Almost 6 months into his Administration, President Trump’s policy towards Chinese investment in the United States remains unclear. During the course of the presidential campaign, then-candidate Trump consistently expressed the belief that the United States was “losing to China,” and made American competitiveness and perceived inequities in the bilateral relationship with China a central theme of his candidacy. Since entering office, the scope, complexity, and strategic imperatives of the relationship have seemingly resulted in President Trump softening his rhetoric on China. However, critics of China hold key economic positions in the Trump Administration, including Cabinet members who have expressed concern with the Chinese acquisition of American technology companies, and advisers who have warned against China’s “conquest by purchase.”
Given this uncertainty, it is crucial that Chinese companies think strategically as they contemplate making acquisitions in the United States. In order to ensure their success, Chinese companies must anticipate the economic and political implications of their investments, and specifically whether they fall within the jurisdiction of the Committee on Foreign Investment in the United States (“CFIUS”). This interagency committee represents the interests of a range of Executive Branch agencies involved in assessing the national security implications of foreign investments in the United States. It has also figured prominently in the fate of many proposed Chinese acquisitions.
Below we outline the jurisdiction of CFIUS and discuss key considerations that Chinese companies must take into account as they prepare to invest in the United States. We also address ongoing political dynamics that may impact the jurisdiction and decision-making of CFIUS over the coming months.
Overview of CFIUS Jurisdiction and Review Criteria
CFIUS has jurisdiction to review “covered transactions” — any transaction that could result in foreign control of a U.S. business — to determine if credible evidence exists that the transaction threatens to impair U.S. national security. Although President Trump does not sit on the Committee, he has control over CFIUS membership. CFIUS includes Cabinet members such as the Secretary of Treasury, as Chair, the Attorney General and the Secretaries of Homeland Security, Commerce, Defense, State and Energy. The CFIUS process may begin either in response to a voluntary notice by the parties or through self-initiation by CFIUS. To address national security concerns, CFIUS can require a mitigation agreement. CFIUS can also recommend that the president block or suspend proposed transactions, or order divestiture of a completed transaction. Political pressure from Members of Congress can also potentially influence the CFIUS process, based on express national security concerns as well as reasons that seemingly fall outside the scope of the statutory basis of CFIUS review.
Given its statutory mandate, CFIUS approaches each transaction that it reviews with a focus on the national security risk posed by the acquisition. As such, in performing its review CFIUS undertakes the following analysis: (1) a vulnerability assessment, which involves an assessment of the aspects of the U.S. business that could impact national security and the potential national security consequences if the vulnerabilities were to be exploited; (2) a threat assessment, which involves an assessment of the intent and capabilities of the acquirer; and (3) an assessment of potential mitigation measures if a national security risk is identified.
Keeping the above-criteria in mind, one of the first considerations that a company must take into account as it contemplates an acquisition in the U.S. is the industry in which the target company operates. Investment in certain industries, particularly those involving critical technologies, are subject to heightened scrutiny from CFIUS, particularly if the acquirer is Chinese. This stems from the fact that American defense and intelligence agencies have expressed longstanding concerns with what they have described as a coordinated effort on the part of the Chinese government to acquire advanced technologies. Nowhere has this concern been more apparent than in the semiconductor industry.
In early-January of this year, at the tail end of the Obama Administration, the President’s Council of Advisors on Science and Technology (“PCAST”) released a report on semiconductor innovation, competitiveness, and security. The report, which was informed by a working group of senior American executives in the technology industry, warned against the negative impact of China’s industrial policies aimed at achieving a global leadership position in semiconductor design and manufacturing. In response, the PCAST report recommended reshaping the application of national security tools available to policymakers to deter and respond to Chinese policies, including U.S. export control laws and investment controls, such as CFIUS.
CFIUS has, however, already played an active role in reviewing prospective acquisitions in the U.S. semiconductor industry, and in some cases blocking them. In December 2016, President Obama issued an executive order blocking the acquisition of the U.S. business of German semiconductor company Aixtron SE by Chinese investor Fujian Grand Chip Investment Fund LP. This marked only the third time that a U.S. president had ordered a transaction blocked or unwound due to national security concerns. CFIUS does not typically publicly issue rationales for its decisions, however the Department of Treasury did issue a statement in the Aixtron case explaining that “the national security risk posed by the transaction relates, among other things, to the military applications of the overall technical body of knowledge and experience of Aixtron.” The statement also referenced Aixtron’s manufacturing of gallium nitride, a material that is suitable for use in semiconductors with advanced military applications.
