On December 2, 2016, President Obama issued an executive order blocking Chinese investors' acquisition of Aixtron U.S., the California subsidiary of a German semiconductor producer, due to national security concerns.
The President's order, which followed a recommendation by the Committee on Foreign Investment in the United States (CFIUS) to block the transaction, directed the buyer and Aixtron "to take all steps necessary to fully and permanently abandon the proposed acquisition." The implications of this decision, coupled with signals from Congress and anticipated members of the incoming Trump Administration, portend increased scrutiny of Chinese investments in U.S. companies, particularly in the semiconductor industry. Entities contemplating deals that involve such investments will need to engage in careful planning to avoid roadblocks raised by the U.S. Government based on national security concerns.
The President took action in the Aixtron case based on his authority under Section 721 of the Defense Production Act of 1950 (Section 721) (codified as amended at 50 U.S.C. App. § 2170) to suspend or prohibit any acquisition, merger, or takeover of a "U.S. person" by a "foreign person" that would threaten to impair the national security of the United States, if the President concludes that provisions of law, other than section 721 and the International Emergency Economic Powers Act (50 U.S.C. 1701 et seq.), do not provide adequate and appropriate authority for the President to protect the national security in this matter. The exercise of this authority is extremely rare: since the statute's enactment in 1988, there have been only two prior cases in which the President has barred or unwound a transaction based on Section 721, both of which involved Chinese investments.
In this case, the proposed buyer was Fujian Grand Chip Investment Fund, an investment collaboration of Chinese investors, some of whom reportedly have connections to the Chinese government.
Consistent with the confidentiality provisions of Section 721, the President's order does not disclose the reasons for blocking the acquisition; however, Aixtron produces semiconductor technology that can have military applications in satellite communications and radar, which clearly is valuable to U.S. national security.
Increased Scrutiny of Chinese Semiconductor Acquisitions
The Aixtron transaction is one of dozens of attempted Chinese investments that CFIUS has scrutinized in recent years. From 2012 to 2014, China was the country whose firms were parties to more transactions reviewed by CFIUS than any other country. China accounted for 19 percent of the total, followed by the United Kingdom, Canada and Japan, each of which accounted for 10 percent or more of the reviewed transactions.
During this same period, CFIUS has reviewed numerous investments by Chinese and other foreign entities in critical infrastructures such as semiconductors and other electronic components. In 2014, for example, CFIUS reviewed 12 deals involving semiconductors or other electronic components and 17 other deals concerning computer or electronic products, out of a total of 147 deals.
With respect to these transactions, CFIUS has cited concerns about "an effort among foreign governments or companies to acquire U.S. companies involved in research, development, or production of critical technologies." Although China is not alone in such efforts, it has attracted particular attention as an aggressive investor. As Michael R. Wessel, a member of the U.S.-China Economic and Security Review Commission, put it: "China's engaged in a buying spree of international semiconductor firms."
CFIUS has cleared several Chinese acquisitions of U.S. technology companies in recent years. In 2015, for example, Uphill Investment successfully acquired Integrated Silicon Solution for US$640 million, and Hua Capital Management successfully acquired OmniVision Technologies for US$1.9 billion, both following CFIUS reviews. And even if CFIUS raises serious national security concerns with a deal, companies can attempt to negotiate conditions that will alleviate those concerns sufficiently to permit clearance for the deal. However, sometimes companies may not wish to invest the time and effort to negotiate these conditions with CFIUS. Other times, public concerns expressed even before a CFIUS review is underway may lead the companies to conclude that the deal will not be viable. Accordingly, the presence or anticipation of CFIUS objections can sometimes cause the parties to a transaction to abandon it, either before or during a CFIUS review. For example:
- By November 2015, Chinese state-controlled firm Tsinghua Unigroup abandoned a US$23 billion bid to purchase Micron, which makes memory chips, after significant Congressional pressure on CFIUS to review "the national security implications of allowing China to gain market control over the production of components tied to modern U.S. defense systems."
- In February 2016, Fairchild Semiconductors rejected a US$2.5 billion bid by China Resources Microelectronics and Hua Capital Management for fear that CFIUS would reject the deal. Fairchild noted in an SEC filing that the Chinese consortium's proposed US$108 million reverse termination fee in the event of CFIUS rejection did not justify the risk.
Additionally, public pressure can derail a deal even after CFIUS has concluded that there is no basis for further action under Section 721. In 2006, Congress intervened to block Dubai Ports World from acquiring a U.S. company that leased port facilities, even though CFIUS had already cleared the deal.
