China's theft of US intellectual property

China's penetration of Silicon Valley creates risks for startups

By Heather Somerville

Stanford University's campus is seen in an aerial photo in Stanford, California, U.S. on April 6, 2016.

SAN FRANCISCO -- Danhua Capital has invested in some of Silicon Valley’s most promising startups in areas like drones, artificial intelligence and cyber security. 

The venture capital firm is based just outside Stanford University, the epicenter of U.S. technology entrepreneurship.
Yet it was also established and funded with help from the Chinese government. 

And it is not alone.
More than 20 Silicon Valley venture capital firms have close ties to a Chinese government fund or state-owned entity, according to interviews with venture capital sources and publicly available information.
While the U.S. government is taking an increasingly hard line against Chinese acquisitions of U.S. public companies, investments in startups, even by state-backed entities, have been largely untouched.
That may well be poised to change as the U.S. Congress finalizes legislation that dramatically expands the government’s power to block foreign investment in U.S. companies, including venture investments.
The new law would give the U.S. government’s Committee on Foreign Investment in the United States (CFIUS) wide latitude to decide what sorts of deals to examine, eliminating certain ownership thresholds, with a particular focus on so-called “critical” technologies.
“The perception is that a lot of the tech transfer of worry to the U.S. security establishment is happening in the startup world,” said Stephen Heifetz, a former member of CFIUS and now a lawyer representing companies going through CFIUS review.
The latest version of the bill exempts “passive” investors, which would cover many of the limited partners that back venture firms. 

But limited partners that have some control over the business, or firms whose managing partner is a “foreign person”, could be subject to scrutiny.
The university endowments and family offices that traditionally provide most of the money for venture firms are usually one of many limited partners and have minimal if any involvement in the startups they help fund.
Chinese entities also sometimes take a passive role in big venture funds. 

But venture capital sources say that Chinese government funds often play a more influential role in the smaller venture firms they back by providing a greater percentage of their funding. 

That empowers them to request information about startups or help them to open offices in China -- potentially opening those startups to CFIUS review.
The possibility of a regulatory crackdown has caused unease in the startup world. 

Venture firm Andreessen Horowitz is counseling startups that if they raise money from a China-backed investor, they put themselves at risk of government scrutiny.
“The window for some startups to raise money from China may be closing,” said Chris Nicholson, co-founder of AI company Skymind, which has raised money from Chinese Internet group Tencent Holdings Ltd and a Hong Kong family office.

SENSITIVE AREAS
Until recently, the original source of funds for venture investments has not been an issue in Silicon Valley. 

Venture firms are not obliged to disclose who their investors are and entrepreneurs rarely ask, leading some dealmakers to question how CFIUS could keep tabs on startup investing.
Danhua Capital, which is backed by the Zhongguancun Development Group, a state-owned enterprise funded by the Beijing municipal government, has holdings in the most sensitive technology sectors.

Its investments include data management and security company Cohesity, which counts the U.S. Department of Energy and U.S. Air Force among its customers.
Drone startup Flirtey, which in May was selected by the U.S. Department of Transportation to participate in projects to help the agency integrate drones safely into U.S. air space, is also part of the Danhua portfolio.

Shoucheng Zhang, Danhua’s founder and a Stanford University physics professor, declined to answer specific questions from Reuters. 

In an email, he said: “Most of our (limited partners) are publicly listed companies in New York or Hong Kong stock exchanges. We will of course fully comply with any legislations and regulations.”
Cohesity declined to comment. 

A spokeswoman for Flirtey said Danhua’s minority investment did not come with any information rights.
The practice of investing through layers of funds, known as funds of funds, can make it all but impossible to know where money is coming from. 

Westlake Ventures, backed by the Hangzhou city government in eastern China, invests in at least 10 other Silicon Valley venture funds, including Palo-Alto based Amino Capital.
Larry Li, founder and managing partner at Amino Capital, said he took the money that was on offer when he launched his fund in 2012. 

He said he felt his firm wasn’t the kind of known quantity that could tap the big pensions and endowments.
“We weren’t going to the Harvard endowment or Yale endowment; that’s like mission impossible,” Li said. 

“You need to have some special source of funds to get started.”
China-backed funds include Oriza Ventures, which belongs to the investment arm of the Suzhou municipal government, and has backed AI and self-driving car startups. 

