Daily Rules, Proposed Rules, and Notices of the Federal Government
The Foreign Investment and National Security Act of 2007 (“FINSA”), Public Law 110-49, 121 Stat. 246, which amends section 721 of the Defense Production Act of 1950 (“DPA”) (50 U.S.C. App. 2170), requires the issuance of regulations implementing its provisions following public notice and comment.
FINSA was passed by Congress as H.R. 556, which adopted the language of S. 1610. Senate Report 110-80, accompanying S. 1610, provides a useful history of the various bills leading to the enactment of FINSA. President Bush signed FINSA into law on July 26, 2007, and it became effective on October 24, 2007.
Section 721 authorizes the President to review mergers, acquisitions, and takeovers by or with any foreign person which could result in foreign control of any person engaged in interstate commerce in the United States, to determine the effects of such transactions on the national security of the United States. FINSA codifies aspects of the structure, role, process, and responsibilities of the Committee on Foreign Investment in the United States (“CFIUS” or “the Committee”) and the role of executive branch departments, agencies, and offices in CFIUS's review of transactions for national security concerns. A brief summary of major aspects of the statute follows.
FINSA formally establishes CFIUS in statute. (Previously, the sole basis for the existence of CFIUS had been Executive Order 11858 of May 7, 1975, 40 FR 20263, 3 CFR, 1971-1975 Compilation, p. 990.) FINSA specifies the following as members of CFIUS: The Secretary of the Treasury (who serves as chairperson), the Attorney General, and the Secretaries of Homeland Security, Commerce, Defense, State, and Energy. FINSA also provides that CFIUS may include, generally or on a case-by-case basis as the President deems appropriate, the heads of any other executive department, agency, or office. The President designated the U.S. Trade Representative and the Director of the Office of Science and Technology Policy as additional members of CFIUS in Executive Order 11858, as amended most recently by Executive Order 13456, 73 FR 4677 (Jan. 23, 2008). In the same Executive Order, the President directed that “[t]he following officials (or their designees) shall observe and, as appropriate, participate in and report to the President on [CFIUS's] activities”: (i) The Director of the Office of Management and Budget, (ii) the Chairman of the Council of Economic Advisors, (iii) the Assistant to the President for National Security Affairs, (iv) the Assistant to the President for Economic Policy, and (v) the Assistant to the President for Homeland Security and Counterterrorism. FINSA also establishes the Director of National Intelligence (“DNI”) and the Secretary of Labor as
FINSA also formalizes the process by which CFIUS conducts national security reviews of any transaction that could result in foreign control of a person engaged in interstate commerce in the United States, which FINSA refers to as a “covered transaction.” Specifically, FINSA provides for CFIUS review of covered transactions, which must be completed within 30 days, to determine the effect of the transaction on national security and to address any national security concerns. Subject to certain exceptions discussed below, FINSA requires an additional investigation, which must be completed within 45 days, in the following types of cases: (1) Where the transaction threatens to impair U.S. national security and that threat has not been mitigated prior to or during the 30-day review; (2) where the transaction is a foreign government-controlled transaction; (3) where the transaction results in foreign control over critical infrastructure that, in the determination of CFIUS, could impair national security, if that impairment has not been mitigated; or (4) where the lead agency recommends, and CFIUS concurs, that an investigation be undertaken. Executive Order 11858 also provides that CFIUS shall undertake an investigation if a member of CFIUS advises the chairperson that it believes that the transaction threatens to impair the national security and that the threat has not been mitigated.
To ensure accountability for CFIUS decisions, FINSA requires that a senior-level official of the Department of the Treasury and of the lead agency certify to Congress, for any covered transaction on which CFIUS has concluded action under section 721, that CFIUS has determined that there are no unresolved national security concerns. The certification must be made at a level no lower than an employee appointed by the President by and with the advice and consent of the Senate, for transactions on which CFIUS concludes action under section 721 after a review, and at the Deputy Secretary level or above for transactions on which CFIUS concludes action under section 721 after an investigation. If the President makes a decision on a transaction under section 721, then he must announce his
In addition, in order for CFIUS to conclude action under section 721 for a foreign government-controlled transaction without proceeding beyond a review to an investigation, the Department of the Treasury and the lead agency must determine, at the Deputy Secretary level or above, that the transaction “will not impair the national security.” Similarly, in cases where the transaction would result in foreign control over critical infrastructure, the transaction could impair national security, but such impairment has been mitigated during the review period, CFIUS may conclude action under section 721 without proceeding beyond a review if the Department of the Treasury and the lead agency determine, at the Deputy Secretary level or above, that the transaction will not impair national security.
Where a covered transaction presents national security risks, FINSA provides statutory authority for CFIUS, or a lead agency acting on behalf of CFIUS, to enter into mitigation agreements with parties to the transaction or to impose conditions on the transaction to address such risks. This authority enables CFIUS to mitigate any national security risk posed by a transaction rather than recommending to the President that the transaction be prohibited because it could impair U.S. national security. FINSA also provides CFIUS with authority to impose civil penalties for violations of section 721, including violations of any mitigation agreement.
