May 22, 2020

Client Alert: CFIUS Proposes Changes to Mandatory Filing Requirements


Jump to...



The U.S. Treasury Department this week published draft regulations changing the requirements for mandatory CFIUS filings for transactions in which a foreign person acquires or invests in a U.S. critical technology company. Under the proposed rule, the trigger for the mandatory CFIUS filing requirement would depend on whether U.S. export licenses are required for shipments of the U.S. target’s products or technology to the foreign investor’s country of origin. This would replace the current system in which a mandatory filing is determined, in part, by whether the U.S. company uses, or designs its critical technology for use, in one of 27 industries identified in the CFIUS regulations based on their classification under the North American Industry Classification System (NAICS). The proposed rule removes some of the guesswork from the current NAICS-based rules, which are generally self-declared by U.S. companies. By tying the criteria for mandatory declarations to export-licensing requirements, the proposed regulations also further limit mandatory declarations to certain higher-risk countries.

The proposed rule is open to public comment until 30 days after publication in the Federal Register. The Treasury Department has indicated for some time that it will transition to an export control focus for determining which transactions would be subject to mandatory filing requirements. As such, it is very likely that the proposals will be implemented as final regulations largely in their current form.

Background: Implementing FIRRMA

Two years ago, Congress passed and the President signed into law the Foreign Investment Risk Review Modernization Act of 2018, which overhauled the CFIUS national security review process. Among the most substantive changes, FIRRMA expanded CFIUS’s jurisdiction to include non-controlling foreign investments in U.S. businesses that operate critical infrastructure, deal in critical technologies or possess sensitive personal data of U.S. citizens. FIRRMA also for the first time required parties to certain transactions involving foreign investors to make a CFIUS filing or short-form declaration. Prior to FIRRMA, CFIUS filings were voluntary in nearly all cases, although CFIUS could self-initiate a review. Companion legislation, called the Export Control Reform Act of 2018, tightened rules governing U.S. export controls, with a particular focus on exports of U.S.-origin emerging and foundational technologies.

In November 2018, the Treasury Department took the first steps in implementing FIRRMA by initiating the Critical Technologies Pilot Program, which required a mandatory short-form CFIUS declaration for controlling and non-controlling foreign investments in U.S. businesses that produce, design, test, manufacture, fabricate or develop a “critical technology” for use in one of 27 industries, provided that the foreign investor had access to “material nonpublic technical information” of the U.S. business; board membership or observer rights in the U.S. business; or involvement in key decision-making regarding the development of critical technologies by the U.S. business. The industries were listed by their NAICS codes.

On February 12, 2020, the Treasury Department issued final regulations implementing most of the provisions of FIRRMA. The new regulations absorbed and replaced the Pilot Program, which was terminated in lieu of the new regulations. Those Pilot Program rules now apply only to transactions completed between November 10, 2018, when the program went into effect, and February 13, 2020. Treasury indicated in the February regulations that it would likely be proposing rulemaking that would revise the mandatory declaration for critical technology investments from one based on NAICS codes to one based on U.S. export licensing requirements.”

The Proposed Rule

The proposed rule, when finalized, will change the mandatory filing requirement for acquisitions of, or investments in, U.S. businesses that produce, design or develop critical technologies so that it is “based on whether certain U.S. government authorizations would be required to export, re-export, transfer (in country), or retransfer the relevant critical technologies by the U.S. business to certain transaction parties and foreign persons in the ownership chain.” The authorizations, which refer to export licensing requirements, would be those required by the major U.S. export control regimes, including the (i) International Traffic in Arms Regulations, which cover defense-related products and services on the U.S. Munitions List and are administered by the U.S. State Department; (ii) the Export Administration Regulations, which cover dual use items and are administered by the U.S. Commerce Department; (iii) certain authorizations administered by the U.S. Energy Department under the regulations governing assistance to foreign atomic energy activities; and certain licenses administered by the Nuclear Regulatory Commission. U.S. export control rules in some cases authorize exporting without applying for a license based on what is known as an “exception.” Exceptions authorize companies to export without applying for a license if certain general conditions are met. The new rule indicates that, with a few noted exceptions, a U.S. export license is considered to be required in the context of a mandatory CFIUS filing even though a license exception or exemption may be available under the EAR or ITAR.

In a provision that is particularly relevant to investments made through private equity or venture capital investment funds, the proposed rule introduces the term “voting interest for purposes of critical technology mandatory declarations” to describe which foreign persons in the ownership chain and their countries of origin should be analyzed in determining whether a particular transaction could trigger a mandatory filing. The rule would apply a threshold of a 25 percent voting interest, direct or indirect, in the foreign persons involved in the transaction to determine which countries are involved in the transaction and which export license requirements apply. This provision appears designed to exercise CFIUS jurisdiction over significant indirect foreign investors who could otherwise be hidden from CFIUS’s view. For entities whose activities are primarily directed, controlled or coordinated by or on behalf of a general partner or equivalent, the threshold would be a 25 percent interest in the entity’s general partner. For purposes of determining the percentage of interest held indirectly by one entity in another, the rule establishes that any interest of a parent entity in a subsidiary entity will be deemed to be a 100 percent interest.

A determination of whether an export license would be required would be based on a foreign investor’s principal place of business or the investor’s nationality under the relevant U.S. regulatory authorizations. The CFIUS regulations define principal place of business as “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 and investments are primarily directed, controlled, or coordinated by or on behalf of the general partner, managing member, or equivalent.”

The proposed rule also includes additional clarifying amendments related to the other situation in which a mandatory CFIUS declaration is required, namely when a transaction could result in a foreign government entity acquiring a “substantial interest” in a U.S. business that deals in critical technologies, performs certain functions in critical infrastructure or collects sensitive personal data of U.S. citizens. “Substantial interest” in this context means that the foreign investor will have at least a 25-percent voting share in a so-called “U.S. TID business” and a foreign government holds an interest of at least 49 percent in the foreign investor. In the case of an entity with a general partner, foreign persons are considered to have a substantial interest when they would hold 49 percent or more of the interest in the general partner. The proposed rule clarifies that this only applies in the case of “an entity whose activities are primarily directed, controlled, or coordinated by or on behalf of a general partner.”

The new rules will apply to transactions that were completed, or for which there was a binding agreement, as of February 13, 2020.

Impact of the Proposed Rule

The latest updates of the CFIUS regulations are important for a number of reasons. First, they take some of the guesswork out of deciding whether a transaction is subject to mandatory CFIUS filing requirements. The NAICS-related criteria that were the basis of the Pilot Program regulations and the broader February update to the regulations made for a difficult analysis of which U.S. targets were covered. Companies generally do their own analysis of their classification under NAICS codes and companies are often covered by several codes. In addition, the business and manufacturing activities of many companies straddle the NAICS codes that are listed in the current regulations. This makes for an especially consequential analysis given the steep penalties provided in FIRRMA for failure to make a mandatory filing.

Second, the new criteria permit policy makers in the U.S. Government to further distinguish among countries in the context of national security. U.S. export license requirements are based on an analysis of the sensitivity of the product, service or technology being exported as well as the national security threat posed by the export’s destination country. CFIUS already distinguishes in its regulations between “excepted” countries and investors and those that are not. It now can rely on export control rules to target investments made by countries the U.S. Government considers a potential national security threat.

Special thanks to Lisa Raisner, Head of Government Relations, who co-authored this publication.