At the Gates of Heaven or Hell: What a CFIUS Action Against Tencent Could Mean for the Game Industry – The Esports Observer

Last week The Esports Observer reported that Riot Games owner Tencent Holdings has been in quiet discussions with the Committee on Foreign Investments (CFIUS) for the last six months in an effort to allay concerns by the U.S. government about how it handles user data.

Tencent, a China-based conglomerate that wholly owns the League of Legends and Valorant developer, also has roughly a 40% stake in Fortnite and Rocket League owner Epic Games, and minority stakes (anywhere from 5-15%) in such companies as Overwatch League and Call of Duty League owner Activision Blizzard and Rainbow Six Siege developer Ubisoft. It also has holdings in plenty of other companies like Uber, Tesla, and Lyft. In short, the Chinese company has a lot of investments in the United States.

One of the things that CFIUS demonstrated last year was that it has the power to affect deals that have failed, in its view, a national security review. Last year, it ordered short-form video app TikTok and Tencent-owned social app WeChat to divest itself of its U.S. operations if it wanted to continue to do business in the country. Those attempts by the Trump Administration ultimately couldn’t stand up to legal challenges in U.S. federal courts and the related enforcement efforts dictated by executive orders and CFIUS rulings remain in limbo.

The review could be harmless if Tencent can easily show that its subsidiary Riot Games doesn’t share its user data and other sensitive information with its parent company, which in turn doesn’t have access to it to share with the Chinese government. But it’s unclear if this is the specific area of focus for the CFIUS review, and if Tencent is able or willing to comply.

To understand what CFIUS does, what the process is like for companies under review, and what the worst-case scenario for Tencent, and in turn Riot Games could be, The Esports Observer spoke with CFIUS expert Michael Burke, a corporate and administrative partner of Washington, D.C.-based law firm Arnall Golden Gregory. While Burke is a seasoned litigator in a number of areas, he focuses a fair amount of his energy on helping corporate clients with CFIUS compliance.

What is CFIUS?

CFIUS is a broad inter-agency program that reviews foreign investments into U.S. companies that might have an impact on U.S. national security. CFIUS is comprised of officials from 20 or more U.S. government agencies but led by the U.S. Treasury Department. Prior to 2019, before the statute governing CFIUS was expanded to cover more facets of foreign transactions, the inter-agency committee focused on obvious national security concerns.

“It used to be that these transaction under review were for national security purposes, so a lot of the CFIUS reviews would occur if there was a foreign company that was to going to acquire, for example, a U.S. contractor or a company that had some kind of defense, infrastructure, or energy-related business,“ Burke said.

Typically, CFIUS doesn’t speak publicly about whether or not it is reviewing a transaction or company, as it is not allowed to do so by law, according to Burke, and companies typically wouldn’t want such inquiries brought to light, particularly if they are publicly traded.

“Unless you’re in the process, it’s really a black box,” he said. “CFIUS will never say, ‘Oh yeah, we’re revealing X, Y, and Z.’ They will never come out and say, ‘we’re discussing things with Tencent, and here’s what we’re discussing, here are our areas of concern.’“

As an attorney that focuses on CFIUS compliance, the first thing Burke tries to ascertain for his clients is, does a transaction pose a potential national security risk to the U.S., real or perceived? A few years ago, that would have been more obvious: a Chinese or Russian company buying a defense contractor or a manufacturer of sensitive technologies. Burke offered the following example of what a typical CFIUS enforcement action used to look like and how the criteria have changed in the last two years: 

“Most famously, CFIUS was used to block a purchase by Dubai Ports World of assets that were in charge of the management of certain U.S. ports. And so that used to be kind of the obvious trajectory of CFIUS, but with some recent changes, it has expanded scope, including transactions where user data above a certain threshold would be shared. There are others where CFIUS now talks about investments by a foreign party that doesn’t necessarily lead to ownership or control of the U.S. Entity and then there’s a list now I think of 19 different economic sectors where a CFIUS filing might be necessary for a transaction.”

While CFIUS reviews and enforcements might seem heavy-handed towards foreign investors looking to bring capital into U.S. markets, Burke says that what the government does here is on par with other countries around the world.