The manufacturing of gallium nitride was also at issue in Royal Philips NV’s efforts to sell an 80 percent interest in its Lumileds light business to a consortium led by Chinese private equity firm Go Scale Capital Ltd. The $3 billion deal was ultimately blocked by CFIUS in January 2016. Public reports indicate that CFIUS had concerns about Chinese control over dual-use semiconductor technology involved in making LEDs because of the technology’s applicability to the development of weapons systems, and also had concerns about Lumileds gallium nitride manufacturing capabilities. Shortly thereafter, in February 2016, Fairchild Semiconductor International—a medium-sized U.S. semiconductor company—rejected an acquisition offer from Chinese investors because of what it described as an “unacceptable level of risk” that CFIUS would reject the deal.
Two proposed acquisitions of U.S. semiconductor companies by Chinese entities are currently under CFIUS review and merit monitoring, as they may provide insight into emerging standards under the Trump Administration. The first involves a proposed $1.3 billion acquisition of Lattice Semiconductor Corporation by Canyon Bridge Capital Partners LLC, a California-based private equity fund with Chinese backing. The parties initially filed with CFIUS in November 2016, at which point the transaction was met with political opposition. Twenty-two members of Congress wrote a letter to then-Treasury Secretary Jack Lew requesting that CFIUS block the transaction on account of the fact that Lattice’s technology allegedly has military uses. The parties withdrew and re-filed with CFIUS in late-March of this year, and reportedly withdrew and re-filed again in early-June. In April of this year, Unic Capital Management and China Integrated Circuit Industry Investment Fund announced their proposed acquisition of Xcerra a Massachusetts-based company that designs and manufactures equipment used to test semiconductors. The parties have since filed with CFIUS. Xcerra is not a major market player—the acquisition is valued at $580 million—and does not manufacture sensitive technology or materials. In light of this, the transaction is viewed by many as a test case for the Trump Administration’s stance towards Chinese investment in a sensitive technology sector.
According to recent reports, a newly commissioned white paper from the Department of Defense’s Defense Innovation Unit (Experimental) raises concerns with efforts taken by Chinese companies with close government ties to invest in American start-ups specializing in critical technologies like artificial intelligence and robotics. This is likely to result in heightened scrutiny by CFIUS of Chinese acquisitions in these industries. Therefore, if an acquisition involves a technology company, it is imperative to understand what potential effect (if any) the acquisition will have on U.S. technological leadership in areas impacting national security. Technology controls are also very much on the minds of key agencies involved in the CFIUS review process, given ZTE’s recent $900 million settlement with the Departments of Justice, Commerce, and Treasury, stemming from its circumvention of U.S. export controls and sanctions. An investigation of Huawei based on similar allegations remains ongoing.
That is not to say that CFIUS is opposed to all Chinese acquisitions of U.S. technology companies. Lenovo has been successful on multiple occasions going before CFIUS, first in 2005 with its acquisition of IBM’s laptop business, in 2014 with its acquisition of Motorola Mobility from Google, and again in 2014 with its acquisition of IBM’s x86 server business. In all three instances, U.S. government concerns were assuaged through mitigation measures.
Although seemingly innocuous, it is important for acquirers to perform due diligence on the location of the target company, as well as any of the operations or facilities that will be acquired. CFIUS is keenly interested in the proximity of acquired assets to military or defense installments or activities, and in recent years this issue has impacted Chinese investments. In September 2012, President Obama issued an executive order formally prohibiting the acquisition by the Ralls Corporation (“Ralls”) of four wind projects located near a U.S. naval facility in Oregon and ordering Ralls to divest itself of the wind farms based on a determination by CFIUS that the transaction threatened to impair national security. Ralls is owned by executives at Chinese manufacturer Sany Group, a state-owned entity. The wind turbines were located near a naval facility where drones are tested. Further compounding the issue, the company did not submit notification to CFIUS until two months after the transaction was closed and construction had begun. Ralls challenged the Obama Administration’s prohibition and ultimately prevailed, as the D.C. Circuit unanimously concluded that the President’s order deprived Ralls of property without due process of law.
In November 2012, a similar issue arose in the CFIUS review of Procon Resource’s (“Procon”) private placement deal with Lincoln Mining Corporation (“Lincoln”), a mining company with its principal mining operations in the U.S., that resulted in Procon owning almost 30 percent of Lincoln’s shares. Procon also had the right to appoint four of Lincoln’s seven directors. China National Machinery Industry, which is a state-owned enterprise, indirectly owned 60 percent of Procon’s shares. As such, Procon’s acquisition of control over Lincoln’s U.S. business was subject to the jurisdiction of CFIUS. In June 2013, the parties agreed that Procon would divest its investment in Lincoln subject to the review and approval of CFIUS. As with Ralls, the proximity of the target’s assets to U.S. military bases in Nevada and Arizona appeared to be of primary concern. According to reports, this was at least the second time that CFIUS had prevented Chinese investment in mining operations in the area.
