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CFIUS AND EXPORT CONTROLS: A DETAILED ANALYSIS OF THE PROPOSED MANDATORY FILING CHANGES

Pursuant to the Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”), the Committee on Foreign Investment in the United States (“CFIUS”) is authorized to review and take action to address national security concerns arising from certain investments and real estate transactions involving foreign persons. On May 21, 2020, the U.S. Department of the Treasury (“Treasury”) published a Proposed Rule that includes two important changes impacting mandatory filings.

In October 2018, Treasury published the “Pilot Program Interim Rule,” an interim rule that implemented—on a temporary basis—a pilot program which imposed a mandatory filing requirement for certain foreign investment transactions involving a U.S. business across the five types of critical technologies as defined by FIRRMA; and with a nexus to specified industries identified in the North American Industry Classification System (“NAICS”). For more details about the critical technologies pilot program, please see our previous article.
Two years later, on January 17, 2020, Treasury published two final rules to implement FIRRMA provisions that expanded CFIUS’s jurisdiction; they became effective on February 13, 2020. The first of these final rules, at 85 Fed. Reg. 3112 (“Part 800 Final Rule”), amended 31 C.F.R. part 800, affecting certain non-controlling “covered investments” that afford a foreign person certain access, rights, or involvement in specific types of U.S. businesses. The second final rule at 85 Fed. Reg. 3158 dealt with certain real estate transactions by foreign persons in the United States. The Proposed Rule amends and modifies the Part 800 Final Rule.

The Part 800 Final Rule includes a mandatory filing requirement for two types of transactions:

  1. Covered transactions where a foreign government has a substantial interest in certain U.S. businesses involved with critical technology, critical infrastructure, or sensitive personal data, referred to as “TID U.S. businesses” for Technology, Infrastructure, and Data; and
  2. Covered control transactions or covered investments in certain U.S. businesses involved with critical technologies, pursuant to the Pilot Program that went into effect in November 2018.

Specifically, the mandatory filing applies to covered investments involving certain U.S. businesses that produce, design, test, manufacture, fabricate, or develop one or more critical technologies (“Critical Technologies Mandatory Filing”).

The Proposed Rule does not come as a surprise. In the Part 800 Final Rule, Treasury noted while integrating the mandatory filing from the Pilot Program Interim Rule (based on U.S. businesses in connection with identified industries by NAICS codes) that it anticipated issuing a future proposed rule that would replace that obligation based upon export control licensing requirements. Treasury is following through with its statement by issuing this Proposed Rule, which includes two major revisions to the mandatory filing requirements. In the first, the Proposed Rule provides clarifying amendments to the definition of “substantial interest.” In the second, it modifies the Critical Technologies Mandatory Filing requirement. Public comments for this Proposed Rule are due by June 22, 2020.

II.        Clarification of “Substantial Interest”

As previously discussed, there is a mandatory filing requirement for covered transactions where a foreign government has a “substantial interest” (see § 800.244) in certain TID U.S. businesses. The filing is triggered (with some exceptions) in a transaction when two factors are met:

  1. The foreign person’s investment in a TID U.S. business results in a “substantial interest,” defined as a foreign person having a voting interest, direct or indirect, of 25% or more in a TID U.S. business; and
  2. The foreign government has a “substantial interest” in the foreign person, defined as the voting interest, direct or indirect, of 49% or more in the foreign person.

The first provision of the Proposed Rule is a clarifying amendment to paragraphs (b) and (c) of the “substantial interest” definition, found at § 800.244. Section 800.244 establishes how to determine the percentage interest held indirectly by one entity in another for purposes of that term.

Specifically, the Proposed Rule adds language to clarify that paragraph (b) applies only where a general partner, managing member, or equivalent primarily directs, controls, or coordinates the activities of the entity. Moreover, the Proposed Rule removes the three instances of the word “voting” that appear before “interest” in § 800.244(c), to avoid confusion and clarify that the calculation rule applies to the calculation of “voting interests” as described in § 800.244(a) and “interests” as described in § 800.244(b).

Overall, the Proposed Rule clarifies the “substantial interest” definition found in § 800.244, and it does not change the mandatory filing requirement triggered by such covered transaction.

