May 7, 2008
On April 21, 2008, the Department of the Treasury released a set of proposed regulations governing mergers, acquisitions and takeovers by foreign persons. These regulations, governing the Committee on Foreign Investment in the United States (“CFIUS”), would supersede procedures in recent decades. These proposed regulations are open for public comment for 45 days.
These proposed regulations will implement section 721 of the Defense Production Act of 1950, as amended by the Foreign Investment and National Security Act of 2007 (“FINSA”). Section 721 authorizes the President “to suspend or prohibit any covered transaction when, in the President’s judgment, there is credible evidence to believe that the foreign person exercising control over a U.S. business might take action that threatens to impair the national security.” FINSA reiterated that the Committee on Foreign Investment in the United States is the executive agency authorized to review transactions which could grant control of a U.S. entity to a foreign person.
The Proposed New Regulations
Under FINSA, CFIUS may undertake a 30-day review of any transaction that could result in foreign control of a U.S. entity, termed a “covered transaction,” to determine its potential impact on national security. The proposed regulations require an additional 45-day investigation in cases where the transaction is foreign government-controlled and indicate that there may be other circumstances that will also require an additional 45-day investigation.
A broad range of transactions is covered under the subjective standard espoused by the proposal: “A transaction which, irrespective of the actual arrangements for control provided for in the terms of the transaction, results or could result in control of a U.S. business by a foreign person.” § 800.206. The “could result” and “irrespective of the actual arrangements” language grants considerable discretion to CFIUS in making its determination.
The scope of the word “transaction” is limited to mergers, acquisitions and takeovers. The regulations define “control” as “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 . . . important matters affecting an entity[.]” § 800.203. This flexible test for “control” creates potential unpredictability for foreign entities interested in investing in U.S. companies.
Rather than using a bright-line test for “control” such as a threshold percentage of shares or board seats, CFIUS considers “all relevant factors . . . in light of their potential impact on a foreign person’s ability to determine, direct, or decide important matters affecting a company.” The proposed regulations “clarify that control can be exercised in a number of ways, both affirmatively and, in some cases, negatively.” Supplemental Information, Sec. III. The regulations note that foreign entities that control ten percent or less of a U.S. entity are generally not subject to CFIUS review. § 800.302(c). Even such low minority ownership, however, may become subject to CFIUS review and investigation if the acquisition of the voting shares is deemed not to be solely for the purpose of investment. § 800.223. Although the new regulations also add some reporting requirements, such as additional information on the ultimate and intermediate parents of the foreign person making the acquisition and other persons with a role in the transactions, the procedural requirements remain largely unchanged from those under the prior legislation. The new regulations further emphasize that businesses should notify and confer with CFIUS before making a voluntary filing. This merely incorporates an informal procedure which had developed under the old law.
Impact on Sovereign Wealth Funds
Sovereign wealth funds are implicated by the new regulations because they are foreign-government controlled entities. The new regulations cover all transactions that could result in control of a U.S. business by a foreign government or a person acting on its behalf. When a sovereign wealth fund buys into a U.S. equity fund, this transaction could be subject to mandatory CFIUS investigation if it is an acquisition for control and if it potentially raises national security concerns.
Interestingly, if CFIUS finds the U.S. equity fund to be even partially controlled by the sovereign wealth fund, the equity fund’s subsequent acquisitions may also be subject to CFIUS review. For example, if such a U.S. equity fund subsequently makes a substantial investment in a U.S. business, or even a small investment if it contains certain conditions possibly limiting management discretion, this action may be considered a grant of control of U.S. business to a foreign person. The definition of “foreign person” in the proposed regulations includes not only “any foreign national, foreign government, or foreign entity,” but also “any entity over which control is exercised or exercisable by a foreign national, foreign government, or foreign entity.” § 800.216. Although the regulations and explanatory examples do not explicitly mention this scenario, a U.S. equity fund that is “controlled” (even in part) by a sovereign wealth fund could be considered a “foreign person,” and for that matter, an entity controlled by a foreign government, under a broad construction of the proposed definitions.
As discussed above, the proposed regulations are similar to the current regulatory scheme and industry practice. Many of the proposed changes are definitional. The proposed regulations define “critical infrastructure” and “critical technologies” to indicate that transactions touching upon either of these may fall within the scope of a “covered transaction.” § 800.206-207.
The proposed regulations also tweak the definitions of “foreign person” and “U.S. business.” The proposal specifies that a “foreign entity” — an entity organized outside the United States whose ownership is widely dispersed among different foreign persons — will be considered a “foreign person” for the purpose of invoking CFIUS review. § 800.212-213. In addition, the term “U.S. person” was replaced by “U.S. business.” “U.S. business,” in turn, is “any entity, irrespective of the nationality of the persons that control it, engaged in interstate commerce in the United States, but only to the extent of its activities in interstate commerce.” § 800.227.
In addition, the proposed regulations create civil penalties for the intentional or grossly negligent submission of material misstatements or omissions or violation of a mitigation agreement. These penalties are capped at $250,000 per violation. § 800.801.
Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or any of the following:
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