Editors Note: Caroline Horton Rockafellow is a member of the Research Triangle Park law firm of Daniels Daniels & Verdonik, P.A.
_______________________________________________________________________________________In December of last year, IBM announced plans to sell its personal computer division to the Lenovo Group, a Chinese computer company based in Beijing. It is a deal valued at around $1.75 billion, and would allow IBM to retain an 18.9 percent ownership interest in the acquired division.

When this sale was announced, the initial buzz centered around a concern over a loss of U.S. jobs. Now it appears that the entire deal may be in jeopardy due to concerns raised by the U.S. government.

The transaction is currently under review by the Committee on Foreign Investment in the United States (“CFIUS”), which reviews acquisitions of U.S. companies by foreign entities. Generally such reviews are routine and are approved without much fanfare, but a small number of cases receive closer scrutiny, and occasionally acquisitions will be halted or even reversed based on the outcome of the CFIUS review. This CFIUS review of the IBM transaction is expected to be completed in early March, with a final determination to be made by the President within fifteen days of the issuance of the CFIUS recommendation. Until a final determination is made by the President, this controversy will be closely monitored both in the U.S. and the international community.

Why is the CFIUS review important?

CFIUS was created in 1988 as a result of an amendment to Section 721 of the Defense Production Act of 1950, which charged the President of the United States with investigation of all foreign acquisitions of U.S. companies in order to determine if such acquisitions might threaten national security. The President is further charged with preventing any such acquisitions that might be a threat to our national security.

The review process is conducted in confidence and can be initiated either through a voluntary filing by one of the parties to the transaction or upon notice from a member of CFIUS. However, if parties do not voluntarily file with CFIUS, the transaction is subject to review at any time, including post closing and without any statute of limitations.

CFIUS is currently comprised of the Secretary of the Treasury (who chairs the committee), the Secretaries of State, Defense, Commerce and Homeland Security, the Attorney General, the Director of the Office of Management and Budget, the U.S. Trade Representative, the Chairman of the Council of Economic Advisers, the Director of the Office of Science and Technology Policy, the Assistant to the President for National Security Affairs, and the Assistant to the President for Economic Policy. CFIUS will make a recommendation to the President, who must render a decision within fifteen days of the recommendation. Only the President has the authority to block such a transaction, and if he determines that a transaction should be blocked, there is no appeal process.

What are the CFIUS concerns?

It appears that the issues raised by CFIUS are twofold. First, there is a concern that the transaction will provide a new opportunity for the transfer of technology to the Chinese government, its military and other entities within China.

There also appears to be a concern that China will use the RTP facility as a base for industrial espionage. It is not unreasonable or unwarranted for the U.S. to have concerns about the possible transfer of technology to China. The 2004 Report to Congress on China’s WTO Compliance issued on December 11, 2004, by the United States Trade Representative, reported that “counterfeiting and piracy rates in China remain among the highest in the world, exceeding 90 percent for virtually every form of intellectual property.”

Accordingly, although Lenovo is not generally regarded as being lax in the area of intellectual property protection, there is a clear history technology theft within China. The issue in this case is whether the transfer of ownership from IBM to Lenovo will have any impact on the misuse of U.S. created technologies, which might threaten U.S security.

Does Chinese Ownership Increase the Risk of Espionage?

Individuals within the U.S. government have raised concerns about this acquisition and point to the fact that Lenovo Group’s parent company is Legend Holdings, which is controlled by a Chinese state-owned enterprise. This connection to the Chinese government is a significant concern to certain U.S. legislators.

According to a press release issued by the U.S. House of Representatives on January 25 of this year, U.S. House Small Business Committee Chairman, Don Manzullo is “concerned that the sale could transfer IBM technology, corporate assets, and possibly licensable or export-controlled technology to the Chinese government.” The press release went on to say that U.S. regulators are worried that “Chinese operatives might use an IBM facility in North Carolina to engage in industrial espionage, using stolen technologies for military purposes.”

Part of the concern regarding access to U.S. technology is the belief that such technologies could be used for military purposes. For years, the Bureau of Industry and Security (BIS) has regulated the export of technology and goods that have both a commercial and a military or proliferation application. Computers are generally covered under these regulated “dual-use” goods. This regulation is intended to ensure that the U.S. complies with its international arms control agreements and maintains its homeland security needs.

Accordingly, in view of the directive regarding the regulation of dual use goods, it makes sense that the U.S. government would take a close look at the IBM/Lenovo transaction. It is important to note, however, that of the 10,000 IBM employees directly impacted by the Lenovo acquisition, 40% of those individuals are already located in China working in manufacturing facilities IBM owns jointly with Great Wall computers.

While export might be one consideration in reviewing this transaction, it is not clear that any additional technology would be moved from the U.S. to China, since much of the manufacturing is already being done on Chinese soil. In addition, officials have voiced concerns about the close access that Lenovo’s personnel will have to IBM’s research facilities in North Carolina.

Again, while this may be a legitimate concern, IBM already has a research laboratory located in China. The IBM China Research Laboratory (“CRL”), which opened in 1995, is located in Shangdi, China just northwest of Beijing. According to the IBM website, “the mission of IBM China Research Laboratory is no different from the mission of IBM Research–to be vital to IBM’s future success.”

It goes further to state that “CRL brings the latest science and technologies from IBM worldwide technical communities and aims to be the model of nurturing local talent and expertise.” Accordingly, while there is a logical concern that Chinese officials may have increased access to North Carolina research facilities, it is not evident that this would be any greater than the access they already have to the Shangdi facility.

In addition, Lenovo already provides system integration services for IBM as well as manufactures microprocessors for Intel and produces computers and printers for Hewlett-Packard. In other words, it clearly has access to much of the technology in question and there has been no evidence to date that this technology transfer has created any security threats for the United States.

The outcome of the CFIUS recommendation to the President and well as his response to this recommendation will be of great interest, not only to our local technology community, but to the international community in general. Regardless of the outcome in this case, as the international community continues to expand its technology base and begins to look more seriously at foreign acquisitions as a means of growth and expansion, it is likely that we will see more cases of foreign acquisition of U.S. technology companies.

As with the IBM transaction, it is very likely that future acquisitions will also raise the same concerns as presented to CFIUS in this transaction. Accordingly, if this acquisition is deemed to be a threat to the security of the United States, and thus blocked by our government, it is likely that we will see many more technology acquisitions brought into question.

Daniels Daniels & Verdonik, P.A. has been serving the legal needs of
entrepreneurial and high technology clients for more than 20 years.
Caroline Horton Rockafellow is a licensed patent attorney who works
primarily in the areas of technology deals and licensing. Questions or comments can be sent to crockafellow@d2vlaw.com