Congress Ramps Up Investigations Of U.S. Venture Capital Firms Investing In Chinese Companies – Corporate and Company Law

Last week, a select committee of the U.S. House of
Representatives sent letters to four venture capital (VC) firms
requesting detailed information about their investments in Chinese
companies developing technology involving artificial intelligence
(AI), semiconductors, and quantum computing. The letters are a
clear sign that Congress is ramping up its investigation of U.S.
investments in Chinese high-tech firms. U.S.-based VC firms that
regularly invest in Chinese companies should be aware that this is
a growing area of concern for Congress, review the information
requests carefully, and develop a plan for how to respond in the
event they are targeted next.

Background

The Biden administration and lawmakers are growing increasingly
concerned that U.S.-based VC firms are helping the Chinese
government develop emerging and critical technologies that could be
used to undermine U.S. national security by investing in Chinese
companies that work in high-tech areas, such as AI, semiconductors,
and quantum computing. Accordingly, the Biden administration is
reportedly drafting an executive order that would create an
outbound-investment screening regime. In addition, lawmakers have
drafted bills that would create a similar regime by statute, but
none of the bills have been passed into law.

In February 2023, Georgetown University’s Center for
Security and Emerging Technology (CSET) published a report analyzing outbound investments into
Chinese AI companies using investment data pulled from Crunchbase.
The report states that 167 U.S.-based investors participated in 401
investment transactions involving Chinese AI companies during the
time period from 2015 to 2021. According to the report, the top-10
U.S. investors in Chinese AI companies during this time period
were:

Source: CSET.

The data shows only that a certain VC firm participated in a
particular funding round for a specific Chinese AI company, but the
data does not show how much money the VC firm invested as part of
the funding round. For example, although the report notes that GGV
Capital participated in 43 funding rounds for Chinese AI companies,
the report’s authors could not determine how much money GGV
Capital invested in each funding round.

Overall, the report noted that most investment in Chinese AI
companies comes from Chinese investors, and that Chinese AI
companies can also raise capital from other, non-U.S. sources.
Based on its findings, the report expressed doubt as to whether an
outbound-investment screening regime would have a “long-term
crippling effect” on China’s AI advancement. However, the
report noted that the existing U.S. outbound investment into China,
and the intangible benefits that flow from such investment, warrant
further investigation.

The Letters

Last week, on July 18, 2023, the Select Committee on the Chinese Communist Party
(China Select Committee or Committee) sent letters to four VC
firms—GGV Capital, GSR Ventures, Qualcomm Ventures, and
Walden International—requesting information relating to their
investments in Chinese AI and semiconductor companies, as well as
any investments they have made in China-based quantum-computing
firms. It appears from the letters that the Committee pulled the
names of these four VC firms directly from the CSET report
published earlier this year. It is not clear why the Committee sent
letters to only four of the VC firms included in CSET’s top-10
list, and not the other six.

In the letters, the Committee asserts that all investments made
in Chinese high-tech firms, particularly in the areas of AI,
semiconductors, and quantum computing, help the Chinese government
perpetrate human rights abuses and enhance China’s military
capabilities, regardless of whether the Chinese company that
receives the investment has ever worked with the Chinese government
or military. Because of China’s civil-military fusion policy,
the Committee takes the position that every Chinese company is the
de facto equivalent of a Chinese state-owned entity, and
that any dual-use technology developed by a Chinese company will
automatically be made available to the Chinese government who will
use the technology for nefarious purposes. As the Committee puts
it, “China’s policy of military-civil fusion . . . ensures
that no technology company in China is truly a private
company.”

The Committee concludes each letter by demanding that each VC
firm provide detailed information about its investments in China,
including:

• a list of each Chinese AI, semiconductor, or quantum company in
  which it has made an investment;




• the dollar amount of those investments;




• all internal policies and procedures that relate to how the VC
  firm decides whether to invest in a company that is based in
  China;




• the risk factors that the VC firm considers during the due
  diligence process when considering whether to invest in a company
  that is based in China;




• the extent of Chinese state ownership in the VC firm’s
  investments;




• whether the Chinese government or the Chinese Communist Party
  maintains a presence within the target company such as through a
  party committee; and




• how the VC firm would respond if the U.S. government placed one
  of its Chinese portfolio companies on a trade restriction
  list.

Takeaways

1. The China Select Committee is trying to fill in some of the
   gaps in the CSET report, including trying to determine how much
   U.S. capital is flowing into entities in China that are working on
   AI, semiconductors, and quantum computing. The requested
   information will likely be used to further refine plans for an
   outbound-investment screening mechanism for outbound investments in
   Chinese high-tech companies.




2. US.-based VC firms that choose to continue investing in China
   should be aware that the U.S. Government is increasingly taking the
   view that all U.S. investments in Chinese high-tech
   companies—particularly companies working in the areas of AI,
   semiconductors, and quantum computing—undermine U.S. national
   security.




3. U.S.-based VC firms are on notice that Congress is requesting
   detailed information about investments in Chinese AI,
   semiconductor, and quantum companies. VC firms should review the
   information requests carefully and develop a strategy for
   responding to similar requests if Congress targets their
   firms.




4. VC firms should not discount the possibility that the China
   Select Committee will transfer information it receives to the
   Office of Foreign Assets Control, the Bureau of Industry and
   Security (BIS) End-User Review Committee, or other U.S. government
   bodies involved in imposing trade sanctions. If your VC firm was
   named in the February CSET report, consider updating the risk
   assessment of your relevant investments. Voluntary self-disclosure
   programs are available to divulge issues to regulatory agencies
   under friendlier and more forgiving settings. Congressional
   investigations have occasionally led to later regulatory
   enforcement, including the largest standalone administrative penalty in BIS
   history against Seagate Technology LLC and its Singaporean
   affiliate this year following a 2021 Senate committee report.

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