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October 31, 2018

Stroock Commentary

By: Chris Griner

The Department of Treasury’s pilot program requires mandatory filing with CFIUS of certain foreign investments in a US business in a specified “pilot program industry” involved in critical technology. The regulation specifies 27 “pilot program industries” by reference to the North American Industry Classification System (NAICS). Parties assessing whether any transaction is subject to the mandatory filing requirement under the interim rule must determine the NAICS code for the US business. Notably, the definition of “pilot program industry” makes clear that it is limited to the 27 NAICS codes identified in an appendix to the regulation. Nevertheless, as noted below, it is possible for a supplier to a pilot program industry to be swept up in the pilot program, even though the supplier is not itself a pilot program industry.

NAICS Background
The NAICS is a hierarchical classification system utilizing 2 through 6 digit codes offering five levels of detail. Each digit in the code offers a narrower classification category with greater detail. The digits designate the following:

  • 1st and 2nd: Economic sector
  • 3rd: Economic subsector
  • 4th: Industry group
  • 5th: NAICS industry
  • 6th: National industry.

There is comparability of NAICS codes across US, Canada and Mexico through the 5th digit, with the 6th digit being country-specific. Companies that use identical or similar production processes are usually grouped together in NAICS.  A complete NAICS code contains six digits. The next round of review and revision of the NAICS is scheduled for 2022.

There is no central agency that assigns, monitors and approves the NAICS code(s) for establishments. The U.S. Census Bureau (Census) assigns a single NAICS code to each company based on its primary activity (usually what generates the most revenue) by relying on information that the company submits to the IRS in its application for Employer Identification Number, Form SS-4. Other agencies and trade associations may assign NAICS codes for their own regulatory or programmatic purposes. Regulatory agencies often expect the company to self-identify its NAICS code. It is not uncommon for companies to report multiple NAICS codes to track different business lines or geographic locations.  

How to Determine Your Company’s NAICS Code?
The Census has provided the following guidance for companies trying to determine their correct NAICS code:

  1. You can use the search feature at www.census.gov/naics. In the "2017 NAICS Search" box on the left side of that page, enter a keyword that describes your kind of business. A list of primary business activities containing that keyword and the corresponding NAICS codes will appear. Choose the one that most closely corresponds to your primary business activity, or refine your search to obtain other choices.
  2. Rather than searching through a list of primary business activities, you may also view the complete 2017 NAICS structure with codes and titles by clicking on "2017 NAICS" on the left-hand column from the NAICS main Web page. Then click on the 2-digit Sector code to see all the NAICS codes under that Sector. Then choose the 6-digit code of your interest to see the corresponding definition, as well as cross-references and index items, when available.  NAICS FAQs 9, available at https://www.census.gov/eos/www/naics/faqs/faqs.html#q5.

The NAICS Manual made available by Census is a rich resource for accessing the latest NAICS structure and determining any establishment’s NAICS code. The Manual, available at https://www.census.gov/eos/www/naics/2017NAICS/2017_NAICS_Manual.pdf, contains the titles and description of the economic sectors, sub-sectors and industries. For each six digit NAICS code, the Manual provides the title and description, sometimes followed by “Illustrative Examples” and “Cross-References”. The Illustrative Examples provide activities typically engaged by establishments covered by that NAICS code, whereas “Cross-References” list similar or related industry group or industries that are covered under a different NAICS code (and, therefore, not covered by that particular NAICS entry). The “Cross-References” could be particularly useful for identifying closely related industries in the production chain (e.g., supplier and end-user industries) and zeroing in on the scope of a particular NAICS code.  The final part of the Manual contains an “Alphabetical Index” that provides primary activities and their corresponding codes.

Companies outside the 27 pilot program industries may still be subject to the mandatory filing requirement

The CFIUS mandatory filing requirement under the interim rule applies to controlling and certain non-controlling foreign investments in any “pilot program U.S. business” that “produces, designs, tests, manufactures, fabricates, or develops” a critical technology that is utilized by the U.S. business’ activity in one or more of the 27 pilot program industries, or “[d]esigned by the U.S. business specifically for use in” one or more of the 27 pilot program industries. Plainly, the pilot program includes businesses in the 27 NAICS codes that make up the pilot program industries.

At the same time, a covered foreign investment in a U.S. business that is itself not covered by any of the 27 pilot program industries may still be subject to the mandatory filing requirement if that business (for example) designs critical technology “specifically for use in” one of the 27 pilot program industries. For this reason, it is imperative to know the NAICS code of not only the U.S. business receiving foreign investment but also any customers/end-users for which that U.S. business may be producing, designing, testing, manufacturing, fabricating, or developing a critical technology.  If foreign investment is likely, companies and investors should do a rigorous assessment of their activities to determine if the investment would involve a “pilot program U.S. business.” In the context of due diligence, it is reasonable for a supplier to ask customers for their NAICS code if it is not readily apparent – and it is reasonable for potential investors to inquire of targets on the NAICS codes of their customers.

This article is for general information purposes only. It is not intended as legal advice, and you should not consider it as such.