Treasury Issues Much-Anticipated Proposed Rule On Executive Order To Curb Certain U.S. Investments In China; Comments Due Soon

On June 21, 2024, the U.S. Department of the Treasury issued a notice of proposed rulemaking to implement Executive Order 14105 of August 9, 2023 (EO 14105), which was intended to address the advancement by the People's Republic of China (PRC) and other countries of concern in sensitive technologies critical for military, intelligence, surveillance or cyber-enabled capabilities. The proposed rule would impose notification requirements―and, in some cases, prohibitions―relating to certain U.S. investments in countries of concern (e.g., the PRC) that involve semiconductors and microelectronics, quantum information technologies or artificial intelligence.

The proposed rule builds on the advance notice of proposed rulemaking (ANPRM) issued by Treasury in August 2023 (discussed in our previous Alert), provides the full draft regulations and invites public comment. Any person or entity that feels that it may be impacted by the draft regulations should consider submitting comments, which are due August 4, 2024.

Scope of the Proposed Rule

As detailed in our previous Alert, EO 14105 directed the Secretary of the Treasury to establish an Outbound Investment Security Program to prohibit or require notification of certain types of outbound investments by United States persons into certain entities located in or subject to the jurisdiction of a country of concern, and certain other entities owned by persons of a country of concern, involved in specific categories of advanced technologies and products. Treasury intends the draft regulations implementing the EO to create a narrow and targeted security program focused on certain U.S. outbound investments that contribute capital as well as intangible benefits to persons of a country of concern engaged in activities involving certain sensitive technologies and products that could pose risks to U.S. national security.

In an annex to EO 14015, President Joe Biden identified the PRC, along with the special administrative regions of Hong Kong and Macau, as a country of concern. There are three categories of national security technologies and products to be covered by the draft regulations:

1. Semiconductors and microelectronics;
2. Quantum information technologies; and
3. Artificial intelligence.

The proposed rule would apply to certain covered transactions by a U.S. person¹ that also involve a covered foreign person²―that is, a person of a country of concern that is engaged in a covered activity³ related to the three categories of covered national security technologies and products, as defined in the draft regulations. Additionally, the proposed rule would include certain transactions involving an entity that has a voting interest, board seat or equity interest in a covered foreign person where more than 50 percent of one of several key financial metrics of the entity is attributable to such covered foreign person.

Covered transactions would include the following by a U.S. person, directly or indirectly:

• The acquisition of an equity interest or contingent equity interest in a covered foreign person;
• Financing of a covered foreign person through a debt instrument that is (i) convertible to equity or (ii) affords the U.S. person the right to make management decisions or appoint a board member;
• Conversion of a contingent equity interests or convertible debt instrument into an equity interest in a covered foreign person;
• A greenfield investment that could result in the establishment of a covered foreign person;
• The establishment of a joint venture that will engage in covered activity; and
• Acquisition of a limited partner interest in a non-U.S. private fund that undertakes a transaction that would be a covered transaction if undertaken by a U.S. person.

As proposed under the draft regulations, a U.S. person undertaking a transaction would have the obligation to determine whether the contemplated transaction is prohibited, permissible but subject to notification or not covered by the rule because either it is an excepted transaction or it is not within the jurisdiction set forth under the proposed rule.

The proposed rule provides details on key concepts and aspects relating to the implementation of the Outbound Investment Security Program, including:

• Obligations of a U.S. person regarding a covered transaction;
• Categories of covered transactions and excepted transactions;
• Technical specifications to inform the scope of covered transactions based on certain technologies and products in the areas of semiconductors and microelectronics, quantum information technologies and artificial intelligence;
• Information that a U.S. person is required to provide to Treasury as part of a notification;
• The knowledge standard and expectations for a U.S. person to conduct a reasonable and diligent inquiry prior to undertaking a transaction; and
• Conduct that would be treated as a violation of the proposed rule and applicable penalties for such conduct.

Treasury has provided a fact sheet and additional information regarding the Outbound Investment Security Program.