Finally, FINSA increases CFIUS's reporting to Congress concerning the work it has undertaken pursuant to section 721. In addition to the certifications described previously, which CFIUS must provide to Congress after concluding action on a transaction under section 721, CFIUS also must provide annual reports on its work, including a list of the transactions it has reviewed or investigated in the preceding 12 months, analysis related to foreign direct investment and critical technologies, and a report on foreign direct investment from certain countries.
The Final Rule contained in this document is based on the Notice of Proposed Rulemaking published on April 23, 2008 (“Proposed Rule”) (73 FR 21868), which proposed amendments to the regulations in part 800 of 31 CFR. The comment period for the Proposed Rule ended on June 9, 2008. The Department of the Treasury received a total of 25 written submissions and some oral comments that were principally provided at a public meeting held at the Department of the Treasury on May 2, 2008. The written and oral submissions comprised approximately 200 distinct comments. The comments represented a wide range of interests, including foreign governments, U.S. business groups, law firms, and a member of Congress. All comments received by the end of the comment period were posted for public viewing at
Among the comments submitted were a number that welcomed the Proposed Rule as helping the Committee to safeguard U.S. national security in a manner consistent with the U.S. commitment to open investment. Although one commenter believed the Proposed Rule would result in the “great majority” of mergers and acquisitions being subject to reviews, the Committee does not expect the changes to the regulations to materially affect the number of transactions that it reviews. From 2005 through 2007, the Committee reviewed less than ten percent of foreign acquisitions in the United States.
We respond to the comments submitted in the detailed section-by-section analysis, below.
The Final Rule retains many of the basic features of the existing regulations, which were adopted in 1991 after the 1988 enactment of section 721 of the DPA. The system continues to be based on voluntary notices to CFIUS by parties to transactions, although FINSA provides CFIUS with the authority to review a transaction that has not been voluntarily notified. The principal new development with regard to the procedures for filing notices with CFIUS is that the Final Rule makes explicit CFIUS's current practice of encouraging parties to contact and engage with CFIUS before making a formal filing. By consulting with CFIUS in advance of filing and, where appropriate, providing CFIUS with a draft notice or some portion of the information that later may be included in the notice, parties can help ensure that their notice, once submitted, will contain the information CFIUS needs to do its work. Such pre-notice consultations can help ensure that reviews of covered transactions are concluded as efficiently as possible. Consistent with the requirement set forth in section 721(b)(2)(E), the Department of the Treasury, as Chairperson of CFIUS, will also be publishing in the
The provisions of Subpart D pertaining to the contents of a voluntary notice have been expanded to reflect information that CFIUS now routinely seeks from notifying parties. By having the relevant information included in each notification, CFIUS will be better prepared to conduct an efficient and in-depth analysis as soon as a notice is accepted. As noted in the proposed regulations, personal identifier information, which is needed to examine the backgrounds of members of the boards of directors and senior company officials of entities in the ownership chain of the foreign acquirer, should be submitted in conjunction with each notification, and should be marked clearly and provided as a separate document to facilitate limited distribution of this information. In addition to the new information requirements, the Final Rule, consistent with FINSA, also requires each of the parties to a notified transaction to provide certifications regarding the accuracy and completeness of their notices, as to information about the party making the certification (including certain affiliated entities), the transaction, and all follow-up information. A notice will not be deemed complete if it lacks certifications that comply with these requirements, and CFIUS may reject a notice that has previously been accepted if the final certification required under § 800.701(d) has not been received. Furthermore, material misstatements or omissions made by a party in connection with a review or investigation may result in the rejection of the notice or the reopening of a completed review or investigation.
Consistent with the new authority provided by FINSA, the Final Rule provides for penalties for material misstatements or omissions made to CFIUS, for false certifications, or for breach of mitigation agreements or conditions entered into or imposed under section 721. The Final Rule also provides that a mitigation agreement may include provisions establishing liquidated damages for violations of the agreement.
Additional changes to the regulations have been made, including revisions to or deletions of existing examples or provisions, to take into account FINSA, and to otherwise add clarity to the regulations. The following discussion addresses changes to several of the key concepts of the regulations.
FINSA introduced the term “covered transaction” to identify the types of transactions that are subject to review and investigation by CFIUS. The statutory definition of covered transaction maintains the scope of section 721 as pertaining to any merger, acquisition, or takeover by or with a foreign person that is proposed or pending after August 23, 1988, which could result in foreign control of any person engaged in interstate commerce in the United States (the latter type of person is defined in these regulations as a “U.S. business”).
