Bloomberg Law
Jan. 15, 2020, 1:44 AM

ANALYSIS: CFIUS Final Rules Shaped by Japan Investor Concerns

Grace Maral Burnett
Grace Maral Burnett
Legal Analyst

Yesterday’s new foreign investment regulations reflect key changes and clarifications in response to comments submitted by Japanese and other foreign investors, as well as U.S. industry groups, companies, and law firms. These final rules, issued by the Department of the Treasury as required by the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA), apply to the process and standards of the Committee on Foreign Investment in the U.S. (CFIUS).

The regulations give special status to investors from Australia, Canada, and the United Kingdom, loosen thresholds relating to excepted investors so that more investors may attain that status, and implement the newly-required mandatory filing requirements for certain transactions. They also make significant improvements in clarity as regards impacted foreign entities and issues that affect investment funds.

The Final Rules Contain Significant Changes from the Proposed Rules

On January 13, 2020, the U.S. Department of the Treasury issued two final CFIUS regulations (one for non-real estate investments, the subject of this article, and one for covered real estate investments) as well as an interim rule and request for comments setting a new interim definition for the term “principal place of business.” Treasury had released proposed versions of the regulations for comment in September 2019. During the comment period, Treasury received 62 comments on the proposed rules on covered investments totaling over 313 pages, including a number of lengthy comments from key stakeholders asking for clarification and in some cases suggesting specific changes to the proposed rules.

The final regulations on covered investments reflect many revisions to the proposed regulations, a large portion of which are substantive and, as explicitly indicated by Treasury in the 45-page introductory section of the regulations entitled “Background,” were made in direct response to comments received. (See a blackline comparing the proposed and final versions here). The Background section primarily reads as a detailed discussion by Treasury of the comments it received, without naming commenters, and its rationale for either adopting or rejecting certain suggestions contained in the comments. The modifications to the proposed rules embodied in the final rules indicate that Treasury thoroughly and seriously considered the comments it received and made real revisions to the proposed rules in response.

Key New Provisions in the Final Rules

Below are some key developments reflected in the final regulations, but the list is not exhaustive as the changes from the proposed regulations are numerous. The final regulations include revisions for clarity, expansions and narrowing definitions, and the addition of many illustrative examples to help stakeholders better understand the rules.

Australia, Canada, and the United Kingdom are the first designated excepted foreign states. The final regulations reveal that CFIUS has selected the first three countries to be considered “excepted foreign states,” investments from which are carved out of the definition of covered investments. (The carve-out does not apply to covered control transactions.)

Regarding the choice of these three countries, Treasury states as follows: “The Committee identified these countries due to aspects of their robust intelligence-sharing and defense industrial base integration mechanisms with the United States. Additionally, as noted in the preamble to the proposed rule, the concept and definition of “excepted foreign states” are new and an expansive application carries potentially significant implications for the national security of the United States. Consequently, the Committee is initially identifying a limited number of eligible foreign states and may expand the list in the future.”

The final rules clarify that the definition of the term excepted foreign state “operates as a two-criteria conjunctive test, with delayed effectiveness for the second criterion.” In short, Australia, Canada, and the U.K. have until 2022 to fulfill the second criterion, which is a determination by the Committee that the country has “established and is effectively utilizing a robust process to analyze foreign investments for national security risks and to facilitate coordination with the United States on matters relating to investment security.”

This two year grace period is intended to give the three countries “time to ensure that their national security-based foreign investment review processes and bilateral cooperation with the United States on national security-based investment reviews meet the requirement under § 800.1001” and also give the Committee time to “to develop processes and procedures for making determinations under § 800.1001, which could be applied to a broader group of countries in the future.”

U.K. investors in the U.S., which have shown a marked increase in M&A activity here since Brexit, will welcome this news. What we can expect now is more fine tuning of the three countries’ own foreign investment restrictions currently in place over the next two years to ensure that they meet all the criteria to keep their excepted status once the grace period passes in 2022.

Some “excepted investor” thresholds have been loosened so more can qualify. Treasury has relaxed some of the criteria related to excepted investors as a result of comments it received to the proposed regulations. Excepted investors, which are certain investors connected to excepted foreign states, may now have up to 25% non-excepted-foreign-state membership on their board of directors. Additionally, the minimum excepted ownership percentage was lowered from 90% to 80%. In other words, the U.S. or excepted foreign state persons or entities must own 80% of an entity in order for it to maintain its status as an excepted investor.

Shearman & Sterling LLP’s Tokyo office commented almost exclusively on the excepted investor criteria, expressing concern to avoid “a disproportionately chilling effect on beneficial investment in U.S. businesses by Japanese investors.“ Their focus was on board memberships: “[W]e ask CFIUS to consider amending §800.220(a)(3)(iii) of the Proposed Rule to (i) permit a foreign entity of an excepted foreign state to appoint members of its board of directors that are not U.S. nationals or foreign nationals of an excepted foreign state so long as the number of any such members does not comprise a majority of the board of directors (or, alternatively, some smaller proportion of the board of directors that may be deemed more appropriate).” The changes in the final rule are consistent with at least a portion of these comments.

The Japanese Business Federation Kiedanren echoed the same concerns raised by Shearman & Sterling vis-à-vis Japanese investors and requested “to lower the floor of members being U.S. nationals or foreign nationals of excepted states to the greatest extent possible [in order to] better align with the realities of international business and thereby promote international investment without harming national security.”

A number of other comments also included questions and concerns about the excepted investor scope, including those of White & Case LLP, Sidley Austin LLP, the National Venture Capital Association, and Singapore’s Temasek Holdings.

