On August 13, 2018, President Trump signed the John S. McCain National Defense Authorization Act for Fiscal Year 2019 (NDAA), which makes a number of significant changes to U.S. export control and national security laws. The NDAA contains the Foreign Investment Risk Review Modernization Act (FIRRMA), which was first proposed last November with strong bipartisan support and, as previously noted, marks the first major change to the Committee on Foreign Investment in the United States (CFIUS) review process in over a decade.

The laws and regulations administered and enforced by CFIUS are the principal mechanism for the United States to regulate in-bound investments in the United States and in U.S. companies. CFIUS is comprised of the heads of nine federal agencies and chaired by the U.S. Treasury Secretary. CFIUS is currently a voluntary process, in that non-U.S. investors in U.S. companies may choose to participate in a CFIUS review process. If successful, the CFIUS process provides a safe harbor against a later finding by CFIUS that the transaction should be blocked or unwound because it presents a risk to U.S. national security.

The final version of FIRRMA makes a number of substantive and procedural changes to the existing CFIUS process and will significantly impact companies with investments in U.S.-based businesses, real estate and other assets, as well as non-U.S. investors wishing to acquire even minority shares in U.S. companies. Among the classes of investors and investments that will be most affected by FIRRMA are:

• Investors from China and Chinese-owned and controlled entities: FIRRMA does not directly mention China or Chinese investments, but as its Congressional sponsors made clear when it was introduced, the legislation is mainly designed to restrict Chinese investments that are believed to threaten or undermine U.S. national security. Accordingly, Chinese companies, investors, and Chinese owned or controlled investment funds can expect to receive heightened scrutiny in any new or increased investments in the United States or U.S. companies. FIRRMA also directs the U.S. Department of Commerce to undertake a comprehensive investigation of Chinese investment in the United States, including the pattern of existing investments in U.S. strategic industries. It is likely that the results of this study will lead to additional controls and scrutiny by CFIUS of such investments.

  • Significantly, Section 1727(c) of FIRRMA authorizes CFIUS to conduct a pilot program to implement the new statute on a more limited scale, even before all other formal rulemaking has been completed. Preparations for this pilot program are reportedly already underway within the Trump administration and are expected to soon begin to impact transactions that are considered to be higher risk, such as investments by Chinese companies in U.S. semiconductor, aerospace, software and other industries targeted for development by China’s own “Made in China 2025” industrial policy and other state-directed strategic investment programs that were the focus of the U.S. Trade Representative’s recent Section 301 investigation.

• Controlling and non-controlling investments that involve “critical infrastructure,” “critical technology” or “sensitive personal data” of U.S. citizens. FIRRMA expands CFIUS jurisdiction to encompass new or expanded definitions of a “covered investment.” In particular, investments of any level or percentage stake will be covered by CFIUS if a foreign investor will thereby gain (i) access to “material nonpublic technical information” held by the U.S. target, (ii) board membership or observer or nomination rights, or (iii) the ability to direct the decisions of the U.S. target with regard to sensitive critical infrastructure, critical technology or sensitive personal data.

  • The definition of “critical infrastructure” is largely unchanged from the existing definition and includes “systems or assets, whether physical or virtual, so vital to the United States” that if they were incapacitated or destroyed, they would “have a debilitating effect on national security.”

  • “Critical technology” includes any technology subject to U.S. export control lists (i.e., the U.S. Munitions List and Commerce Control List) as well as yet-to-be-defined “emerging and foundational technologies.” These “emerging and foundational technologies” will be defined by U.S. export control authorities and may include certain new technologies that are not currently subject to significant export controls, such as Artificial Intelligence, some forms of quantum computing and advanced materials, as well as more traditional technologies deemed fundamental to the U.S. industrial base, such as chemicals, energy, metallurgy and transportation.

  • Covered “sensitive personal data” will include information about U.S. citizens that “may be exploited in a manner that threatens national security,” such as certain sensitive health and insurance records of individual Americans. Given the broad scope of this statutory definition, companies in the healthcare and insurance industries will want to pay close attention to the CFIUS rulemaking process in the coming weeks and months and consider making their voices heard in the notice and comment process.

• Non-U.S. investors in which foreign governments, sovereign wealth funds, and other state-owned and controlled entities hold shares or other interests: FIRRMA directs CFIUS to require mandatory filings for investments by foreign companies, investment funds and other entities in which a foreign government has, directly or indirectly, a “substantial interest,” if the investment would, in turn, result in gaining, directly or indirectly, a “substantial interest” in the U.S. target of the investment. Congress has left it to CFIUS to develop the precise definition of “substantial interest” through implementing regulations, but has instructed the committee to focus on indicia of control such as board membership, ownership interests or shareholder rights. In general, total shareholding by the foreign government that is less than 10 percent of the total shares in the non-U.S. investor would not constitute a “substantial interest” in that non-U.S. investor.

• U.S. real estate investments: FIRRMA expands CFIUS jurisdiction over investments in real estate to include the purchase, lease or concession of U.S. real estate to a non-U.S. person if the real estate (i) is in “close proximity” to U. S. military or other sensitive U.S. government facilities and would allow for the collection of intelligence or compromise the national security-related activities of the U.S. government installation, or (ii) is within or functions as part of a port or airport. Some classes of real estate, such as single housing units, are exempted as are real estate investments that are located too far from covered U.S. government facilities to pose a national security threat.

• Private equity and other investment funds: FIRRMA clarifies that investments by U.S.-based investment funds that are held by U.S. person general partners normally will not be subject to CFIUS review, so long as any non-U.S. person limited partners or other passive investors will not gain access to material non-public information about the investment and will not otherwise have the ability to control decisions of the fund with regard to any investments. This new provision should provide much needed certainty for U.S. funds that have sought to attract capital from non-U.S. sources.

• Investments from close U.S. allies: FIRRMA authorizes CFIUS to develop categories of non-U.S. investors that may be subject to greater or lesser degrees of scrutiny. The details will need to be worked out through the upcoming rulemaking process, but is expected to exempt or reduce the burden of participating in the CFIUS process for investors from close U.S. allies. By contrast, as noted above, investors from China and other “countries of concern” and those who have a track record of not complying fully with CFIUS requests may be placed in categories that subject any future transactions to heightened CFIUS scrutiny.

FIRRMA also introduces a number of important changes to the CFIUS review and investigation process, including filing fees, additional resources for CFIUS staffing, greater authority for CFIUS to investigate transactions that were not notified to CFIUS, and mandatory or optional “short-form” filings. These new short form filings may provide an opportunity for investors from U.S. allies and others to obtain greater certainty and reduce the costs of participating in the CFIUS process.

FIRRMA does not contain a “grandfathering” mechanism, and it will generally apply to all pending and future transactions on or after August 13, 2018. Having said that, the statute contains many provisions that will require notice and comment rulemaking to implement (a process that FIRRMA requires to be completed by February 13, 2020). In contrast, the trial program provisions of the statute may begin to impact higher risk transactions as soon as this fall.