Based on the recommendation of the inter-agency Committee on Foreign Investment in the United States (“CFIUS” or the “Committee”), earlier this month the President prohibited the proposed $1.3 billion acquisition of Lattice Semiconductor Corporation (“Lattice”), a publicly-traded semiconductor manufacturer headquartered in Oregon, by Canyon Bridge Capital Partners (“Canyon Bridge”), a U.S. headquartered private equity fund whose sole investor reportedly is owned and controlled by the Chinese government. See 82 Fed. Reg. 43665 (Sept. 18, 2017). This is only the fourth time a President has issued a blocking order, but it was not unanticipated that the Lattice transaction would fail to survive the CFIUS review process given the sensitivity of the U.S. semiconductor industry and potential military supply chain issues, which has given rise to an inordinately high number of CFIUS reviews, and the historically intense scrutiny of Chinese investments in that sector.1
Looking forward, certain aspects of the rationale for the blocking hint at the use of the CFIUS process as a means of ensuring that the United States maintains its technological advantage over China in the semiconductor industry, even without there being an obvious nexus to U.S. national security. Indeed, this and prior actions seemingly reflect an effort by the United States to counter the recent trend of Chinese government efforts to purchase, rather than organically develop, an advanced semiconductor industry — a trend borne out in the most recent CFIUS report to Congress.
Furthermore, the Lattice transaction demonstrates the increasing unpredictability of the CFIUS process in terms of timing, partially as a result of a record number of filings and the corollary failure of this Administration to address high-level vacancies within, in particular, the Department of the Treasury, but possibly also as a result of the sentiment of the CFIUS member agencies that the CFIUS review process can be indefinitely elongated.
Overview of the Lattice Transaction
Lattice manufacturers semiconductors for communications, consumer, and industrial applications, but notably not any longer for military applications. Lattice’s primary semiconductor product lines are programmable logic devices, which are general purpose semiconductors that customers can program to provide functionality similar to chips that are designed and produced for specific applications.
The proposed acquisition was announced in November 2016. Presumably in light of the sensitivities associated with semiconductor technology and Chinese investment, the parties opted to file a joint voluntary notice with CFIUS. The endgame for such a filing is “clearance” by CFIUS, such that the transaction is inoculated from any post-closing risk of scrutiny on national security grounds, which potentially could result in the unwinding of the transaction or divestitures.
The filing of a joint voluntary notice triggers an initial 30-day review, but, if there are national security concerns that have yet to be resolved, CFIUS is authorized to initiate a secondary, 45-day investigation. In the event additional time is required to reach consensus, for example on the terms of any CFIUS-proposed mitigation, it is customary for the parties to agree to withdraw and refile their notice, which allows CFIUS to restart the clock on a new review. But in such instances, CFIUS may not provide any assurance it will curtail the review period. Indeed, many matters that have been withdrawn and refiled have taken a second 75-day period. Furthermore, transaction agreements that have termination dates well into the future may signal to CFIUS that it has longer than the statutory time period to conduct its assessment. While we do not have insight into the parties’ strategy in the Lattice matter, it is notable that they withdrew and refiled their notice on three separate occasions to enable CFIUS consideration of various mitigation proposals. CFIUS apparently was not convinced that the proffered proposals were sufficient to mitigate the risk to U.S. national security. Ordinarily, the parties would voluntarily abandon the transaction, but the parties to the Lattice transaction instead opted for a rare presidential review.
The President ultimately agreed with the recommendation made by CFIUS that, through its control of Lattice, Canyon Bridge “might take action that threatens to impair the national security of the United States” and that other regulatory regimes do not “provide adequate and appropriate authority . . . to protect the national security . . . .” Id. According to a statement issued by the Secretary of the Treasury, the CFIUS chair, the “national security risk posed by the transaction relates to, among other things, the potential transfer of intellectual property to the foreign acquirer, the Chinese government’s role in supporting this transaction, the importance of semiconductor supply chain integrity to the U.S. government, and the use of Lattice products by the U.S. Government.” The President’s decision is not subject to appeal.
