When are investments in US companies made by venture capital or private equity funds with foreign investors subject to review by the Committee on Foreign Investment in the United States (CFIUS)? What soon will be an Act of Congress answers that question.

Since the arrival of the Trump Administration, CFIUS has been scrutinizing investments that may be acquisitions of control by investment funds with foreign fund investors.  The Committee would seek to determine whether the foreign investor was obtaining control over the US operating business, notwithstanding that the foreign investor was investing through the fund.  If control was acquired, the investment was a “covered transaction” and CFIUS then could reject the investment or subject it to a mitigation agreement.  The existing regulatory regime did not provide much guidance beyond a few examples.  Typically the parties argued to CFIUS that the fund’s investment in an operating business was not an acquisition of control and therefore not a “covered transaction” subject to CFIUS jurisdiction or that it was purely passive.  CFIUS staff would request information regarding the fund's governance documents.  When the foreign investor was on an advisory board or committee of the fund and technically did not have control in the statutory sense, CFIUS would investigate deep and even withhold clearance.  Industries such as communications received substantial attention.

New legislation that will significantly broaden and institutionalize CFIUS review of covered transactions now has passed both houses of Congress, and the President signed it into law on August 13, 2018.  In broad terms, the bill will re-charter CFIUS and make it into a full-blown federal agency, with the right to charges fees for its reviews and even more meaningful enforcement authority. Recognizing the importance of fund investments to the U.S. economy, include start-ups, and the prevalence of investment by foreign persons in managed funds, the bill provides what it refers to as “specific clarification for investment funds.”  

Under the new legislation, the Committee's jurisdiction extends beyond M&A deals to certain minority investments by investment funds in certain US operating businesses.  The operating businesses within the scope of concern are those that deal with critical infrastructure (a term with its own special definition), those that produce or develop critical technologies (another term with special meaning) or those that maintain or collect sensitive personal data of US citizens.  If the minority investment affords the foreign investor access to material nonpublic technical information, board membership or board observer rights for the US business or involvement in decision-making of the US business regarding sensitive personal data, critical infrastructure or critical technologies, then the investment is subject to CFIUS review.

This significant extension of CFIUS jurisdiction required a safe harbor for investment funds with foreign investors.  Subject to future regulations, an indirect investment in one of these businesses by a foreign person through an investment fund that also affords the foreign person membership on an advisory board or committee of the fund itself will be exempt from consideration as an "other investment" if the fund's governance complies with certain conditions. 

The special governance conditions are that a general partner or managing member that is not a foreign person manages the fund; the advisory board or committee does not have the ability to control the fund’s investment decisions; the foreign person does not otherwise have the ability to control the fund; and the foreign person does not have access to material nonpublic technical information as a result of its advisory board or committee position.  However, the converse will also be true--investments by funds that do not comply with the specified conditions will not be exempt and will be subject to review by CFIUS either on a voluntary or, after the passage of FIRRMA, a mandatory basis in certain circumstances.  

The legislation becomes effective 18 months after the enactment date or 30 days after CFIUS determines that the regulations and resources to administer the new regime are in place.  We should expect to see regulations implementing the clarification regarding investment funds in the near future.  

Should you have questions on this or other related matters, please contact William A. Newman.