The Xiaomi States: How U.S. National Security Authorities View Private and State-Owned Chinese Companies
In a break from the approach taken by other U.S. authorities, in March 2021, a U.S. court found Xiaomi Corporation, a Chinese-headquartered, U.S.-listed consumer electronics company, to be functionally independent from the Beijing government because it is not a state-owned enterprise. Xiaomi obtained an injunction from the court preventing the U.S. Department of Defense from enforcing its designation of Xiaomi as a Communist Chinese Military Company (CCMC); this designation would have prevented U.S. citizens from owning Xiaomi’s securities. The approach adopted in Xiaomi was cited in a May 5 ruling by the same court in favor of Luokung Technology Corp., a British Virgin Islands technology company headquartered in China and whose shares are also U.S.-listed. Like Xiaomi, Luokung had been designated by DoD as a CCMC.
The Xiaomi and Luokung rulings
The ruling in favor of Xiaomi by the U.S. District Court for the District of Columbia (discussed in further detail in our March 23 client alert) as well as the ruling in Luokung (which frequently cited Xiaomi) noted a number of evidentiary and technical flaws in DoD’s arguments to the court. The decisions also relied on a finding that DoD’s designation of Xiaomi and Luokung as CCMCs was not done in accordance with the law defining a CCMC as a person
owned or controlled by, or affiliated with, the People’s Liberation Army or a ministry of the government of the People’s Republic of China or that is owned or controlled by an entity affiliated with the defense industrial base of the People’s Republic of China; and ... engaged in providing commercial services, manufacturing, producing, or exporting.
DoD did not claim that Xiaomi or Luokung is owned by the Chinese government, but did assert that both companies are affiliated with it. The court rejected this assertion, citing various definitions of “affiliate” that relate to common ownership or control.
The court’s reliance on the companies’ private-sector ownership and the lack of “effective control” by the Chinese government differs greatly from the approach taken by various US government authorities with national security responsibilities.
Approach of US government authorities
CFIUS seeks to identify national security risks arising from non-U.S. investments in U.S. businesses. It requires filers to identify indicia of foreign government control and also has a separate clearance process for foreign government-controlled transactions.
Despite these administrative requirements, when CFIUS reviews a U.S. investment from China, the outcome is not likely to be different whether the investor is privately held or a state-owned entity. In fact, Presidents Obama and Trump, on the advice of CFIUS, have formally rejected more U.S. investments from China by privately-owned firms than by state-backed firms.
This approach likely reflects CFIUS’s concern with the level of influence that the Beijing government can exert over any Chinese business, as underscored by the November 2020 suspension of Ant Financial’s planned IPO and restructuring of the company earlier this month. CFIUS is also likely to consider the impacts of China’s State Security Law and National Intelligence Law, under which Chinese companies are required to support government security functions.
Directorate of Defense Trade Controls
The Directorate of Defense Trade Controls, which administers export controls on military items subject to the International Traffic in Arms Regulations (22 C.F.R. Parts 120-130), does not care whether a prospective Chinese investor in a U.S. business is owned by the government or the private sector. This is because the ITAR includes a blanket prohibition on the sale, export, transfer, reexport, or retransfer to China of all ITAR-controlled defense articles and services. As a result of this prohibition, DDTC does not allow foreign ownership (a majority voting interest) or control (ability to establish or direct the general policies or day-to-day operations) of a U.S. business registered under ITAR by a Chinese investor, no matter who ultimately owns the investor.
Defense Counterintelligence and Security Agency
The Defense Counterintelligence and Security Agency is responsible for mitigation of foreign ownership, control, or influence (FOCI) of U.S. government contractors that hold facility security clearances, generally because they require access to classified information as prime or sub-contractors for the U.S. government. Under the National Industrial Security Program Operating Manual, foreign government ownership or control can be a factor in determining the need for FOCI mitigation. In practice, however, FOCI mitigation resulting from Chinese investments has rarely been approved by DCSA. This approach does not appear to reflect any statutory requirement or formal policy established by DCSA or its predecessor, the Defense Security Service, but anecdotally, represents long-standing DoD concerns that standard FOCI mitigation provisions will not be effective at restricting unauthorized access by Chinese owners of cleared U.S. contractors to classified or other sensitive information.
Federal Communications Commission
The Federal Communications Commission is responsible for licensing and other regulatory issues related to telecommunications services and facilities and considers U.S. national security when non-U.S. parties are involved. In doing so, the FCC regularly relies on other executive branch agencies with relevant national security expertise, including “Team Telecom” (or as it is now called officially, the Committee for the Assessment of Foreign Participation in the United States Telecommunications Services Sector), led by the U.S. Departments of Justice, Homeland Security, and Defense, as well as the U.S. intelligence community.
In recent years, the FCC has reached a number of adverse decisions concerning licensees and other companies from China. In 2019, the FCC denied the U.S. affiliate of China Mobile, a Chinese state-owned enterprise, a license to provide international facilities-based and resale services between the United States and other countries. Currently, the FCC is carrying out proceedings to revoke the existing international and domestic carrier licenses of Pacific Networks, its subsidiary ComNet, and the U.S. affiliate of China Unicom, each of which is ultimately owned by the government of China. FCC has indicated in each of these cases that Chinese state ownership is a concern, but also notes the broad influence and control that Beijing can exert over commercial enterprises.
An example of this latter point is illustrated in the 2019 FCC designations of Huawei Technologies Company and ZTE Corporation (Huawei/ZTE Report and Order, November 22, 2019) as companies whose equipment cannot be purchased using the FCC’s Universal Service Fund. While ZTE was formed by China’s Aerospace Ministry and was believed to be a state-owned entity, Huawei was privately held, though it had received, according to the FCC’s report, substantial government financial support. Still, the FCC treated both companies as equally risky, noting with respect to Huawei that
the Chinese government is highly centralized and exercises strong control over commercial entities, permitting the government, including state intelligence agencies, to demand that private communications sector entities cooperate with any governmental requests, which could involve revealing customer information, including network traffic information.
In short, while the Xiaomi and Luokung courts were prepared to view privately held Chinese companies as functionally independent from the Beijing government, that view appears to be an isolated one within the U.S. government. Privately-owned Chinese companies should therefore not expect any advantages over state-owned enterprises when investing in U.S. businesses or in other commercial situations in which U.S. national security could be a regulatory issue.