More National Security Reviews of Semiconductor Industry Transactions
According to data provided in the most recent CFIUS report to Congress, there is a continuing positive trend in the number of notices filed to the Committee concerning transactions relating to semiconductor manufacturing business. Although the unclassified report is a lagging source of information — the last report released covers the 2015 fiscal year — the most recent data show a continuation of the sharp uptick in semiconductor transaction notices, which began in 2014 following four straight years with declines in the number of such notices. The most recent number of eighteen semiconductor transactions noticed to CFIUS in 2015 was just off the highest number reported in 2009 — where twenty such notices were filed — and three times as many as were noticed as recently as 2013 — where only six semiconductor transactions were noticed to CFIUS. While there are likely many factors influencing the trend, one likely factor is the recent proposed acquisitions by Chinese companies, some of which appear to be government-backed efforts to purchase semiconductor technologies in an effort to boost their domestic industry. These efforts have not gone unnoticed, and many inside and outside of Congress have called for CFIUS to block such deals on the grounds of insuring economic security and technological superiority. And CFIUS has been willing to oblige by recommending the blocking of several such transactions, including proposed Chinese investments in Aixtron, which was the transaction ultimately blocked by President Obama, Lumileds, Global Eagle Entertainment, Inc., Inseego Corp., and Fairchild Semiconductor.
Semiconductor Industry Raises National Security Concerns Despite There Being No Obvious Nexus to National Security
The Treasury statement concluded by asserting that U.S. national security is the sole focus of the CFIUS review process: “Consistent with the long-standing, bipartisan U.S. commitment to open investment, the CFIUS process focuses exclusively on identifying and addressing national security concerns.” Id. But, the nexus to U.S. national security was not abundantly clear as Lattice reportedly had ceased supplying its products to the U.S. military. Of course, while the acquisition of technology with military applications undoubtedly raises legitimate national security risks, there certainly could be exclusively commercial technologies that raise similar risks, as appears to be the case with semiconductor-related technologies. By enumerating concerns regarding intellectual property transfers and supply chain integrity as factors in its review, even though U.S. export control regulations ordinarily would operate to protect U.S. national security, CFIUS has emphasized technological superiority as a critical component of U.S. national security in connection with the semiconductor industry even when the technology at issue is not stringently controlled and the risk to national security appears to be attenuated. While the Lattice transaction does not quite see CFIUS introducing economic security considerations that are independent of national security considerations into its review process, this notion has gained traction in certain legislation already pending in Congress, whereby CFIUS’ mandate to evaluate potential national security concerns explicitly would include economic security considerations or, potentially, a “net benefits” test.
CFIUS Process Unpredictability
The Lattice transaction also highlights the growing unpredictability of the CFIUS review process in terms of timing. This unpredictability variously has been attributed to CFIUS’s record 2017 workload coupled with senior-level vacancies, which has resulted in elongated delays in commenting on draft filings and in accepting formal filings. However, as noted above, the CFIUS member agencies, as evidenced by the Lattice transaction, seem increasingly willing, notwithstanding the statutorily-mandated review and investigation timetables, to accept a series of withdrawals and refilings. While, as also noted above, this practice has become commonplace, our recent experience suggests that the CFIUS member agencies have come to treat the withdrawal and refile process as a crutch, which enables them to kick the proverbial can down the road almost indefinitely. This lack of urgency very well may result in adverse consequences for the parties to a proposed transaction undergoing CFIUS review.
The Lattice transaction is but one of several recent transactions that clearly demonstrate the strategic importance of the U.S. semiconductor industry to the U.S. Government. The President’s decision to block the deal strongly suggests that transactions involving this sector, especially those involving entities from arguably adversarial countries, like China and Russia, likely will face strong headwinds. Furthermore, the Lattice transaction, as well as the swirl of trade-related activity involving China and the increasingly bellicose language being used by the Administration with respect to China, suggests the need for Chinese parties to a proposed acquisition even in less sensitive sectors to carefully consider whether to voluntarily submit to the CFIUS process and to factor a potentially elongated timeline into their initial negotiations in the event the parties opt for CFIUS review. Finally, the decision by the parties to the Lattice transaction to withdraw and refile multiple times and ultimately to take their case to the President should impress upon parties considering submitting to the CFIUS process to clearly delineate their expectations in the transactions, in particular the efforts expected to be undertaken by the acquiring parties to secure CFIUS clearance.