The Final Rule further clarifies the meaning of the term “covered transaction,”
The term “transaction” is defined in § 800.224, and implements the statutory requirement that a covered transaction be one that involves a “merger, acquisition, or takeover” that is proposed or pending after August 23, 1988, by encompassing both proposed and completed transactions. This definition continues to exclude start-up or “greenfield” investments and includes only a very limited type of long-term lease.
FINSA does not define “control,” but rather requires that CFIUS prescribe a definition by regulation.
The Final Rule maintains the long-standing approach of defining “control” in functional terms as the ability to exercise certain powers over important matters affecting an entity. Specifically, “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 the [matters listed in § 800.204(a)], or any other similarly important matters affecting an entity.”
Demonstrating its significance to this regulatory framework, the concept of control appears in several different places throughout the regulations, both in those sections that define the nature of the acquirer and those that define the transaction itself. For example, control is a key concept in the definitions of “foreign person” and “foreign government-controlled transaction.” A foreign person is any foreign national (
Conversely, transactions that could not result in foreign control of a U.S. business are not subject to section 721. Thus, a start-up or “greenfield” investment is not subject to section 721.
Section 800.204 lays out the basic definition of “control,” provides an illustrative list of matters that are deemed to be important, states that CFIUS will consider certain relationships between persons in evaluating whether an entity is considered to be controlled by a foreign person, and identifies certain minority shareholder protections that are not considered in themselves to confer control over an entity. The regulations add a number of examples to provide greater clarity as to the application of this definition.
Section 800.226 defines “U.S. business,” a term contained in the regulatory definition of “covered transaction,” to mean any entity engaged in interstate commerce in the United States, but only to the extent of its activities in interstate commerce in the United States. In determining whether a person is a U.S. business, CFIUS first will consider whether the subject of the transaction is an “entity” (which is defined to include any branch, partnership, group or sub-group, association, estate, trust, corporation or division of a corporation, or organization; assets, whether or not organized as a separate legal entity, operated by any one of the foregoing as a business undertaking in a particular location or for particular products or services; and any government). If the subject of the transaction is an entity, CFIUS will consider whether the entity is engaged in interstate commerce.
The term “foreign person” is defined in § 800.216. The Final Rule introduces the new concept of a “foreign entity,” further discussed below in the section-by-section analysis of § 800.212, and specifies that an entity that falls within the definition of a “foreign entity” will be deemed a foreign person.
Sections 800.301 and 800.302 illustrate the types of transactions that are and are not covered transactions, respectively. Section 800.301(a) further develops the reference in § 800.204 to “power, whether or not exercised,” by making clear that, if a foreign person has the ability to exercise control over a U.S. business at the time a transaction is consummated, whether at will or after a particular period of time, then the person cannot avoid a determination that “control” exists for purposes of section 721 by voluntarily forgoing, or delaying, the exercise of control.
Section 800.302(b) provides a very limited qualification to the application of the general control principle. Pursuant to § 800.302(b), a foreign person does not control an entity if it satisfies a two-pronged test: (1) It holds ten percent or less of the voting interest in the entity; and (2) its interest is held solely for the purpose of passive investment. Section 800.223 lays out the test for whether an interest is held solely for the purpose of passive investment. Under that test, an interest would be held solely for the purpose of passive investment if the foreign person has no plan or intent to control the entity, neither possesses nor develops any purpose other than passive investment, nor takes any action that is inconsistent with an intent to hold the interest solely for the purpose of passive investment. This special rule applies to all types of investors equally, rather than assuming that certain types of institutions are passive investors.
Sections 800.301(c) and 800.302(c) further illustrate the extent to which particular types of transactions, such as greenfield investments; the acquisition of branch offices, assets from multiple sources, and defunct businesses; and the entry into commodity purchase contracts, service contracts, and technology license agreements, are or are not covered transactions. Section 800.301(d) addresses joint ventures, which may be covered transactions only if they involve the contribution of a U.S. business.
Sections 800.302(d) and (e) and § 800.303 establish special rules with regard to securities underwriting, insurance, and lending, to clarify certain circumstances in which a foreign person may obtain, in the ordinary course of its business, an interest in an entity that may not be considered control of that entity because of those circumstances.
Section 800.101 of the Proposed Rule states that the regulations implement section 721, which authorizes the President and the Committee to take certain actions with respect to covered transactions that threaten to impair U.S. national security. Several commenters noted that the regulations do not define “national security” and other related terms. A commenter suggested that there is a perception that the scope of CFIUS's reviews is broader than national security. Another suggested that “national security” be specifically defined to encompass economic security. A commenter also suggested that the Committee identify certain excepted industries or businesses, investments in which would not be subject to review.
