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CFIUS Reform Legislation Unveiled: Senator Cornyn and Representative Pittenger Introduce the Foreign Investment Risk Review Modernization Act (FIRRMA)November 9, 2017
On November 8, 2017, Senator John Cornyn (R-TX) and Representative Robert Pittenger (R-NC) introduced legislation to “modernize and strengthen the Committee on Foreign Investment in the United States [CFIUS] to more effectively guard against the risk to the national security of the United States posed by certain types of foreign investment[.]” As Mr. Pittenger put it more succinctly, he is “Taking Aim at China.”
Section 721 of the Defense Production Act of 1950 (50 U.S.C. § 4565) authorizes the President to block foreign acquisitions of control of US businesses (whether through majority or minority interests) on national security grounds. CFIUS is an inter-agency committee, chaired by the Department of the Treasury, that largely implements the President’s Section 721 authority. The law provides the statutory basis for CFIUS and establishes the basic procedures under which it operates. Congress last enacted major CFIUS reforms in 2007, and CFIUS operates under amended regulations promulgated in late 2008. 31 C.F.R. Part 800.
The long-anticipated bill—the Foreign Investment Risk Review Modernization Act (FIRRMA)—attracted bipartisan co-sponsors, including Senator Dianne Feinstein (D-CA). The 79-page bill proposes numerous amendments to CFIUS’s jurisdiction, substantive responsibilities, investment review process, and internal administration. While many of these changes would simply codify current CFIUS administrative practices, others would have a more far-reaching impact on cross-border transactions, particularly those involving Chinese investors. As the sponsors make clear, the bill responds directly to increasing alarm about Chinese government-backed acquisitions of advanced technologies held by US companies.
Significant Changes to Jurisdiction, Process, and Enforcement
- Expanded CFIUS Jurisdiction: FIRRMA would expand the reach of Section 721 in several respects, while codifying other administrative practices (e.g., CFIUS routinely reviews real estate transactions). Newly within CFIUS jurisdiction would be:
- Any “type of arrangement” (including joint ventures) involving a US “critical technology company” to which the US company contributes intellectual property and “associated support.” CFIUS would have jurisdiction over these transactions—even if they do not involve an investment by the foreign party in the US. The proposal targets the product development joint ventures into which many US technology companies have entered with Chinese partners in recent years. The provision exempts arrangements that contribute IP “through an ordinary customer relationship.” By rule, CFIUS may exempt other types of transactions as well, including ones that it finds may be addressed through alternative statutory authorities (e.g., export control rules).
- Minority investments that afford virtually any right to the foreign investor beyond voting its interests consistent with its investment share. CFIUS rules provide safe harbors for certain “passive” investments and other minority investments that are not “dominant.” CFIUS administrative practice in the past few years, however, has essentially eliminated every real-world conception of what constitutes a passive or non-dominant minority, finding that even small voting stakes with limited board representation are covered transactions. FIRRMA would erase the last vestiges of such safe harbors.
- Transactions that CFIUS determines are structured to “evade or circumvent” CFIUS jurisdiction. It is not clear what types of transactions the sponsors have in mind by including this entirely subjective basis for asserting jurisdiction. It can only mean, however, that CFIUS may assert authority to review transactions that are otherwise not within its jurisdiction.
- Emphasizing “Fundamental Technologies”: While CFIUS already gives particular scrutiny to transactions involving US “critical technologies” and “critical infrastructure,” FIRRMA emphasizes this core focus. The bill would introduce expanded definitions of “critical technologies” and “critical infrastructure,” add the concept of “critical materials,” and infuse the CFIUS review process with the concept of protecting fundamental technologies that contribute to US technological superiority from a national security standpoint.
- Good Guys and Bad Guys: The bill would direct scrutiny of various types of transactions where the foreign investor is from a “country of special concern”—“a country that poses a significant threat to the national security interests of the United States.” CFIUS need not identify these countries, but the sponsors certainly assume that China and Russia fit that profile.
On the other hand, FIRRMA offers the prospect of exemptions and more streamlined reviews for various investments by persons from “Identified Countries.” CFIUS will identify these countries based on any “appropriate” criteria that it chooses. But the bill specifically frames the concept as an exemption for countries with which the United States has a mutual defense treaty or otherwise shares a common approach to national security reviews of foreign investments. Identified Countries thus likely would include the members of NATO, Japan, South Korea, the Philippines, Australia, and New Zealand—which in fact were collectively the sources of the vast majority of foreign direct investment into the United States (and CFIUS cases) in recent years.
- Alternative Short-form Notifications: In a bid to attract support from those doing business with Identified Country investors, FIRRMA would create a wholly new avenue for securing CFIUS clearance: filing “declarations” of no more than five pages. Although FIRRMA would not require CFIUS to act on these declarations, it directs the Committee to “endeavor” to take one of four actions within 30 days: (1) request a formal notice; (2) advise the parties that it cannot complete action based on the declaration, while informing them that they may file a formal notice to initiate a review; (3) initiate a formal review; or (4) clear the transaction.
As with formal notices, parties to covered transactions would make the voluntary decision to file a declaration instead of a formal notice. However, in a significant departure from the historic voluntary notification approach under Section 721, the bill would require parties to file at least declarations for any transaction for which (a) the buyer is a foreign government or controlled by a foreign government, and (b) the proposed acquisition would transfer an interest of at least 25% to the buyer. CFIUS further would be authorized to require declarations to be filed regarding other types of sensitive transactions.
