CFIUS: Implications for Private Equity and Venture Capital Firms (Ropes & Gray)
Recent developments have significantly expanded the jurisdiction of the Committee on Foreign Investment in the United States (“CFIUS”), the interagency committee charged with reviewing foreign investment in U.S. businesses. These changes have immediate implications for U.S. and non-U.S. private equity and venture capital firms, as well as companies seeking their investment capital.
What is CFIUS?
CFIUS is an interagency committee with authority to (1) review foreign investments in U.S. businesses; and (2) impose mitigating measures—or even to recommend that the President block the transaction entirely—if the Committee determines that a foreign investment threatens to impair U.S. national security.
Historically, CFIUS’s jurisdiction was limited to transactions in which a foreign person could acquire “control” of a U.S. business. The CFIUS regulations do not define “control” in terms of a minimum equity percentage or number of board seats. Rather, “control” means the power, direct or indirect, to determine, direct, or cause decisions regarding important matters affecting an entity.
Recent legislation expanded CFIUS’s jurisdiction to certain non-passive, non-controlling investments in U.S. critical technology companies and critical infrastructure companies, as well as businesses that maintain or collect sensitive personal identifier information of U.S. citizens. Importantly, the legislation clarified that indirect investments by foreign persons through investment funds will not automatically trigger CFIUS jurisdiction, even if the foreign person obtains representation on the fund’s advisory board (provided that the board does not control investment decisions and such representation does not afford the foreign person control or access to material nonpublic technical information).
In addition, pursuant to a “pilot program” announced in October, CFIUS notification is mandatory for certain foreign investments in U.S. critical technology companies, if the investment would result in a foreign party obtaining:
- board member or observer rights,
- access to material nonpublic technical information regarding the critical technology, or
- involvement in substantive decision-making involving the critical technology.
Determining whether a U.S. business deals in “critical technology” (and thus potentially within the scope of the pilot program’s mandatory notification requirement) is complicated by the fact that U.S. government has not yet defined a key category of critical technology, so-called “emerging and foundational technology.” An interagency committee has been established to identify emerging and foundational technologies that will be subject to U.S. export controls going forward. The U.S. Commerce Department recently issued a list of technologies for notice and comment that may be considered “emerging technology.”
In brief, the CFIUS regulations’ broad definition of control, coupled with the extension of jurisdiction to certain noncontrolling investments, means that even U.S.-based firms and funds may need to contend with CFIUS if their limited partners or co-investors include non-U.S. parties.
What Should Private Equity and Venture Capital Firms Consider?
In light of the recent changes to the regulations governing the CFIUS review process, U.S. and non-U.S. firms alike should consider the following steps to address CFIUS risk in connection with their investment activities:
- Assessing the rights granted to non-U.S. limited partners and co-investors, such as their scope of participation on fund advisory boards and other governing committees;
- Restricting the information provided to non-U.S. investors to ensure that they do not gain access to material nonpublic technical information (other than financial information);
- Limiting the rights of non-U.S. limited partners over the general partner (e.g., the ability to terminate unilaterally the general partner or nominate a replacement); • Providing the general partner the right to exclude a non-U.S. limited partner from a proposed investment due to CFIUS concerns;
- Reviewing potential non-U.S. investments for CFIUS concerns, including whether a mandatory filing under the pilot program is necessary or the exception for indirect investments through investment funds may apply; and
- Evaluating the national security implications of a proposed investment earlier in the pre-investment review process.
In light of recent changes, early and proactive identification and management of CFIUS risk has never been more important.