The Committee will continue its practice of focusing narrowly on genuine national security concerns alone, not broader economic or other national interests. The longstanding policy of the U.S. Government, which was reaffirmed in the President's Statement on Open Economies on May 10, 2007, is to welcome foreign investment. Section 1 of Executive Order 11858, as amended, applies that policy to the Committee's work: “It is the policy of the United States to support unequivocally [international] investment, consistent with the protection of the national security.” The Committee reviews transactions for national security concerns on a case-by-case basis. This approach allows the Committee to fully address the national security concerns that a particular transaction may raise, rather than identifying certain sectors in which foreign investment is prohibited, restricted, or discouraged. As directed by FINSA, the Department of the Treasury is also publishing guidance regarding the types of transactions that the Committee has reviewed and that have presented national security considerations.
Several commenters expressed concern that new provisions in the regulations will cause uncertainty for transactions completed prior to the effective date of FINSA or this Final Rule and that parties should be given sufficient time to adjust to any new standards.
As provided in section 721 as amended by FINSA and further elaborated in § 800.207 and § 800.601(b) of the Final Rule, the Committee has the authority to review any covered transaction. However, to allow parties time to adjust to this Final Rule, the amendments to part 800 made by this Final Rule will become effective thirty days after their publication in the
With respect to actions already taken by parties to transactions, the Committee does not intend for this Final Rule to disrupt certain expectations created by the provisions of the regulations, prior to their amendment by this Final Rule.
As provided in § 800.103(a), the provisions of this Final Rule apply as of the effective date of this Final Rule, with certain exceptions. These exceptions are spelled out in § 800.103(b), and consist of the various provisions that relate to whether a particular transaction is a covered transaction. Provisions that pertain to procedural matters are thus not listed in paragraph (b) but, rather, apply to all CFIUS reviews and investigations as of the effective date. Accordingly, for example, all notices filed with the Committee on or after the effective date of this Final Rule must contain the information specified in § 800.402 of this Final Rule, regardless of when the transaction occurred or will occur. Notices filed with the Committee prior to the effective date of this Final Rule are required to contain at least the information specified in § 800.402 of the prior regulations.
As provided in § 800.103(b), particular sections of subparts B and C of this Final Rule apply to any transaction for which the execution of the agreement, or other comparable action underlying the transaction, occurs on or after the effective date of this Final Rule. As noted above, these provisions concern the assessment of whether a transaction is a “covered transaction.” Paragraphs (b)(1) through (b)(4) of § 800.103 specify the particular event that needs to occur on or after the effective date in order for the relevant provision of the Final Rule to apply to the transaction. For example, if a letter of intent establishing the material terms of a transaction is signed on or after the effective date of this Final Rule, then the provisions of the Final Rule will govern the analysis of whether the transaction is a “covered transaction.” Conversely, if the letter of intent was signed before the effective date of this Final Rule, then the Committee will look at the provisions of the prior regulations in analyzing whether the transaction is a “covered transaction,” even if the transaction was notified to the Committee after the effective date of this Final Rule.
Note that if parties sign a letter of intent prior to the effective date of this Final Rule, but the material terms differ in the final definitive agreement signed by the parties, then the Committee would look to the date on which that final definitive agreement was signed to determine the rules under which the assessment of whether the transaction is a “covered transaction” will be made.
When reviewing any transaction notified to the Committee on or after the effective date that falls within the scope of § 800.103(b) and that includes minority shareholder protections listed in § 800.204(c), the Committee will take into account § 800.204(c) of the Final Rule to the extent that doing so would support a conclusion that the transaction is not a covered transaction.
As provided in subpart H, the provisions concerning penalties will apply to any action after the effective date of this Final Rule that constitutes a violation under subpart H, regardless of when the related transaction occurred or when the mitigation agreement was signed. If, for example, after the effective date of this Final Rule, a party intentionally violates a mitigation agreement signed in 2000, the party may be subject to civil penalties under § 800.801(b) of the Final Rule. Damages provisions written into mitigation agreements entered into prior to the effective date of this Final Rule are independent of, and not affected by, this Final Rule.
The Proposed Rule made a number of changes to clarify the definition of “control,” which is now at § 800.204. These include, among other revisions, clarification that control depends on powers over “important matters” affecting an entity, expansion of the illustrative list of “important matters,” and the addition or revision of examples to demonstrate what constitutes control. The Overview of Significant Issues, above, like the preamble to the Proposed Rule, also explains that the acquisition of influence falling short of the definition of control over a U.S. business is not sufficient to bring a transaction under section 721. The Proposed Rule also introduced a new paragraph concerning minority shareholder protections, which is addressed below in the discussion of § 800.204(c) of the Final Rule.
Several commenters suggested that the Proposed Rule provided too expansive a definition of control, or, by not providing a more objective standard, risked inappropriate expansion of the definition. A commenter suggested that the definition of control would cause foreign investors to disclaim
The Final Rule makes numerous modifications to the language of § 800.204(a) to provide greater clarification of what constitutes “control,” including by clarifying circumstances where influence does not rise to the level of control. Examples in this section show that, although an investor might have influence within a business—for example, through a board seat, exercising
Commenters suggested further clarification of several specific important matters listed in § 800.204(a). Several commenters suggested that the power to determine, direct, or decide a single important matter affecting an entity should not constitute control and that, at the least, the Committee should clarify that it will consider the totality of the circumstances in making its assessment. Another commenter asked whether there is an ownership threshold at which control will always be found.
