Treasury Department Issues Final CFIUS Regulations

November 19, 2008

On November 14, 2008, the Department of the Treasury issued final regulations to implement the Foreign Investment and National Security Act of 2007 (FINSA). The final 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 of U.S. businesses that raise national security concerns. The regulations are expected to be published in the Federal Register tomorrow.

The final regulations generally implement the proposed regulations on which we reported in April 2008, with only a few substantive amendments and additional examples. Like the proposed regulations, the final regulations are structured around the key concept of a “covered transaction,” a term introduced by FINSA and 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) The reach of the CFIUS notification process depends on how CFIUS interprets the terms “control,” “U.S. business” and “foreign person.”

Treasury received about 200 separate comments on the proposed regulations in numerous written and oral submissions. The preamble to the final regulations responds to those comments, explains why Treasury did or did not change the proposed regulations, and provides additional commentary on several issues. In accordance with FINSA, Treasury will also be publishing guidance on the types of transactions that CFIUS has reviewed in the past and that have presented national security considerations.

While the new regulations codify a number of existing CFIUS practices, they also refine and expand the regulatory process. Parties will need to open discussions with CFIUS earlier, to provide substantial new, detailed information as part of a voluntary notice, and to answer CFIUS requests for follow-up information within three business days or risk having the notice rejected. As a result, parties will need to engage in even greater advance planning to develop complete information at the front end, before filing a notice that triggers the tight statutory deadlines for CFIUS review.

The following is a summary of the main changes from the proposed regulations.

1. Effective Date: In general, the effective date of the regulations will be December 19, 2008 (i.e., 30 days from their publication in the Federal Register). However, certain provisions, mostly related to whether a particular transaction is a covered transaction, will not apply where parties have made a commitment to engage in a transaction before the effective date, such as by executing a written agreement establishing the material terms of the transaction, making a public offer to shareholders to buy shares of a U.S. business, or soliciting proxies in connection with an election of the board of directors of a U.S. business requesting the conversion of convertible voting securities.

2. Control: The final regulations add two additional examples of minority shareholder protection rights that will not be considered to confer control:

The power to prevent an entity from voluntarily filing for bankruptcy or liquidation; and
The power to prevent changes in existing legal rights or preferences for a particular class of stock.

The final regulations also add a provision on incremental acquisitions: a foreign person that acquires an additional interest in a U.S. business that was previously the subject of a covered transaction for which CFIUS concluded all action will not be considered a covered transaction.

3. Definitional Issues: The definition of “entity” clarifies that it can include assets with no distinct legal personality. The definition of “foreign entity” has been revised to include an entity organized under the laws of a foreign state if either (1) its principal place of business is outside the United States or (2) its equity securities are primarily traded on one or more foreign exchanges. (This definition does not include an entity that is majority-owned by U.S. nationals. However, such a non-foreign entity may still be a “foreign person” if control is nevertheless exercised by a foreign national, foreign government or foreign entity.)

4. Lending Transactions: While most foreign lenders to U.S. companies in the ordinary course do not expect to acquire control over collateral, the final regulations clarify that a loan or other financing arrangement may constitute a covered transaction if it involves any of the following:

The foreign person is acquiring an interest in profits of a U.S. business;
The foreign person is acquiring the right to appoint members of the board of directors of a U.S. business; or
The financing arrangement involves other financial or governance rights characteristic of an equity investment rather than a typical loan.

5. Convertible Voting Instruments: The final regulations include an expanded provision for determining whether the acquisition of convertible voting instruments may confer control. Rights that will be acquired upon conversion may be taken into account by CFIUS based upon factors that include:

The imminence of conversion;
Whether conversion depends on events within the control of the acquiring party; and
Whether the voting interest and rights that would be acquired upon conversion can be reasonably determined at the time of acquisition.

If CFIUS concludes that rights to be acquired upon conversion should not be included in determining whether a transaction is covered, the regulations specify that the convertible instruments should be disregarded except to the extent that they convey immediate governance rights.

