Investment screening is in vogue. Countries recently have enhanced (or created) mechanisms to “screen” foreign investments and acquisitions. One of the sectors affected by these mechanisms is “artificial intelligence,” a term that often lacks a clear definition.

The Committee on Foreign Investment in the United States (CFIUS) is one prominent investment screening authority, with enhancements implemented from 2018-20. The United Kingdom’s National Security and Investment Act of 2021 introduced the Investment Security Unit, now screening investments into companies operating in the UK. Many countries have similar regimes.

Unfortunately, these screening mechanisms often yield legal activity benefitting neither transaction parties nor screening authorities. This unproductive activity should be mitigated.

Context Counts

The stated purpose of investment screening mechanisms, sometimes referenced as FDI or “foreign direct investment” regimes, is to protect national security: ensuring an investment does not adversely affect the security of a country in which the recipient operates.  

A security problem could arise, for example, if an investment enables a suspect investor to obtain information that facilitates espionage, say, a Russian-backed fund investing in a social media company with details about millions of people.  

Many screening rules have been spurred by concerns about China and Russia. But screening rules typically do not specify countries of concern, instead often applying prophylactically even to well-known investors from allied countries. A filing can be triggered by, e.g., the investment recipient being involved with amorphously defined “dual use technology” or “artificial intelligence".

Under the UK National Security and Investment Act, there is a mandatory notification regime for transactions involving targets that carry on specified activities in any of the following 17 key sectors: advanced materials; advanced robotics; artificial intelligence; civil nuclear; communications; computing hardware; critical suppliers to government; cryptographic authentication; data infrastructure; defence; energy; military and dual-use; quantum technologies; satellite and space technologies; suppliers to the emergency services; synthetic biology; and transport. In the UK, each sector, including “artificial intelligence,” is then further defined through regulation (2021 No. 1264). Because of the frequency with which companies have subsidiaries in many countries, parties to transactions sometimes find themselves making FDI filings in a half-dozen countries or more – e.g., a UK acquisition of a UK company that has subsidiaries in 10 other countries might trigger mandatory FDI filings not only in the UK but in those 10 other jurisdictions.

Being attentive to these rules is important, as violations can result in monetary penalties, void transactions, and even criminal penalties.

Sometimes, though, FDI lawyers are attentive in ways that serve neither client interests nor the security of the countries affected by the transactions. In particular, FDI lawyers occasionally insist filings are required even when this ignores the security purpose and geopolitical context of the rules. This can result in unnecessary legal fees and timing problems. FDI reviews generally take at least a month, and sometimes many months – often delaying transaction closings – with concomitant expense.

Interpretations of screening rules that permit parties to forgo filings might be preferred not only by the parties but also investment screening officials: cluttering their queues with transactions that do not present plausible security concerns does not enhance security.

But when to scrutinize advice that a filing is required? That often is the million euro/pound/dollar equivalent question.

Discretionary and Mandatory Reviews

Although FDI rules across countries differ in innumerable ways, there are functional similarities:

• Discretionary reviews. Screening authorities generally have discretionary authority to “call in” a wide array of transactions; regarding these transactions, the parties might (i) file voluntarily, because approval by the screening authority provides a safe harbor for the transaction, or (ii) forgo a filing unless the transaction is specifically called in (potentially signaling adverse action, such as compelled divestment).
• Mandatory filings. A subset of transactions trigger mandatory filings, with respect to which the parties cannot forgo a filing; failure to make a mandatory filing potentially is subject to monetary fines, forced divestment, and/or criminal penalties.

Discretionary review authority generally exists regarding a broad array of investments and acquisitions. Under CFIUS rules, for example, CFIUS may review any equity transaction in which a “foreign person” acquires “control” of any “U.S. business,” as well as certain non-controlling investments. Key terms “foreign person,” “control” and “U.S. business” are broadly defined, e.g., the acquisition of a 15% voting stake might constitute “control.”  

Despite the breadth of discretionary review authority, FDI lawyers do not typically insist that transaction parties must file merely because an investment screening authority might decide to conduct a review. Rather, FDI lawyers advise clients they have a choice: they can forgo a filing (because the transaction does not trigger a mandatory filing) or make a voluntary filing.  

If the parties forgo filing, they assume risk that the screening authority might later conduct a review and take adverse action, such as forcing divestment. If the parties make a voluntary filing, the parties must navigate the review process but, if they receive approval, the transaction is insulated from future adverse action.

Whether to forgo or submit a voluntary filing depends on the risks and anticipated costs and benefits entailed in either course. This analysis requires assessing, among other things, the likelihood that a screening authority will be concerned about a transaction and the consequences if that occurs. So, for example, an FDI lawyer counseling a Spanish buyer might advise that a voluntary filing for an acquisition of a UK online education company is not warranted in light of the small risk of UK authorities being concerned; but an FDI lawyer counseling a Chinese buyer likely would urge a voluntary filing in light of the risk that the acquisition could be “called in” post-closing, with the buyer forced to divest at a loss.  

Fortunately, most lawyers holding themselves out as FDI lawyers are experienced in making these assessments; unfortunately, they sometimes seem to believe this judgment is irrelevant to advising on whether there is a mandatory filing obligation.

Ambiguity and Client Choice

Whether a FDI filing is mandatory often depends on applying ambiguous rules to the transaction parties, particularly the party receiving an investment. For example, whether the investment recipient is involved with “dual use technology” or “artificial intelligence” may be dispositive under some FDI regimes.

To emphasize a key point:  these and other critical terms often have ambiguous definitions. Companies that make software utilizing encryption, for example, might be considered to have “dual use technology” because of that encryption. On the other hand, if the “primary purpose” of the software is something other than information security, networking, communications, or computing, the “dual use” label might not apply. Of course, assessing the “primary purpose” often entails a subjective judgment.  

Similarly, use of “artificial intelligence” might trigger a mandatory filing, but that term often lacks a clear definition. Mandatory filing rules are replete with ambiguity.

This means there often are reasonable arguments that a filing is mandatory but, often, reasonable counterarguments. This ambiguity does not always exist–sometimes there are no reasonable arguments against a mandatory filing; and even when there is ambiguity, risks typically are higher from forgoing a filing that authorities might view as mandatory, as penalties and reputational damage are more likely. Particularly for large acquisitions, the certainty obtained by receiving approval from investment screening authorities may be important.

But . . . if it’s a Dutch investor making a small investment in a U.S. or UK social media company and there are reasonable arguments that the mandatory filing triggers are not present? An FDI lawyer should at least consider whether U.S. or UK authorities have manifested concern in similar circumstances by taking adverse action.

More generally: parties should insist that FDI lawyers highlight ambiguities in the rules, if any, that might provide reasonable bases for not making filings and that the lawyers apprise parties of the practical risks, costs, and benefits both of making and not making filings. Often, these factors depend on (i) whether there appears to be a significant national security risk entailed in the transaction, e.g., whether the investor is closely tied to China or Russia, and (ii) the history of the investment screening authorities taking adverse action when national security risks are not evident. The parties then should make decisions in view of these risks.  

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Stephen Heifetz is a partner at the law firm Wilson Sonsini Goodrich & Rosati and previously served as an investment screening official for the U.S. government. The views expressed here do not necessarily represent the views of his firm or clients of the firm.