A new executive order (the “EO”) signed by President Biden on June 3, 2021, amends existing prohibitions on US investments in companies that the US government has determined support the military of the People’s Republic of China (“PRC”). The EO, Executive Order 14032, builds on the national emergency declared in Executive Order 13959 ("EO 13959") signed by President Trump in November 2020 regarding threats from China’s military-industrial complex (see our previous Legal Update) and broadens it to include threats from the “use of Chinese surveillance technology outside the PRC and the development or use of Chinese surveillance technology to facilitate repression and serious human rights abuses.” The EO effectively establishes limited sectoral sanctions on China’s defense and surveillance technology sectors. These sanctions are structurally similar to the approach taken by the United States toward Russia’s financial and energy sectors in that they do not prohibit all transactions with China generally nor all transactions involving the targeted sectors. Rather, they impose targeted restrictions on US persons from engaging in or facilitating certain transactions with companies designated as operating in the targeted sectors—in the case of the EO, prohibiting US investment in the publicly traded securities of these companies. We summarize below key aspects of the EO, including what has changed and what has stayed the same from EO 13959.
The new EO expands the US person investment ban established in EO 13959 to include investments in the publicly traded securities of companies operating in the surveillance technology sector in addition to the defense and related sectors of the PRC. Specifically, the EO prohibits US persons from purchasing or selling any publicly traded securities, or any publicly traded securities that are derivative of such securities or are designed to provide investment exposure to such securities, of:
a. Any person listed in the EO’s Annex or
b. Any person determined by the Secretary of the Treasury (in consultation with the Secretary of State and, in some cases, the Secretary of Defense):
i. To operate or have operated in the defense and related materiel sector or the surveillance technology sector of the economy of the PRC; or
ii. To own or control, or to be owned or controlled by, directly or indirectly, a person who operates or has operated in one of the targeted sectors, or a person who is listed in the EO’s Annex or who has otherwise been determined to be subject to the EO’s prohibitions.
The EO goes into effect on August 2, 2021, (60 days after signing), and provides a one-year period during which US persons can purchase or sell the targeted securities solely for the purpose of divesting from these securities. (Going forward, the same 60-day and one-year grace periods will apply to any newly designated entities.) The Annex to the EO names 59 entities that are subject to the EO’s prohibitions. The Treasury Department’s Office of Foreign Assets Control (“OFAC”) will also list these companies on its new Non-SDN Chinese Military-Industrial Complex Companies List ("NS-CMIC List"), which replaces and supersedes OFAC’s previous Non-SDN Communist Chinese Military Companies List ("NS-CCMC List"), which had identified entities subject to EO 13959. The list of 59 companies includes many but not all of the entities on the NS-CCMC List as well as several new ones that were not previously listed. The EO is one of several complex and overlapping sanctions and export control measures directed at China, and many of the entities designated under the EO may be subject to other restrictions, in addition to those described above.
The EO and new guidance issued in parallel by OFAC reflect the current administration’s effort to both expand and streamline the sanctions framework established under the previous administration toward Chinese military-linked companies. As noted above, the new EO applies not only to entities operating in the defense and related materiel sectors of the Chinese economy that were the target of EO 13959 but also to companies operating in the surveillance technology sector. This reflects what the Biden administration describes as its “commitment to protecting core U.S. national security interests and democratic values”1 and demonstrates its willingness to use sanctions measures to further these interests. Although the surveillance technology sector is not defined in the EO, statements by both the White House and OFAC indicate that these sanctions could target a broad range of companies, including those determined to have supported China’s policies and actions toward Hong Kong and the Xianging province. For instance, OFAC issued guidance that it “expects to use its discretion to target, in particular, persons whose operations include or support, or have included or supported, (1) surveillance of persons by Chinese technology companies that occurs outside of the PRC; or (2) the development, marketing, sale, or export of Chinese surveillance technology that is, was, or can be used for surveillance of religious or ethnic minorities or to otherwise facilitate repression or serious human rights abuse.”
The EO streamlines the identification of companies subject to the EO by giving designation authority to the Treasury Department and removing designation through the Department of Defense’s list of Chinese military companies operating in the United States that had been part of EO 13959. OFAC has also issued guidance that removes some of the elements of the implementation of EO 13959 that had caused confusion. For instance, OFAC has clarified that only entities whose names exactly match the names of the entities on the NS-CMIC List are subject to the investment prohibitions, which is a change from OFAC’s previous position with respect to EO 13959 that entities whose names “closely match” listed entities would be subject to the prohibitions. In addition, OFAC has issued guidance stating that the investment prohibitions will only apply to a subsidiary of a listed company if that subsidiary itself is publicly listed on the NS-CMIC list by Treasury and that its “50 Percent Rule” will not apply to entities solely listed on the NS-CMIC List. This means that the prohibitions apply only to the securities of entities positively identified on the NS-CMIC List and do not extend to the securities of any subsidiaries that are owned 50 percent or more by one of the listed entities.
Finally, the agency has published several Frequently Asked Questions (“FAQs”) on its website specifically addressing what activities and transactions US persons are permitted to engage in with respect to the publicly traded securities of the targeted companies. For example, OFAC has clarified that US persons are not prohibited from providing investment advisory, investment management, or similar services (such as advising on, authorizing, directing, or approving purchases or sales) to a non-US person who purchases or sells covered securities provided that the underlying purchase or sale would not otherwise be prohibited. Another FAQ states that US market makers and non-US market makers with US person employees may engage in activities necessary to divest during the authorized one-year period, including conversion of American depositary receipts (ADRs) of a targeted company into underlying securities of the targeted company on the foreign exchange where the underlying securities are listed.
Although the EO’s investment prohibitions apply to US persons, non-US persons could have potential exposure in connection with the EO under a number of scenarios (including potentially under facts in which they could be viewed as “causing” a US person’s violation of the sanctions or “aiding and abetting” or “conspiring” in such a violation by a US person). Similarly, the EO provides broad authority to impose sanctions against non-US/non-Chinese persons whose operations in the targeted sectors may support a US determination that sanctions action is warranted (for which there is recent precedent for the use of similar authority against a number of “third country” actors under other sanctions programs).
The new EO signals that the Biden administration will not abandon the previous administration’s approach to sanctions toward China. As practical matter, the new EO is likely to have a limited impact in the immediate term as most of the 59 designated companies are either state-owned or private and do not have publicly traded securities but nonetheless is significant because of the potential escalation and further expansion of current targeted sanctions between the United States and China.