The Final Rule makes no changes to the list of important matters at § 800.204(a) in response to the commenters' requests for specific clarifications. The Committee approaches its analysis of whether a transaction could result in foreign control on a case-by-case basis, considering the level of ownership interest, the rights that emanate from such ownership, other rights held, restrictions on the exercise of such rights, and all other relevant facts and circumstances. The examples in § 800.204 demonstrate this approach of considering together all relevant facts and circumstances in light of their potential impact on a person's ability to determine, direct, or decide important matters affecting an entity. As a result of this approach, the regulations provide no ownership threshold or other bright lines above which CFIUS would find control in all circumstances.
Several commenters suggested that the Proposed Rule did not adequately illustrate that ownership and control can be separated through certain transaction structures—for example, in private equity funds structured as limited partnerships. One commenter suggested that the Committee clarify that it will review transactions involving private equity funds. The Final Rule adds Examples 8 and 9 in § 800.204, which provide greater clarification of the relationship between ownership and control and make clear that the Committee will focus on “control,” as defined, within any transaction structure rather than
A commenter asked for clarification of the meaning of “indirect” power in § 800.204(a). The Final Rule, like the Proposed Rule, defines “control” in functional terms. Therefore, for example, a person that has the power to determine important matters of an entity does not avoid having control of that entity by voting the shares of a wholly-owned subsidiary that, in turn, votes the shares of the entity, or by acting through another intermediary or agent.
The Proposed Rule provided that, in examining questions of control in situations where more than one foreign person has an ownership interest in an entity, consideration will be given, pursuant to what is now § 800.204(b), to whether the foreign persons are related or have formal or “informal” arrangements to act in concert. A commenter asked for clarification of what constitutes an “informal” arrangement and whether this would include a voting trust.
The Final Rule makes no change to the proposed language, which is now at § 800.204(b), in response to this comment. If a trustee has the legal authority to vote the shares of different parties, even if unrelated, then those shares would be considered as being voted in concert if the trustee can vote the shares according to its discretion or is required to vote all shares in the same way. Example 1 in § 800.204 illustrates an informal arrangement to act in concert, where no formal agreement is disclosed but it is clear from other evidence that the foreign persons have agreed to act as a group in the exercise of their powers over important matters affecting the U.S. business.
The Proposed Rule identified several minority shareholder protections at what is now § 800.204(c) and provided that the Committee will not deem those negative rights (
This Final Rule expands the list of minority shareholder protections, now at § 800.204(c), to include two additional negative rights: The power to prevent an entity from voluntarily filing for bankruptcy or liquidation, and the power to prevent the change of existing legal rights or preferences of the particular class of stock held by minority investors as provided in the relevant corporate documents governing such shares.
The list in § 800.204(c), however, expressly is not intended to be exhaustive of the rights that shall not in themselves be deemed to confer control over an entity. Section 800.204(c) includes a list of negative rights that the Committee recognizes as minority shareholder protections because they protect the investment-backed expectations of minority shareholders and do not affect strategic decisions on business policy or day-to-day management of an entity or other important matters affecting an entity.
The Committee recognizes, however, that other negative rights proposed by commenters for inclusion in § 800.204(c) are often provided to minority shareholders. Section 800.204(d) explicitly provides that the Committee will consider, on a case-by-case basis, whether minority shareholder protections other than those listed in § 800.204(c) do not confer control over an entity. Non-inclusion in § 800.204(c) of any particular right does not mean that the Committee has determined that such a right necessarily results in control and does not prejudge whether the Committee would determine under § 800.204(d) that such a right does not confer control in a particular transaction.
The Committee will consider favorably in the context of specific transactions notified to the Committee the parties' opinion that the following minority shareholder protections do not in themselves confer control: The power to prevent changes in the capital structure of the entity, including through mergers, consolidations, or reorganizations, that would dilute or otherwise impair existing shareholder rights; the power to prevent the acquisition or disposition of assets material to the business outside the ordinary course of business; the power to prevent fundamental changes in the business or operational strategy of the entity; the power to prevent incursion of substantial indebtedness outside the ordinary course of business; the power to prevent fundamental changes to the entity's regulatory, tax, or liability status; and the power to prevent any amendment of the Articles of Incorporation, constituent agreement, or other organizational documents of an entity. The Committee's favorable consideration of these rights does not preclude it from finding that the existence of one or a combination of these rights confers control under the facts and circumstances of a particular transaction.
