For many in the open source community, code and technology are meant to be free, shared with all of humanity in the pursuit of a better present and future. That is not how governments see it though. In their minds, technology is a strategic asset that provides a competitive advantage against other countries. These assets lead to wealth, to jobs, and ultimately, to domestic tranquillity.
The U.S. is a technology leader, and it has a robust set of economic warfare tools to protect its competitive advantages. One of those tools is CFIUS, or the Committee on Foreign Investment in the United States. You might have heard it in the news recently because of its potential impact on Broadcom’s mega offer to buy Qualcomm, or because Congress is considering strengthening its provisions to potentially regulate startup investments from foreign firms.
CFIUS is becoming a lot more important these days due to a single country: China. There are few economic stories more fundamental than the continued rise of China as a world superpower. From humble experiments with capitalism in the early 1980s to the behemoth it is today, China’s economic growth has been nothing short of extraordinary. Underpinning that growth has been a deep appetite for technology and scientific research, first learned through overseas universities, and now through indigenous development.
As China’s wealth has grown, so has its desire to own the most distinguished technology companies in the world, and that’s where CFIUS comes in. The United States’s latest National Security Strategy labels China a “strategic competitor.” As tensions flare, CFIUS will be at the heart of the battle for who will ultimately own the technology industry.
What are we talking about?
Before diving into CFIUS, let’s start with an illustrative example. You are a technology founder, and you have built an AI startup (yes, I realize that is practically redundant today) from humble origins into a world-class unicorn. As excitement about your startup diffuses around the world, acquisition offers start pouring in from Silicon Valley’s leading tech companies.
One acquisition offer though comes from a Chinese company, and it’s a doozy. It’s significantly higher than domestic offers, and even better, the Chinese company has promised that it won’t intervene in any way with the company, allowing you complete freedom to continue growing the company you just spent every waking moment building.
You handshake on a deal, and then you get your lawyers in a room, and they say: “there’s a problem, and it is CFIUS.”
WTF is CFIUS?
CFIUS is a government committee charged with protecting national security by reviewing economic transactions (such as mergers and acquisitions) by foreign entities. The committee is chaired by the Secretary of the Treasury, and its members include the secretaries of Justice, Homeland Security, Commerce, Defense, State, and Energy, along with the U.S. Trade Representative and the head of the White House’s Office of Science and Technology Policy.
There are an enormous number of laws, processes and regulations around CFIUS, and highly-specialized lawyers now handle the process for parties involved. Only “covered transactions” are required to undergo CFIUS review, for example, and what counts as a national security concern is up for interpretation.
The process generally starts when two companies decide they want to conduct a transaction, and they believe CFIUS is likely to be involved. The two companies would file a joint voluntary notice with the committee, which would explain the transaction, the history of the companies, and a bevy of other information required by the rules. CFIUS then has 30 days to make a decision on the transaction (which can be extended another 45 days). In rare cases, it may refer the case to the president for a decision.
For the companies involved, the best decision is a no action (what is known as a “safe harbor”) decision where CFIUS declines to intervene. However, if CFIUS believes there are national security concerns, it can pretty much demand whatever it wants from the parties, from blocking the transaction entirely to putting specific conditions on the structure of the transaction in order to receive its approval. The parties can then either consummate the transaction or walk away.
Has CFIUS actually blocked transactions?
Yes, although answering this question is hard because parties often voluntarily decline to move forward with a transaction rather than follow the advice of the committee. CFIUS was originally established with the passage of the Defense Production Act of 1950, and as the Congressional Research Service noted, it operated in “relative obscurity” for most of its existence.
That has changed in recent times for two reasons. One is the heightened sensitivity around the acquisition of American companies by foreign companies, which became particularly intense following the potential acquisition of management leases to six U.S. ports by Dubai Ports World in 2005. Second, globalization has spurred companies across the globe to seek out partnerships and acquisition targets, increasing global M&A transaction volume significantly.
Back during the Dubai Ports World controversy, there were a total of 64 notices offered to CFIUS in 2005. That number increased to 138 in 2007, crashed during the Great Recession, and reached a new peak in 2014 at 147 notices.
More importantly though, the number of CFIUS investigations has increased. Of the 313 notices given to the committee between 2005 and 2007 at the tail end of the Bush administration, only 14 were investigated, or roughly 4.5%. Of the 770 notices delivered to the committee between 2009 and 2015, 310 were investigated, or 40.3% — a nearly ten-fold jump in the proportion receiving scrutiny.
China has increasingly dominated these proceedings. From 2005 to 2007, China-related transactions were just 4 of the 313 notices, or 1.3%. But in the time period of 2013 to 2015, China was 74 of 387, or 19.1% of all notices. That is a massive increase, and shows both the increasing financial clout of Chinese companies, as well as the increasing concerns in Washington of Chinese acquisition of American companies, particularly those in the technology sector. As an example of its power, CFIUS blocked the acquisition of MoneyGram by Ant Financial, which is closely associated with China’s Alibaba through Jack Ma and other Alibaba executives.
Is CFIUS becoming more powerful?
Almost certainly. CFIUS regulations have changed dramatically over the past decade as more scrutiny has been placed on foreign companies, and particularly state-owned enterprises, attempting to buy American companies. Now, Congress is considering various pieces of legislation to further strengthen CFIUS.
One of the proposals that has been circulated would likely put startup venture capital investments under the purview of CFIUS. Today, the committee looks at transactions that would result in foreign control, which is generally regarded to be complete or at least majority control of a company. The proposed law would extend control to include minority stakes as well in critical technology sectors.
If such legislation were to pass, it would throw cold water on foreign venture capital firms investing in Silicon Valley startups, regardless of how CFIUS actually acts on the legislation. The additional complication of CFIUS review, particularly in early-stage venture capital, would almost certainly dissuade founders from accepting such money and dealing with the multi-week ambiguity of the CFIUS decision-making process.
The reform bill was sponsored by John Cornyn of Texas in the Senate and Robert Pittenger in the House. A bipartisan group of legislators has joined those bills, including California senator Dianne Feinstein. Hearings have been held on the bill in the Senate, and its prospects remain decent although the final language of the bill is still being worked out.
Beyond Congress, one other important change potentially comes from Singaporean-owned Broadcom’s potential acquisition of Qualcomm. Qualcomm is pretty much the only U.S. company with technology capable of competing in the race for 5G telecommunications standards, which the Trump administration has labeled a national security priority.
John Cornyn, who is leading the Senate’s potential reform of CFIUS, has asked the committee to preemptively review the deal before the two parties submit their voluntary notice. That is not standard practice, and if CFIUS were to unilaterally block a deal before a deal was even agreed to, it would be a watershed moment for the once obscure agency. Expect to see CFIUS more often in the coming months.