Controlling Innovation Through Non-Controlling Investment: A Look into CFIUS Post-FIRRMA

Shane Anderson, Articles Editor (‘20)

The Committee on Foreign Investment in the United States (CFIUS) is responsible for reviewing transactions involving foreign investment in the United States.[1] More specifically, the CFIUS operates at the behest of the President of the United States to supervise the ramifications of foreign direct investment (FDI) in the United States economy.[2] The CFIUS derives its authority from the Exon-Florio Amendment to Section 721 of the Defense Production Act of 1950, which maintains the President has the authority to block or delay “any merger, acquisition, or takeover . . . by or with any foreign person that could result in foreign control of any United States business.”[3] Congress has since amended such authority, most recently via the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA).[4]

The purpose of such amendment was primarily to provide the President, and consequently the CFIUS, with the authority to review and intercede in transactions that in its judgment will result in non-controlling investments and real estate transactions involving foreign entities.[5] However, since the FIRRMA became law in August 2018, the legislation has provided some unintended results. Namely, in September 2019, the Department of Treasury, whose Secretary chairs the CFIUS, published in the Federal Register a series of rules to fully implement the FIRRMA.[6] These proposed rules were met with a series of comments from technology, private equity, and venture capital firms with apprehensions that the narrow rules would stifle unintended transactions.[7]

The final rules, which were published in the Federal Register in January 2020, are set to take effect on February 13, 2020.[8] Such rules appear to have broadened the CFIUS’s jurisdiction to include foreign transactions that fall short of a true controlling interest in the sectors of critical infrastructure, critical technology, and sensitive data.[9] However, in light of several comments from concerned venture capital and private equity firms, the final rules appear to be less restrictive toward non-controlling, passive investors.[10] For example, the final rules clarify the definition of “principal place of business” as “the primary location where an entity’s management directs, controls, or coordinates the entity’s activities, or in the case of an investment fund, where the fund’s activities are primarily directed, controlled or coordinated by or on behalf of the general partner, managing member, or equivalent.”[11]

The Department of Treasury notes the benefit to this interim definition; specifically, foreign entities with their “nerve centers” in the United States are likely to receive fair treatment in line with their representations to the CFIUS.[12] However, those entities organized outside the United States for tax purposes or otherwise may find themselves classified as foreign entities for purposes of CFIUS investigation.[13] On balance, it would appear that many CFIUS-savvy attorneys agree that the proposed definition of “principal place of business” will ease many transnational entities’ concerns.[14]

Perhaps the true cause of stifled investment will not rear its ugly head in the form of nuanced definitions dealing with control but instead via the definitions of “excepted investors” and “excepted foreign states.”[15] After much comment and debate, the CFIUS decided on the select countries of the United Kingdom, Canada, and Australia for eligibility as “excepted foreign states.”[16] Congress chose such countries “due to aspects of their robust intelligence-sharing.”[17] However, it remains to be determined whether such unequal treatment will ultimately serve FIRRMA’s underlying goal: maintenance of United States technological dominance over the likes of Russia and China.[18] Indeed, Chinese investment was down 27% in the second half of 2019 when compared to the same time period in 2018.[19] However, the regulatory uncertainty surrounding which deals will be subject to CFIUS review has caused Chinese investment to forge ahead.[20] Deals concerning consumer trends and analytics have seemingly marched forward without being subject to CFIUS review.[21] Yet the concerns of Congress relating to critical infrastructure and technology appear to be palpable in some sense as American-based cybersecurity venture capital firms continue to receive backhanded offers from Russian and Chinese firms attempting to mask their true identity.[22] At the end of the day, it is the CFIUS’s prerogative as to how broadly the nuanced definitions of the FIRRMA and its accompanying regulations will work in protecting national security, even if that means sources of foreign capital drying up.[23]

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[1] See The Committee on Foreign Investment in the United States (CFIUS), U.S. Dep’t of the Treasury, https://home.treasury.gov/policy-issues/international/the-committee-on-foreign-investment-in-the-united-states-cfius (last visited Jan. 28, 2020).

[2] James K. Jackson, Cong. Research Serv., The Committee on Foreign Investment in the United States (CFIUS) 1 (2020).

[3] 50 U.S.C. § 4565 (a)(4)(B)(i) (2012).

[4] See U.S. Dep’t of the Treasury, supra note 1.

[5] Id.

[6] See Provisions Pertaining to Certain Investments in States by Foreign Persons, 84 Fed. Reg. 50174 (Sept. 24, 2019) (to be codified at 31 C.F.R. pt. 800).  

[7] See Alexander Davis, Investors Get a Win as US Rules on National Security Reviews Are Unveiled, Pitchbook (Jan. 17, 2020), https://pitchbook.com/news/articles/investors-get-a-win-as-us-rules-on-national-security-reviews-are-unveiled.

[8] See Chelsea Naso, Final CFIUS Regs Ready New Era Of Inbound Deal Scrutiny, Law360 (Jan. 15, 2020), https://www.law360.com/articles/1234129/final-cfius-regs-ready-new-era-of-inbound-deal-scrutiny.

[9] See id. (explaining the post-FIRRMA rules broadened jurisdiction).

[10] See Davis, supra note 7.

[11] See Provisions Pertaining to Certain Investments in States by Foreign Persons, 85 Fed. Reg. 3112, 3117 (Jan. 17, 2020) (to be codified at 31 C.F.R. pt. 800) (noting this proposed definition is subject to its own notice and comment period that ends February 18, 2020).

[12] Id.

[13] See Naso, supra note 8.

[14] Id.

[15] See Provisions Pertaining to Certain Investments in States by Foreign Persons, 85 Fed. Reg. at 3116 (discussing public comment concerning the proposed disparate treatment of foreign entities).

[16] See id. The benefit to classification as an “excepted foreign state” is omission from the expanded non-controlling investment concepts ushered in by the FIRRMA. Id.

[17] Id.

[18] See Davis, supra note 7 (“Behind-the-scenes haggling on the matter centered on the tensions between today's global nature of dealmaking and Washington's longstanding policy that aims to safeguard US tech supremacy over China and other rivals.”).

[19] See Heather Somerville, China Investors Keep Making Deals in Silicon Valley Amid Washington Pushback, Wallstreet Journal (Oct. 28, 2019, 7:07 PM), https://www.wsj.com/articles/chinese-investors-u-s-tech-entrepreneurs-continue-to-make-deals-11572275105?mod=searchresults&page=1&pos=7 (noting the 27% decrease is in U.S. dollar terms).

[20] See id. (discussing the business and legal maneuvering conducted by American venture capital firms receiving Chinese investment). 

[21] See id.

[22] See id. (examining the legal structures Chinese and Russian firms have employed to mask their identities).

[23] See David Zaring, CFIUS as a Congressional Notification Service, 83 S. Cal. L. Rev. 81, 84 (2009) (“To be sure, determining a ‘law of CFIUS’ is not easy. The Committee's legal mandate is replete with discretion.”).