Background on the Huawei Transaction
In mid-February, the Committee on Foreign Investment in the United States ("CFIUS") informed Huawei Technologies Co. ("Huawei") that it should unwind its recent purchase of certain assets for approximately $2.0 million from 3Leaf Systems ("3Leaf"), a California-based company which provides technology for cloud computing. CFIUS conducted a review and a follow-on investigation of the purchase pursuant to the "Exon-Florio" statute, which provides the President with the power to block certain foreign acquisitions, takeovers or mergers that he determines threaten national security. After the investigation, CFIUS informed Huawei that it would have to divest the assets or CFIUS would recommend to the President that he order the parties to unwind the transaction. Although Huawei initially decided to await the President's decision, it ultimately agreed to divest the assets beforehand.
However, when Huawei agreed to dissolve the asset purchase from 3Leaf in February, it also negotiated an arrangement with CFIUS for ongoing oversight of Huawei's operations in the U.S. The agreement set up a formal communications channel between Huawei and CFIUS, which Huawei reportedly welcomed as a way to demonstrate its transparency. Shortly after the deal was reached, Huawei released a public letter in which it asked the U.S. government to conduct a full investigation of the company to clear any misconceptions about the company. In addition to the arrangement with CFIUS, Huawei has also contracted third-parties to perform security audits of its software and hardware products, to further assure regulators that its products do not present a security risk.
Huawei has come under the scrutiny of the U.S. government before. Certain members within the U.S. government believe that Huawei is closely connected to China's People's Liberation Army, particularly since, Huawei's founder and current chief executive officer was once a member. Regulators and U.S. elected officials are also concerned that network equipment made by the Chinese company could be vulnerable to manipulation from China and particular concerns have been raised about possible "back door" code in Huawei software that would let the Chinese government or military disrupt or spy on U.S. telecommunications.
The Huawei transaction is the third reported acquisition by a Chinese company that CFIUS has not approved since late 2009. It is important to note that CFIUS proceedings are confidential and, as a result, there could be additional acquisitions by Chinese companies that CFIUS has not approved.
Background on CFIUS
The U.S. government generally welcomes and encourages foreign investment in U.S. companies, so long as national security and critical infrastructure and technology are not threatened. Huawei is not an indication that the U.S. government is generally closed to Chinese investment. Rather, Huawei is a unique example of the government's longstanding concern over a particular company with strong ties to a foreign government and access to critical U.S. infrastructure. Hueawei's persistent difficulties with CFIUS illustrate how not to approach a foreign investment or acquisition in a U.S. company.
Filings with CFIUS are not mandatory. However, parties obtain a safe-harbor for their transaction by voluntarily submitting to CFIUS' confidential vetting process. CFIUS performs a 30-day national security review of foreign acquisitions of U.S. businesses for any national security implications and if red flags are raised, CFIUS conducts a second-stage, 45-day investigation. If concerns are still not relieved, the President has an additional 15 days to review or block the transaction.
A U.S. President has ordered divestiture pursuant to the "Exon-Florio" statute only once before. In 1990, President George H.W. Bush ordered China National Aero-Technology Import & Export Corporation to divest itself of a U.S. aircraft parts manufacturer, Mamco Manufacturing Co. Typically, if CFIUS advises a potential foreign acquirer that it will recommend that the President prohibit the consummation of a transaction, the acquirer will voluntarily abandon the transaction or divest the U.S. business or assets.
The Huawei transaction confirms CFIUS' longstanding assertion that there are no bright-line standards applied in determining whether a transaction raises foreign control or national security concerns. Such cases are determined on a case-by-case basis and U.S. companies and foreign investors should undertake a pre-acquisition internal analysis to determine whether CFIUS review is warranted, or if one is desired to provide a safe harbor from post closing review and challenge.