A new executive order, issued by President Trump on November 12, 2020, will prohibit investments in companies that the US government determines support the military of the People’s Republic of China. The order builds on the US Department of Defense’s (“DoD”) recently released list of “Communist Chinese military companies” by prohibiting US individuals and entities from purchasing these companies’ securities. The executive order is the latest in a series of US government actions to address national security concerns cited by the Trump administration with respect to certain Chinese companies operating in the United States and the export of US-origin technology that benefits the Chinese military. These actions include addressing concerns with the Chinese app WeChat and an executive order addressing the US information and communications technology and services supply chain. (Our previous Legal Updates on these subjects can be found here, and here.)
As with the increased controls imposed earlier this year on exports of US-origin technology and other items that benefit the Chinese military (see our Legal Update here), the new executive order is aimed at what the US government has described as China’s national military-civil integration strategy. The order states that, through this strategy, “the PRC increases the size of the country’s military-industrial complex by compelling civilian Chinese companies to support its military and intelligence activities.” In his own statement about the order, National Security Advisor Robert C. O’Brien said that it “serves to protect American investors from unintentionally providing capital that goes to enhancing the capabilities of the People’s Liberation Army and People’s Republic of China intelligence services, which routinely target American citizens and businesses through cyber operations, and directly threaten the critical infrastructure, economy, and military of America and its allies and partners around the world.”1
Specifically, the executive order prohibits any US person from any transaction in the publicly traded securities of any “Communist Chinese military company” as well as in any securities that are derivative of or are designed to provide investment exposure to such securities. These prohibitions are effective January 11, 2021, though the order provides an exemption for transactions made through November 11, 2021, that are made solely to divest, in whole or in part, from securities of such companies that a US person held as of January 11, 2021. As a result, US persons have a grace period through November 11, 2021, to divest from the securities of the companies at issue.
The order defines the term “Communist Chinese military company” to initially reference determinations made by DoD. In June of this year, DoD publicly released a list of “Qualifying Entities Prepared in Response to Section 1237 of the National Defense Authorization Act for Fiscal Year 1999” (the “DoD List”). This list was supplemented in August with additional entities and at present totals 31 companies, including Huawei, Hikvision and Inspur Group.2
The DoD List was originally prepared pursuant to a requirement in Section 1237 of the 1999 National Defense Authorization Act (“FY99 NDAA”), which required the Secretary of Defense (in consultation with the Attorney General, the Director of the Central Intelligence Agency and the Director of the Federal Bureau of Investigation) to identify parties “operating directly or indirectly in the United States or any of its territories and possessions that are Communist Chinese military companies.”3 The FY99 NDAA defines “Communist Chinese military companies” as anyone named on two Defense Intelligence Agency documents that are not publicly available and “any other person that is owned or controlled by the People’s Liberation Army and is engaged in providing commercial services, manufacturing, producing, or exporting.”4 The FY99 NDAA provides the President with authority to exercise the broad authorities set forth under section 203(a) of the International Emergency Economic Powers Act (“IEEPA”) without declaring a national emergency as required by section 202 of IEEPA, “in the case of any commercial activity in the United States by a person that is on the list.” However, the President declared a national emergency under IEEPA in the executive order, declaring that the “PRC’s military-industrial complex, by directly supporting the efforts of the PRC’s military, intelligence, and other security apparatuses, constitutes an unusual and extraordinary threat, which has its source in substantial part outside the United States, to the national security, foreign policy, and economy of the United States.” Although the executive order is limited to prohibitions on investments in securities, we note that IEEPA provides extremely broad authority to the President to impose restrictions on a wide range of activities, which could be used to take further actions against the targeted Chinese companies.
The restrictions of the executive order also apply to companies that the Secretary of Defense and the Secretary of the Treasury determine to be Communist Chinese military companies operating directly or indirectly in the United States—and therefore are to be listed on the DoD List—going forward. Transactions in the publicly traded securities, or any securities that are derivative of or are designed to provide investment exposure to such securities, of such companies are prohibited beginning 60 days after a company is determined to be a Communist Chinese military company. As with companies currently on the DoD List, the executive order provides a wind-down period of 365 days for transactions that are made solely to divest from the securities of companies that are subsequently determined to be Communist Chinese military companies.
The investment restrictions apply to companies that the Secretary of the Treasury publicly determines to meet the criteria of a “Communist Chinese military company” found in the FY99 NDAA and to listed subsidiaries of such companies. In other words, the restrictions do not apply to subsidiaries of companies on the DoD List unless those subsidiaries are also publicly listed by DoD or the Department of the Treasury.
The executive order also applies to purchases of securities after the expiration of the grace period pursuant to contracts entered into prior to November 12, 2020 (the date of the executive order). However, the executive order does not explicitly indicate the status of securities merely owned by persons after the expiration of the grace period.
The executive order could have important impacts for investors, especially if additional companies are listed as Communist Chinese military companies in the future, as it is clearly intended to limit the ability of companies that the US government views as sensitive to raise capital from US investors. We note that the initial impact may be limited as several of the companies on the DoD List, including Huawei, are not publicly listed and therefore would not be affected by the order’s restrictions on investments in securities. The order may also be indicative of further restrictions related to China that may be imposed during the “lame duck” period before President-elect Biden takes office on January 20, 2021. It remains to be seen whether the Chinese government will take retaliatory action or whether the Biden administration will revise or rescind this order upon taking office, so investors should closely monitor developments in this area in the coming weeks.