Proposed Rules on National Security Reviews
The Treasury Department has published proposed regulations implementing the Foreign Investment and National Security Act of 2007 (FINSA), the first major overhaul of the laws that govern national security reviews of foreign acquisitions. Under FINSA, foreign acquisitions of U.S. businesses that may affect national security are subject to prior review by the multi-agency Committee on Foreign Investment in the United States (CFIUS), which the Treasury Department chairs. Though ostensibly voluntary, CFIUS review is effectively required for any acquisition involving a company holding a security clearance. Moreover, the ability of CFIUS to launch its own investigations makes filing prudent in any case that implicates national security, including transactions that affect the "critical infrastructure" of the United States.
The proposed rules target "covered transactions" which, regardless of the actual arrangements for control, "result or could result in control of a U.S. business by a foreign person." The test is "control," but the definition of control pointedly "eschews bright lines" in favor of an evaluation of "all relevant factors" that affect the ability of a foreign person to "determine, direct, or decide important matters affecting an entity." Board membership or shareholding, in and of itself, is not determinative.
At the same time, the Treasury Department makes clear that it is not interested in anything less than control. While avoiding bright lines, the proposed regulations identify categories of transactions that will not be deemed covered transactions, such as stock splits or pro rata stock dividends that do not involve a change in control; acquisitions of convertible voting instruments that do not involve control; a purchase of assets or purchase of any part of an entity that does not constitute a U.S. business; a securities acquisition by a person acting as an underwriter in the ordinary course of business, in the process of underwriting; or an acquisition in connection with an insurance contract relating to fidelity, surety, or casualty obligations if made by an insurer in the ordinary course of business.
The proposed rules also make clear that the extension of a loan or similar financing by a foreign person will not, by itself, make the loan transaction a covered transaction, unless control is acquired at the time of the loan — or unless, because of imminent default or other condition, there is a "significant possibility" that a foreign person may obtain control of a U.S. business.
Finally, under the proposed rules, a foreign person is deemed not to control an entity if it holds 10% or less of the voting interest in an entity "solely for the purpose of investment." Both prongs of this test must be met to exempt a transaction. An investment up to 10% will not fly under the radar if the investment is coupled, for example, with contractual rights that give the foreign investor "the power to control important matters." Nevertheless, it is expected that the "10% rule" will guide investments by sovereign wealth funds, since acquisitions that would give control to foreign government-controlled entities are subject to mandatory investigation unless the Secretary of the Treasury and the head of the lead agency investigating the transaction certify that the investment "will not impair the national security of the United States."
The proposed rules would greatly expand the questions put to filers whose acquisitions fall within the definition of a "covered transaction." In particular, as written, the proposed rules make clear that filers must know, at the time of filing, whether the products and technology made by the target are — or could be — export-controlled and how controlled products and technology are classified for export purposes. The full list of questions and illustrative responses fills close to four pages of the Federal Register.
FINSA gave the Secretary of Labor a non-voting seat on CFIUS, giving rise to speculation that CFIUS would pay greater attention to labor practices in its reviews. That may yet happen, but the proposed rules officially assign a much more limited role to the Labor Secretary, that of identifying mitigation provisions that may violate U.S. labor laws.
The proposed rules also prescribe monetary penalties, for the first time, for violations of mitigation agreements through intentional wrongdoing or gross negligence. Penalties are also assigned for material misstatements or omissions of material fact in filings. In each case, penalties can reach $250,000 per violation or, for violations of mitigation agreements, the value of the transaction. In addition, the rules separately provide for liquidated damages for violations of mitigation agreements.
Much of the rest of the rulemaking restates prior rules or mirrors longstanding practice. Nevertheless, the proposal bears close scrutiny. Some provisions may unintentionally impose significant burdens on filers. Others lack clarity and may create unnecessary confusion unless rewritten. Problems that are not corrected with the publication of the final rule may take years to work out, if ever. The proposed rules are open to comment until June 9, 2008.
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