Added Compliance for Foreign Investment

The Treasury Department has proposed new rules to bring more order and oversight to foreign investment in U.S. companies. They’re also likely to bring more demands and paperwork to corporate compliance and legal departments.

In some respects, experts say, the proposals simply codify existing procedures and provide more clarity into the workings of the Committee on Foreign Investment in the United States, which reviews certain foreign investments in domestic businesses. They do add some new requirements, however, which will increase the overall burden of preparing a notice to CFIUS.

The proposed amendments are out for public comment until June 9.

Bayz

Aki Bayz, of counsel in the law firm Morrison & Foerster, says the proposals “give companies a better sense of what CFIUS is looking for and how to proceed in a voluntary notification.” The rules largely reflect practices CFIUS already put in place to enforce the Foreign Investment and National Security Act of 2007, he says.

FINSA was enacted last October in response to the controversy surrounding a 2006 deal where Dubai Ports World tried to buy U.S. port operations. The Arab company later withdrew the plan amid fierce criticism that it endangered national security.

Wall

The proposals “signal that there hasn’t been a change in basic U.S. policy in maintaining open markets for foreign investment,” says Christopher Wall of the law firm Pillsbury Winthrop Shaw Pittman. In that respect, he says, “People should breathe a huge sigh of relief.”

Still, the compliance obligations for companies—which mostly center on when they should notify CFIUS that it might want to review an investment deal—will get more complicated.

While the proposals simply codify current practices in many cases, for example, encouraging parties in a covered transaction to consult with CFIUS prior to making a submission, they do add some new requirements experts says will increase the overall burden of preparing a notice to CFIUS. For example, the contents of the voluntary notice have been expanded to include personal information about the directors and officers in the ownership chain of the foreign company.

The proposed regulations also provide for civil penalties of up to $250,000 for submission of a material misstatement or omission in a notice to CFIUS, or for making a false certification or breaching a material agreement entered into with CFIUS.

In addition, the proposals include a new two-business day response time for any requests for information from CFIUS, which Bayz says, “puts a lot of companies at risk of having their application rejected if they don’t respond timely.”

DEFINING CONTROL

Below is an excerpt of the definition of “control” under the Treasury Department’s proposed new rules for foreign investment in U.S. companies.

A. The term control means 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 following matters, or any other similarly important matters affecting an entity.

(1) The sale, lease, mortgage, pledge, or other transfer of any of the tangible or intangible principal assets of the entity, whether or not in the ordinary course of business;

(2) The reorganization, merger, or dissolution of the entity;

(3) The closing, relocation, or substantial alteration of the production, operational, or research and development facilities of the entity;

(4) Major expenditures or investments, issuances of equity or debt, or dividend payments by the entity, or approval of the operating budget of the entity;

(5) The selection of new business lines or ventures that the entity will pursue;

(6) The entry into, termination, or non-fulfillment by the entity of significant contracts;

(7) The policies or procedures of the entity governing the treatment of non-public technical, financial, or other proprietary information of the entity;

(8) The appointment or dismissal of officers or senior managers;

(9) The appointment or dismissal of employees with access to sensitive technology or classified U.S. Government information; or

(10) The amendment of the Articles of Incorporation, constituent agreement, or other organizational documents of the entity with respect to the matters described in paragraphs (A)(1) through (9) of this section.

B. In examining questions of control in situations where more than one foreign person has an ownership interest in an entity, consideration will be given to factors such as whether the foreign persons are related or have formal or informal arrangements to act in concert, whether they are agencies or instrumentalities of the national or subnational governments of a single foreign state, and whether a given foreign person and another person that has an ownership interest in the entity are both controlled by any of the national or subnational governments of a single foreign state.

C. The following minority shareholder protections shall not in themselves be deemed to confer control over an entity:

(1) The power to prevent the sale or pledge of all or substantially all of the assets of an entity;

(2) The power to prevent an entity from entering into contracts with majority investors or their affiliates;

(3) The power to prevent an entity from guaranteeing the obligations of majority investors or their affiliates;

(4) The power to purchase additional shares to prevent the dilution of an investor’s pro rata interest in an entity in the event that the entity issues additional interests; or

(5) The power to prevent the amendment of the Articles of Incorporation, constituent agreement, or other organizational documents of an entity with respect to the matters described in paragraphs (C)(1) through (4) of this section.

D. The Committee will consider on a case-by-case basis, whether minority shareholder protections other than those listed in paragraph (C) of this section do not confer control over an entity.

Source

Treasury Department (May 2, 2008).

In addition to more time and more costs, the proposed regulations are also likely to result in more voluntary applications, too. That’s because greatly expanded definitions of some of the key terms in the proposals could “potentially sweep in a wider range of transactions,” Wall says.

Indeed, the proposed definitions of terms such as “covered transaction,” “control,” and “critical infrastructure,” are likely to draw the most attention from companies, since their decision on whether to file an application with CFIUS will hinge on their analysis of whether the regulations apply to them.

Unfortunately, some say, companies may not find all the answers they hoped for in the proposals as written.

Schlossberg

“To the extent people were looking for great clarity, I’m not sure we’re getting it with the proposed regulations,” says Robert Schlossberg with the law firm Freshfields Bruckhaus Deringer.

Schlossberg says some of the proposed definitions are less than clear. For example, the definition of critical infrastructure “is a bit circular” and the proposed definition of control gives “little to no comfort.”

The proposed rules define control 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.”

The problem with that definition of control is that it is not connected to any specific shareholding threshold or to the right to have seats on the board, Schlossberg says. “There’s no bright line test for control.”

Sanchez

Ignacio Sanchez of the law firm DLA Piper agrees that the proposed regulations provide “helpful examples and details to help companies navigate the process.”

For example, the definition of control includes a new list of minority shareholder protective rights that won’t be interpreted as surrendering control, such as the power to prevent the sale of substantially all of the assets of the entity or the dilution of the foreign investor’s interests. Stephen McHale of the law firm Patton Boggs says companies should that find helpful.

On the other hand is the proposed definition of “critical infrastructure,” which McHale says is unclear.

McHale

“It’s problematic because FINSA defines ‘national security’ as including homeland security, which is significantly broader than the traditional meaning of national security,” he says.

The CFIUS review process could also now take as long as three months, which adds yet another dimension to what would-be buyers will need to remember as they plot how to structure a deal.

Under FINSA, CFIUS can undertake a 30-day review of any “covered transaction”—defined as any transaction that could result in foreign control of a U.S. entity—to determine its potential impact on national security. The proposed regulations require an additional 45-day investigation if the transaction is controlled by a foreign government or in certain other cases.

Statistically, Bayz says, only a small number of deals end up in a CFIUS investigation. But, he notes, “The potential for a 90-day review period does exist and should be factored into any deal analysis.”

And McHale notes that the compliance headaches don’t always end with the application process. Any mitigation agreement parties enter into with CFIUS to get the committee’s approval is open-ended, he says.

“If one agency decides the conditions have been breached, they can rescind their approval and re-start the process,” he says. The takeaway is that companies entering into a mitigation agreement should “make sure they have a compliance program in place to ensure they comply with it.”