U.S. Political Climate for Chinese Investment
U.S. government agencies have had concerns about Chinese investments in semiconductors for many years. In December 2003, DoD created the Defense Science Board Task Force on High Performance Microchip Supply to examine semiconductor concerns for the defense supply chain. In October 2012, the House Permanent Select Committee on Intelligence reported on its investigation into Huawei and ZTE, two top Chinese telecommunications equipment manufacturers doing business with the U.S. telecommunications infrastructure, and highlighted the potential security risk such companies pose.
And in October 2015, the House Armed Services Oversight and Investigations Subcommittee held a hearing to discuss acquisitions by Chinese companies in the microelectronics industry, which focused on the DoD Task Force's recommendations on foreign investment in the U.S. semiconductor industry, and several Subcommittee members focused their questions and remarks on Chinese acquisitions in particular.
Going forward, CFIUS may well feel pressured to apply increased scrutiny to deals involving proposed Chinese investments in U.S. companies, and could also see changes to its underlying statute. There are a number of continuing sources of such pressure:
Representative Robert Pittenger (R-NC) has been vocal in criticizing Chinese access to U.S. industries, including finance. After a Chinese company planned to acquire the Chicago Stock Exchange, Representative Pittenger and other members of Congress wrote a letter to CFIUS opposing the deal. Representative Pittenger asserted that allowing China, a purported currency manipulator, to control a stock exchange would wreak havoc on the U.S. economy.
Representative Pittenger serves on the House Financial Services Committee and thus is well-positioned to push for CFIUS review of Chinese financial sector investments.
Senator John McCain (R-AZ), Chairman of the Senate Armed Services Committee, and Representative Dana Rohrabacher (R-CA) also have spoken out on this issue. For example, in a letter to CFIUS in June 2016, Representative Rohrabacher wrote: "In view of the critical importance of semiconductor technologies to our national defense and infrastructure, I urge you to carefully scrutinize China's semiconductor strategy as well as the collective impact of these recently announced acquisitions."
As Chairman of the Europe, Eurasia, and Emerging Threats Subcommittee of the House Foreign Affairs Committee and a member of the House Committee on Science, Space, and Technology, Representative Rohrabacher could well have influence in seeking to restrict Chinese investment in the U.S. technology sector.
In September, sixteen members of Congress signed a letter requesting that the Government Accountability Office review CFIUS to determine whether its statutory and administrative authority is sufficient to protect against national security risks.
The letter cited "the rise in state-owned enterprises and state-controlled enterprises from China and Russia."
The U.S.-China Economic and Security Review Commission, which released its annual report and recommendations in November,
has advocated for additional significant restrictions. The Commission recommended that Congress amend Section 721 to bar Chinese state-owned enterprises from acquiring or otherwise gaining effective control of U.S. companies.
In early December, Senate minority leader Chuck Schumer (D-NY) wrote a letter to the U.S. Trade Representative and the Treasury Secretary, who serves as the Chair of CFIUS, calling for increased scrutiny into China's Dalian Wanda group, which has been acquiring American movie theater and production companies.
In 2012, Dalian Wanda acquired AMC, and earlier this year, it acquired Legendary Entertainment and Dick Clark Productions. In his letter, Senator Schumer stated that "the new Congress in 2017 will work on legislation to further expand CFIUS oversight authority."
These calls for Congressional action may receive support from the new Trump Administration. Throughout the presidential campaign, President-elect Trump was very critical of China's trade and investment policies. Since the election in November, President-elect Trump's transition team has expressed its interest in expanding the scope of CFIUS review to include the economic impact of deals, including consideration by CFIUS of whether the home country of a foreign buyer would permit a similar acquisition of a domestic company by a U.S. company.
And several of President-elect Trump's Cabinet nominees and candidates—including Commerce Secretary nominee Wilbur Ross, U.S. Trade Representative candidate Robert Lighthizer, and Director of the Office of Management and Budget nominee Mick Mulvaney—have voiced strong criticisms of Chinese policies.
Increased or broader scrutiny by CFIUS could portend significantly larger obstacles on the road ahead for Chinese, and potentially other foreign, investment in the United States in technology sectors that might have some relationship to national security. Anticipating this, U.S. companies seeking foreign investment should conduct strong due diligence in order to ascertain whether a potential buyer has connections to the Chinese government or other governments that are not currently strong U.S. allies. Chinese companies considering investing in U.S. businesses should likewise conduct strong due diligence in order to ascertain whether the target companies have technology or are engaged in activities that may be deemed valuable to U.S. national security. In pursuing an acquisition, such a company should be prepared to mitigate risk by negotiating conditions acceptable to both the company and CFIUS. And as a forward-looking matter, companies should continue to monitor executive and legislative developments affecting CFIUS's overall jurisdiction and review process, as well as trends in its decisions.
*Amanda Claire Hoover contributed to this article. She is a Harvard Law School graduate employed at Arnold & Porter LLP and is not admitted to the bar.