Amid reform considerations, Trump utilizes foreign deal reviews

On the campaign trail, President Trump repeatedly challenged the international business community, leveling particularly agitated accusations against China for undercutting American manufacturing, manipulating currency, and theft of intellectual property.

The White House has put action behind its complaints. The Committee on Foreign Investment in the United States (CFIUS) blocked the sale of Lattice Semiconductor to a consortium of Chinese investment funds that had agreed to buy it for $1.3 billion. Among the thwarted buyers was China Venture Capital Fund, a Chinese corporation owned by Chinese state-owned entities that manages industrial investments and venture capital.

Trump issued the executive order, rejecting an appeal by Lattice Semiconductor, on Sept. 13.

“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 executive order says.

Under the Defense Production Act, the President is authorized to suspend or prohibit certain acquisitions that result in foreign control of a U.S. business if he concludes, among other things, that there is credible evidence that the foreign interest exercising control might take action that threatens to impair national security.

A statement by Lattice Semiconductor and Canyon Bridge Capital Partners announced the termination of their merger agreement and pushed back against the decision.

“We believe our CFIUS mitigation proposal was the single most comprehensive mitigation proposal ever proposed for a foreign transaction in the semiconductor industry and would have maximized U.S. national security protection while still enabling Lattice to accept Canyon Bridge’s investment and double American jobs,” it said.

Coincidentally, the following day, the Senate Banking Committee held a public hearing on potential reforms to CFIUS.

The role of CFIUS is to review certain types of foreign transactions to determine if there is: a threat to impair U.S. national security; a foreign investor present which is controlled by a foreign government, like a state-owned enterprise; and something that can affect homeland security or result in control of any critical infrastructure that might impair national security.

Increasingly, in a multinational business climate, concerns arise regarding national security and the intellectual property held by domestic companies that do business abroad.

Nevertheless, as an adjunct to Commerce Department export controls, CFIUS rebukes are fairly uncommon and largely underreported. In the course of 40 years, only three other deals have been scuttled, like Lattice Semiconductor, through a post-appeal Presidential order.

“China is a strategic competitor who seeks a way to circumvent CFIUS protections. The laws, policies, and regulations that were adequate in the past, whether for export control or for foreign investment, must be reviewed and reconsidered to manage the challenge America faces from China’s managed economy.”

James Lewis, SVP, Center for Strategic and International Studies

A recent report on CIFUS activities in 2015 (the most recent year for which data is publicly available) shows that while a direct Presidential rejection may be rare (traditionally, at least), there is plenty of work to done. That year’s review of 143 transactions is expected to at least double this year and into 2018. China, as expected, was (and will be) the top filer for its proposed investments.

“The importance of the semi-conductor supply chain integrity to homeland security and the use of Lattice’s products by the U.S. government was something that could further impair national security,” Sen. Mike Crapo (R-Idaho), chairman of the Senate Banking Committee, said during the CFIUS hearing. “The Lattice case sounds like it should be considered textbook CFIUS, and it is reassuring that the President made this decision based on the careful due diligence of the various government entities that comprise it.”

“Nonetheless,” Crapo said, “there are some congressional and administration concerns over a broad-based set of potential risks arising from China’s steadily increasing use of Foreign Direct Investment to acquire companies and their sensitive technology in the U.S.”

He urged a discussion of whether or not the CFIUS process “is functioning appropriately, to the extent that it has sufficient authority to look at the transactions that are affected most by today’s evolving national security considerations.”

The United States, with $7 trillion in total outward FDI and $6.5 trillion in inward FDI, is the world’s number-one investor overseas and the world’s number-one recipient of foreign investment.

CFIUS, an interagency committee, was established by executive order in 1975 with the Secretary of the Treasury as its chair.

In 1988, driven by concerns regarding growing Japanese investment in the United States, Congress enacted an amendment that expanded these powers, including giving CFIUS the responsibility to investigate foreign acquisitions of companies engaged in business in the United States and providing the President the ability to prohibit a covered transaction that threatens national security.

