In June, the White House released a report outlining the threats posed by China’s investment in and acquisition of U.S. companies. Spoiler alert: The report noted that China is engaged in “state-sponsored IP theft through physical theft, cyber-enabled espionage and theft, evasion of U.S. export control laws, and counterfeiting and piracy.” Apparently, someone recognized that those $1 million to $5 million-dollar companies in Silicon Valley may be getting capital injections from folks who are not in it simply for the investment return. Worse still, until now, the United States has had no mechanism to review or prevent such foreign investment and resultant control.
Last week, both houses of Congress passed companion legislation titled the Foreign Investment Risk Review Modernization Act (FIRRMA), which, in large part, seeks to address Chinese investment and technology transfer, particularly in artificial intelligence, augmented reality/virtual reality, robotics, and financial technology. So what will FIRRMA accomplish? It will expand both the jurisdiction and authority of the Committee on Foreign Investment in the United States (CFIUS). CFIUS may review any transactions affecting national security, including transfers of minority interests in entities that make critical technology or are a part of critical infrastructure. The White House appears set to greenlight FIRRMA, warning Congress that failing to pass CFIUS reform would result in unilateral steps to protect “the crown jewels of American technology and intellectual property from transfers and acquisitions that threaten our national security…that will do so globally.”
Although the House and Senate versions will need to be reconciled before the final regulations are promulgated by the Treasury Department, in our view, key among the FIRRMA proposals are (1) expanded CFIUS jurisdiction into minority investments, (2) new export controls on foundational and emerging technologies, and (3) disparate treatment for transactions involving countries of special concern. Below are the pertinent points.
Expansion of CFIUS Purview and Disparate Treatment of Special-Concern Countries
CFIUS may choose from an expanded list of factors to evaluate a transaction, including whether it is likely “to reduce the technological and industrial advantage of the United States relative to any country of special concern” and whether it “may pose a risk to the national security.”
- A revised definition of “covered transactions” will further expand CFIUS jurisdiction. Specifically, covered transactions will include certain real estate transactions, any nonpassive investment in a U.S. critical technology or critical infrastructure company, and any change in foreign investor rights. The House legislation broadens the definition of “critical technology company” as any U.S. entity that “produces, trades in, designs, tests, manufactures, services, or develops one or more critical technologies, or a subset of such technologies, as defined by regulations” and of “critical infrastructure company” as a U.S. business that “owns, operates, or primarily provides services to an entity or entities that operate within a critical infrastructure sector or subsector, as defined by regulations.”
- CFIUS may also review “any investment in an unaffiliated United States business by a national, government, or foreign entity of a ‘country of special concern’ or a foreign entity controlled by, organized under, or with ‘substantial interest’ held by a ‘country of special concern’ that would result in obtaining either (1) sensitive personal data of U.S. citizens that ‘may be exploited in a manner that threatens national security’ or (2) ‘influence over substantive decision making’ regarding use or release of such personal data or critical technologies.”
- Additional scrutiny of transactions involving countries of special concern, i.e., those that are not, for example, a member of NATO, do not adhere to nonproliferation-control regimes, or have their own effective process for reviewing national security effects of foreign investments. Of course, countries of special concern would include those currently subject to U.S. export restrictions or U.S. arms embargo, state sponsors of terrorism, and other factors as determined by regulations.
- Passive investment would be defined as investments that do not afford the foreign investor certain rights, including access to nonpublic technical information or membership or observer status on a board of directors.
New Export Control and Related Reforms
Expand export control authority vested in the Commerce Department to address “the contribution by a United States critical technology company of both intellectual property and associated support to a foreign person through any type of arrangement, such as a joint venture.”
- Establish a “regular, ongoing interagency process to identify emerging and foundational technologies” in coordination with the departments of Commerce, Defense, State, Energy, and others. The process would consider intelligence from the director of National Intelligence and information from CFIUS reviews and investigations, development of such technologies by other countries, and the effect of new export controls on development of such technologies in the United States.