III.       Changes to the Criteria for Critical Technologies

As noted above, a mandatory filing requirement may be triggered when a U.S. business produces, designs, tests, manufactures, fabricates, or develops one or more critical technologies in any of the 27 industries identified by the respective NAICS codes. The Part 800 Final Rule largely incorporates the scope of the Pilot Program Interim Rule. But, as explained below, it also included some exceptions to the mandatory filing requirement (but not from CFIUS jurisdiction).

Specifically, the Proposed Rule revises the scope of the mandatory filing for certain critical technologies to put the focus on export control requirements, instead of NAICS code industries. Consequently, the Proposed Rule removes the NAICS code criteria and the list of NAICS codes at Appendix B to part 800. Importantly, the Proposed Rule does not modify the definition of “critical technologies,” which is defined by FIRRMA, and implemented at § 800.215.[1]

As such, the Critical Technologies Mandatory Filing requirement is now based on whether certain “U.S. government authorization” (defined below) would be required to export, re-export, transfer (in country), or retransfer the critical technology or technologies produced, designed, tested, manufactured, fabricated, or developed by the U.S. business to the foreign persons involved in the transaction or certain foreign persons in the ownership chain.

The export control regulations require licenses or authorizations in certain transactions premised on the jurisdiction and classification of the item, end-user, and foreign country for export, re-export, transfer (in country), or retransfer. Pursuant to the Proposed Rule, parties would no longer need to consider whether the U.S. business produces, designs, tests, manufactures, fabricates, or develops a critical technology utilized in connection with the U.S. business’ activity in, or designed by the U.S. business for use in, one or more industries identified by reference to NAICS codes.

In short, because of the modified scope in the Proposed Rule, the new test to determine whether a mandatory filing is triggered includes:

  1. Is there a covered transaction involving a TID U.S. business?
  2. Does that TID U.S. business produce, design, test, manufacture, fabricate, or develop one or more “critical technologies” as defined in FIRRMA and § 800.215?
  3. Is a “U.S. regulatory authorization” (defined in new § 800.254) required for the export, re-export, transfer (in-country), or retransfer of such critical technology to a foreign person that is a party to the covered transaction?
  4. With respect to the TID U.S. business, the foreign person or foreign person’s:
    1. Could obtain direct control; or
    2. Will directly acquire an interest that is a covered investment; or
    3. Rights from the direct investment in the TID U.S. business will change, resulting in a covered control transaction or covered investment; or
    4. “Is a party to any transaction, transfer, agreement, or arrangement described in § 800.213(d) [evade or circumvent applicable law] ….”;[2] or
    5. “Individually holds, or is part of a group of foreign persons that, in the aggregate, holds, a voting interest for purposes of critical technology mandatory declarations in a foreign person described in [§ 800.401(c)(1)(i) through (iv)]….”[3]

To implement the export control criteria, the Proposed Rule amends § 800.104 (Applicability Rule) and § 800.401 (Mandatory Filings), and introduces two new definitions: “U.S. regulatory authorization” at new § 800.254 and “voting interest for purposes of critical technology mandatory declarations” at § 800.256. The amended and new sections are further discussed below.

A.        Applicability Rule § 800.104

The amendments for § 800.104 include retaining paragraph (c), which stipulates the applicability period for transactions subject to the Pilot Program Interim Rule; and adds paragraphs (d) and (e) to clarify the applicability period of the provisions in the Part 800 Final Rule considering the changes under this Proposed Rule. The Proposed Rule results in three important applicability time frames.

  1. Pilot Program Interim Rule: The Pilot Program Interim Rule continues to apply to transactions for which specified actions (e.g., execution of a binding written agreement) occurred on or after November 10, 2018, and prior to February 13, 2020 (see 31 C.F.R. § 801.103).
  2. Existing Critical Technology Mandatory Filing: The existing Critical Technologies Mandatory Filing based on NAICS codes (see Part 800 Final Rule) will apply to transactions for which specified actions occurred from February 13, 2020, until the effective date of the rule finalizing this Proposed Rule, as specified in proposed § 800.104(d).
  3. Modified Critical Technology Mandatory Filing: Per proposed § 800.104(e), the modified Critical Technologies Mandatory Filing based on export control requirements and new defined terms would apply—once finalized—starting on the effective date of the final rule, except for certain transactions for which specified actions occurred prior the effective date of the final rule.