In 2007, following concerns that had been raised over a Middle Eastern investment in U.S. port facilities, Congress further strengthened CFIUS through the Foreign Investment and National Security Act.  A new executive order arrived in early 2008. Key reforms included: increasing accountability in the executive branch; a broadening of the factors that CFIUS may consider in terms of investigating cross-border M&A transactions; and raising the certification bar for cases in which the acquirer is a state-controlled entity.

Core questions used during a CFIUS evaluation:

Does the acquirer pose a threat to national security?

Is national security made more vulnerable by virtue of the acquisition of the U.S. assets?

Do the consequences of permitting the threat and vulnerabilities to be combined through a specific transaction risk impairing national security?

When experts raise concerns about national security issues that may have recently become more prominent and recommend that the best, and sometimes only, tool to address those concerns is CFIUS, testified Clay Lowery, managing director of Rock Creek Global Advisors, a consulting firm that advises clients on international economic and financial policy matters.

Lowery previously served as assistant secretary of international affairs at the Treasury Department, overseeing CFIUS during “the last time substantial reform occurred.”

EXECUTIVE ORDER DETAILS

The following is from an executive order, issued by President Trump on Sept. 13.
By the authority vested in me as President by the Constitution and the laws of the United States of America, including section 721 of the Defense Production Act of 1950, as amended (section 721), 50 U.S.C. 4565, it is hereby ordered as follows:
Section 1. Findings. (a) There is credible evidence that leads me to believe that (1) Canyon Bridge Merger Sub, Inc., a corporation organized under the laws of Delaware (Merger Sub); (2) Merger Sub's parent companies Canyon Bridge Acquisition Company, Inc., a corporation organized under the laws of Delaware (Acquisition Company), Canyon Bridge Capital Investment Limited, an entity organized under the laws of the Cayman Islands (Capital Investment), and Canyon Bridge Fund I, LP (CBFI), a limited partnership organized under the laws of Delaware; and (3) CBFI's limited partner Yitai Capital Limited, a company organized under the laws of Hong Kong (Yitai), and Yitai's parent company China Venture Capital Fund Corporation Limited, a corporation organized under the laws of the People's Republic of China (CVCF and, together with Merger Sub, Acquisition Company, Capital Investment, CBFI, and Yitai, the Purchasers), through exercising control of Lattice Semiconductor Corporation, a corporation organized under the laws of Delaware (Lattice), might take action that threatens to impair the national security of the United States; and
(b) Provisions of law, other than section 721 and the International Emergency Economic Powers Act (50 U.S.C. 1701 et seq.), do not, in my judgment, provide adequate and appropriate authority for me to protect the national security in this matter.
Sec. 2. Actions Ordered and Authorized.  On the basis of the findings set forth in section 1 of this order, considering the factors described in subsection 721(f) of the Defense Production Act of 1950, as appropriate, and pursuant to my authority under applicable law, including section 721, I hereby order that:
(a) The proposed acquisition of Lattice by the Purchasers (the proposed transaction) is prohibited, and any substantially equivalent transaction, whether effected directly or indirectly by the Purchasers, through the Purchasers' shareholders or shareholders' immediate, intermediate, or ultimate foreign person beneficial owners, or through the Purchasers' subsidiaries, is also prohibited.
(b) The Purchasers and Lattice shall take all steps necessary to fully and permanently abandon the proposed transaction not later than 30 days after the date of this order, unless such date is extended by the Committee on Foreign Investment in the United States (CFIUS) for a period not to exceed 90 days, on such conditions as CFIUS may require. Immediately upon completion of all steps necessary to terminate the proposed transaction, the Purchasers and Lattice shall certify in writing to CFIUS that such termination has been effected in accordance with this order and that all steps necessary to fully and permanently abandon the proposed transaction have been completed.
(c) From the date of this order until the Purchasers and Lattice provide a certification of termination of the proposed transaction to CFIUS pursuant to subsection (b) of this section, the Purchasers and Lattice shall certify to CFIUS on a weekly basis that they are in compliance with this order and include with that certification a description of all efforts to permanently abandon the proposed transaction and a timeline for projected completion of remaining actions necessary to effectuate the abandonment.
(d) Any transaction or other device entered into or employed for the purpose of, or with the effect of, avoiding or circumventing this order is prohibited.
(e) The Attorney General is authorized to take any steps necessary to enforce this order.
Sec. 3. Reservation. I hereby reserve my authority to issue further orders with respect to the Purchasers or Lattice as shall in my judgment be necessary to protect the national security of the United States.
Sec. 4. Publication and Transmittal. (a) This order shall be published in the Federal Register.
(b)  I hereby direct the Secretary of the Treasury to transmit a copy of this order to the parties to the proposed transaction named in section 1 of this order.
Source: White House

