International Law Advisory - Treasury Department Issues Long-Awaited Proposed CFIUS Regulations

On April 21, 2008, the Department of the Treasury issued proposed regulations to implement the Foreign Investment and National Security Act of 2007 (FINSA). The proposed regulations update the 1991 regulations that govern the Committee on Foreign Investment in the United States (CFIUS), the inter-agency committee responsible for reviewing foreign acquisitions in the United States that raise national security concerns.  The proposed regulations reflect reforms made to the CFIUS process by FINSA and Executive Order 13456, which the President issued on January 23, 2008.

Signed into law on July 26, 2007, FINSA codifies the structure, role, process and responsibilities of CFIUS.  Executive Order 13456 clarified certain issues, such as the membership of CFIUS and the circumstances under which a transaction will be referred to the President for final decision.  

The proposed regulations are lengthy, approximately 90 pages including the preamble.  The following is a summary of their main provisions.

A.        Definitional Issues

There are a number of key definitions in the proposed regulations that are at the core of the CFIUS review process, and to a large extent drive the scope of transactions that may be subject to US government review.

1.   “Covered transaction,” a term introduced by FINSA, is defined as any transaction “by or with any foreign person, which could result in control of a U.S. business by a foreign person.”  (emphasis added)  As a result, the scope of transactions covered by the CFIUS voluntary notification process depends on the definitions of “control,” “U.S. business,” and “foreign person.”

2.  “Control” is defined as the “power, direct or indirect, whether or not exercised, through the ownership of a majority or a dominant minority of the total outstanding voting interest in an entity, board representation, proxy voting, a special share, contractual arrangements, formal or informal arrangements to act in concert, or other means, to determine, direct, or decide important matters affecting an entity; in particular, but without limitation, to determine direct, take, reach, or cause decisions regarding . . . important matters affecting an entity.”  Again, this definition contains a number of key terms and concepts that need to be analyzed in determining whether a proposed transaction would confer “control.”

• CFIUS has declined to adopt a bright line test for control.
• The proposed regulations include an illustrative list of matters that are deemed to be “important” in determining control. 
• The percentage of shares or number of board seats held (while relevant) is not necessarily determinative. 
• The proposed regulations provide that a foreign person does not control an entity if it holds 10 percent or less of the voting interest in the entity and it holds that interest “solely for proposes of investment.”  Certain minority shareholder protections are also specified as not conferring control.

3.  “U.S. business” is defined as “any entity, irrespective of the nationality of the persons that control it, engaged in interstate commerce in the United States.”  The only determination CFIUS will make in deciding whether an entity is a US business is whether it is engaged in interstate commerce.  A foreign entity’s branch or subsidiary that is engaged in interstate commerce will be considered a US business.

4.  “Foreign person” includes any “foreign national, foreign government, or foreign entity” or “any entity over which control is exercised or exercisable by a foreign national, foreign government, or foreign entity.”

• The proposed regulations add the term “foreign entity” and define it to mean (1) a public company organized under the laws of a foreign country whose shares are primarily traded on foreign exchanges, or (2) an entity organized under the laws of a foreign country in which foreign nationals hold at least 50% of the outstanding ownership interest.
• Therefore, a transaction will not be covered if the purchaser is incorporated in a foreign country, but traded on a US exchange or majority owned by US nationals.

B.        Covered Transactions

The proposed regulations specify, with numerous examples, transactions that are and are not “covered transactions.”  The main substantive change to the list of covered transactions relates to joint ventures, and harmonizes the control standard for joint ventures with the standard used for other transactions.

In describing transactions that are not covered, the proposed regulations clarify the factors CFIUS will take into account in determining whether the acquisition of convertible instruments, rather than the conversion of such instruments, would be the covered transaction.  They also make clear that the 10% ownership interest threshold for control is determinative only if the entity holds that interest “solely for proposes of investment.”  In other words, if a foreign person acquires less than 10% of a US business, but is using that investment as a means to assert shareholder rights or have input into the management of the company, the 10% ownership safe haven will not apply and the transaction could be covered if other criteria are met.

C.        CFIUS Notices

The Treasury Department proposes to make explicit the opportunity for interaction between CFIUS and the parties to a transaction before a notice is formally filed.  Any information provided as part of a pre-notice consultation would become part of the formal notice and subject to confidentiality protections.  In this sense, the proposed regulations suggest that all pre-notice consultations will now be considered “on the record.”  Parties are “encouraged” to consult with CFIUS, and possibly file a draft notice, at least five business days before filing the formal notice. 

Also, pursuant to new authority provided in FINSA, if CFIUS determines that a transaction that was not noticed to CFIUS may in fact be a covered transaction and raises national security concerns, it may request the parties to provide information necessary to determine whether it is a covered transaction.  If so, CFIUS may request the parties to file a notice.

The proposed regulations also set forth in detail the information that must be included in a voluntary notice.  While much of this information was already required, some of the newly required items are:  additional information regarding ultimate and intermediate parents of the foreign person making the acquisition; transaction value information; identification of other persons with a role in the transaction; additional information regarding contracts with and goods supplied directly or indirectly to the US government; additional product information; identification of any special foreign government rights over the foreign person making the acquisition; description of any agreements among foreign persons to act in concert with respect to parties to the transaction; and personal identifier information (such as name, address, date and place of birth, national identity/Social Security number, passport number and foreign government/military service information) for certain key personnel.