SAIC Capital, the venture arm of state-owned auto company SAIC Motor, has invested in Silicon Valley autonomous driving, mapping and artificial intelligence startups.
Even well-known startup accelerator 500 Startups raised part of its main fund from the Hangzhou government.
500 Startups and Oriza declined to comment, while SAIC did not respond to a request for comment.
Capital controls have slowed the flow of Chinese money into the United States since 2016, but sources say venture investments have been more resilient than sectors like real estate, in part due to the Chinese government’s focus on improving its domestic high-tech industry.

‘CROWN JEWELS’
U.S. politicians were galvanized by a Department of Defense report released last year that warns that Chinese venture investors are accessing “the crown jewels of U.S. innovation.”
The report helped guide Sen. John Cornyn, a Texas Republican who sponsored the Senate version of the CFIUS reform bill, people with knowledge of the matter said. 

A spokeswoman said Cornyn “is especially concerned with Chinese state-backed venture capital investments.”
For now, at least, President Donald Trump has backed away from his declared intention to clamp down on a wide range of Chinese technology investments through a special emergency order, saying he would leave the job to CFIUS. 

But if Congress fails to pass the bill quickly, Trump said he would use his executive powers.

Nation of Spies: DJI drones are spying for China

Homeland Security released a memo detailing DJI’s main targets.
By Mallory Locklear

Chinese flying spies

A memo from the Los Angeles office of the Immigration and Customs Enforcement bureau (ICE) has been making the rounds and it states some pretty bold claims about drone-maker DJI. 

The memo, which was apparently issued in August, says that the officials assess "with moderate confidence that Chinese company DJI Science and Technology is providing US critical infrastructure and law enforcement data to the Chinese government." 

The LA ICE office also says that the information is based on, "open source reporting and a reliable source within the unmanned aerial systems industry with first and secondhand access."

Part of the memo focuses on targets that the LA ICE office believes to be of interest to DJI. 

"DJI's criteria for selecting accounts to target appears to focus on the account holder's ability to disrupt critical infrastructure," it said. 

The memo goes on to say that DJI is particularly interested in infrastructure like railroads and utilities, companies that provide drinking water as well as weapon storage facilities. 

The LA ICE office concludes that it "assesses with high confidence the critical infrastructure and law enforcement entities using DJI systems are collecting sensitive intelligence that the Chinese government could use to conduct physical or cyber attacks against the United States and its population."
This isn't the first time that the US government has butted heads with DJI. 

In August, a US Army memo directed its members to immediately stop using all DJI products due to cybersecurity concerns -- something that the Australian Defense Force also did temporarily. 

Shortly thereafter, DJI released its Local Data Mode, which allows users to cut off drones from all internet activity. 

And there have been many legitimate security vulnerabilities brought up in regards to DJI's systems. 

U.S. Tech Quislings

How Qualcomm Is Backing China’s Tech Ambitions
By DAVID BARBOZA

As the Chinese government develops drones, the American technology giant Qualcomm is helping. The same goes for artificial intelligence, mobile technology and supercomputers. 

Qualcomm is also working to help Chinese companies like Huawei break into overseas markets in support of China’s “go global” campaign to develop big multinational brands.
Qualcomm is providing money, expertise and engineering for Beijing’s master plan to create its own technology superpowers.
Big American companies fiercely protect their intellectual property and trade secrets, fearful of giving an edge to rivals. 

But they have little choice in China — and Washington is looking on with alarm.
To gain access to the Chinese market, American companies are being forced to transfer technology, create joint ventures, lower prices and aid homegrown players. 

Those efforts form the backbone of Xi Jinping’s ambitious plan to ensure that China’s companies, military and government dominate core areas of technology like artificial intelligence and semiconductors.
As concerns mount about Beijing’s industrial policy, the Trump administration is preparing a broad investigation into potential violations of American intellectual property, according to people with knowledge of the matter. 

Congress is also considering ways to restrict China’s ability to acquire advanced technology by toughening rules to prevent the purchase of American assets and limit technology transfers.

In this arena, America’s economic interests are aligned with its national security needs. 

The worry is that by teaming up with China, American companies could be sowing the seeds of their own destruction, as well as handing over critical technology that the United States relies on for its military, space and defense programs.
Advanced Micro Devices and Hewlett Packard Enterprise are working with Chinese companies to develop server chips, creating rivals to their own product. 

Intel is working with the Chinese to build high-end mobile chips, in competition with Qualcomm. IBM has agreed to transfer valuable technology that could enable China to break into the lucrative mainframe banking business.
“There’s a great deal of unease in Washington,” said James Lewis, an analyst at the Center for Strategic and International Studies, a Washington-based think tank. 