Lowery stressed the importance of foreign investment. Roughly seven million American workers—about six percent of total U.S. private-sector workers—are employed directly through foreign direct investment.

These jobs are higher paying, providing average compensation per worker 24 percent higher than U.S. private-sector wages, he said. Two-thirds of the manufacturing jobs created from 2010 to 2014 can be attributed to foreign direct investment.

The United States has always been the leader in defining “national security” in a “reasonable and fair way,” Lowery said, adding that actions the federal government takes are likely to be copied and used by other countries, which could potentially hurt U.S. interests abroad.

“That said, there is little question that the investment landscape has changed substantially in those ten years,” Lowery added. “By far, the most important change has been the rise of China as a direct investor in the U.S.”

“While I believe we should welcome Chinese investment and that each transaction should be judged on its own merits, these transactions have more complex financial structures, sometimes are more opaque, and come from a country where the state plays a much larger role in the economy,” he said. “Often these factors and others raise the threats to national security.”

Lowery expressed concern that a significant expansion of CFIUS oversight “will overwhelm the system and significantly impact its effectiveness and ability to function.”

Potential reforms should adopt a set of guiding principles, he added, among them: Minimize the opportunity for politicizing transactions; keep CFIUS narrowly focused on national security and resist the impulse to use it for broader economic policy goals; ensure accountability of the executive branch for protecting national security while welcoming foreign investment; maintain CFIUS’s focus on reviews triggered by foreign mergers and acquisitions of U.S. businesses; and not broaden the scope to sweep in thousands of commercial or licensing transactions.

In 2016, Chinese companies invested a total of $51 billion into the United States through 65 deals, a 360 percent surge from 2015, Sen. Sherrod Brown (D-Ohio) said.

“While I have serious concerns about many of China’s economic and industrial policies, not all Chinese investments pose national security threats, he added. Fuyao Glass, which has invested in his home state, was cited as an example of a project “which poses no such threat, and is creating jobs.”

Nevertheless, “we have seen an increase in smaller private investments to obtain access to new technological know-how,” Brown said. “We know that some foreign governments and companies have tried to gain access to sensitive information about Americans and pose other cyber-security concerns, and that has to be considered as well.”

Concerns regarding China punctuated the testimony of James Lewis, senior vice president for the Center for Strategic and International Studies.

“China is a strategic competitor who seeks a way to circumvent CFIUS protections,” he said. “The laws, policies, and regulations that were adequate in the past, whether for export control or for foreign investment, must be reviewed and reconsidered to manage the challenge America faces from China’s managed economy.”

China’s goal, Lewis warned, is “to end its dependence on foreign technology and overtake the U.S., as it has overtaken other nations … The fundamental issue for the U.S. and other western nations is how to respond to a managed economy with a well- financed strategy to create domestic industries intended to displace foreign suppliers.”

In the last few years, there have been a number of efforts by Chinese companies with links to the government to buy western semiconductor firms, “using a multibillion-dollar acquisition fund created by the Chinese government,” Lewis testified. “While the CFIUS process has been successful in blocking many of these efforts, China’s policy to end its reliance on foreign semiconductors manufacturers by creating its own companies has not changed and there will be continued pressure.”