Other new requirements include:  (1) a statement whether the parties have been involved previously in a transaction notified to CFIUS, and whether any party is a party to a mitigation agreement; and (2) a purchase agreement or similar document establishing the terms of the agreement, which must reflect terms as to which there is an actual agreement between the parties, particularly with respect to matters relating to post-closing control and governance.

CFIUS will also require certain export-control related information, including identification of products, services, and technical data subject to the Export Administration Regulations (EAR) and International Traffic in Arms Regulations (ITAR).  This requirement is slightly broader than in the current regulations.

D.        CFIUS Procedures

The proposed regulations require that CFIUS accept a voluntary notice the business day after the Staff Chairperson has (1) determined that the notice complies with the regulatory requirements, and (2) distributed the notice to all CFIUS members.  The 30-day review period begins on the date the notice is accepted.

CFIUS is also required under the proposed regulations to notify the parties at critical stages in the process, including acceptance of the notice, determination whether or not to undertake an investigation, and completion or termination of an investigation.  In the case of withdrawn notices, the proposed regulations require CFIUS to track withdrawn transactions, establish interim protections to address specific national security concerns, and specify a time frame to refile the notice.

The proposed regulations broaden the circumstances under which the Staff Chairperson may reject a voluntary notice to include situations in which (i) information comes to light that contradicts material information in the notice, (ii) CFIUS requests follow-up information that is not provided within two business days of the request (absent written agreement to a longer response time), or (iii) final certification is not provided.  They also permit the Staff Chairperson to defer acceptance of an incomplete notice and permit the parties to provide missing information within seven days. 

The proposed regulations also update CFIUS procedures for handling notices, determining whether to commence an investigation, making a recommendation to the President and related matters to confirm to the requirements of FINSA and Executive Order 13456.   These matters are described in more detail in Steptoe & Johnson's October 12, 2007 International Law Advisory.  

E.        Certification and Confidentiality

The proposed regulations would require parties, for the first time, to formally certify in writing that the information provided to CFIUS is complete and accurate. Certification is required both for the notice itself and for follow-up information. A sample certification is provided on Treasury’s website.

The CFIUS confidentiality provisions would be clarified to apply to all information submitted during the course of a withdrawn notice or with regard to a rejected notice.  Submitted information, however, may be shared with Congress as appropriate.

F.        Penalties

A new section implements FINSA’s requirement for the imposition of civil penalties.  CFIUS will be able to impose civil penalties of up to $250,000 per violation for any violation of its regulations, or for any failure to comply with a mitigation agreement or conditions imposed by CFIUS.  Mitigation agreements may also include a separate liquidated or actual damages provision for breaches.  CFIUS would set the amount of any liquidated damages as a reasonable assessment of the harm to national security that could result from a breach, but it must also consider the severity of the breach in deciding whether to seek lesser damages.

Some Closing Observations

As expected, and as with FINSA and Executive Order 13456, the proposed regulations do not greatly alter the pre-existing CFIUS process.  They generally follow the structure and content of the existing regulations, while adding and clarifying some concepts.  However, a few aspects of the proposed regulations are especially notable. 

First, they clarify the meaning of “control,” and list additional situations that will be deemed to confer control.  The proposed definition is flexible and states that a 10% ownership stake is not necessarily determinative of control, but it also gives numerous examples and makes clear that certain minority protections do not confer control.

Second, although the issue was prominently discussed in a pre-rulemaking public meeting, the proposed regulations do not mention sovereign wealth funds (SWFs) at all.  Presumably, CFIUS will treat investments by SWFs the same as other transactions involving a foreign government.  While SWF investments have attracted much attention in industry and some parts of the US Government, CFIUS had not addressed the issue.  According to recent comments by Scott Morris, majority counsel to the House Committee on Financial Services, FINSA adequately provides CFIUS with the tools to deal with foreign government transactions.

Third, CFIUS will continue to look into transactions for which no notice was filed, and if appropriate, request that a notice be filed.  In recent comments, Assistant Secretary of Homeland Security Stewart Baker said that CFIUS has already begun this process.  Noting that parties only have certainty if they decide to file, Assistant Secretary Baker stated that CFIUS would prefer parties to file voluntarily rather than have CFIUS determine outside the normal process whether national security concerns exist.  In fact, transactions that were not noticed may receive additional scrutiny if CFIUS believes the parties deliberately avoided national security review.

Fourth, the proposed regulations provide numerous examples throughout to provide guidance in applying such concepts as control, foreign person, parent, US business, covered transactions and whether a notice contains the required information.

Fifth, the proposed regulations provide civil penalties for violations of the regulations, mitigation agreements or other conditions relating to the review of a covered transaction. 

The nature and scope of the changes made in the proposed regulations, as well as the recent comments by government officials, clearly communicate that CFIUS will be a more transparently active regulatory agency, requiring more detailed information, encouraging parties to file voluntary notices, reviewing transactions that may raise concerns that are not noticed, and imposing penalties on parties that fail to comply with regulatory requirements.

Public comments in response to the proposed regulations must be received by Treasury within 45 days of the publication of these proposed regulations in the Federal Register, which is expected shortly.  Treasury is also holding a public meeting on May 2, 2008 to discuss issues associated with these proposed regulations.  If you have any questions regarding the proposed regulations, please contact Tim Walsh at 202.429.6277, Ed Krauland at 202.429.8083, or Michael Gershberg at 202.429.6208.