CFIUS 2018 in Review: New Powers, Greater Consistency Marked Year of Expansion

Takeaways
 

• The enactment of the Foreign Investment Risk Review Modernization Act, or FIRRMA, in August is the most significant statutory expansion of CFIUS’ powers in more than a decade. FIRRMA takes aim straight at Chinese investment in both critical technologies and industries.
• Implementation of FIRRMA began almost immediately, with the announcement of a pilot program making it mandatory for parties to file notices and/or petitions for transactions in critical industries or critical technologies. The nine constituent agencies of CFIUS also began hiring to fill the newly authorized expansion of staff servicing the multi-agency panel.
• There were also a number of noteworthy actions on specific deals that highlight CFIUS’ current thinking on national security risks, such as blocking Broadcom’s proxy pursuit of Qualcomm, as well as in the comprehensive mitigation agreement with China Oceanwide and Genworth Financial.
• Large deals involving companies from NATO and other treaty allies continued to receive timely approval, notably Monsanto/Bayer, XL/AXA, Gemalto/Thales, Sprint/T-Mobile and ECYT/Novartis.
• The Dec. 22 lapse in appropriations has paused almost all CFIUS reviews. Deals that were announced in 2018 awaiting clearance or further action include Integrated Device Technology/Renesas, Nexperia/Wingtech, Amer Sports/Anta Sports and Momentive Performance/South Korean investment consortium.

The enactment of the Foreign Investment Risk Review Modernization Act, or FIRRMA, in August makes 2018 one of the most impactful years in the history of CFIUS. FIRRMA, as described below, marks the most significant expansion of CFIUS’ role in more than a decade.

From a deal perspective, the new powers did not bring with it the uncertainty and delayed reviews that occurred in 2017 with the transition from the Obama administration to the Trump administration and the dramatic shift in policy toward China. CFIUS reviews, on the whole, were somewhat more predictable in 2018, with companies domiciled in countries that are close allies with the U.S. generally receiving treatment under the same principles as have been applied in previous administrations, while deals involving China, directly and indirectly, continued to receive the tough scrutiny that began last year.

The year closed with a highly unusual shutdown of almost all CFIUS operations due to the Dec. 22 lapse in government funding. Consequently, the Treasury Department announced that CFIUS would suspend reviews and not accept new filings during the lapse in government funding that began just before Christmas. A number of mergers, including Nexperia/Wingtech, Integrated Device Technology/Renesas, Amer Sports/Anta Sports, InfraREIT/Oncor and Momentive Performance Materials/South Korean investment consortium, have either seen previously disclosed deadlines slip past or announced the receipt of a letter from Treasury pausing reviews during the partial shutdown.

Statutory and Policy Changes

Foreign Investment Risk Review Modernization Act

Following nearly a year of debate, negotiation and reforms, the Foreign Investment Risk Review Modernization Act was enacted into law in August. The law significantly changes and expands CFIUS’ authority in a variety of ways; many provisions of which were designed to ensure the national security panel is able to review any foreign investment that has security implications for the United States.

FIRRMA creates a mandatory filing regime for foreign investments in a variety of enumerated critical industries or in critical/emerging technologies. In some cases a simple declaration is required; in others a full application is needed.

The mandatory filing regime was implemented almost immediately upon the law’s enactment with the establishment of a “pilot program.” That program, which has attracted some concerns from foreign companies, such as the UK defense contractor BAE Systems, will be replaced by a permanent program by March 2020, once implementing regulations are promulgated.

FIRRMA also expands the types of investments that fall under the panel’s jurisdiction. Until FIRRMA’s enactment, CFIUS was restricted to investments where a foreign person or entity could exercise “control” over a U.S. enterprise. That threshold trigger was eliminated by FIRRMA and CFIUS’ jurisdiction now extends to any foreign investment that can be deemed “non-passive.”

Certain real estate transactions also now fall under CFIUS’ purview. Prior to FIRRMA, CFIUS examined real estate transactions - generally for proximity to national security locations - only in the context of foreign investment in a U.S. company. Now CFIUS will have jurisdiction for foreign acquisitions of U.S. real estate without requiring a link to a corporate investment.