A commenter asked that the regulations clarify whether CFIUS will review voluntary notices when a foreign person acquires an additional interest in a U.S. business after the Committee has concluded its review of a prior covered transaction involving the same parties and the President did not prohibit or suspend the transaction. The Proposed Rule did not address this point explicitly. The commenter suggested that clarifying this point would help to ensure that the Committee is not overburdened and can focus its resources appropriately on transactions that raise national security concerns.
This Final Rule adds § 800.204(e) and accompanying Example 7 to clarify the Committee's approach to incremental acquisitions. Pursuant to § 800.204(e), a transaction in which a foreign person acquires an additional interest in a U.S. business that was previously the subject of a covered transaction for which the Committee concluded all action under section 721 will not be considered a covered transaction.
If a prior investment by a foreign person in a U.S. business was not notified to CFIUS, or if CFIUS determined that the prior investment was not a covered transaction, then the subsequent investment may be a covered transaction, depending on whether the subsequent investment could result in the foreign person's control of the U.S. business.
With respect to any covered transaction, any mitigation agreement or conditions may include, subject to the requirements of section 721 and Executive Order 11858, measures to address any national security risk posed by the covered transaction, including any increased risk if the foreign acquirer were to have a greater ownership interest in the U.S. business.
The Proposed Rule defined “covered transaction” consistent with the definition of that term in section 721. The Proposed Rule provided additional clarity about what transactions are covered by section 721 in numerous other provisions, including §§ 800.301 and 800.302 and the definitions of “control,” “foreign person,” and a “U.S. business.” A commenter suggested that the Committee regularly release redacted descriptions of transactions that have been filed with the Committee, along with descriptions of
The Final Rule does not adopt this suggestion. Public release of any assessment by the Committee of whether a transaction is a covered transaction would implicate significant potential national security and confidentiality concerns. The Final Rule, at §§ 800.207, 800.301 and 800.302, provides greater clarity regarding what transactions are covered by section 721. Parties to a transaction, at their own discretion, may make available to the public information about transactions that they have voluntarily notified to the Committee.
The Proposed Rule defined “critical infrastructure” consistent with the definition of that term in section 721 and clarified that, in determining whether a covered transaction involves critical infrastructure, the Committee would consider the “particular” systems or assets involved, rather than defining certain classes of systems or assets as critical infrastructure. Several commenters expressed support for this approach. Others suggested that the scope of “critical infrastructure” be further illustrated by identifying infrastructure that would or would not be considered critical.
The Final Rule, at § 800.208, continues the case-by-case approach of section 721 and the Proposed Rule towards identifying critical infrastructure. Under this approach, the Committee determines whether (1) a particular transaction notified to it is a “covered transaction,” (2) that particular covered transaction would result in foreign control of critical infrastructure of or within the United States, and (3) that particular covered transaction has potential national security effects. Accordingly, the definition of critical infrastructure turns on the national security effects of any incapacity or destruction of the particular system or asset over which a foreign person would have control as a result of a covered transaction. Consistent with this approach, the Committee will not deem classes of systems or assets to be, or not to be, critical infrastructure.
The Proposed Rule made clear that an entity need not have a distinct legal personality in order to fall within the definition of “entity” under these regulations. A commenter asked for clarification of the circumstances in which assets with no distinct legal personality would be considered an “entity.”
The Final Rule amends the proposed text of § 800.211 to add a cross-reference to §§ 800.301(c) and 800.302(c), which provide additional clarity regarding when assets with no distinct legal personality can constitute an “entity” and, in turn, a “U.S. business.” This additional clarification is provided, in particular, by Examples 6 and 7 in § 800.301(c) and Examples 1, 2, 4, and 5 in § 800.302(c).
The Proposed Rule introduced a new term, “foreign entity,” to refer to entities the Committee considers to be foreign persons based on either their place of organization and foreign exchange listing or the extent of their foreign ownership, even if no single foreign person controls the entity. Commenters expressed concern that the definition of “foreign entity” in the Proposed Rule would have captured entities that were incorporated outside of the United States if they were primarily traded on foreign exchanges, even if the entities were in fact majority-owned by U.S. nationals.
The Final Rule revises the proposed text of § 800.212 to cover entities organized under the laws of a foreign state if either its principal place of business is outside the United States or its equity securities are primarily traded on one or more foreign exchanges. The Final Rule excludes from the definition of “foreign entity,” however, any entity that is able to demonstrate to the Committee that a majority of the equity interest in the entity is ultimately owned by U.S. nationals. Note that, under the definition of “foreign person” at § 800.216(b), any entity over which control is exercised or exercisable by a foreign person would still itself be deemed a foreign person, even if that entity does not constitute a “foreign entity.” Accordingly, an entity controlled by a foreign person is itself a foreign person, even if it is majority owned by U.S. nationals.
