CFIUS Law Reform Imposes Serious Threats to Chinese Investments in the US

CFIUS has jurisdiction to review any transaction in which a foreign person could gain control of a U.S. business, but in broad terms, CFIUS has been guided by national security considerations, such as the vulnerability of the U.S. business being acquired and the national security threat of the foreign person acquiring control of the U.S. business.

Why do you think they recently expanded the powers of CFIUS?

U.S. lawmakers and executive branch officials have become increasingly concerned about alleged Chinese state-driven efforts in recent years to acquire sensitive U.S. technologies, particularly through minority investments in U.S. companies. This concern has led to a sense of urgency among lawmakers for a need to reform the underlying authorities governing CFIUS so that China and other economic and national security competitors of the United States are less likely to threaten U.S. national security through inbound investments.

How would Chinese investments in the US affect national security?

Depending on the nature of the U.S. business being acquired and the identity of the Chinese persons acquiring the U.S. business, there are a range of issues that might affect U.S. national security. CFIUS's concerns about Chinese investments include the potential that they will result in unauthorized transfers of critical technologies, exploitation of vulnerabilities in U.S.-origin software and technology, weakening of U.S. critical infrastructure, and exploitation of sensitive personal data of U.S. citizens. These concerns are heightened in Chinese investments made or financed by Chinese state-owned enterprises.

Has the Made in China 2025 policy affected U.S. decision?

Yes. U.S. lawmakers have specifically cited 'Made in China 2025' as a policy initiative of Beijing's that was, in part, an impetus for passing CFIUS reform legislation. Many U.S. lawmakers believe that China, as a state policy, seeks to acquire advanced U.S. technologies in order to compete against the United States in both the economic and national security spheres.

What is the main role or purpose of FIRRMA? How would their processes affect a lawyer's role?

FIRRMA, driven by concerns of China's acquisition of advanced U.S. technologies, particularly through minority investments, will result in the most significant reform to CFIUS in over a decade. Once implemented through regulations, the changes would expand the kinds of transactions subject to CFIUS review, particularly ones involving critical technologies, critical infrastructure, and sensitive personal data of U.S. citizens, and make CFIUS filings mandatory for certain transactions.

FIRRMA will significantly increase the number of transactions subject to CFIUS's review and will mandate CFIUS filings for certain transactions, so the demand for outside counsel and in-house counsel with knowledge of the CFIUS legal framework and practical experience routinely dealing with CFIUS will increase as well. Moreover, lawyers will have to analyze closely the regulations that will be promulgated under FIRRMA because FIRRMA grants CFIUS substantial discretion to further shape its jurisdiction through regulation.

What do legal practitioners in China – lawyers or in-house counsels need to know with regards to facilitating foreign investments in the US with this stricter enforcement?

Three key features of FIRRMA that Chinese lawyers or in-house counsels need to understand are:

• Non-controlling investments – FIRRMA will lower the threshold for CFIUS's jurisdiction – even certain minority Chinese investments involving critical technologies, critical infrastructure, and sensitive personal data of U.S. citizens will be subject to CFIUS's scrutiny.

• Mandatory filings – FIRRMA will mandate that short-form filings be submitted to CFIUS for certain transactions, including those involving Chinese government investors.

• Investment fund exemption – Notwithstanding FIRRMA's expansion of CFIUS's jurisdiction, FIRRMA also offers foreign investors an exemption, if certain criteria are met, for non-controlling investments through investment funds that are controlled by U.S. citizens.

What are some of the factors that CFIUS would consider in their review that investors should consider, especially in the private equity context?

For any CFIUS review, the Committee would consider the potential threat posed by the foreign investor and the vulnerability or sensitivity of the U.S. business. In assessing the potential threat posed by the foreign investor, CFIUS would consider, among other factors,

• the home country of the investors;
• the relationship of the government of the investors' home country with the U.S. Government; and
• whether the investors are owned, controlled, or influenced by a foreign government.

