Continuing Increase in Regulation of Foreign Direct Investment: Final Part?

October 15, 2020 effective date for final regulation on foreign direct investments in U.S.

The push over the last two years to expand oversight into Foreign Direct Investment (FDI) will culminate on October 15, 2020, with the effective date of final rules on the implantation of the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA).

As background, U.S. regulation of foreign investment began in 1975 with the creation of the Committee on Foreign Investment in the U.S. (CFIUS). CFIUS was further refined in 2007 by the Foreign Investment and National Security Act. Historically, CFIUS was limited to technologies, industries and infrastructure directly involving national security. It was also a voluntary filing. Foreign investors began structuring investments to avoid national security reviews. As a result, FIRRMA was signed into law in August 2018 to address such abuses. FIRRMA’s initial enabling regulations took effect in February 2020,  and applied to U.S. businesses that are involved with critical technologies, critical infrastructure, or sensitive personal data — referenced in the regulations as “TID.” Anyone engaged in international and cross-border transactions should add TID to their diligence discussions when assessing a prospective deal.

On September 15, 2020, the U.S. Treasury Department, Investment Security Office, issued a proposed FIRMMA final rule that significantly modifies the requirements for making mandatory CFIUS filings based on a regulatory authorization test and determination of foreign investor. The final regulations will require additional early due diligence, and will focus on participating foreign investors and transaction planning.

In general, the final regulation requires that FDI involving a U.S. business engaged in critical or emerging technologies should be analyzed for export licensing and authorization in determining whether a particular transaction will trigger a mandatory CFIUS declaration. More specifically, the regulation will eliminate a determination based on industry classification as to whether U.S. licenses or authorizations would be required to export, reexport, transfer of critical technologies produced, designed, tested, manufactured, fabricated, or developed by the U.S. business to persons or entities having an interest in the proposed acquirer. The regulation specifically eliminated the application of the North American Industry Classification System (NAICS) codes, and amended the definition of “substantial interest.” The regulation also introduced two new terms: “U.S. regulatory authorization” and “voting interest for purposes of critical technology mandatory declarations.” The regulation also specifies how to determine the percentage interest held indirectly by one entity in another for purposes of whether a foreign person obtains a “substantial interest” in a U.S. business where a foreign government in turn holds a “substantial interest” in the foreign person. This definition establishes the declaration requirement where a foreign government has a substantial interest in a foreign person that will acquire a substantial interest in covered U.S. businesses.

The final regulation also clarifies the analysis required to determine if an investor is a “foreign investor” and the investor’s nationality. The regulation also clarifies the application of the rule to general partner, managing member, or equivalent officer that directs, controls, or coordinates the activities of the entity, and removes the use of “voting” to clarify the calculation of “voting interests.” More specifically, Section 800.401(c)(1) provides the following additional guidance:

• Foreign control transaction investors are those that can directly control the covered U.S. business.
• Foreign covered investment investors are those that directly acquire an equity interest in the covered U.S. business and that obtain access to any “material nonpublic technical information;” membership, participation, or nomination rights to the board of directors or equivalent governing body; and/or “involvement” or participation in “substantive decision making” regarding the use, development, manufacture, supply, acquisition, storage or release of TID.
• Change in rights foreign investors where such change can result in a control transaction or a covered investment.
• Foreign investors party to evasive/circumventing transactions intended to circumvent CFIUS jurisdiction.
• Foreign threshold owners of other Section 800.401(c)(1) foreign investors as a foreign individual or entity who individually holds, or is part of a group of foreign persons that in the aggregate holds, a voting interest (direct or indirect) of 25% or more in a foreign investor.

As of October 15, 2020, parties will need to perform a more detailed assessment of CFIUS filing requirements – particularly with respect to the requisite export control/regulatory authorization analysis and determinations of “investor” and “control.” Based on such, if you have a process, merger, acquisition underway, or even a change in foreign ownership, be mindful of how the final FIRRMA regulations may affect your negotiations, contract documents and closing – and any resulting disclosures.

David Vance Lucas is a member of Bradley’s Intellectual Property and Cybersecurity and Privacy practice groups and leads the International and Cross Border team. Much of David’s experience was accumulated as general counsel for a multinational technology company. He now advises both U.S. and foreign clients on the harmonized application of U.S., UK and European laws and represents clients in various legal proceedings in U.S. and foreign venues.