Commenters also asked whether a foreign person's ownership of shares of an entity could result in that entity being considered a “foreign entity” if the right to vote that person's shares were transferred to U.S. nationals through a voting trust. Example 3 in § 800.301(a) of the Final Rule illustrates that an agreement to delay the exercise of voting rights for a limited period of time does not preclude a finding of control. Similarly, if a voting trust is revocable or time-limited, the Committee would consider the foreign person that placed its shares in such a voting trust as still holding the shares.
Finally, a commenter asked whether the definition of “foreign entity” was intended to be a standard for determining foreign government control. The definition of “foreign entity” is not intended to be a standard for determining foreign government control. If an entity could be controlled by a foreign government, the question of whether it is a “foreign entity” would never arise, as “foreign entity” is a term that is intended to cover situations where there is significant foreign ownership but ownership is dispersed.
The Proposed Rule defined the term “foreign government” to include non-elected heads of state with governmental responsibilities. A commenter said that the term “head of state” in § 800.213 was unclear.
The Final Rule amends § 800.213 to delete the clause referring to certain heads of state, since it imprecisely defined the circumstances under which the Committee may treat an investment by a government official as being an investment by a foreign government. Consistent with the reference in § 800.214 to a person “acting on behalf of a foreign government,” the Final Rule permits the Committee to treat investments by foreign government officials as investments by foreign governments where the circumstances so warrant, such as in certain cases where an official invests to advance governmental objectives.
The Proposed Rule defined “foreign government-controlled transaction” to mean any covered transaction that could result in control of a U.S. business by a foreign government or a person controlled by or acting on behalf of a foreign government. Commenters suggested that, in considering whether a transaction is foreign government-controlled, the regulations should treat certain types of entities owned by foreign governments or that have a “government background” as not foreign government-controlled—for example, if they operate on a purely commercial and market-driven basis.
The Final Rule makes no changes to the proposed text of § 800.214. “Foreign government-controlled transaction” is defined by statute at section 721(a)(4) and may not be modified by regulation in a manner that is inconsistent with the statute. The statute makes clear that transactions are “foreign government-controlled transactions” if they could
The Proposed Rule expanded the definition of “foreign person” to include the term “foreign entity” and added a number of examples. A commenter suggested that the examples in § 800.216 and § 800.226, which respectively define “foreign person” and “U.S. business,” be expanded to make clear that the two concepts are distinct. A commenter also expressed concern that an acquisition by an investment fund controlled by a foreign bank may be treated differently under the regulations than would an acquisition by an investment fund controlled by U.S. nationals.
The Final Rule makes no changes to the proposed text of § 800.216 and § 800.226. The terms “foreign person” and “U.S. business” are independent of one another and serve distinct purposes in the Final Rule. Accordingly, it is possible that a particular entity may be just a foreign person, just a U.S. business, both a foreign person and a U.S. business simultaneously, or neither a U.S. business nor a foreign person.
Section 721 and this Final Rule, which implements section 721, cover transactions after a certain date that could result in control of a U.S. business by a foreign person. Accordingly, whether a party that controls an investment fund is, or is not, a foreign person is central to the statutory and regulatory framework.
The Proposed Rule provided, at § 800.220(f), that any party in a role comparable to a party listed in paragraphs (a) through (e) of § 800.220 would also be deemed a “party to a transaction.” A commenter suggested that § 800.220(f) provides the Committee with excessive discretion.
The Final Rule makes no change to the proposed text of § 800.220. Paragraph (f) of that section does not expand the scope of what constitutes a covered transaction. Rather, it identifies what persons, in circumstances other than those covered by paragraphs (a) through (e), are considered to be a “party to a transaction” and, therefore, may file a voluntary notice with the Committee consistent with the requirements of § 800.402.
The Proposed Rule replaced the term “acquisition” with the term “transaction,” at § 800.224, in order to harmonize the terminology of the regulations with that of FINSA, and provided that a transaction is a “proposed or consummated merger, acquisition, or takeover.” One commenter suggested that the Committee should not have the authority to review transactions after they have been completed. However, if a transaction is proposed after August 23, 1988 and could result in foreign control of a U.S. business, then it would be a “covered transaction,” as defined in section 721, even if the transaction has been consummated by the time of review.
In addition to other clarifications of the definition, the Proposed Rule also clarified that certain joint ventures and long-term leases are “transactions.” In particular, the Proposed Rule provided that long-term leases are transactions when, because of the terms of the lease and the extent of the lessee's authority over the U.S. business, the lessee operates the business as if it were the owner. A commenter asked whether a long-term lease in which a lessor retained only minimal oversight responsibilities and the ability to impose penalties in the event of a contractual breach would not constitute a “transaction” under § 800.224(f) and the example in § 800.224.
The Final Rule makes no change to § 800.224(f) or the example in § 800.224 in response to the comment. As a general matter, and as reflected in the example in § 800.224, the more significant the substantive responsibilities retained by the lessor over the leased property, the likelier that the lease would not be viewed as a transaction.
