On October 10, 2018, the U.S. Department of the Treasury (Treasury) announced the first pilot program implemented by the Committee on Foreign Investment in the United States (CFIUS or the Committee) under the recently enacted Foreign Investment Risk Review Modernization Act (FIRRMA).

The pilot program, which takes effect on November 10, 2018, expands the scope of transactions subject to review by the Committee significantly to encompass certain non-controlling investments by foreign persons in U.S. critical technologies in certain industries. The pilot program also implements FIRRMA's mandatory declarations provision, a CFIUS first, for all transactions subject to the pilot program. To give the mandatory declarations some teeth, the pilot program authorizes CFIUS to assess potentially massive civil monetary penalties, up to the total value of the transaction, for non-compliance with the filing requirement.

As the initial pilot program under FIRRMA, as well as the Committee's first foray into reviewing certain non-controlling investments by foreign persons, it was inevitable that this announcement would create concern, and likely a bit of chaos, among those companies and investment firms impacted by it most directly. However, the breadth of the industries covered in conjunction with the mandatory declarations and the prospect of millions, if not billions, of dollars in potential civil liability for a failure to file amplifies those concerns considerably. Any company, whether inside or outside the United States, that makes or receives investment in connection with businesses that use or develop U.S. critical technology should consider assessing immediately whether its activities may be covered by the pilot program. Failing to do so presents significant risk, as FIRRMA has broadened CFIUS's enforcement mandate markedly and the current administration may push CFIUS to act more aggressively than it has historically.

Not surprisingly, the scope of the program and the industries it covers appear to focus on sectors favored by Chinese investment, although the regulations implementing the pilot program do not single out any specific country. With the pace of inbound U.S. investment from China having slowed considerably in recent months, the program could curtail that even further. Nevertheless, it bears monitoring whether the increased transparency and accountability that the pilot program demands may spur an uptick in certain types of Chinese investment not subject to the program.

Garnering far less attention than the pilot program was Treasury's issuance on October 11, 2018 of an interim rule amending and updating certain provisions of the CFIUS regulations to make them consistent with portions of FIRRMA that became effective immediately upon its enactment. Although the changes are largely technical in nature, and do not address many aspects of the new law, Treasury is accepting public comments on the interim rule through November 10, 2018. Some of the most notable revisions are those implementing penalties and other consequences for violations of mitigation agreements.

Scope of the Pilot Program

FIRRMA authorized CFIUS to conduct pilot programs to implement any provisions of the new law that were not immediately effective. This initial pilot program enlarges the Committee's jurisdiction, consistent with FIRRMA's expanded definition of a covered transaction, to include "other investments" by foreign persons that do not constitute an acquisition of control of a U.S. critical technology company. Transactions that could result in foreign control of such a company, including those carried out through joint ventures, are likewise covered by the program.

The primary elements of the pilot program are summarized below. The specifics of each element, as well as other definitions and details, are set forth in the Pilot Program Regulations. CFIUS also issued a Fact Sheet and FAQs to assist parties in navigating the requirements of the new program. In sum, to be covered by the pilot program there must be (1) an equity investment by a foreign person that affords the foreign investor certain rights (2) in a target U.S. business that utilizes or designs (3) "critical technologies" (4) for use in one or more of the 27 identified pilot program sectors listed in Annex A to the Pilot Program Regulations.

The concept of "other investment" or "pilot program covered investment" is essentially an attempt to define the middle ground—between control and a passive investment—where CFIUS can exercise jurisdiction. To constitute a covered investment under the pilot program, an investment, direct or indirect, must afford the foreign investor: (a) access to any material nonpublic technical information in the possession of the target U.S. business; (b) membership or observer rights on the board of directors or equivalent governing body of the U.S. business or the right to nominate an individual to a position on the same; or (c) any involvement, other than through voting shares, in substantive decisionmaking of the U.S. business regarding the use, development, acquisition, or release of critical technology. Notably, however, an indirect foreign investment in a pilot program business through an investment fund that affords the foreign investor membership as a limited partner or equivalent on an advisory board or a committee of the fund shall not be considered a covered transaction under the pilot program as long as certain specified criteria, designed to ensure the foreign investor has essentially no influence over or access to sensitive information, are met.

