On August 9, 2023, President Joseph Biden issued an executive order, and the US Treasury Department kicked off a rulemaking process, to prohibit or require notification of outbound investments by US persons in companies from countries of concern, or certain subsidiaries or parents of such companies, which are engaged in activities related to identified sensitive technologies: semiconductors and microelectronics, quantum information technologies, and artificial intelligence. The order is framed as the natural complement to existing authorities (namely, export controls and inbound investment reviews like CFIUS) that restrict the development of those technologies by nations that could use them to threaten the national security of the United States. The order assigns the Treasury Department implementing responsibility, and concurrent with the order, the Treasury released an Advance Notice of Proposed Rulemaking (“ANPRM”) to solicit comments from the public. Under the order, the term “countries of concern” is defined to include China, including Hong Kong and Macau; other countries can be added to the list in the future.
Notably, the ANPRM seeks comment on three aspects that could have effect as of the issuance of the executive order (August 9, 2023): (1) the Treasury Department can request information, after the effective date of the final regulation, about transactions completed or agreed after August 9; (2) the regulations might apply to a transaction conducted after the final regulation takes effect, but done pursuant to a binding, uncalled capital commitment entered into after August 9; and (3) an exception for intracompany transfer of funds from a US parent company to a subsidiary located in a country of concern might be limited to subsidiaries established prior to August 9.
The ANPRM is scheduled for official publication on August 14; thus, comments on the ANPRM are likely due by Sep. 28. Below we outline the scope of the regulatory regime, based on the ANPRM.
Covered Foreign Persons/Person of a Country of Concern
The ANPRM proposes a definition of “covered foreign person” to mean (1) a person of a country of concern that is engaged in, or a person of a country of concern that a US person knows or should know will be engaged in, an identified activity with respect to a covered national security technology or product; or (2) a person whose direct or indirect subsidiaries or branches are referenced in item (1) and which, individually or in the aggregate, comprise more than 50 percent of that person’s consolidated revenue, net income, capital expenditure, or operating expenses. Thus, the term is intended to sweep in parent companies whose significant subsidiaries qualify as covered foreign persons.
Additionally, the term “person of a country of concern” is proposed to mean (1) any individual that is not a US citizen or lawful permanent resident of the United States and is a citizen or permanent resident of a country of concern; (2) an entity with a principal place of business in, or an entity incorporated in or otherwise organized under the laws of a country of concern; (3) the government of a country of concern, including any political subdivision, political party, agency, or instrumentality thereof, or any person owned, controlled, or directed by, or acting for or on behalf of the government of such country of concern; or (4) any entity in which a person or persons identified in items (1) through (3) holds individually or in the aggregate, directly or indirectly, an ownership interest equal to or greater than 50 percent. In other words, the definition would encompass entities located outside a country of concern that are majority-owned by a person of a country of concern.
A key issue in the development of the order has been its scope—i.e., the types of transactions that would be covered by the outbound investment regime. The ANPRM proposes to use the term “covered transaction” to apply to both notifiable and prohibited transactions. The term would be defined to mean a US person’s direct or indirect:
- acquisition of an equity interest or contingent equity interest in a covered foreign person;
- provision of debt financing to a covered foreign person where such debt financing is convertible to an equity interest;
- greenfield investment that could result in the establishment of a covered foreign person; or
- establishment of a joint venture, wherever located, that is formed with a covered foreign person or could result in the establishment of a covered foreign person.
In addition, the Treasury Department is considering including indirect transactions within this term, to ensure that transactions involving intermediary entities are included.
Certain transactions would be excepted by definition, including:
- investments made (a) into publicly traded securities; (b) into an index fund, mutual fund, or exchange-traded fund; or (c) as a limited partner into a venture capital fund or private equity fund, provided the contribution is solely of capital, the limited partner cannot make managerial decisions or influence fund decision making, and the investment is below a to-be-determined de minimis threshold;
- the acquisition of the equity or other interest owned or held by a covered foreign person in an entity or assets located outside of a country of concern where the US person is acquiring all interests in the entity or assets held by covered foreign persons;
- an intracompany transfer of funds from a US parent company to a subsidiary located in a country of concern (note this exception does not include investments from other US persons (i.e., non-parents), and the Treasury is also considering defining a parent as having an ownership interest as 50 percent or greater); or
- a transaction made pursuant to a binding, uncalled capital commitment entered into before the date of the executive order (August 9, 2023).
With respect to such limited partner investments, the Treasury Department is considering whether the proposed exception should only include limited partner investments below a defined threshold, on the theory that larger investments are more likely to involve intangible benefits as well. Such intangible benefits include those often associated with larger institutional investors, including standing and prominence, managerial assistance, and enhanced access to additional financing.
Investments that afford a US person board membership or observer rights, or involvement in business decisions, management, or strategy would not be excepted.