CFIUS has adopted the “nerve center” test used by U.S. federal courts to determine diversity jurisdiction as the basis for new interim definition of “principal place of business.” The proposed regulations did not define the term “principal place of business,” one of the criteria for being considered an excepted investor. The American Investment Council’s October 17, 2019 comment “on behalf of its members in the U.S. private equity community” to the proposed regulations raised the concern about U.S. funds who use offshore structures but maintain their principal places of business in the U.S. and specifically suggested the “nerve center” test that has been adopted by Treasury. This modification, along with others, shows that CFIUS is taking seriously the concerns of the private equity industry, which lobbied extensively on FIRRMA, and which represents nearly a quarter of all U.S. M&A activity.

There is a mandatory filing requirement for critical technology covered transactions. The final rules adopt the Critical Technologies Pilot Program interim rule’s mandatory filing requirement for covered transactions involving critical technologies. The proposed regulations had not addressed this issue, stating that Treasury was still considering the scope of the new mandatory filing requirements relating to critical technologies, but the question is now resolved. Key aspects of the critical technologies pilot program, which was the first test of CFIUS’s new mandatory filing authority under FIRRMA, have made it into the final rules. Prior to FIRRMA, the filing procedures were voluntary. The critical technology pilot program interim rules still apply as of this writing and are effective through February 12, 2020.

NAICS codes, as the basis for critical technologies definition, are soon to be scrapped. Treasury states in the Background of the final regulations that it “anticipates issuing a notice of proposed rulemaking that would revise the mandatory declaration requirement regarding critical technology at § 800.401(c) from one based upon North American Industry Classification System (NAICS) codes to one based upon export control licensing requirements.”

There are new exemptions to the critical technology mandatory declaration requirement. The new exemptions relate to “excepted investors, FOCI-mitigated entities, certain encryption technology, and investment funds managed exclusively by, and ultimately controlled by, U.S. nationals. Foreign Ownership, Control or Influence (FOCI) is a U.S. Department of Defense designation for certain entities; FOCI entities must be “mitigated” by DSS, a Defense agency, by agreement or other mechanisms in order to get facility security clearance (FCL).

The final regulations contain an important clarification regarding the ownership chain of a foreign entity for the purposes of the excepted investor criteria. They state that “[c]ommenters expressed an inaccurate view of the minimum excepted ownership criterion’s application up the ownership chain of the foreign person. All of the conditions under § 800.219(a)(3), including the minimum excepted ownership conditions, apply to each “parent” (as defined at § 800.235) of the foreign person.” The conditions contained in § 800.219(a)(3) are a portion of the criteria required to be fulfilled for a foreign entity to be considered an excepted investor. Among a longer list of criteria, the provision requires that an excepted investor (and per this clarification all of its parents) be (i) “organized under the laws of an excepted foreign state or in the United States”; and (ii) “has its principal place of business in an excepted foreign state or in the United States”; and (iii) 75% “or more of the observers of the board of directors or equivalent governing body are (A) U.S. nationals; or (B) Nationals of one or more excepted foreign states who are not also nationals of any foreign state that is not an excepted foreign state.” See, § 800.219(a)(3) for full enumeration of applicable criteria.

This clarification regarding parents seems in large part to address White & Case LLP’s comment regarding the definition of parent companies, which it views as ambiguous. Per White & Case, “[u]nder the proposed rules, the concept of “parent” takes on even more significance—necessitating additional clarity in the “parent” definition. For example, the concept of “parent,” and the characteristics and conduct of such “parents,” now factors into: who qualifies as an “excepted investor” (under 800.220(a)(3), each “parent” of a foreign entity must satisfy certain criteria for that entity to qualify as an “excepted investor”.”

Genetic information covered by “sensitive personal data” is clarified. In the final regulations, what used to say “genetic information as defined pursuant to 45 CFR 160.103” now says: “The results of an individual’s genetic tests, including any related genetic sequencing data, whenever such results constitute identifiable data. Such results shall not include data derived from databases maintained by the U.S. Government and routinely provided to private parties for purposes of research. For purposes of this paragraph, “genetic test” shall have the meaning provided in 42 U.S.C. 300gg-91(d)(17).” This narrowing of the definition was in response to comments.

On September 25, 2019, Treasury staff met with participants from the Biotechnology Innovation Organization (Bio) and Wiley Rein, LLP to discuss, inter alia, “the scope of the Proposed Regulations’ definition of genetic data and identifiable data [and] the characteristics of the biotech industry.” The clarified provision may have stemmed from that meeting, and Bio and Genetech Inc’s comments.

Fees are still TBD. In the proposed regulations released in September 2019 Treasury stated that it was still “considering how to implement” its new authority under FIRRMA to collect fees for covered transactions for which a notice is filed. The final regulations state that Treasury “will publish a separate proposed rule implementing the Committee’s fee authority at a later date.”

Who Submitted Comments?

Here are a few of the organizations, some of which are mentioned above, whose comments appear to have shaped the changes reflected in the final regulations:

· Covington & Burling LLP
· Sidley Austin LLP
· White & Case LLP
· Shearman & Sterling LLP (Tokyo Office)
· The U.S. Chamber of Commerce
· EQT Partners Inc.
· The American Investment Council (AIC)
· Keidanren (Japan Business Federation)
· Canada Pension Plan Investment Board
· Temasek Holdings


The final rules, which become effective on February 13, 2020, implement the FIRRMA, 2018’s sweeping CFIUS reform legislation. The new interim definition of “principal place of business” will have a comment period of 30 days ending on the same day the final rules go into effect.

While there are many new updates contained in the final regulations, the FIRRMA framework and its expansion of jurisdiction to certain non-controlling investments and real estate transactions (the separate rulemaking for which is not covered in this piece) remains unchanged. The final regulations serve to work out many of the details of how FIRRMA will be implemented.