Although China is not mentioned by name anywhere in the statute, the authors of the legislation, as well as supporters within the Trump administration, repeatedly and clearly asserted that FIRRMA was a direct response to China’s licit and illicit attempts to acquire U.S. technology. The 2018 U.S. National Defense Strategy describes China as “a strategic competitor using predatory economics to intimidate its neighbors while militarizing features in the South China Sea.” That official summary of the U.S. view of China greatly informed the basis of equipping CFIUS with the ability to detect and block China’s “predatory economics” in the United States.

Assistant Secretary of Treasury for International Markets and Investment Policy Heath Tarbert, who oversees CFIUS, told Reorg M&A that in response to FIRRMA, Treasury has reorganized into three new offices to serve CFIUS. Tarbert gave brief summaries of each office’s duties:
 

• The Office of Reviews and Investigations will “process investigations” and “will probably have the bulk of our employees, the case officers and the senior case officers;”
• The Office of Policy and International Engagement will be in charge of “writing the rules” and “drafting the regulations,” as well as “keeping in touch with many of our foreign counterparts and their regulatory regimes,” and “reaching out in particular cases where we may want to share information;” and
• The Office of Mitigation Monitoring and Enforcement will “be on the lookout for non-notified transactions” which “nonetheless have CFIUS jurisdiction,” as well as reviewing proposed mitigation agreements in active cases.

The last office is a direct response to concerns that CFIUS was unable to monitor compliance with previous mitigation agreements it had entered into with foreign investors.

New Corporate Disclosures in Reaction to FIRRMA Requirements

The enactment of FIRRMA has resulted in an increase in disclosures from companies regarding the applicability, or lack thereof, of the new law in relation to specific transactions.

For example, Endocyte and Novartis disclosed that CFIUS notified them that the agency “cannot conclude action under Section 721 with respect to the proposed merger and that the parties may file with CFIUS a written notice pursuant to Section 721 to seek written notification that CFIUS has concluded all action under Section 721.” One CFIUS practitioner noted that the market may see similar “convoluted” language until law firms and investors begin to settle upon standardized disclosures.

Companies have also begun to include representations and warranties in merger agreements that the provisions in the CFIUS pilot program do not apply to their specific transaction. For example, real estate company Alexander & Baldwin, when it announced the sale of agricultural land on Maui to a group including Canada’s Public Sector Investment Board and California-based Pomona Farming, included a provision in the sale agreement that explicitly provided that it was not a covered transaction.

In the Tesaro/GlaxoSmithKline transaction, the merger agreement specifically stated that none of the criteria that would subject the transaction to the new mandatory filing requirements applied.

Relatedly, the merger agreement between Black Box and India-based AGC Networks included a provision that stated that CFIUS clearance was not a closing condition; however, the merger agreement also provided that, if the deal were to break due to complications associated with CFIUS, Black Box would be required to pay a specified “expense amount.”

Some disclosures filed after the pilot program started specifically state that a transaction is not subject to CFIUS clearance, or that the companies will file only after determining it is required. Seth Moore, Overstock.com’s chief strategist and aide to the CEO, said on the company’s earnings call that it was working with GSR Capital to structure potential investments in tZero in such a way as to avoid having to go through CFIUS review. In the transaction between Edgewater and Alithya Group, the merger agreement states CFIUS’ approval is required if the companies determine such approval is required.

CFIUS practitioners expect that the use of these clauses will continue.

The expansion on CFIUS’ jurisdiction was cited as a risk factor by many companies in disclosures, whereas in previous analogous disclosures such risks were not explicitly mentioned. Examples include Casa Systems’ Nov. 8 10-Q, Beigene’s Nov. 8 10-Q and Pacific Biosciences’ Nov 5. 10-Q. Casa stated that the expansion of CFIUS’ jurisdiction “may impose additional burdens on or may limit certain investors’ ability to purchase our common stock, potentially making our common stock less attractive to investors,” and Pacific Biosciences specifically listed “enhanced oversight” by CFIUS and “substantial restrictions on investment from China” as risks to international operations.