In the private equity context – for example, a foreign fund that invests in U.S. businesses – CFIUS would further examine

• who controls the fund;
• the identities, home countries, economic stakes, and rights of the general partner and the limited partners;
• the powers of any fund investment committees or advisory boards;
• the other investments of the fund and its investors, including any separate investments in the fund's U.S. portfolio companies; and
• any agreements to collaborate or act in concert among the investors or between the person or entity that controls the fund and the investors.

In assessing the vulnerability or sensitivity of the U.S. business, CFIUS would consider whether the company:

• develops, manufactures, or tests critical technologies, including in cutting edge sectors, such as artificial intelligence, robotics, biotechnology, semiconductors, nanotechnology, and cybersecurity;
• manufactures, possesses, or services critical infrastructure;
• holds sensitive personal data of U.S. citizens; or
• is providing products or services, directly or indirectly, to U.S. Government agencies.

Could you give some case studies/ examples of a CFIUS action against foreign investment?

In recent years, President Obama and President Trump have each issued orders either blocking the foreign acquisition of U.S. business or ordering a foreign acquirer to divest of its interest in a U.S. business:

• Ralls - In March 2012, Ralls Corporation ('Ralls'), a U.S. company that was owned by two Chinese nationals and was affiliated with China's Sany Group, acquired four wind farm project companies whose properties were located near a U.S. Navy facility in Oregon. In September 2012, President Obama ordered Ralls to sell its interest in the wind farm project companies.
• Aixtron - In December 2016, President Obama blocked Grand Chip Investment GmbH ('Grand Chip'), a Chinese-owned German company, from acquiring the U.S. subsidiary of Aixtron SE, a German semiconductor equipment manufacturer.
• Canyon Bridge - President Trump blocked Canyon Bridge Capital Partners, a U.S.-based private equity firm allegedly backed by the Chinese government, from acquiring Lattice Semiconductor Corporation, a U.S. semiconductor manufacturer.
• Broadcom - On March 12, 2018, President Trump blocked the proposed hostile takeover of Qualcomm Incorporated, a semiconductor and telecommunications equipment company headquartered in California, by Broadcom Limited, a semiconductor device supplier organized in Singapore with operations headquartered in California.

In addition, for official U.S. Government statistics on CFIUS reviews, including annual reports submitted to Congress, please see the Treasury Department's webpage.

Would enhanced regulatory measures and IP protection rights in China relax the CFIUS process?

Perhaps slightly, but it is difficult to say in the abstract. CFIUS reviews are, by definition, driven by the facts and circumstance of individual 'covered transactions.' Moreover, the U.S. Government's concerns about China in the national security sphere are significant, so Chinese concessions in the economic sphere probably would not lead to sweeping changes in CFIUS reviews of Chinese investments in the U.S.

What would be the impact if China retaliates taking a somewhat similar approach, as China seems to be opening its doors more recently?

In general, the Trump administration and many U.S. lawmakers believe that China, by virtue of its tariffs, cyber activity, and forced transfer of intellectual property, already does not operate on a level playing field as it relates to U.S. inbound investment into China. The basic premise of President Trump's view towards rebalancing the trade deficit between the United States and China is that Beijing's current trade policy is disadvantageous to American efforts to invest in Chinese markets. President Trump appears willing to engage in a long-term trade war with China involving retaliatory tariffs between the two sides.

Do other countries employ similar approach in terms of foreign investment?

Yes. Some countries use a national security-driven foreign investment review. Other countries consider not only national security factors, but also a net-economic benefits test when evaluating certain kinds of foreign investment.

Aaron Cutler contributes high-level knowledge of policy and regulatory matters to his practice at Hogan Lovells. Now a partner in our Legislative Practice Group, he lobbies Congress in energy and natural resources; banking and financial services; and technology, media, telecom sectors. He provides strategic advice to CEOs and executive managers on transactions and risks related to those transactions, and monitors companies and investment funds.