Other Key Considerations
Beyond industry and location, there are a variety of other considerations that have historically been significant to CFIUS, including:
- Does the target entity have U.S. government contracts? If so, do any of the contracts involve U.S. government agencies with national security responsibilities? Contracts do not have to be classified to raise CFIUS concerns.
- Does the target entity own, have access to, or operate critical infrastructure? Critical infrastructure is defined by the statue governing CFIUS as “a system or asset, whether physical or virtual, so vital to the United States that the incapacity or destruction of the particular system or asset…would have a debilitating impact on national security.” This definition is interpreted broadly by CFIUS, therefore a transaction that results in foreign control over major telecommunications, energy, financial, or other systems is likely to result in review.
- Background on the acquirer. While there are a number of key considerations related to the target entity, CFIUS is also interested in the acquirer, and will want to know who owns or controls the acquirer. Is the foreign acquirer directly or indirectly owned or controlled by a foreign government? And what are the foreign person’s plans for the business and its strategic purpose in pursuing the acquisition?
Expansion of CFIUS Jurisdiction
Chinese companies considering acquisitions in the United States would also be wise to monitor ongoing efforts by members of Congress to expand the jurisdiction of CFIUS. Two prominent senators, Majority Whip John Cornyn (R-TX) and Senate Minority Leader Chuck Schumer (D-NY) are reportedly drafting separate bills aimed at reforming CFIUS. Neither of their bills are public, but descriptions of both proposals indicate they could potentially impact Chinese investments. Senator Cornyn’s focus is apparently on ensuring that CFIUS has the ability to review acquisitions in the technology sector, while Senator Schumer’s proposal is reportedly aimed at expanding the definition of “national security” to include economic security.
Similar proposals have been introduced in previous Congresses. However, several factors point to a higher likelihood of passage for Senator Cornyn and Schumer’s bills. First, both Senators are senior members of party leadership and therefore have the influence and relationships to move legislative reform proposals in Congress. Second, there seems to be legitimate bi-partisan interest in reforming and expanding CFIUS’ jurisdiction. Finally, certain members of the Trump Administration likely support these efforts, and could potentially convince President Trump to sign such legislation.
Additional legislative proposals may emerge in the coming months from the Government Accountability Office (“GAO”), a government agency that provides evaluation and investigative services for the U.S. Congress. In September 2016, 16 members of Congress wrote to the GAO requesting a comprehensive review of the jurisdiction of CFIUS. The letter specifically sought answers to the following questions:
- Are existing review processes sufficient to safeguard national security interests “threatened by massive Chinese commercial and economic activity in the U.S.?”
- Does the scope of CFIUS review capture Chinese angel/venture capital funds being established in the U.S. or Chinese investment in tech accelerators and incubators?
The GAO indicated that it would commence its study following the presidential election. No firm deadline has been set for release of a report.
For foreign acquisitions involving the jurisdiction of the Federal Communications Commission (“FCC”) there is a separate review process known as Team Telecom. Team Telecom’s review, which is both broader and more narrow than CFIUS, involves the Departments of Justice, Homeland Security, and Defense, as well as the Federal Bureau of Investigation. Unlike CFIUS, Team Telecom does not act pursuant to any particular law, and has not adopted any formal regulations.
In May 2016, the FCC announced that it was seeking comments on a set of proposals to streamline the Team Telecom process. This announcement was, at least in part, in response to longstanding complaints about the delays and inefficiencies of the review process. Unlike CFIUS which is mandated by statute to review transactions within an allotted period of time, Team Telecom operates informally, without set deadlines. As a result, reviews can stretch for many months, and in the case of some transactions, even longer. Some Chinese companies have been subjected to these prolonged reviews, and the resulting uncertainty.
After soliciting public input on the Team Telecom process, the FCC ultimately shelved a formal review. It is unclear if the Trump Administration will prioritize similar, or other reforms, to Team Telecom.
The Trump Administration’s policy towards Chinese investment is currently unclear and may remain uncertain for months to come given the unpredictability of President Trump and his Administration. Chinese companies considering acquisitions in the United States would be wise, therefore, to closely monitor political developments involving CFIUS and Team Telecom. Moreover, if sound investment opportunities arise, prospective acquirers should make every effort to abide by the lessons of prior transactions we have outlined above. If they address these considerations they will position themselves to be successful.
Kent Bressie is a partner in the Washington, D.C. office of Harris, Wiltshire & Grannis LLP, where he chairs the firm’s International Trade and Investment practice.