The pilot program covers all critical technologies, as defined under FIRRMA, provided that the target U.S. business is subject to the pilot program, as discussed below. In addition to the traditional core of "critical technologies"—items subject to U.S. export control laws, regulated nuclear facilities, equipment, parts and components, materials, software and technology, and select agents and toxins—FIRRMA expanded the definition to include a new sub-category of "emerging and foundational technologies" controlled pursuant to the Export Control Reform Act of 2018. The Secretary of Commerce is charged with establishing appropriate export controls for "emerging and foundational technologies," and it is expected that a related notice of proposed rulemaking could be issued soon. Because the concept of "emerging and foundational technologies" is truly novel and its scope is uncertain, it will require careful monitoring as the regulations evolve and potential new investment in such technologies comes under the umbrella of the pilot program. It is worth noting that technologies such as artificial intelligence, biotechnology, nanotechnology, semiconductors, and micro-electronics, to name a few, are widely thought to be under consideration for designation as emerging and foundational technologies.

Only certain types of U.S. businesses working with critical technology are covered by the pilot program. The pilot program includes any U.S. business that produces, designs, tests, manufactures, fabricates, or develops a critical technology that is: (1) utilized in connection with the U.S. business's activity in one or more pilot program industries; or (2) designed by the U.S. business specifically for use in one or more of the pilot program industries.

With respect to the specific industries covered by the pilot program, there are 27 in total, which are listed in an annex to the Pilot Program Regulations accompanied by their respective North American Industry Classification System (NAICS) codes. The pilot program industries were, according to CFIUS, chosen to protect against certain strategically-motivated foreign investment that could pose a threat to U.S. technological superiority and national security. Although some of the industries have a clear nexus to U.S. military or defense interests (e.g., Guided Missile and Space Vehicle Manufacturing; Military Armored Vehicle, Tank, and Tank Component Manufacturing), many of listed industries are quite broad and diverse, meaning that it may not be immediately obvious to parties that their transaction implicates a covered industry. For instance, the following are pilot program industries: Semiconductor and Related Device Manufacturing; Computer Storage Device Manufacturing; Electronic Computer Manufacturing; Petrochemical Manufacturing; Primary and Storage Battery Manufacturing; Research and Development in Nanotechnology and Biotechnology; and Radio and Television Broadcasting and Wireless Communications Equipment Manufacturing.

Lastly, the pilot program covers all foreign persons and is not country-specific. The Committee acknowledged that it chose not to exempt any country from the mandatory declaration requirement to better understand the nature of foreign direct investment in the United States as it relates to critical technologies and the pilot program industries. That suggests, at the very least, that the final version of the rule could include country-specific exemptions or, conversely, even more restrictive requirements for countries of special concern like China or Russia.

Mandatory Declarations and Civil Monetary Penalties

In addition to the substantive expansion of the Committee's jurisdiction, the pilot program marks the first time that mandatory declarations will be required. Here, the pilot program establishes that mandatory declarations must be filed for foreign transactions involving pilot program U.S. businesses that are within the purview of CFIUS (i.e., both controlling investments and "other investments").

FIRRMA established the possibility of filing a declaration in certain circumstances in lieu of filing a full notice, at least in part, to create a more efficient CFIUS review process. It is expected that declarations will be abbreviated versions of traditional notices, which generally should not exceed five pages in length. Despite the more streamlined nature of declarations under the pilot program, there are still nearly twenty discrete categories of required information (not counting sub-parts) that must be included. In general, declarations must be filed at least 45 days prior to a transaction's expected completion date. For affected transactions scheduled to close before December 25, 2018, the declaration must be filed by November 10, 2018, or promptly thereafter. The Committee will have 30 days to take action with respect to a declaration once it has been accepted by the Staff Chairperson of CFIUS and circulated to the Committee.

