On September 15, 2020, the Committee on Foreign Investment in the United States (CFIUS), the inter-agency U.S. government body responsible for reviewing certain forms of inbound investment for national security risks, published a final rule, effective October 15, making important changes to the rules defining “critical technology” transactions subject to mandatory filing requirements.
CFIUS has traditionally allowed, but not required, parties to “covered transactions” to submit a filing to CFIUS to seek approval of their transaction. However, the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) authorized CFIUS to mandate filings for certain types of transactions. Transactions subject to mandatory filings under FIRRMA fall into two categories: certain investments involving “critical technology” and certain investments involving foreign governments. (See our prior International Law Advisory on FIRRMA’s implementing regulations here).
The final rule changes the circumstances in which a “critical technology” investment will trigger a mandatory filing requirement. The rule ends the use of North American Industry Classification System (NAICS) codes to identify specific industries subject to mandatory “critical technology” filings, in favor of a filing requirement based on U.S. export controls. A mandatory “critical technology” filing requirement is triggered under the final rule when a “U.S. regulatory authorization” would be required for the export, reexport, or transfer (in country) of the U.S. target company’s goods or technologies to the foreign investor or certain other foreign persons involved in the transaction. The final rule also makes modest clarifications to the second category of transactions involving foreign government interests. (See our prior blog post on the proposed version of the rule here).
Critical Technology Mandatory Filings
The new rule mandates filings for covered transactions involving a U.S. business that “produces, designs, tests, manufactures, fabricates, or develops one or more critical technologies” where a “U.S. regulatory authorization” would be required for the export, reexport, or transfer of such critical technologies to a foreign person that:
- Could directly control such a business as a result of the transaction;
- Is directly acquiring an interest that is a “covered investment” in such a business;
- Has a direct interest in such a business and whose rights are changing in a manner that constitutes a covered transaction;
- Is a party to a transaction or similar dealing designed or intended to evade or circumvent the CFIUS process; or
- Individually or as part of a group of foreign persons holds a “voting interest for purposes of critical technology mandatory declarations” in one of the above described persons.
The term “voting interest for purposes of critical technology mandatory declarations” will be defined at Section 800.256 to mean “a voting interest, direct or indirect, of 25 percent or more.” The rule adds that for entities directed, controlled, or coordinated by a general partner or equivalent, “a person will be considered to have a voting interest for purposes of critical technology mandatory declarations in such entity only if it holds 25 percent or more of the interest in the general partner, managing member, or equivalent of the entity.” For purposes of determining voting interests held indirectly, any interest of a “parent,” as defined in Section 800.235 of the current CFIUS regulations (generally entities with a 50% or greater interest), “will be deemed to be a 100 percent interest in any entity of which it is a parent.”
The term “U.S. regulatory authorization includes:”
- A license or other approval issued by the Department of State under the International Traffic in Arms Regulations (ITAR);
- A license from the Department of Commerce under the Export Administration Regulations (EAR);
- Certain authorizations from the Department of Energy related to assistance to foreign atomic energy activities; or
- A specific license from the Nuclear Regulatory Commission under its regulations governing the export or import of nuclear equipment and material.
Importantly, under Section 800.401(c)(2)(i) whether a U.S. regulatory authorization is required must be determined “without giving effect to any license exemption available under the ITAR or license exception available under the EAR,” subject to limited exceptions for three EAR license exceptions: (1) Technology and Software Unrestricted (TSU); (2) paragraph (b) of Encryption, Commodities, Software, and Technology (ECN); and (3) paragraph (c)(1) of Strategic Trade Authorization (STA).
The shift away from NAICS codes and toward U.S. export controls will have important implications for whether certain transactions are subject to the mandatory filing requirements of CFIUS. As a general matter, the shift should result in a reduced number of mandatory filings for transactions involving U.S. allies and countries participating in multilateral export control regimes such as the Wassenaar Arrangement, and relatively more transactions involving countries subject to higher levels of U.S. export controls such as China.
The change also underlines the importance of U.S. companies and foreign investors conducting a careful export controls analysis of the U.S. target company’s products and technologies before closing on a given transaction, including determining the appropriate classification of all relevant items, including technology; reviewing the applicable controls for such items and whether a license is required for export to foreign persons involved in the transaction; and whether one of the enumerated license exceptions, noted above, is applicable.
Mandatory Filings for Transactions Involving Foreign Governments
The CFIUS regulations also mandate filings for transactions in which a foreign person is acquiring a “substantial interest” in a U.S. critical technology, critical infrastructure, or sensitive personal data company, as defined in CFIUS’s current regulations, and a foreign government has a “substantial interest” in that foreign person. The new CFIUS rule makes two modest changes to the definition of “substantial interest.” The first change applies to Section 800.244(b), the provision calculating substantial interest in situations in which there is a “general partner, managing member, or equivalent.” The new rule clarifies that the provision applies only in situations in which an entities’ activities are “primarily directed, controlled, or coordinated by or on behalf” of a general partner, managing member, or equivalent. The second change adjusts the term “voting interest” to just “interest” in Section 800.244(c), which outlines how to calculate the interest of a parent entity in a subsidiary.