U.S. Security Concerns Block China’s 3Com Deal

Team Infidel

Forum Spin Doctor
New York Times
February 21, 2008 By Steven R. Weisman
WASHINGTON — Does the “America for Sale” sign require a warning label?
That would seem to be the case in light of the apparent collapse on Wednesday of a Chinese company’s effort to purchase a stake in 3Com, an American maker of Internet router and networking equipment, in the face of Bush administration questions about the deal’s national security risks.
The proposed $2.2 billion deal had called for Bain Capital, a private equity firm based in Boston, to join with a Chinese company, Huawei Technologies, to acquire 3Com. The snag was that 3Com makes antihacking computer software for the military, among other things, and Huawei Technologies has ties to the Chinese military.
A special federal panel, the Committee on Foreign Investment in the United States, or Cfius, had been examining the national security risks of the deal. A person briefed on the talks said that at one point, 3Com offered to divest itself of the antihacking software unit, known as TippingPoint, but that the Bush administration was unswayed.
The concern in Washington was that the Chinese company would be able to alter the electronic equipment and computer software sold to the military in a way that made it less than 100 percent effective. “It is easier to hide than it is to find,” a United States official said about problems in software.
Despite the collapse of the 3Com deal, American officials and specialists in the field said it would be premature to conclude that the United States had decided it needed to crack down on foreign investments, even in delicate technology areas.
Last year, for example, there were nearly 2,000 mergers and acquisitions of foreign and American companies in transactions involving more than $400 billion, according to Thomson Financial.
Yet Cfius examined only 147 of the transactions for possible security violations. In nine cases, the companies withdrew from the process once concerns were raised, as 3Com did on Wednesday, though it hinted that it might still try to win approval down the road.
The person with knowledge of the 3Com talks, who was not authorized to comment, said that given the concerns of the Pentagon and the Department of Homeland Security, it was doubtful that 3Com could arrive at what is called a “mitigation agreement” to let the deal go through. Such accords usually involve safeguards, pledges and internal separation walls.
“We are very disappointed that we were unable to reach a mitigation agreement with Cfius for this transaction,” said Edgar Masri, 3Com’s chief executive, in a statement. He added that 3Com would seek “alternatives that would address Cfius’s concerns” and continue to try to build its global networking business.
The troubles of the 3Com deal cast new light on the committee, which consists of representative of 12 agencies and is led by the Treasury Department. The panel’s mandate to block foreign investments was bolstered last year after criticism of its handling of the 2006 purchase of a company that operates American ports by a company in Dubai.
The withdrawal of the bid by Dubai Ports World occurred not because the foreign investment committee rejected it but because of a torrent of criticism from Capitol Hill, around the same time that similar criticism of a deal by the Chinese state energy company to buy Unocal also led China to withdraw.
The activities of the little-known committee have multiplied since 2006, in part because there are more foreign acquisitions and mergers involving American properties and companies and also because the buyers and sellers are increasingly alert to the fallout and choose voluntarily to submit their deals to the review process.
“There’s no question that Dubai Ports World led to an increase in filings of transactions with Cfius,” Clay Lowery, assistant secretary of Treasury for international affairs, said in an interview last week before the 3Com withdrawal.
“Cfius is a voluntary process,” Mr. Lowery added. “Any of the agencies that sit on the committee can request a filing, but most companies recognize that it’s in their interest to file if the transaction might raise national security questions.”
The Treasury Department would not comment on the 3Com situation.
Meanwhile, the problems of the 3Com deal are sure to aggravate tensions with China.
This month, federal officials charged a Defense Department official with passing classified documents to China. In a separate case, the Justice Department arrested a former Boeing engineer in California on charges of economic espionage for the Chinese.
Members of Congress have also asked the Bush administration to defend its decision last year to allow certain Chinese companies to import crucial military technologies without licenses, after a report by the Wisconsin Project on Nuclear Arms Control, an independent research group, charging that the companies have ties to the military.
The 3Com deal had already drawn criticism in Congress from Republicans and Democrats, who cited a study by the RAND Corporation a few years ago outlining the ties between Huawei Technologies and the Chinese military.
The RAND study said that the Chinese company had been founded by the man who is now its chief, Ren Zhengfei, a former senior figure in the People’s Liberation Army.
American officials said his identity had led to particular concerns at homeland security, which began a cyber-security initiative recently.
The questions being raised in Congress over the deal — led by Representative Ileana Ros-Lehtinen of Florida and Senator John Kyl of Arizona, both Republicans, as well as many prominent Democrats — made some people wary of another firestorm like the Dubai Ports deal of two years ago.
“It’s hard to conceive that, at some senior levels in the administration, there wasn’t an appreciation that if this were concluded favorably, there might be an adverse political reaction,” said a Republican aide, who was authorized to speak as long as he remained anonymous. “There are growing concerns about cyber-security, and it’s a presidential election year.”
China’s increasing involvement in the United States economy, including the recent purchase by a Chinese government investment fund of stakes in the private equity firm Blackstone and in the investment banker Morgan Stanley, has aggravated concerns in Congress. But the Bush administration does not view these as threats to national security.
In addition, foreign investors have been careful to make sure their investments are below the 10 percent threshold that would lead to questions of whether a foreign government would control the American-owned entity. The 3Com deal involved a stake of more than 16 percent by the Chinese company.
Some lawmakers like Senator Charles E. Schumer, Democrat of New York, have suggested that the federal law should be expanded to allow the United States government to block foreign acquisition of companies in economically strategic areas, especially when the investors are foreign governments.
But the Treasury Department adamantly opposes extending the curbs on foreign investments into areas that affect economic security as opposed to national security, though it says it will monitor growing foreign investments in whole sectors of the economy, even in the financial sector.
The major deals of the last several months in which sovereign wealth funds owned by foreign governments have bought sizable stakes in Morgan Stanley, Merrill Lynch, Citigroup, Blackstone, the Carlyle Group and others are thus not likely to be blocked by Cfius, according to most experts.
Michael J. de la Merced in New York and Eric Lipton in Washington contributed reporting.