Revised U.S. national security program may change the way you do business in the U.S.
Under new rules in the United States, foreign persons are required to make mandatory filings for both controlling equity investments in U.S. “critical technology” companies and smaller, non-controlling equity investments in such businesses if a foreign person receives certain rights related to that business.
What’s Important to Know?
- “Critical technology” includes traditional national security areas but is expected to soon include a variety of technologies associated with U.S. economic competitiveness.
- Transactions involving the acquisition of an equity interest of any size are subject to the new rules if certain rights accompany the equity rights, such as the right to a board seat in the U.S. business.
- It makes no difference whether funds are invested
- directly into such U.S. business
- into an Israeli or other non-U.S. parent company, which in turn controls such U.S. business, or
- by a foreign private equity or hedge fund into such U.S. business.
- Failure to file a required notification could subject both the investor and target company to penalties up to the amount of the investment.
Overview of the New Rules:
The new rules provide that foreign persons and the target companies they invest in must make mandatory filings (called “Declarations”) for both controlling equity investments in U.S. “critical technology” companies and smaller, non-controlling equity investments in these companies if foreign person receives certain rights related to that business. The investor rights that would trigger a Declaration include member or observer rights on the board, access to material nonpublic technical information, or any involvement in substantive decision making about the technology (including the right to access a company’s key decision makers).
The Committee on Foreign Investment in the United States, or CFIUS, adopted this “Pilot Program” to address the threat from foreign parties (especially China) using non-controlling transactions to obtain information on critical technologies impacting U.S. national security.
Foreign person is broadly defined – for example, a private equity or hedge fund could be considered a foreign person if it has a foreign GP or even one actively involved foreign LP.
Similarly, “critical technology” is broadly defined. In addition to traditional defense-related areas, such as military, civilian/military dual-use, nuclear, and select agents and toxins, “critical technology” also includes “emerging and foundational technologies”, which when defined by regulation in the coming months may include a variety of high-tech industries not typically associated with national security, such as:
- artificial intelligence
- machine learning
- 5G wireless
- financial tech
- virtual reality, and
Declarations must be filed 45 days before an applicable transaction closes and require description of the background of the transaction and financing, the U.S. business and “critical technology” involved, and details regarding all foreign parties to such transaction (including the ultimate owners). CFIUS may take up to 30 days to consider the impact on U.S. national security, after which it may allow the transaction to proceed or, as has been reportedly commonplace in the first several months of the program, indicate that it is unable to complete its review on the basis of the Declaration, requesting or requiring that a long form “Notice” be filed to provide more detail on the transaction (and further delaying the process).
As a threshold matter, all transactions in the U.S. going forward should be evaluated for potential CFIUS issues before proceeding. This review should consider whether “critical technology” is involved, including the possibility of “emerging and foundational technologies” (once defined). Since “critical technology” is defined by reference to various U.S. export control lists, the process for making such determination is not always straight-forward.
If “critical technology” is or is likely to be involved, it is important to identify early in the planning stage potential deal structures, including rights granted to foreign investors, that could trigger the requirement to file a Declaration.
Similarly, when setting up new funds, private equity and hedge funds should carefully consider whether they are likely to invest in “critical technology”.
If there is “critical technology” involved and the Pilot Program conditions may be triggered as a result of the investment, a variety of strategies are possible to either avoid the need for a Declaration altogether, or minimize the potential impact of any required review, including:
- Limiting the rights of foreign investors in U.S. startups
- Restricting the role of foreign LP’s in investment funds
- Bifurcating a transaction with the first stage not requiring filing and the second stage becoming effective only upon CFIUS approval, and
- Structuring transaction timelines to allow for any required or potential filing.
Given the magnitude of the penalty for non-compliance, it is advisable that all Israeli companies, investment funds or individuals who invest in the U.S. understand the new Pilot Program and identify potential CFIUS issues early in the process of considering transactions in the U.S.