“Every other country in the world has a similar mechanism for reviewing foreign investments. I’ve done a couple of filings in the past couple of years for one of our clients, a Canadian entity, we’ve never had an issue. One time we had a question come back about some of the assets that were being transferred, but it was more of a clarification issue. With Canadian companies, it’s easier.” 

Looking to the future of CFIUS policy under the Biden Administration, Burke thinks that things will calm down a bit, but it will take time because there continue to be serious concerns about Chinese investments in U.S. businesses and the Chinese Communist Party’s influence on those investors.

“I think the timing is going to be longer-term and gradual,” Burke said. “They’re not going to come out tomorrow and say, ‘we’re revising policy.’ I still think that there is a deep concern in the administration on the potential adverse impacts of Chinese investments in the U.S.. That being said, I don’t think it’s going to be a big change immediately since the government is not making policy on Twitter, ratcheting up tensions, and rubbing faces in what they are doing, I think it’s going to be there for a little while, but will probably start to fade.”

Finally, Burke believes that the new changes to CFIUS have to be met head-on by any foreign entity that wants to invest in a U.S. company so that they know whether or not they will be in compliance.

“Tencent is caught up in this issue now that if those transactions were started today, in BIG CAPITAL LETTERS, I would advise they have to file prior to closing and have to condition the closing on regulatory clearance. If you do that, and if you go to CFIUS and say, ‘Hey, we completed this transaction, can you sign off on it there?’ they are not going to be all that happy to see you because of the risk of these recent changes. CFIUS has the power to cause the modification of a transaction or either terminate or unwind a transaction. And what that means is, because there’s sensitive information, defense sensitive assets involved, or something like that, they can try to exclude that asset from a transaction, or they can condition the use of that asset to certain people.”

CFIUS and Tencent

At the heart of this review, which began under the Trump Administration, is where Tencent is headquartered, Burke notes. It’s certainly not a new trend for the U.S. government to take aim at countries that it views as a serious competitor on the world stage, whether it’s Russia, Japan, or now China.

“Part of the issue that is muddying the waters is that Tencent is a Chinese Chinese company. I remember as a teenager in the eighties, there were Japanese companies buying up companies and real estate all over New York. Everybody was gnashing their teeth and saying, ‘what are we going to do about these Japanese investors?’ Now we seem to have moved on to Chinese investors.

“So in this case, I think that what’s happened is, you’ve got Tencent who has various assets in the U.S. because they are obviously a foreign party, a Chinese company.”

The inquiry into Tencent began last year following a failed attempt by the Trump Administration to ban the company’s WeChat app in the United States. Several politicians began taking aim at it and TikTok as serious national security threats, though no proof was ever produced publicly or in multiple federal court cases. The main focus in this particular inquiry appears to concern user data.

“I would say that starting with the Trump administration, the CFIUS process was pretty difficult when it came to Chinese purchasers, mostly for geostrategic reasons. So you’ve got Tencent and even though the companies that it has invested in are saying that they don’t share user data with Tencent, that’s going to be a concern. I don’t think gaming itself is really a focus area for CFIUS, but this is a Chinese company, there is user data at issue, and there may be some IT issues that we’re not seeing publicly that may be at issue as well.”

So where does Burke see this inquiry going in a best-case scenario?

“One of the things that typically would happen would be an agreement among all parties that no user data gets shared with the Chinese government. Riot Games said, ‘we don’t share with Tencent.’ That’s at least one thing that can happen.”

And as for a worst-case, doomsday scenario? That could be very ugly and messy for Tencent, and by extension, any company it has investments in if CFIUS really wanted to play hardball.

“The worst-case scenario here is if they can’t come to some kind of conclusion that’s acceptable to CFIUS and Tencent, the ultimate remedy here is for CFIUS to call for the unwinding of these transactions within a relatively short time period.”

The other issue that could arise is investor panic, as Tencent has a lot of investments in numerous U.S. companies.

“Let’s say they go to Tencent and say ‘Here are the three things to divest yourself of.’ The market may take that as, Oh my God, this is a signal that they’re going to be coming after everybody. But the market will calm down after a little bit.”

At the end of the day, Burke thinks that CFIUS, under the new administration, will take a thoughtful approach if enforcement is necessary.

“My understanding is that when it comes to divestitures, that was always viewed by CFIUS as the option of last resort.”

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