FIRRMA: exploring new CFIUS proposals

January 2020  |  FEATURE  |  MERGERS & ACQUISITIONS

Financier Worldwide Magazine

January 2020 Issue

Much anticipated, and in the view of many, long overdue, the Foreign Investment Risk Review Modernization Act (FIRRMA) was signed into law by president Donald Trump on 13 August 2018, with an expectation that it would have a profound impact on the level of investment in the US.

A driving factor in FIRRMA’s introduction was the perception that the Committee on Foreign Investment in the US (CFIUS) – an interagency committee authorised to review certain transactions involving foreign investments in the US in order to determine their effect on US national security – lacked the authority to review and potentially block such investments. Many of these transactions pertain to China, which, it is alleged, deploys foreign direct investment (FDI) as a tool to access sensitive US technology and infrastructure.

Enacted with overwhelming bipartisan support, FIRRMA’s purpose is to broaden the authority of CFIUS to block transactions that could conceivably threaten US national security. Moreover, on 10 October 2018, the US Department of the Treasury, which chairs CFIUS, issued an interim rule establishing the FIRRMA Pilot Program to implement portions of the legislation.

The Pilot Program expanded CFIUS’s jurisdiction to cover certain non-controlling, non-passive investments in companies involved with critical technologies within a specific subset of industries, and mandated that parties file declarations for all transactions covered by the Pilot Program. However, despite the best efforts of officials, the impact of FIRRMA thus far has been difficult to quantify.

“It does not appear that FIRRMA itself has had a discernible impact on investment in the US,” suggests Gregory L. Kinzelman, special counsel at Schulte Roth & Zabel LLP. “FIRRMA does not seem to be the most significant of the many factors that influence foreign investment. For example, foreign investment from China has been down since China restricted the outflows of capital a few years ago, which preceded FIRRMA and was unrelated to CFIUS activity.

“Although stricter CFIUS enforcement in areas such as computer software, chip technology and sensitive personal data is seen as being responsible for the view that some US businesses are now off limits to investors from countries believed to present security risks to the US, of the recent CFIUS enforcement action that has become public, none of it appears to have been as a direct result of the FIRRMA Pilot Program or FIRRMA provisions,” he continues. “Indeed, FIRMMA, in many ways, codified existing CFIUS practice that had expanded beyond prior regulations.”

What FIRRMA has done, however, is to persuade some US funds to restructure themselves and their governance to ensure that they comply with the requirements of the FIRRMA Pilot Program ‘safe harbour’ – a provision which gives US investment funds with foreign investors protection from being treated as a foreign person under CFIUS rules.

“We are also seeing US businesses in which funds invest and other counterparties requesting representations from funds and investors that they satisfy the safe harbour requirements or otherwise do not qualify as a foreign person subject to CFIUS enforcement,” adds Mr Kinzelman.

The new CFIUS proposals

In a move designed to better address national security concerns arising from certain investments and real estate transactions, on 17 September 2019, CFIUS proposed additional regulations that will continue the implementation of FIRRMA and further widen the scope of FDI transactions subject to CFIUS review.

According to the US Department of the Treasury, the proposed regulations, among other things, implement CFIUS’s new jurisdiction over certain non-controlling investments into certain US businesses involved in critical technology, critical infrastructure or sensitive personal data. They also implement CFIUS’s new jurisdiction over certain real estate transactions involving foreign persons.

“The US welcomes and encourages investment in our country and our workforce,” said treasury secretary Steven T. Mnuchin. “The proposed regulations will provide clarity and certainty to investors regarding CFIUS’s enhanced authorities to address national security risks that arise from certain foreign investments and continue modernising the CFIUS process.”

The proposed regulations have been issued in two parts. First, provisions pertaining to non-controlling investments in the US by foreign persons. Second, provisions pertaining to certain transactions by foreign persons involving real estate in the US.

