With the signature of President Trump on August 13, 2018, the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) became law. FIRRMA represents the most significant changes to the law governing the Committee on Foreign Investment in the United States (CFIUS or Committee) since the creation of the U.S. foreign investment regime in 1988. Although prompted primarily by national security concerns with Chinese investments, the legislation will affect investments by all non-U.S. investors, including investors in private equity and other funds. The changes reflect a trend across advanced markets for greater scrutiny of investments made via fund vehicles.
While an extended timeline for the CFIUS review process entered into force immediately, most FIRRMA provisions will go into effect following the CFIUS agencies' issuance of regulations and significant expansion of staff, processes that will likely take over a year. In the meantime, CFIUS is authorized to implement "pilot" programs to test certain FIRRMA provisions. CFIUS would be required to provide at least 30 days public notice prior to the commencement of any such pilot programs.
FIRRMA's biggest impact on private equity is found in the new "mandatory declaration" provision. For the first time, investors affiliated with non-U.S. governments (including sovereign wealth funds) and investors targeting certain types of U.S. businesses designated by CFIUS will be required to file a short (about five pages) notification of certain proposed investments. After receiving a declaration, CFIUS will have 30 days either to approve the transaction or to require a full CFIUS review. Declarations will be mandatory for:
- Investments by non-U.S. persons in which a non-U.S. government has a "substantial interest", including sovereign wealth funds. FIRRMA instructs CFIUS to define the term "substantial interest" to clarify what type of influence from a non-U.S. government would fall within scope. An investment with less than a ten percent voting interest will not be considered to constitute a "substantial interest". In addition, declarations may be waived by CFIUS with respect to non-U.S. investors that demonstrate that their investments are not directed by a non-U.S. government and that have "a history of cooperation" with CFIUS.
- Investments by any non-U.S. persons in certain types of U.S. businesses that CFIUS will delineate in the regulations, likely including businesses involved in critical infrastructure, critical technologies including "emerging technologies", and handling of sensitive personal data of U.S. citizens. This provision will impact investments in the technology sector. Private or seed investments by non-U.S. persons that might have flown under the radar previously may (depending on the language of the regulations) require declarations to CFIUS.
Exceptions to the mandatory declaration requirements
The role of non-U.S. persons on fund advisory boards has created interpretative questions about the extent to which advisory boards can influence the fund's management. FIRMMA creates an exception to the mandatory declaration requirements for non-U.S. persons that serve on advisory boards or committees of the fund, if:
- the fund is managed exclusively by a general partner/managing member who is a U.S. person;
- the advisory board does not have the ability to approve, disapprove, or otherwise control:
- investment decisions of the fund; or
- decisions made by the general partner, managing member or equivalent related to entities in which the fund is invested;
- the non-U.S. person does not otherwise have the ability to control the fund, including the authority:
- to approve, disapprove, or otherwise control investment decisions of the fund;
- to approve, disapprove, or otherwise control decisions made by the general partner, managing member, or equivalent related to entities in which the fund is invested; or
- to unilaterally dismiss, prevent the dismissal of, select, or determine the compensation of the general partner, managing member or equivalent; and
- the non-U.S. person does not have access to material nonpublic technical information as a result of its participation on the advisory board.
FIRMMA also clarifies that certain traditional advisory board rights, such as the ability to waive conflicts or permit investments in excess of concentration limits, do not alone constitute the control of the fund's investment decisions.
The exceptions will not cover every fund. For many technology-focused funds and some private equity funds, advisory boards will, as a matter of course, have access to information that likely will constitute "material nonpublic technical information" for CFIUS purposes. Also, many commonly used investment structures fall outside the scope of the exception - e.g., in a fund-of-one, separately managed account, or certain co-investment vehicles, investors generally do not put advisory boards in place and may retain direct influence over the structure.
FIRRMA amends the CFIUS process in a number of other ways. While CFIUS previously had broad authority to review investments that could result in a non-U.S. person's control of a U.S. business, the new law expands CFIUS's authority to review, subject to certain limitations:
- non-controlling foreign investments in a company involved in critical infrastructure, critical technologies, or that collects sensitive personal data of U.S. citizens; and
- the purchase, lease, or concession by or to non-U.S. persons of real estate that is located within a port, or is proximate to a "sensitive" U.S. government property even if the real estate is not associated with commercial activities.
In terms of timing, FIRRMA extends the initial review period from 30 to 45 days, and adds a possible 15 day extension to the investigations phase (i.e., an investigation phase may take up to 60 days). FIRRMA also clarifies CFIUS's authority to block transactions or impose conditions during a review process or when parties withdraw. For the first time, CFIUS will be authorized to collect a filing fee. The fees will be determined by regulation, and will be based on the value of the transaction — they will be capped at the lesser of one percent of the value of the transaction, or US$ 300,000.
Of broader importance, FIRRMA authorizes CFIUS to disclose to a U.S. ally or partner information arising from a CFIUS process in order to advance the common national security interests of the U.S. and that other government. This new authority will facilitate greater cooperation between regulators in the U.S. and partner countries.
In the face of increased scrutiny of private equity transactions by CFIUS, clarification of the fund exception is a welcome development. But the addition of mandatory declarations may affect a number of key investors in private equity. FIRRMA may also alter the calculus regarding what kinds of investment structures managers use for non-U.S. investors; the operating documents for co-investment vehicles may require amendment; funds-of-one may simply become less attractive. CFIUS's expanded reach also does not occur in isolation: managers operating in Europe and elsewhere may find their acquisitions similarly subject to review on the basis of national security.