As noted above, the proposed rule builds on the ANPRM issued by Treasury in August 2023. Key areas in the draft regulations that have evolved since the ANPRM include:

• The scope of coverage of transactions involving AI systems;
• The knowledge standard (which describes the knowledge⁴ a U.S. person must have about certain facts and circumstances related to a transaction to trigger obligations under the proposed rule);
• The scope of the prohibition on U.S. persons “knowingly directing” certain transactions; and
• The scope of investments as a limited partner that would be covered by the proposed rule and those that would be excepted.

The proposed rule also introduces a “national interest” exemption, allowing a U.S. person to request an exception from a prohibition or notification requirement by arguing that the transaction serves the national interest of the United States.

The proposed rule is not proposing that the Outbound Investment Security Program provide for retroactive application of the provisions related to the prohibition of certain transactions and the notification of others. However, Treasury may, after the effective date of the final regulations, request information about transactions by U.S. persons that were completed or agreed to after the date of the issuance of EO 14105 to better inform the development and implementation of the program.

Violations

The proposed rule outlines the penalty and disclosure framework for violations that include:

• Penalties: A violation would be subject to civil and criminal penalties as set forth in the International Economic Emergency Powers Act (IEEPA). In the event of a violation, Treasury is authorized to impose civil penalties and could also refer criminal violations to the U.S. Attorney General's Office.
• Divestment: The Secretary of the Treasury could take any action authorized under IEEPA to nullify, void or otherwise require divestment of any prohibited transaction.
• Voluntary self-disclosure: The proposed rule provides a process for a U.S. person to submit a voluntary self-disclosure if they believe their conduct may have resulted in a violation of any part of the proposed rule. Such self-disclosure would be taken into consideration during Treasury's determination of the appropriate response to the self-disclosed violation.

Opportunity to Comment on the Draft Regulations

Interested parties now have an opportunity to comment on Treasury's draft regulations. Treasury invites comments on all aspects of the proposed rule including feedback on the scope of a covered transaction, definitions of key terms, the notification requirements and the penalty and enforcement processes for violations. Treasury will carefully consider comments received before issuing the final implementing regulations.

Written comments are due by August 4, 2024, and may be submitted online at regulations.gov. Comments may be submitted anonymously or with attribution. 

Conclusion

The proposed rule will be followed at a later date by final implementing regulations, which will set an effective date for the Outbound Investment Security Program. However, given the potential breadth of the forthcoming final regulations, any U.S. person currently investing or contemplating investing in China or its special administrative regions of Hong Kong and Macau should take note and consider submitting comments on the draft regulations.

For More Information

If you have any questions about this Alert, please contact Geoffrey M. Goodale, Hope P. Krebs, Thomas R. Schmuhl, Eduardo Ramos-Gómez, Raul Rangel Miguel, Lauren E. Wyszomierski, any of the attorneys in our International Practice Group or the attorney in the firm with whom you are regularly in contact.

Footnotes

1. Under the proposed rule, a U.S. person would include any United States citizen or lawful permanent resident, as well as any entity organized under the laws of the United States or any jurisdiction within the United States, including any foreign branch of any such entity, or any person in the United States. While this definition covers the U.S. subsidiaries of a foreign company, it would not cover the foreign parent of a U.S. person solely because of its relationship to the U.S. person. Conversely, foreign subsidiaries of U.S. persons would be captured by the rule.

2. Under the proposed rule, a person of a country of concern would include an individual who is a citizen or permanent resident of a country of concern (and not a U.S. citizen or permanent resident of the United States); an entity that is organized under the laws of a country of concern, headquartered in, incorporated in or with a principal place of business in a country of concern; the government of a country of concern; or an entity that is directly or indirectly majority-owned by any persons or entities in any of the aforementioned categories.

3. The proposed rule identifies activities that would provide the relevant nexus between the covered foreign person and the covered national security technologies and products.

4. The proposed definition of “knowledge” would include any the following: (i) actual knowledge that a fact or circumstance exists or is substantially certain to occur; (ii) an awareness of a high probability of a fact or circumstance's existence or future occurrence, or (iii) reason to know of a fact or circumstance's existence.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.