B.         Mandatory Filings § 800.401(c), (e)(6), and (j)
As discussed, the Proposed Rule includes a new scope based on export control requirements for the Critical Technologies Mandatory Filing requirement, modifying § 800.401(c), (e)(6), and (j), and removing Appendix B to part 800 (NAICS codes list). The core of the revised scope is prescribed in revised § 800.401(c).

1.         § 800.401(c)

Overall, § 800.401 enumerates the covered transactions that trigger mandatory filings and those that do not. The proposed amended language at § 800.401(c)(1) adds subparagraphs (i)-(v) and enumerates the new requirements for the Critical Technologies Mandatory Filing based on export control requirements. See proposed § 800.401(c)(1)(i)-(v).
Furthermore, proposed § 800.401(c)(2) clarifies the analysis required under revised § 800.401(c)(1). Proposed § 800.401(c)(2)(i) explains that, except for certain Export Administration Regulations (“EAR”) license exceptions specified at § 800.401(e)(6) which are discussed below, a “U.S. regulatory authorization” is considered to be required even though a license exception or exemption may be available under the EAR or the International Traffic in Arms Regulations (“ITAR”).

This is very important because industry may wrongfully assume that because certain license exceptions or exemptions exist under the EAR or ITAR, they would equally apply to the CFIUS analysis. That is not the case.

Additionally, proposed § 800.401(c)(2)(ii) specifies how to analyze a foreign investor’s nationality for purposes of this provision. Foreign entities will use the “principal place of business” defined in § 800.239, and individuals will use the foreign person’s nationality or nationalities under the relevant U.S. regulatory authorization, as applicable.

Finally, the proposed language at § 800.401(c)(2)(iii) specifies that for purposes of this analysis, in cases where the applicable “U.S. regulatory authorization” is tied to the “end-user” status of the person receiving the critical technology, the foreign person(s) specified in § 800.401(c)(1)(i)-(v) should be considered the end-user(s). Again, this may differentiate from the “end-user” definition that applies in general export control requirements.

2.         § 800.401(e)

In the Part 800 Final Rule, § 800.401(e) identifies the exceptions that remove the mandatory filing requirement for certain transactions involving critical technologies based on the NAICS codes. The six exceptions currently enumerated in § 800.401(e) relate to five categories: 1) excepted investors; 2) foreign ownership, control, or influence (“FOCI”) mitigated entities; 3) investment funds managed exclusively by, and ultimately controlled by, U.S. nationals; 4) air carriers; and 5) certain encryption technologies.

Relevant to the proposed amendment detailed below, currently § 800.401(e)(6) provides an exception for a TID U.S. business that solely falls under the mandatory filing requirement because they produce, design, etc. a critical technology that is eligible for export, re-export, or transfer (in country) under EAR license exception for encryption commodities, software, and technology (“ENC”), hereinafter “ENC License Exception,” at 15 C.F.R. § 740.17.

The Proposed Rule retains the exceptions in § 800.401(e)(1) to (5) and revises the exception at paragraph (e)(6). Notably, the Proposed Rule modifies the description of the ENC License Exception at § 800.401(e)(6), and as such only subpart (b) of the ENC License Exception found at 15 C.F.R. § 740.17 is applicable to the mandatory filing requirement.
Two additional license exceptions under the EAR are added to paragraph (e)(6) including: i) a technology and software unrestricted (“TSU”) exception at 15 C.F.R. § 740.13; and ii) certain elements of a strategic trade authorization (“STA”) exception at 15 C.F.R. § 740.20(c)(1).

Importantly, for any of the EAR license exceptions to relieve a foreign person from the mandatory filing requirement, such foreign person must be eligible to utilize the license exception (including based on end-user status, if relevant). Finally, CFIUS also notes that the restrictions on the use of all license exceptions found in 15 C.F.R. § 740.2 would apply and must also be considered.

3.         § 800.401(j)

As published in the Part 800 Final Rule, § 800.401(j) provides several examples of transactions that would trigger the Critical Technologies Mandatory Filing requirement based on NAICS codes. The Proposed Rule also updates the examples at § 800.401(j) to reflect the revisions to § 800.401(c). Section 800.403 regarding procedures for filings and § 800.404 regarding contents of filings remain the same.