Discussion of Specific CFIUS Transactions

While the 2018 changes in CFIUS law have been dramatic, the actual decisions made by CFIUS in the past year were largely unsurprising, particularly when compared to the committee’s actions in 2017. In 2017, the transition from the Obama administration to the Trump administration, coupled with delays in appointments at the nine CFIUS constituent agencies, led to significant delays, even for non-controversial deals. Additionally, while not all Chinese investments were blocked, the majority of deals that were abandoned due to CFIUS concerns involved a Chinese enterprise.

A number of specific actions taken by CFIUS in 2018 warrant a deeper look for their applicability to other transactions going forward.

CFIUS Blocks Broadcom From Pursuing Qualcomm

One of the most dramatic exercises of CFIUS’ authority in recent years occurred in March when CFIUS blocked Broadcom from pursuing an acquisition of rival chipmaker Qualcomm. CFIUS’ involvement in the transaction was unusual for a variety of reasons.

Broadcom had already announced its intention to redomicile to the U.S. However, it made a tactical and strategic error in beginning its hostile pursuit of Qualcomm while it was still technically a Singapore-based company. Consequently, Qualcomm was able to initiate a CFIUS review of the potential deal.

Additionally, Broadcom had not yet made a formal offer to Qualcomm at the time President Trump issued his order blocking the potential deal. At that time, Broadcom had endorsed a rival slate of candidates for Qualcomm’s board of directors but Qualcomm shareholders had not yet voted in the contested election. The presidential order issued by Trump forced Broadcom to withdraw its candidates for the board and enjoined Broadcom from ever pursuing an acquisition of Qualcomm, even after Broadcom again redomiciled and was no longer subject to CFIUS jurisdiction. A presidential order issued pursuant to CFIUS recommendation is not judicially reviewable.

An intriguing epilogue to the Qualcomm/Broadcom corporate battle occurred in October when a small group of Congressmen, backed by an apparently forged Defense Department memo, attempted to have CFIUS review Broadcom’s acquisition of Computer Associates. CFIUS declined to assert jurisdiction over a deal involving two U.S. companies and the transaction closed on Nov. 5.

CFIUS Clears China Oceanwide Purchase of Genworth With Significant Mitigation

Another important CFIUS decision was the clearance of China Oceanwide’s acquisition of U.S. life and mortgage insurer Genworth Financial.

CFIUS took more than 18 months to approve the transaction, with the merging parties filing five separate applications with the panel. CFIUS cleared the transaction in the midst of a brief flurry of approvals involving Chinese enterprises. Intriguingly, the June 6 Genworth clearance, along with the clearance of COSCO’s acquisition of Orient Overseas International and Evergrande’s investment in Faraday Futures, coincided with Treasury Secretary Steven Mnuchin’s public disputes with other members of the Trump administration over China policy. Mnuchin had been endeavoring to take a less hostile attitude toward China than that of Commerce Secretary Wilbur Ross, U.S. Trade Representative Robert Litzhager and White House trade aide Peter Navarro.

The Genworth mitigation agreement, which was disclosed in full in Genworth’s insurance filings in Delaware and Virginia, was thought by some practitioners to be the most extensive such agreement disclosed by a public corporation. Highlights of that agreement include:
 

• Genworth and China Oceanwide agreed to outsource the management and monitoring of all the personal information of Genworth’s policyholders. Not only must Genworth transfer operational control to a U.S-based third-party provider, it must also transfer all IT staff that handle personal information to the new company.
• Genworth and China Oceanwide gave CFIUS approval authority over a majority of its board of directors, including four directors who were selected, with CFIUS approval, specifically for their national security expertise.
• Persons from China Oceanwide may not have any operational or other access to individual policyholder information.
• Genworth must appoint a full-time liaison to CFIUS who will keep the national security panel apprised of Genworth’s compliance with the mitigation agreement.
• Genworth must hire an outside auditor that will provide yearly reports to CFIUS on Genworth’s compliance with the mitigation agreement.

CFIUS Blocks Japan’s Lixil from Selling an Italian Building Materials Subsidiary to Chinese Investors

One deal that exemplifies the extent of CFIUS’ concerns about China was the proposed asset sale by Japanese conglomerate Lixil, which tried to sell its Italian building materials subsidiary, Permasteelisa Group, to China’s Grandland Holdings. The transaction was unable to obtain CFIUS clearance. Lixil executives attributed the block to trade tensions with China. CFIUS practitioners who spoke to Reorg M&A said that the block more accurately reflected the scale of CFIUS’ conviction that China will use any avenue, including implanting listening devices into the exterior building materials manufactured by Permasteelisa, to obtain intelligence. One example of Permasteelisa’s products are the glass panels used on the exterior of New York City’s One World Trade Center.