- Grant the Secretary of Commerce explicit authority to “establish appropriate controls under the Export Administration Regulations on the export, re-export, or in-country transfer” of emerging and foundational technologies, as identified.
- Direct the Department of Commerce, in coordination with other agencies, to specify the applicable level of control, based on several factors, and at a minimum must require licenses before export or transfers of technology to any country subject to an embargo. In the case of license applications involving a joint venture or similar collaborative arrangement, Commerce may require the disclosure of “any foreign person with significant ownership interest in a foreign person participating in the arrangement.” Certain exemptions apply to the proposed controls, largely to allow for the sales and service of finished products.
- Place existing authorizations (expired Export Administration Act of 1979 [EAA], as amended, and the export licensing system created under the authority of the EAA has been continued by a presidential declaration of a national emergency and the invocation of the International Emergency Economic Powers Act (P.L. 95-223)), under a permanent statutory basis.
Declarations for Certain Covered Transactions
An option was established for foreign entities to voluntarily file a “declaration” with “basic information regarding the transaction,” instead of or in advance of a written notice. The process was mandatory if the foreign investor acquired 25% or more of the voting shares of a U.S. company and if a foreign government owned 25% or more directly or indirectly in the foreign firm. CFIUS is given authority to penalize for noncompliance. The trigger appears to be the foreign investor having “substantial interest,” which ought to include a review of the means by which a foreign government could influence the actions of a foreign person, including through board membership, ownership interest, or shareholder rights.
- An exemption applies to “passive investment,” i.e. an acquisition of less than a 10% voting interest does not qualify as “substantial interest.” In addition, foreign entities from “identified countries” can be exempted.
- CFIUS may not require a declaration more than 30 days in advance of the completed transactions (45 days in the Senate version), and CFIUS must take action within 15 days of receiving a declaration (30 days in the Senate version).
Timing, Confidentiality and Fee Collection
Following an initial 45-day review and a 45-day time frame for a possible investigation, the Senate allows CFIUS to use one 30-day extension (the House version allows for only a 15-day extension) before the president reviews the transaction.
- FIRRMA would require CFIUS to list all the transactions for which full notices were filed, including a description of the U.S. business and the results of the CFIUS review. This presents a significant change in the treatment of information submitted to CFIUS.
- CFIUS would have authority to assess and collect filing fees for covered notices not higher than 1% of the value of an investment transaction, or $300,000.
Key Takeaways for Mergers and Acquisitions
First, make friends with an export control and government contracts attorney. More than ever, you must understand, fully, the technology and assets in any transaction because the stakes have never been higher. This means understanding export controls and their respective application, appropriately identifying “critical technologies,” and evaluating the nature and extent of CFIUS risks are key to any deal. Similarly, CFIUS will request information regarding a foreign buyer’s business dealings with U.S.-sanctioned countries and entities. Be prepared to produce it.
Anticipate that CFIUS will request information regarding limited partners and their control rights, especially when they are foreign government–controlled entities (regardless of the size of their investment). Much like critical technologies, CFIUS is interested in all government contracts (yes, purchase orders are contracts). Any meaningful assessment requires the U.S. entity or its counsel to understand whether they have contracts with the U.S. government and be able to identify them.
Don’t fail to notify CFIUS. Until now, CFIUS filings have been voluntary. It appears likely that certain transactions would trigger a mandatory filing. CFIUS is likely to ramp up the monitoring of announced deals and issue inquiries about transactions of which CFIUS is not notified. CFIUS retains the power to require that a transaction be submitted for review even after the deal has closed (assuming no notice was submitted beforehand). Allow for more time and possibly more money (aside from the legal fees) for CFIUS due diligence, filing, and review. Finally, anticipate possible CFIUS review if you are involved in outbound technology transfers, as they soon may be subject to new export controls.