Finally, Treasury clarifies that, pursuant to FIRRMA, the mandatory filing provision at § 800.401(c) applies only to critical technology businesses under § 800.248(a), not to businesses that are TID U.S. businesses solely under § 800.248(b) (critical infrastructure) or § 800.248(c) (sensitive personal data).

C.        New Terms and Definitions § 800.254 and § 800.256

As noted above, the Proposed Rule introduces two new terms and definitions to the export control criteria for the Critical Technologies Mandatory Filing. The first term and definition, “U.S. regulatory authorization,” is defined at new § 800.254 and specifies the types of regulatory licenses or authorizations that are required under the four main U.S. export control regimes, including:

  • ITAR: Licenses and other approvals (e.g., approved Technical Assistance Agreements or Manufacturing License Agreements) required under the ITAR for defense articles or defense services on the U.S. Munitions List.
  • EAR: Licenses required for certain items on the Commerce Control List (“CCL”) as identified in § 800.215(b), including CCL items controlled pursuant to multilateral regimes, for example reasons relating to national security, chemical and biological weapons proliferation, nuclear nonproliferation, or missile technology; or reasons relating to regional stability or surreptitious listening.
  • Department of EnergySpecific or general authorizations required under the regulations governing assistance to foreign atomic energy activities administered by the Department of Energy at 10 C.F.R. part 810, except the general authorization at 10 C.F.R. § 810.6(a) for the export of certain controlled nuclear technology to specified countries or entities.
  • Nuclear Regulatory CommissionAny specific license required under the regulations governing the export or import of nuclear equipment and material administered by the Nuclear Regulatory Commission at 10 C.F.R. part 110.

The second term and definition in the Proposed Rule is “voting interest for purposes of critical technology mandatory declarations,” defined at proposed § 800.256. The new term used in the proposed language at § 800.401(c)(1)(v), specifies which persons in the ownership chain of foreign persons described in § 800.401(c)(1)(i) to (iv) should be analyzed for export licenses and authorization purposes to determine whether a particular transaction could trigger a mandatory filing.

The proposed language at § 800.401(c)(1)(v) states, “Individually holds, or is part of a group of foreign persons that, in the aggregate, holds, a voting interest for purposes of critical technology mandatory declarations in a foreign person described in paragraphs (c)(1)(i) through (iv) of this section.” In the Proposed Rule, Treasury explains that the definition in § 800.256(a) establishes a threshold of 25% voting interest, direct or indirect, to set a clear criteria with respect to the foreign person that needs to be analyzed under § 800.401(c)(1)(i) to (iv).
For a foreign person that is an entity whose activities are primarily directed, controlled, or coordinated by or on behalf of a general partner, managing member, or equivalent, the applicable threshold is a 25% interest in an entity’s general partner, managing member, or equivalent (see § 800.256(b)). For purposes of determining the percentage of interest held indirectly by one person in another, the rule establishes that any interest of a parent entity in a subsidiary entity will be deemed to be a 100% interest (see § 800.256(c)).

The approach to determine the percentage interest is consistent with the proposed amendments of “substantial interest” at § 800.244 discussed above. Lastly, the Proposed Rule in § 800.256(d) specifies when the ownership interests of separate foreign persons will be aggregated for the purposes of § 800.256, including for example, when foreign persons are related, or there is a formal or informal arrangement to act in concert, among others (see § 800.256(d)).
***

In conclusion, the Proposed Rule provides implementing regulations that, if finalized, clarify the definition of “substantial interest,” which impacts one of the triggers for a mandatory filing. Importantly, the Proposed Rule includes a new scope based on export control requirements for the Critical Technologies Mandatory Filing requirement. Consequently, it modifies § 800.401(c), (e)(6), and (j), and removes Appendix B to part 800 (NAICS codes list).

Public comments for the Proposed Rule are due by June 22, 2020. The changes that CFIUS will make to the provisions in this Proposed Rule after the public comment period closes remain uncertain, but it is anticipated that CFIUS will publish the final rule in the coming months.

 


[1] In brief, “critical technologies” is defined to include five categories, related to certain items subject to export controls and other regulatory schemes, and emerging and foundational technologies controlled under the Export Control Reform Act of 2018.

[2] See proposed § 800.401(c)(1)(iv).

[3] See proposed § 800.401(c)(1)(v).