“The defense, intelligence agencies and others are concerned that advanced chip-making capabilities are going to China.”
Qualcomm declined to comment, as did Intel.
Qualcomm is caught in the middle.
The world’s dominant mobile phone chip maker, Qualcomm ran afoul of the Chinese government, getting hit in 2015 with a record $975 million fine for anticompetitive behavior. 

To get back in Beijing’s good graces, the company agreed to lower its prices in China, promised to shift more of its high-end manufacturing to partners in China, and pledged to upgrade the country’s technology capabilities.
The extent of Qualcomm’s involvement with the Chinese government — and the complications for American tech giants — is seen in a low-slung office building in the southwest part of the country. There, a team of engineers is developing leading-edge microchips to compete with the finest made by Intel. 

The chips will help power a huge data and cloud center with the potential to strengthen the country’s computing capabilities. 

No longer content to rely on buying the chips that go into cellphones, computers and cars, China now wants to design and build the brains that drive much of the digital world.
The government is providing land and financing to the start-up formed with Qualcomm, called Huaxintong Semiconductor. 

Qualcomm has provided the technology and about $140 million in initial funding.
“Qualcomm has a balancing act,” said Willy Shih, who teaches at Harvard Business School. 

“Most of the world’s PCs are made in China, and most of the world’s smartphones too, so they have to play along. It’s a fact of life.”
Qualcomm was early to break into China.
In the mid-1990s, as China’s economy began to boom, Bill Clinton pressed the country’s leaders to open to American technology companies.
Members of the Clinton administration, including Charlene Barshefsky, the United States trade representative, and William M. Daley, the secretary of commerce, were dispatched to Beijing to hammer out the details. 

They pushed for one company by name: Qualcomm.
“At the time, they were the only U.S. show in town,” Ms. Barshefsky said.
“Bill Daley and I pushed the Chinese hard on accepting the U.S. standard for wireless technology,” she added, “and that was Qualcomm.”
Mobile phone adoption was taking off globally, largely backed by a European wireless standard called G.S.M., or global system for mobile communications. 

Qualcomm had a competing American standard called C.D.M.A., or Code Division Multiple Access.
Irwin M. Jacobs, a founder of Qualcomm, spearheaded an aggressive lobbying campaign in Washington and Beijing, promoting the technology’s potential to transform wireless communication markets.
“We knew China would be important, and they didn’t have their own system,” said Perry LaForge, a former Qualcomm executive. 

“We also told them this system would give them an opportunity to manufacture their own handsets, and not rely on buying them from other countries.”
When Qualcomm first entered China in the late 1990s, it was slow to gain traction. 

The company struggled to find Chinese partners to produce mobile phones that worked with its network. 

China also tried to develop its own wireless standard.
Qualcomm eventually won out, helping write the standards for next-generation mobile technology, 3G and 4G service. 

The standard championed by European telecom providers faded rapidly. 

And China’s homegrown technology struggled.
By 2013, virtually every wireless device around the world was reliant on either Qualcomm’s chips or its patents — enough to provide some of the technology industry’s fattest profit margins.
With its dominance rising, global brands like Apple and Samsung began complaining to regulators around the world, citing “discriminatory” pricing practices and high royalty fees. 

In China, a trade group made up of the country’s major handset makers complained about patent holders levying “exorbitant licensing fees.”
“These days a smartphone is covered by about 250,000 patents,” said Dieter Ernst, a senior fellow at the East-West Center, a research and educational center based in Honolulu. 

“A Chinese smartphone maker needs to negotiate license agreements with companies like Qualcomm that own the essential patents.”
“The Chinese government was worried about this,” he added. 

“That all these costs could constrain Chinese companies.”
The raids began at dawn, in late November 2013. 

Investigators descended upon Qualcomm’s offices in Beijing and Shanghai, questioning the staff and hauling away laptops and documents.
At the time of the raids, the San Diego-based company’s senior managers were at the Ritz-Carlton Hotel in New York, attending an investor conference. 

The executives were planning to talk about the company’s strategy. 

Instead, they began fielding frantic phone calls from China.
The China business, which accounted for more than half of its global revenue, was in trouble.
A week later, one of the country’s most powerful regulatory agencies, the National Development and Reform Commission (N.D.R.C.), announced that it was looking into whether Qualcomm had abused its power in the sale of mobile phone chips. 

“Qualcomm came to control so much of the chip market in China,” said Louie Ming, a former Qualcomm executive in China. 