Consistency In Approach to Deals Involving Allied Nations

Deals involving China, including those that have indirect relationships to China, were intensely scrutinized by CFIUS in 2018. However, reviews of investments emanating from NATO and other treaty-allied nations remained mostly consistent with previous administrations.

Complexity and scale were not barriers to obtaining CFIUS clearance. A number of very large deals involving complex global companies obtained clearance in a timely fashion, including Monsanto/Bayer, Sprint/T-Mobile, Endocyte/Novartis, Gemalto/Thales, Avista/Hydro One and Praxair/Linde to highlight a few.

Deals involving defense contractors, life sciences, financial services, and energy and agriculture continued to receive relatively positive treatment at CFIUS. Shipping deals, such as clearance of OOIL/COSCO as well as the decision not to intervene in the Gulftainer lease of the Port of Wilmington, also demonstrated that those industries generally received a lesser degree of concern than did technology sector deals.

Several deals involving Chinese enterprises did get approved, although they were generally smaller deals or involved asset purchases out of bankruptcy, such as Harbin’s acquisition of GNC and Key Safety Systems purchase of Takata.

A Look at the Blocked Deals

While not all deals directly or indirectly involving China were blocked, the overwhelming majority of deals that faced CFIUS opposition in 2018 involved concerns about China at some level.

These are the China-related deals blocked by CFIUS in 2018:
 

• Oct. 22: Lixil’s (Japan) sale of Permasteelia (Italy) to Grandland Holdings (China)
• Aug. 8: Shenzhen Energy’s acquisition of three solar facilities in California from Recurrent Energy
• May 9: CNHTC Sinotruk’s new investment in UQM
• April 30: HNA’s acquisition of Skybridge Capital
• March 8: Broadcom’s proxy fight/hostile acquisition of Qualcomm
• Feb. 22: Unic Capital’s acquisition of Xcerra
• Feb. 21: BlueFocus’ acquisition of Cogint
• Jan. 2: Ant Financial’s acquisition of Moneygram

One non-China deal that did not receive CFIUS clearance was the attempt by Germany’s Voltabox to acquire Navitas Systems. Lithium-ion battery technology, which is a main product of Navitas, is considered highly sensitive by CFIUS and may have been a cause of the panel’s unwillingness to clear the deal. However, Voltabox also noted at the time that Navitas had not “developed in line with Voltabox’s expectations,” raising the possibility that Voltabox used the delays at CFIUS to back out of the transaction.

Looking Ahead at 2019

This year will be another year of transition and change at CFIUS as the nine-member agencies, led by Treasury, begin drafting permanent regulations to implement FIRRMA. The statute gave CFIUS 18 months to complete the rulemaking. It is expected, according to administration officials, to take the full 18 months.

CFIUS will also be undergoing a leadership transition, as Assistant Treasury Secretary Heath Tarbert, who is in charge of CFIUS, will be departing Treasury. Tarbert was nominated to become the next chairman of the Commodity Futures Trading Commission and is expected, upon confirmation by the Senate, to take that post by April. No successor to Tarbert has yet been named.

The nine constituent agencies of CFIUS are also aggressively attempting to increase the staff servicing the multi-agency panel. As Tarbert said, the agencies had received an exemption earlier this year from the government-wide hiring freeze. This hiring moratorium is separate from the current partial federal government shutdown. The exemption allows CFIUS to fill the positions necessary to meet the expected volume of mandatory filings and declarations.

Some deals that were announced in 2018 and which are still awaiting CFIUS clearance - although the government shutdown has paused the clock on all pending reviews - are Nexperia/Wingtech, Integrated Device Technology/Renesas, Amer Sports/Anta Sports, InfraREIT/Oncor and Momentive Performance Materials/South Korean investment consortium.

--Andrew Lowenthal and Lucas Ballet

Footnote: This Year in Review is based upon government databases, open sources and interviews that comprise the source materials for Reorg M&A’s weekly CFIUS Week in Review.