Parties subject to the pilot program may also choose to file a notice under CFIUS's standard procedures rather than a declaration. This may be advisable when the parties assess that it is highly unlikely the Committee will be able to complete all action with respect to a transaction based on a declaration alone. Although CFIUS timing considerations impacting deal closures have always been of great concern, the uncertainty surrounding the pilot program's new mandatory declaration requirement, and the potential volume of filings that CFIUS may be fielding once the program takes effect, could prompt parties to skip the new initial step altogether and move straight to a traditional notice.

The pilot program also grants CFIUS a powerful tool to enforce the mandatory declaration requirement—civil monetary penalties. Parties that have a mandatory filing requirement with CFIUS under the pilot program, and fail to comply, can be assessed a civil monetary penalty up to the value of the transaction.

The significance of this potential enforcement tool cannot be overstated. Although there are many questions regarding how this will work in practice—Will CFIUS have the resources to detect covered pilot program transactions that fail to file? How harshly will parties be penalized if they were unaware of the mandatory filing requirement? How harshly will parties be penalized if they were aware of the requirement and elected to ignore it?—it seems clear that CFIUS will be adopting a more aggressive enforcement posture, consistent with FIRRMA and the policy goals of the current administration. Consequently, assessing whether an investment is potentially covered by the pilot program should be a focus for U.S. businesses and investment firms engaged in any investment activities connected to the pilot program industries or, more broadly, the U.S. technology sector. Once that initial assessment is undertaken, parties can make informed, risk-based decisions about how and whether to engage with CFIUS on a transaction-by-transaction basis.

Final Thoughts on the Launch of the Pilot Program

As the initial pilot program under FIRRMA, as well as the Committee's first foray into reviewing certain non-controlling investments by foreign persons, it was inevitable that this announcement would create concern, and likely a bit of chaos, among those companies and investment firms impacted by it most directly. However, the breadth of the industries covered in conjunction with the mandatory declarations and the prospect of millions if not billions of dollars in potential civil liability for a failure to file amplifies those concerns considerably. Any company, whether inside or outside the United States, that makes or receives investment in connection with businesses that use or develop U.S. critical technology should consider assessing immediately whether its activities may be covered by the pilot program. Failing to do so presents significant risk, as FIRRMA has broadened CFIUS's enforcement mandate markedly and the current administration may push CFIUS to act more aggressively than it has historically.

Not surprisingly, the scope of the program and the industries it covers appear to focus on sectors favored by Chinese investment, although the regulations implementing the pilot program do not single out any specific country. With the pace of inbound U.S. investment from China having slowed considerably in recent months, the program could curtail that even further. Nevertheless, it bears monitoring whether the increased transparency and accountability that the pilot program demands may spur an uptick in certain types of Chinese investment not subject to the program. For example, Chinese investors interested in the United States may elect to pursue purely passive investments, even more than they have historically, that do not rise to the level of "other investments." It is also possible that Chinese investors could turn their attention to investment opportunities in substantive areas not covered by the program, but which may still be subject to CFIUS scrutiny.

As a complement to the pilot program, Treasury also issued an interim rule on October 11, 2018, which amended and updated certain provisions of the CFIUS regulations to make them consistent with portions of FIRRMA that became effective immediately upon its enactment. These amendments were intended, among other things, to clarify the current process and procedures regarding reviews and investigations undertaken by the Committee in the post-FIRRMA era. Although the changes are largely technical in nature, and do not address many aspects of the new law that will be implemented in the coming months, Treasury is accepting public comments on the interim rule through November 10, 2018. Some of the most notable revisions are those implementing penalties and other consequences for violations of mitigation agreements.

Miller & Chevalier will continue tracking new FIRRMA-related developments closely. Please contact us should you have specific questions or need assistance regarding any CFIUS issues affecting your company.

For more information, please contact any lawyer in our Export Controls & Economic Sanctions practice.

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