- Filing Fees: Among several provisions addressing the resources available to support CFIUS operations, the most consequential for parties is provision for a mandatory filing fee, the amount to be set by CFIUS. Fees would be capped at the lesser of 1% of the transaction’s value or $300,000 (indexed for inflation), so that transactions valued at $30 million or more would face a $300,000 fee. Currently, no filing fees are required for CFIUS notifications.
- Extended Periods of Review and Investigation: FIRRMA would extend the initial CFIUS review period to 45 calendar days from 30, and authorize CFIUS to extend the investigation period from 45 days to 75 days in “extraordinary” cases. Parties thus should assume a baseline period of 120 days for processing sensitive cases, instead of 75 days.
- Expanded Enforcement Authority: FIRRMA would substantially increase Section 721’s requirements for mitigation agreements, monitoring, and enforcement. It would codify existing practice by requiring CFIUS to determine that mitigation agreements are effective, verifiable, and able to be monitored effectively. The bill also would (1) authorize CFIUS to require mitigation agreements for abandoned transactions and (2) authorize CFIUS to initiate an enforcement action for breaches that are not intentional, and to require sanctioned parties to file notices with the Committee of any transaction for five years.
- Effective Dates: FIRRMA provides for separate effective dates for two groups of amendments. First, numerous provisions that require no further consideration by CFIUS take effect on the date of the enactment and apply to any covered transaction for which CFIUS initiates a review or investigation on or after that date. Second, all other amendments would become effective 30 days after publication in the Federal Register of a determination by the CFIUS Chair “that the regulations, organizational structure, personnel, and other resources necessary to administer the new provisions are in place[.]” This group includes the application of Section 721 to transactions, including IP licensing deals, that fall within the expanded scope of jurisdiction; the new declaration procedure; filing fees; monitoring and compliance provisions that will require time to implement; and various other provisions that similarly are dependent on promulgation of interpretative rules by CFIUS. The second effective date would apply to any covered transaction for which CFIUS initiates a review or investigation on or after that date.
- Geographically Divergent Treatment of Investments: Non-discriminatory treatment of investment is a central tenet of US investment policy, enshrined in Bilateral Investment Treaties and countless statements by government officials. FIRRMA would create different tracks for CFIUS scrutiny based on criteria that would routinely treat transactions differently because of the nationality of the investors from “Countries of Special Concern,” “Identified Countries,” and all others. To be sure, the criteria are grounded in rational assumptions about national security risk, but one may expect serious protests from disadvantaged countries and potentially retaliatory treatment of US investors in those countries.
The option of filing short-form declarations, with the potential for fast-track final decisions and at no fee, could provide real benefits to companies operating in many industries, especially outside of the tech sector, and from countries that ordinarily are not the sources of national security concern. For example, of the 143 new CFIUS cases in 2015 (the last year for which data are available), 97 involved investors from Europe, Canada, Japan, or Australia, while 29 involved Chinese investors. FIRRMA’s provision allowing CFIUS to create “exemptions” from the filing requirements for countries that do not pose security concerns suggests this could be a significant change.
- Extraterritorial Jurisdiction and Focus on Technology: Enlarging the scope of CFIUS jurisdiction to capture outbound licensing transactions and joint ventures could have far-reaching consequences for the “critical technology” companies that are directly impacted. Giving CFIUS the responsibility to regulate transactions outside the US that are not investments also gives pause as a precedent. This provision squarely presents the question of whether the CFIUS process or export control regulations are the proper mechanism to address the issues raised by China’s aggressive push to acquire important US technologies.
- “To Be Determined”: FIRRMA leaves ambiguous the ultimate scope of numerous provisions by authorizing CFIUS to complete the picture through regulation. This approach leaves open the possibility for limiting the negative impact of some provisions and no doubt is intended to calm fears among those most directly impacted by the bill. But, CFIUS may deploy the same discretion to interpret the legislation more, not less, expansively. Most importantly, key concepts such as the expansions of jurisdiction likely will not take effect until well into 2018. After Congress amended Section 721 in 2007, final regulations reflecting the changes did not become effective until December 2008.
- Paths Not (Yet) Taken: What FIRRMA does not propose is also noteworthy. The bill passes on a number of more restrictive approaches that various commentators and lawmakers have proposed, including an economic benefits or reciprocity test, a prohibition on all investments by state owned entities from listed countries, and an even greater range of mandatory notices.
1 By comparison, public companies and other issuers must pay the Securities and Exchange Commission a fee to register their securities; for FY2018, the fee is $124.50 per million dollars. Parties to transactions that are notified to the Federal Trade Commission under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 must pay fees according to the size of the transaction. For 2017, the fees are set at $45,000 for transactions valued at less than $161.5 million; $125,000 for transactions valued from $161.5 million to $807.5 million; and $280,000 for transactions valued at $807.5 million or more.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Theodore Kassinger, an O'Melveny partner licensed to practice law in the District of Columbia and Georgia, and Mary Pat Dwyer, an O'Melveny associate licensed to practice law in the District of Columbia and Pennsylvania, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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