“It was clear they were eventually going to run into antitrust problems.”
While Qualcomm agreed to fully cooperate with the investigation, some senior executives appealed to the Obama administration, pressing the White House to raise the issue with China’s senior leaders, according to a former administration official.
Qualcomm’s troubles went beyond China. 

The company was also under scrutiny by antitrust regulators in the European Union and South Korea, as well as by the United States Federal Trade Commission.
China didn’t back down. 

The head of the N.D.R.C. branded Qualcomm a monopoly.
In February 2015, after a 15-month-long investigation, Qualcomm settled allegations in China that it had charged unfairly high prices for its chips and patents. 

The company agreed to pay the $975 million fine — about 8 percent of its annual revenue in China — and to lower the prices for chips sold in the country.
“We are pleased that the resolution has removed the uncertainty surrounding our business in China, and we will now focus our full attention and resources on supporting our customers and partners in China,” said Steve Mollenkopf, the company’s chief executive, said at the time.
Qualcomm then went into business with the Chinese government.
There was a $150 million investment fund to help Chinese start-ups; new research and design facilities set up with Chinese companies such as Huawei and Tencent; and a partnership with a Beijing-based company called Thundersoft to develop drones, virtual reality goggles and internet-connected devices.
Qualcomm is also helping the Chinese government develop supercomputers, a technology the United States government has discouraged American companies from supporting overseas. 

In May, Qualcomm agreed to form a joint venture with other state-backed firms to design and sell mass-market smartphone chips. 

And to help make Chinese chip manufacturing more competitive, Qualcomm has pledged to shift more of its high-end production — long done by outside contractors in Taiwan and South Korea — to China.Continue reading the main story

Continue reading the main story

The Price of Access to a Big Market

Beijing is pressing American technology giants to form joint ventures or partnerships with Chinese companies and transfer advanced technology. The enterprises, in which American companies usually take a minority stake, are backed by the government.

Company	Partner	Date	Product	Investment
AMD	Tianjin Haiguang Advanced Technology Investment Company	2016	Server chips	$293 million
Qualcomm	Guizhou government	2016	High-end server chips	$280 million
Brocade	Guizhou government	2016	Data center networking solutions	unknown
VMWare	Sugon Information	2016	Cloud computing and virtualization software	$50 million
Hewlett Packard Enterprise	Tsinghua Holdings Unisplendour Group	2016	Networking servers and storage systems	$4.5 billion
Microsoft	C.E.T.C. Group	2015	Software	$40 million
Western Digital	Tsinghua Holdings Unisplendour Group	2016	Data center storage systems	$300 million
Cisco Systems	Inspur Group	2016	Networking systems	$100 million
Intel	Spreadtrum/ RDA Microelectronics	2014	Mobile phone chips	$1.5 billion

The investment figure is either the initial investment in the venture or the U.S. company's investment in it. | By THE NEW YORK TIMES

“This is what China does better than anyone else,” said Robert D. Atkinson, president of the Information Technology and Innovation Foundation, a think tank focused on technology policy that has conducted studies detailing the Chinese government’s pressure on technology companies.
“They have a large carrot and a large stick,” he said. 

“And they have a market no C.E.O. can walk away from.”
Qualcomm’s biggest new venture is taking shape in southwest China’s Guizhou Province. Determined to leap into advanced technology, China has designated a large parcel of land in the provincial capital of Guiyang as the home of a new industrial park for supercomputing, data centers and cloud computing. 

The country’s large state-run telecom operators and its internet behemoths, including Alibaba and Tencent, are moving in, to build massive server farms. 

The region offers lower energy costs and abundant supplies of water, necessary to cool server farms.
A year ago, Qualcomm set up a joint venture with the Guizhou government and pledged to invest about $140 million for a minority stake in the business, situated in a development zone that has also attracted the interest of Microsoft and Dell. 

Qualcomm says it received American government approval for the deal.
The new Qualcomm joint venture, Huaxintong Semiconductor, broke ground on the site in 2016, and now operates in a 46,000-square-foot design and engineering center. 

A major test of the partnership will come when the joint venture’s first server chips are released — helping Qualcomm and the Chinese government stake out new ground. 

The Chinese government will control the chips and reap most of the profits.
In late March, Qualcomm’s president, Derek K. Aberle, flew to Guizhou to meet a powerful local government leader, Chen Min'er, a confidant of the Chinese president. 

Seated in a government hall, before an enormous landscape painting, Mr. Aberle pledged to “continually cooperate” with the Chinese government.