Provisions pertaining to non-controlling investments in the US by foreign persons. The first issuance expands CFIUS’s jurisdiction beyond transactions that could result in foreign control of a US business to also include a non-controlling investment, direct or indirect, by a foreign person that affords the foreign person: (i) access to any material non-public technical information in the possession of a US business; (ii) membership or observer rights on the board of directors or equivalent governing body of a US business or the right to nominate an individual to a position on the board of directors or equivalent governing body; and (iii) any involvement, other than through voting of shares, in substantive decision making of a US business regarding the use of sensitive personal data of US citizens or the use of critical technologies and critical infrastructure.

Furthermore, these regulations would only apply to a non-controlling investment in a US business that produces, designs, tests, manufactures, fabricates or develops one or more critical technologies. Or owns, operates, manufactures, supplies or services critical infrastructure. Or maintains or collects sensitive personal data of US citizens that may be exploited in a manner that threatens national security. Also, FIRRMA requires CFIUS to prescribe regulations that further define the term ‘foreign person’ in the context of non-controlling investments by specifying criteria to limit its applicability over certain categories of foreign persons.

Provisions pertaining to certain transactions by foreign persons involving real estate in the US. The second issuance is a result of Congress authorising CFIUS to review the purchase or lease by, or a concession to, a foreign person of private or public real estate that is, is located within, or will function as part of, an air or maritime port, is in close proximity to a US military installation or another facility or property of the US government that is sensitive for reasons relating to national security, could reasonably provide the foreign person the ability to collect intelligence on activities being conducted at such an installation, facility or property or could otherwise expose national security activities at such an installation, facility or property to the risk of foreign surveillance.

In addition, the second set of proposed regulations would introduce a new term, ‘covered real estate transactions’, which is defined as: (i) any purchase or lease by, or concession to, a foreign person of covered real estate, that affords the foreign person at least three qualifying property rights; (ii) a change in the rights that a foreign person has with respect to covered real estate in which the foreign person has an ownership or leasehold interest or concession arrangement if that change could result in the foreign person having at least three qualifying property rights; and (iii) any other transaction, transfer, agreement or arrangement, the structure of which is designed or intended to evade or circumvent the application of the CFIUS regulations as relates to real estate.

“The key takeaways are that certain foreign government acquisitions of US businesses will be subject to mandatory reporting, and CFIUS has provided greater specificity on the types of sensitive personal data, infrastructure activities and real estate locations that are likely to raise national security concerns,” says Mr Kinzelman. “The ability of CFIUS to except certain countries and investors from the burden of reporting minority investments in US businesses may prove helpful, but much remains to be seen as to which countries are excepted and whether countries that make significant investments in the US will be included.”

The future of FDI

If, as is expected, the proposed CFIUS regulations are rubber-stamped – following a consultation, finalised versions are scheduled to take effect no later than 13 February 2020 – their impact on the investment level in the US could prove significant.

“Under prior legislation, CFIUS has had authority to review transactions that could result in control of a US business by a foreign person,” says David J. Levine, counsel at McDermott Will & Emery. “FIRRMA expanded the authority of CFIUS to review certain foreign non-controlling investments and real estate transactions that previously fell outside its jurisdiction. The new regulations would provide important clarity and predictability for the business community concerning how CFIUS will treat foreign investment transactions.”

Less convinced by the capacity of the proposed regulations to disrupt the FDI space is Mr Kinzelman. “We do not see the level of foreign investment in the US being significantly impacted by the new regulations themselves,” he opines. “Any CFIUS impact on investment depends on how vigorously CFIUS enforces both the existing and new rules, and whether that results in a chilling effect on future foreign investment in US business.

“Depending on how active CFIUS is over the next few years, it is possible that US businesses may prefer to find investors based in the US and turn down offers of investment from foreign parties if they believe their investments will either be held up by a lengthy CFIUS investigation or would be liable to divestiture if CFIUS objects,” he continues. “Timing issues may be particularly significant for US research and development companies that require venture capital, and are unable to risk delay given a need to meet immediate expenses.”

While CFIUS remains very much open to investment in the US, key developments since the enactment of FIRRMA – in the main, the proposed regulations detailing expanded CFIUS scope and authority – has created a substantially different dynamic compared to the pre-FIRRMA period. As the regulations await the green light, this element of FIRRMA is an area to monitor.

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Fraser Tennant