The Treasury highlights that, although not explicitly excepted, the definition of “covered transaction” is not intended to apply to the following activities, so long as they do not involve any of the definitional elements of a “covered transaction” and are not undertaken as part of an effort to evade these rules:
- University-to-university research collaborations;
- Contractual arrangements or the procurement of material inputs for any of the covered national security technologies or products;
- Intellectual property licensing arrangements;
- Bank lending;
- The processing, clearing, or sending of payments by a bank;
- Underwriting services;
- Debt rating services;
- Prime brokerage;
- Global custody; and
- Equity research or analysis.
Provisions Potentially Taking Effect As of August 9, 2023
As noted in the introduction, with respect to the exception for intracompany transfer of funds from a US parent company to a subsidiary located in a country of concern, the ANPRM explicitly seeks comments on what would be the impact if the exception were applicable only to relevant subsidiaries that were established before the date of the order (August 9, 2023). Similarly, by only excepting the fulfillment of uncalled, binding capital commitments with cancellation consequences made prior to the issuance of the order, the ANPRM implies that the requirements might apply to a transaction conducted after the final regulation takes effect, but done pursuant to a binding, uncalled capital commitment entered into after August 9. Finally, the Treasury Department may, after the effective date of the regulations, request information about transactions by US persons that were completed or agreed to after August 9 to better inform the development and implementation of the program
Covered National Security Technologies and Products
To expand upon the three types of covered national security technologies and products defined in the order, the ANPRM provides highly specific proposed definitions based on product and technology descriptions, as well as relevant capabilities and end uses.
With respect to semiconductors, the ANPRM proposes a prohibition on transactions involving covered foreign persons to address the following concerns:
- specific technology, equipment, and capabilities that enable the design and production of advanced integrated circuits or enhance their performance;
- advanced integrated circuit design, fabrication, and packaging capabilities; and
- the installation or sale to third-party customers of certain supercomputers, which are enabled by advanced integrated circuits.
The ANPRM also proposes a notification requirement with respect to the design, fabrication, and packaging of less sophisticated integrated circuits.
The ANPRM proposes to prohibit transactions involving:
- quantum computers and components: The production of a quantum computer (defined as a computer that performs computations that harness the collective properties of quantum states, such as superposition, interference, or entanglement), dilution refrigerator, or two-stage pulse tube cryocooler;
- quantum sensors: The development of a quantum sensing platform designed to be exclusively used for military end uses, government intelligence, or mass surveillance end uses; or
- quantum networking and quantum communication systems: The development of a quantum network or quantum communication system designed to be exclusively used for secure communications, such as quantum key distribution.
The ANPRM does not propose to require notification with respect to quantum technologies.
As highlighted in both the order and the ANPRM, the outbound investment regime is intended to address artificial intelligence (“AI”) systems related to the military modernization of countries of concern, in particular with respect to weapons, intelligence, surveillance, cybersecurity, and robotics.
Thus, the ANPRM proposes to define the term “AI system” as “an engineered or machine-based system that can, for a given set of objectives, generate outputs such as predictions, recommendations, or decisions influencing real or virtual environments. AI systems are designed to operate with varying levels of autonomy.”
To address the military threat, a potential prohibition is envisioned for US investments into covered foreign persons “engaged in the development of software that incorporates an AI system and is designed to be exclusively used for military, government intelligence, or mass-surveillance end uses.”
Additionally, the ANPRM proposes notification requirements with respect to covered foreign persons “engaged in the development of software that incorporates an artificial intelligence system and is designed to be exclusively used for: cybersecurity applications, digital forensics tools, and penetration testing tools; the control of robotic systems; surreptitious listening devices that can intercept live conversations without the consent of the parties involved; non-cooperative location tracking (including international mobile subscriber identity (IMSI) Catchers and automatic license plate readers); or facial recognition.”
The ANPRM also provides detail on the types of notifications that will be required and the information to be provided. In particular, the ANPRM envisions collecting information on the identity of a transaction’s participants, business information about the parties, the date and nature of the transaction and any relevant transaction documentation, information about the covered foreign person’s products, services, and business plan, as well as information about previous transactions into the covered foreign person involved. Notifications would be required within 30 days of the closing of a covered transaction, and a failure to make a required notification could be subject to civil penalties under the International Emergency Economic Powers Act.
Penalties and Remedies
The executive order grants the Secretary the power to “nullify, void, or otherwise compel the divestment of any prohibited transaction entered into after the effective date” of the implementing regulations. The ANPRM notes that the Treasury Department would not use this authority to unwind a transaction that was not prohibited at the time it was completed. Moreover, the ANPRM proposes penalizing the following with a civil penalty up to the maximum allowed under International Emergency Economic Powers Act: (i) material misstatements made in or material omissions from information or documentary material submitted or filed with the Treasury Department; (ii) the undertaking of a prohibited transaction; or (iii) the failure to timely notify a transaction for which notification is required.
Next Steps for Interested Parties
The order and the ANPRM are a long-awaited first step in the development of an outbound investment regime, which will be an iterative process. As a first step, once published in the Federal Register, comments on the ANPRM will be due within 45 days; thus, comments on the ANPRM are likely due by Sep. 28. The Treasury Department will then review these comments and issue proposed rules.