Many countries have been overhauling the rules that allow regulators to review, and possibly block or force divestiture of, foreign investments that pose a risk to “national security”, but the United States has been a trailblazer. The Committee on Foreign Investment in the United States (CFIUS) has long reviewed transactions by which non-U.S. persons acquire control of companies operating in sensitive business areas. However, last August, the Foreign Investment Risk Review Modernization Act (FIRRMA) expanded the scope of CFIUS review to include certain minority equity investments by non-U.S. persons. The expansion, when effective, could apply to non-U.S. private equity and venture capital funds that invest in sensitive sectors of the U.S. economy. (For a more detailed review of the changes, click here.

Most of the U.S. rules are unchanged. For controlling equity investments, the definition of “control” remains broad, and includes positive or negative control of board decisions or influence that arises from a dominant economic interest, even if it falls short of a majority position. The range of factors that can give rise to national security concerns also remains broad and includes: businesses that have government contracts; are the sole or a dominant source or supply of an important product; operate critical infrastructure; develop critical technology; collect or maintain sensitive personal information; or are proximate to U.S. military installations.

FIRRMA’s expansion means that a non-U.S. private equity fund sponsor making a non-controlling investment in a business that operates critical infrastructure, is involved with critical technology, or collects sensitive personal data of U.S. citizens, will need to consider whether to make a CFIUS filing. In such cases, the investment is within CFIUS’s jurisdiction if the non-U.S. “investing person” (which could be the fund managed by a non-U.S. sponsor or an investor) either has access to material non-public technical information (if the business involves critical technology), has a board (or observer) seat, or has substantive decision-making power with respect to the business.

FIRRMA recognises that investment funds may have non-U.S. investors and that these do not, of themselves, trigger a CFIUS filing. A new statutory safe harbour will apply where a foreign investor is a passive participant in a fund and is not involved in decision-making about the fund or the portfolio company. Importantly, however, this safe harbour is unlikely to help most European (or other non-U.S.) funds because it is available only if the general partner is a U.S. person.

In general, filings with CFIUS by parties to a transaction are voluntary. Last November, however, CFIUS launched a pilot programme that requires mandatory filings when non-U.S. persons invest in businesses that develop or manufacture “critical technologies” used in certain specified industries. In addition, FIRRMA expands the definition of “critical technologies” to include “emerging and foundational technologies,” which will be specified through separate regulatory proceedings.

This eventual expansion of the definition of “critical technology” might also worry some European funds, especially those focused on, among other things, biotechnology, artificial intelligence or robotics. If a European fund is investing in critical technologies used in certain industries, and if the non-U.S. fund sponsor or investors (including through Advisory Committee seats) are given access to material non-public technical information (about a start-up, for example), a mandatory pre-closing filing might need to be made.

The expansion of the scope of CFIUS review, and the possibility of having to make a mandatory filing, could affect the timetable for a deal, even when the investment does not raise meaningful national security concerns. Therefore, European private fund managers, especially those investing in sectors that give rise to U.S. national security issues, will need to become familiar with these new U.S. rules and work through the specific impacts for their funds, given their structure and investor base. FIRRMA’s full-on expansion does not come into effect until implementing regulations are finalised, which will be February 2020 at the latest, but fund managers can start to prepare now.

For a more detailed review of FIRRMA and its impact on private equity funds, please consult the latest edition of Private Equity Report, which is available here.