6. CFIUS Notices: The final regulations make several changes to the content of a CFIUS notice. Those changes generally narrow the scope of information that the proposed regulations would have required (but still represent a significant increase from what is required under the old regulations). Notable changes include:

Requiring a “good faith approximation of the net value of the interest acquired” instead of a statement of the full value of the transaction and how it was derived.
Identifying the methodology used to determine market share instead of how the estimate was derived. (The new requirement that the notice disclose market shares by product and service category for the U.S. business being acquired, together with the new requirement that direct competitors be identified, may present special concerns in transactions that also are subject to antitrust/competition reviews such as Hart-Scott-Rodino Act filings, or otherwise raise antitrust/competition issues.)
Limiting the disclosure requirement for government contracts within the past three years to those involving national defense, homeland security or other national security responsibilities.
Clarifying that articles or services “under development” that may in the future be designated or determined to be ITAR-controlled must be disclosed, and requiring disclosure of ITAR-controlled defense articles and services but not related technical data.
Designating the directors and officers of the foreign person and all of its parent companies, as well as all individuals owning 5% or more of the foreign person or its ultimate parent, as individuals for whom a curriculum vitae or similar document, as well as other personal identifier information, must be submitted, and slightly narrowing the scope of foreign military service information that must be provided as part of the personal identifier information.

The final regulations also provide parties three business days (instead of two) to respond to requests from CFIUS for additional information during its review or investigation of a transaction. Failure to meet that deadline may result in CFIUS rejecting the notice.

7. Finality of CFIUS Action: The final regulations delete a provision in the proposed regulations specifying circumstances in which CFIUS could reopen a previously-completed review of a covered transaction. However, the preamble makes clear that CFIUS continues to have the power to reopen in those circumstances pursuant to the statute and Executive Order 11858.

8. Confidentiality: The final regulations expressly make the confidentiality protections apply to pre-filing consultations and submissions, and add the following as circumstances those protections cover:

When CFIUS has concluded action concerning a notified transaction;
When CFIUS determines that a notified transaction is not a covered transaction; and
When information has been provided in a pre-filing submission but the parties did not subsequently file a notice.

9. Penalties: The penalty provisions authorized by FINSA for violations of the statute, regulations or mitigation agreements will apply to any actions taken as of the effective date, even if the transaction or voluntary notice occurred earlier.

Observations and Analysis

While the final regulations provide guidance, transparency and detailed examples on key issues, they preserve substantial flexibility for CFIUS in practice. The regulations eschew bright-line tests for critical determinations that must be made, instead providing non-exclusive lists of factors to be considered and factual illustrations. For example, in defining “control,” they do not set any percentage ownership threshold or other bright line; rather, CFIUS will engage in a case-by-case assessment of all relevant facts and circumstances. Similarly, CFUIS will evaluate what qualifies as “critical infrastructure” and the timing of convertible voting instruments based on multiple factors. This approach—which is consistent with prior CFIUS practice—allows CFIUS to assert jurisdiction over a wider range of transactions based on the concerns of its member agencies.

CFIUS also has maintained wide discretion on procedural matters. Because the new regulations encourage pre-filing consultations, several commenters suggested that CFIUS should provide a binding decision on whether a transaction is covered prior to submission of a full voluntary notice. While it noted the potential utility of that approach, CFIUS rejected the suggestion as overly burdensome. The upshot is that parties may find it necessary to file a notice even if CFIUS jurisdiction appears doubtful.

Despite extensive discussion in public meetings during the rulemaking process, neither the proposed regulations nor the final regulations mention sovereign wealth funds (SWFs). CFIUS presumably will continue to treat investments by SWFs the same as other transactions involving a foreign government, which require mandatory review and investigation except in limited special circumstances.

These final regulations, as well as recent CFIUS practice and statements, reflect the fact that CFIUS has become more activist in pursuing its mandate—by requiring more detailed information, by encouraging parties to file voluntary notices, and by reviewing transactions that may raise concerns even if a voluntary notice has not been filed. However, CFIUS has also sought to make its process more transparent—by providing extensive factual examples illustrating how it intends the rules to apply and by encouraging communication with the parties, including pre-filing consultations. The new regulations confirm and formalize the considerable leverage that CFIUS has—and has exercised—over parties in potentially covered transactions. Making that process more transparent in the CFIUS regulations should help parties anticipate and prepare for contingencies that could delay or derail CFIUS review.

If you have any questions regarding these final regulations, please contact Tim Walsh at 202.429.6277, Ed Krauland at 202.429.8083, or Mike Gershberg at 202.429.6208.