companies engaged in the targeted segments present the need for careful analysis of a FIRMMA filing with CIFIUS.