The Proposed Rule, in § 800.301(d), harmonized the application of the term “covered transaction” to joint ventures with its application to all other transactions. Thus, the Proposed Rule provided that the creation of a joint venture is a covered transaction if a U.S. business is contributed to the joint venture and a foreign person could gain control of that U.S. business through the creation of the joint venture. Example 1 in § 800.301(d) of the Proposed Rule stated that the creation of a 50/50 joint venture by a foreign person and a party that contributes a U.S. business is a covered transaction, with respect to the U.S. business. A commenter suggested that such a transaction should not be a covered transaction because the power that the foreign person has over the U.S. business is no greater than the other party's.
The Final Rule makes no change in response to the comment described above. To the extent that a joint venture involves the contribution of a U.S. business, a foreign 50/50 joint venture partner would obtain the same degree of power over the important matters affecting that joint venture—and therefore the U.S. business—as if the foreign person had made a direct investment in that U.S. business to obtain a 50 percent interest. The acquisition of a 50 percent interest in an existing U.S. business is not viewed differently with regard to foreign control based on whether it is structured as a direct investment or a joint venture. When all ownership interests in a U.S. business are held by two equal partners, each partner is able to veto all important matters affecting the U.S. business, so each partner controls the U.S. business.
The Proposed Rule omitted a provision that had been included in the 1991 regulations, at § 800.302(b). The omitted provision stated that an acquisition is not subject to review under section 721 if the parent of the entity making the acquisition is the same as the parent of the entity being acquired. A commenter suggested reintroducing the omitted provision or confirming that the principle continues to apply.
The Final Rule does not reintroduce the omitted provision. Section 721, as amended by FINSA, requires the Committee to review any transaction notified to it that could result in control of a U.S. business by a foreign person. A corporate reorganization that results in a new foreign person acquiring control of a U.S. business would be a covered transaction, even though the ultimate parent of the U.S. business may not have changed. Thus, the Committee must treat such a reorganization as a covered transaction. Such a reorganization, however, will present national security considerations only in exceptional cases, as is explained in greater detail in guidance that the Department of the Treasury, as Chairperson of the Committee, is publishing on the types of transactions that the Committee has reviewed and that have presented national security considerations.
The Proposed Rule provided in § 800.302(c) that a transaction that results in a foreign person holding ten percent or less of the outstanding voting interests in a U.S. business is not a covered transaction if the transaction is “solely for the purpose of investment.” In § 800.223, “solely for the purpose of investment” was defined to refer to ownership interests in which the person holding or acquiring such interests has no plan or intent to exercise control, and takes no actions that indicate otherwise. Some commenters suggested that the term “solely for the purpose of investment” was too vague and created additional uncertainty for portfolio investors. A commenter also suggested clarifying that investors holding less than ten percent of the interests of a business can wield significant influence.
The Final Rule addresses these comments by clarifying that the rule for holdings of ten percent or less of the outstanding voting interests in a U.S. business—which is now at § 800.302(b) of the Final Rule—applies only to interests that are held or acquired “solely for the purpose of passive investment.” The addition of the word “passive” emphasizes that this rule does not pertain to a transaction if the foreign person plans or intends to gain control over the U.S. business. The example in § 800.223 of the Final Rule also makes clear that the Committee will consider whether the foreign person's negotiation of rights constitutes evidence that the foreign person possesses a purpose other than passive investment. Under the Final Rule, a transaction would not be a “covered transaction” if the foreign person holds ten percent or less of the voting shares in a U.S. business and the investment is passive such as where, for example, the foreign investor has no affirmative rights other than the ability to vote its shares
A commenter also suggested that the Proposed Rule be revised to identify a mechanism for tracking whether, after the Committee determines that this rule applies to a transaction, the foreign person develops plans or an intent to control the U.S. business or takes action inconsistent with passive intent. The Final Rule makes no change to the proposed language in response to this comment. The Committee will inform the parties if it determines a notified transaction is not a covered transaction because the investment is held or acquired solely for the purpose of passive investment. Should material facts change in the future relating to whether the foreign person has control of the U.S. business, the transaction may become a covered transaction subject to section 721.
A commenter also suggested that the rule regarding transactions solely for the purpose of passive investment should be expressed in terms of whether the foreign person has ten percent or less of the outstanding “ownership interest” in the U.S. business, rather than the “voting interest.”
The Final Rule does not adopt this suggestion because it would not cover an investor whose voting power in a U.S. business is disproportionately large compared to its ownership interest. Such an investor could have the ability to exercise control, even though its ownership interest is under the ten percent threshold. For example, where a company has issued a class of non-voting stock, it is possible that a foreign person may have ten percent or less of the outstanding stock of a company, but still have greater than ten percent of the voting stock, possibly giving it powers that are disproportionate to its share of all outstanding stock.
The Proposed Rule, at § 800.303, established a special rule that described the circumstances in which a foreign lender may obtain ownership of collateral but not be deemed to control tha