After nearly a year of contentious negotiations, an unusual bipartisan alliance in Congress approved legislation in the summer of 2018 designed in part to make it harder for China to acquire US technology. Lawmakers—listening to US industry and the defense community as well as those worried about technology transfers—struck a delicate balance to protect US intellectual property while avoiding excessive controls that would stifle the US investment climate.
President Donald Trump signed this legislation, the Foreign Investment Risk Review Modernization Act (FIRRMA) and the Export Control Reform Act (ECRA) into law in August. The acts expand the power of the Committee on Foreign Investment in the United States (CFIUS), an interagency group designed to protect against foreign investments that might put national security at risk; they also authorize the Department of Commerce to update controls on technology leakage through exports. However, the Treasury Department recently issued new regulations for a pilot program to start November 10 that implements parts of FIRRMA and that may partly deviate from the carefully negotiated approach hammered out on Capitol Hill. The new rules, albeit only in effect for a year and a half at most, sidestep the intense process of public hearings and private deliberations that were crucial to helping Congress strike a sensible compromise.
The pilot program will take effect quickly, before any comments from the public and affected industries can be considered and before definitions of critical terms are completed. The worrisome part is that its coverage—quite narrow in the initial phase—will soon automatically balloon to include another undefined set of technologies. Combined with the new requirement that foreigners from all countries must report their investments in US companies, the resulting surge in filings could overwhelm CFIUS’s still limited resources. American technology firms are in the dark about whether the law will affect them. They are preparing to keep a close eye on the coming definitions to avoid getting slapped with a fine up to the value of the entire investment if they fail to comply.
The risk remains that much of the well-balanced compromise that Congress and industry reached on FIRRMA could be swept away if the Trump administration adopts overly broad definitions of “emerging” and “foundational” technologies.
Pilot Starts Narrow
The pilot covers any US business that “produces, designs, tests, manufactures, fabricates, or develops a critical technology” for 27 industries “in which the threat of erosion of technological superiority from some foreign direct investment requires immediate action.” Industries listed span from ball bearings and aluminum to semiconductors, batteries, telephones, and computers. Within this pilot scope, CFIUS coverage expands along three dimensions:
- Foreign investments that do not result in control of the US business, under certain conditions relating to technology access and control (explicitly called for in FIRRMA)
- Addition of “emerging and foundational technologies” to critical technologies (explicitly called for in FIRRMA, but no clarity yet on which technologies)
- Investors from all countries must report, even NATO allies (not explicitly in FIRRMA)
Covered firms must report any investment that allows foreign investors to access “material nonpublic technical information,” attend its board meetings, or influence decision making over use of its technology. They must submit a written declaration or notice to CFIUS with intricate details about the transaction, which could trigger a more extensive review of its national security implications. CFIUS could then decide whether to demand changes to the deal to mitigate its concerns or reject the transaction.
New Technologies Will Expand the Pilot
The pilot’s definition of “critical technologies” is mostly made up of items like military equipment or nuclear components that clearly relate to national security and deserve enhanced scrutiny. But the scope will most likely widen considerably when a Commerce Department–led interagency process defines which “emerging and foundational” technologies will be both part of the pilot and controlled for export. A broad definition including machine learning, cybersecurity, and nebulous “artificial intelligence” could end up covering just about any advanced American technology firm with clients in the 27 listed industries. Thankfully, to avoid excessive regulatory uncertainty in the short term, Treasury has clarified that “emerging and foundational” technologies are not part of the pilot until Commerce defines them.
All Foreigners, Including Allies, Must Report
While FIRRMA was generally understood to be aimed at investments from countries like China and Russia, the pilot program covers investments from every single foreign country, including those from investors based in allied countries like Canada, the United Kingdom, and France. This may well be necessary at least in the short run to ensure that, for example, a Chinese state-owned military contractor cannot evade the rules by setting up a company in Germany that then makes investments in the United States without triggering scrutiny. CFIUS requires all parties involved in a deal to trace their owners back to the ultimate parent, which should allow CFIUS to gain an understanding of the ways China and other countries use multiple companies to hide investment origins.
Despite efforts to tailor its industry coverage and carefully follow definitions in FIRRMA, the pilot’s inclusion of all countries will almost certainly lead to an unprecedented rise in declarations and notices once the new wave of technologies become part of the pilot. Even today’s better resourced CFIUS may not be able to process these quickly and effectively, leading to delays and increased investment uncertainty. A rare bipartisan letter from the leadership of the House Financial Services Committee in September urged the Treasury to focus CFIUS “on countries or governments that pose the greatest national security risk,” and stated that “NATO allies and other friends around the world…should not be the target of CFIUS’s limited resources.” Hopefully, when the pilot is completed, no later than March 2020, the information gathered from these notices will help CFIUS tailor the final regulations to catch evasion attempts without putting American technology firms at a disadvantage in attracting investment.
Concerns about expanded applications of CFIUS are hardly unwarranted. After all, the Trump administration has claimed that aluminum cans and perhaps cars imported from allies are threats to national security. Congress and the public will therefore need to be vigilant to ensure that FIRRMA authority is exercised carefully. The pilot has raised the already high stakes for the Commerce Department’s definition process, which remains the most critical matter yet to be decided. Such uncertainty risks chilling investment if foreigners looking to invest in American technologies, even those unlikely to have tripped a CFIUS review until now, decide to delay until these definitions are clear. In the meantime, they might decide to fund an Israeli, French, or German firm with comparable technology instead of braving the CFIUS process.