An Eight-Part Introduction to the Foreign Investment Risk Review Modernization Act
Part 4: “Passive Investment” Redefined
Earlier this month, in anticipation of The Foreign Investment Risk Review Modernization Act’s (“FIRRMA”) impending passage, we provided an overview of the exceptions contained in FIRRMA for certain types of transactions that would otherwise be under the Committee on Foreign Investment in the United States’ (“CFIUS”) expanded jurisdiction. Since that time, the text of FIRRMA was finalized, and on August 1, 2018 FIRRMA was sent to the president as part of the National Defense Authorization Act for Fiscal Year 2019 (the “NDAA”). Over the next few weeks we will continue to summarize FIRRMA’s critical provisions as the president prepares to sign the NDAA and the Department of the Treasury begins drafting the implementing regulations. This week, we will focus on the manner in which FIRRMA adjusts the existing exception for “passive investments.”
Under the existing CFIUS regulations, a transaction is not “covered” (i.e., is outside CFIUS’ jurisdiction) if it results “in a foreign person holding ten percent or less of the outstanding voting interest in a U.S. business (regardless of the dollar value of the interest so acquired), but only if the transaction is solely for the purpose of passive investment.” 31 C.F.R. 800.302(b). The regulations further indicate that “[o]wnership interests are held or acquired solely for the purpose of passive investment if the person holding or acquiring such interests does not plan or intend to exercise control, does not possess or develop any purpose other than passive investment, and does not take any action inconsistent with holding or acquiring such interests solely for the purpose of passive investment.” 31 C.F.R. 800.203.
Consistent with the existing CFIUS regulations, under FIRRMA an investment in a critical technology company or a critical infrastructure company that would otherwise constitute a covered transaction is exempted if it constitutes a passive investment. However, the definition of a “passive investment” under FIRRMA is significantly more restrictive than it is at present. As an initial matter, in order for an investment to qualify as “passive” it must “not afford the foreign person—
(a) access to any material nonpublic technical information1 in the possession of the United States critical infrastructure company or United States critical technology company;
(b) membership or observer rights on the board of directors or equivalent governing body of the United States critical infrastructure company or United States critical technology company or the right to nominate an individual to a position on the board of directors or equivalent governing body; or
(c) any involvement, other than through voting of shares, in substantive decisionmaking relating to the management, governance, or operation of the United States critical infrastructure company or United States critical technology company.
Furthermore, the foreign person may “not have a material parallel strategic partnership or other material financial relationship, as described in regulations prescribed by the Committee, with the United States critical infrastructure company or United States critical technology company.”
Notably, FIRRMA eliminates from the definition of “passive investment” any sort of ownership interest threshold and, as such, the level of the foreign person’s ownership interest is not, in and of itself, relevant. FIRRMA does, however, open the door to a determination by CFIUS via the forthcoming implementing regulations that investments above a certain level will not be considered passive, regardless of the extent of the foreign person’s control over the critical infrastructure company/critical technology company.
Undoubtedly, FIRRMA’s proponents recognized that many investments in U.S. companies are indirectly made by foreign persons via an investment fund. Accordingly, FIRRMA makes clear that “an indirect investment by a foreign person in a United States critical infrastructure company or United States critical technology company through an investment fund that afford the foreign person (or a designee of the foreign person) membership as limited partner or an advisory board or committee of the fund shall be considered a passive investment if—
(a) the fund is managed exclusively by a general partner, a managing member, or an equivalent;
(b) the general partner, managing member, or equivalent is not a foreign person;
(c) the advisory board or committee does not have the ability to approve, disapprove, or otherwise control—
i. the investment decisions of the fund; or
ii. decisions made by the general partner, managing member, or equivalent related to entities in which the fund is invested;
(d) the foreign person does not otherwise have the ability to control the fund, including the authority—
i. to approve, disapprove, or otherwise control investment decisions of the fund;
ii. to approve, disapprove, or otherwise control decisions made by the general partner, managing member, or equivalent related to entities in which the fund is invested; or
iii. to unilaterally dismiss, prevent the dismissal of, select, or determine the compensation of the general partner, managing member, or equivalent; and
(e) the investment otherwise meets the requirements [of the related section of the statute].
In reformulating the manner in which CFIUS will treat passive investments, FIRRMA closes, or at least narrows, a loophole that U.S. adversaries can use to circumvent CFIUS’ oversight. However, the implications of this modified approach for well-intentioned foreign investors, and their U.S. counterparts, will also be profound. As such, both sets of parties should carefully assess the updated CFIUS regulations, once published, before foregoing a CFIUS review on the basis of passivity.
Up Next: We will examine the FIRRMA's creation of a “declaration” as a groundbreaking new filing mechanism.
1. FIRRMA indicates that the definition of “material nonpublic technical information” will be defined in the updated regulations but also makes clear that “the term does not include financial information regarding the performance of a United States critical infrastructure company or United States critical technology company.”
About the Authors
Jennifer S. Huber and Adam Munitz are Partners in FH+H's International Trade & Transactions Practice. Focusing primarily on the defense, security, and intelligence sectors, Jennifer and Adam position U.S. businesses for overseas growth and help foreign investors/acquirers and U.S. sellers navigate the CFIUS review process.
FH+H Of Counsel Mary Beth Long is the first-ever Senate confirmed female Assistant Secretary of Defense and worked directly with Secretaries of Defense Rumsfeld and Gates on the Department’s highest priority issues. As the Defense Secretary’s principle advisor on the Middle East, Europe and Africa, including Iraq and Afghanistan, Ms. Long represented the Department of Defense at the National Security Council and the White House, and with foreign Ministers of Defense. She has expertise in export compliance, securities regulations, and other regulatory regimes.
Additional information regarding the FH+H International Trade & Transactions Practice and previous representations can be found here.