Key Notes:
- The rule would implement Executive Order 14105 of August 9, 2023, “Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern.”
- Treasury has reiterated that any final rule will not prohibit all investment in a country of concern, and that the intent of this process is not to create a case-by-case review of transactions.
- Treasury’s Office of Investment Security is seeking public comment by August 4, 2024, on the proposed rule. Treasury will consider this further input before issuing the final implementing regulations.
On June 21, 2024, the Department of the Treasury’s (Treasury) Office of Investment Security issued a proposed rule to implement President Joseph Biden’s Executive Order (EO) 14105 of August 9, 2023, “Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern.” The proposed rule builds on the Advance Notice of Proposed Rulemaking, also issued in August 2023, that initially set forth proposed regulations prohibiting U.S. investments in certain industry sectors of countries of concern and imposing certain notification requirements. The president’s EO currently identifies only China (and the special administrative regions of Hong Kong and Macau) as a “country of concern.” For additional details on these earlier actions, see Thompson Hine’s International Trade Update of August 11, 2023. This June 2024 proposed rule sets forth a full draft of the proposed regulations and seeks further public comments.
In general, the proposed rule would: (i) require U.S. persons to provide notification to the Treasury “regarding certain transactions involving persons of a country of concern who are engaged in activities involving certain national security technologies and products that may contribute to the threat to the national security of the United States” and (ii) prohibit U.S. persons “from engaging in certain other transactions involving persons of a country of concern who are engaged in activities involving certain other national security technologies and products that pose a particularly acute national security threat to the United States.”
The proposed rule does set forth certain categories of exempt transactions and provides for a “national interest exemption” from the notification requirement or prohibition on certain categories of transactions.
Executive Order Restrictions
The August 2023 EO was deemed necessary “to address the national security threat to the United States posed by countries of concern that seek to develop and exploit sensitive or advanced technologies and products critical for military, intelligence, surveillance, or cyber-enabled capabilities.” The proposed rule would apply to three technology/product categories: (i) semiconductors and microelectronics, (ii) quantum information technologies, and (iii) artificial intelligence (AI) capabilities.
The EO notes that as part of this strategy, “countries of concern are exploiting or have the ability to exploit certain United States outbound investments, including certain intangible benefits that often accompany United States investments and that help companies succeed.” It notes that some intangible benefits include enhanced standing and prominence, managerial assistance, investment and talent networks, market access, and enhanced access to additional financing. It also indicates that certain United States outbound investments “may accelerate and enhance the successful development of sensitive technologies and products by countries of concern that develop them to counter United States and allied capabilities.” President Biden determined that such actions are a national security threat, declared a national emergency, and ordered the Treasury Department to prepare and implement regulations to address such threats.
Proposed Rule
The proposed rule would place certain obligations upon any U.S. person in connection with a “covered transaction” involving or resulting in the establishment of a covered foreign person. A covered transaction may be a prohibited transaction that could not legally be undertaken, or it may be a notifiable transaction under which the U.S. person would need to submit specified information to the Treasury Department.
A U.S. person would also have certain obligations under the proposed rule regarding certain transactions undertaken by any non-U.S. person entity that it controls. Further, under the proposed rule, a U.S. person would be prohibited from knowingly directing a transaction to a third party that would be banned if undertaken by a U.S. person.
The proposed rule would not require a case-by-case review by the Treasury of covered transactions or any other transactions, nor would it establish a licensing process by which a U.S. person would be required to seek prior authorization for a covered transaction. Instead, the relevant U.S. person undertaking a transaction would have the obligation to determine whether the given 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.
Key Concepts
A “U.S. person” would include any United States citizen or lawful permanent resident, any person in the United States, and 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.
A “covered foreign person” would be a person of a country of concern (currently limited to China and the special administrative regions of Hong Kong and Macau) who is engaged in a covered activity related to the identified three technology/product categories in the EO. Under the proposed rule, a person of a country of concern would include (i) an individual who is a citizen or permanent resident of a country of concern, (ii) 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, (iii) the government of a country of concern, or (iv) an entity that is directly or indirectly majority-owned by any persons or entities in any of the previously mentioned categories. Additionally, the proposed rule would include certain transactions involving an entity having 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.
A “covered transaction” would include certain transactions by U.S. persons, such as the acquisition of an equity interest or contingent equity interest; certain debt financing that is convertible to an equity interest or that affords certain rights to the lender; the conversion of a contingent equity interest; a greenfield investment or other corporate expansion; a joint venture; and certain investments as a limited partner (LP) or equivalent in a non-U.S. person pooled investment fund. A covered transaction would include a transaction that is an indirect and direct investment in a covered foreign person.
The obligations of a U.S. person under the proposed rule would apply if the person had knowledge of relevant facts or circumstances related to the transaction. Under the proposed “knowledge standard,” liability may apply if the U.S. person possesses actual knowledge that a fact or circumstance exists or is substantially certain to occur; if the U.S. person possesses an awareness of a high probability of a fact or circumstances existence or future occurrence; or, if the U.S. person could have possessed such information through a reasonable and diligent inquiry.
A “notifiable transaction” would be as follows: (1) for semiconductors and microelectronics, covered transactions related to the design, fabrication, or packaging of integrated circuits not otherwise covered by the prohibited transaction definition; (2) for certain artificial intelligence (AI) systems, the development of any AI system not otherwise covered by the prohibited transaction definition, where such AI system is designed or intended to be used for certain end uses or is trained using a specified quantity of computing power. Currently, there is no descriptive text for a notifiable transaction involving quantum information technologies. The intent of requiring the notification of certain transactions is to increase the U.S. government’s visibility into a transaction involving technologies and products relevant to the threat to the national security of the United States since such information would help identify sectoral trends and related capital flows in the covered activities.
A “prohibited transaction” would be: (1) for semiconductors and microelectronics, covered transactions related to electronic design automation software; certain fabrication and advanced packaging tools; the design, fabrication, or packaging of certain advanced integrated circuits; and supercomputers; (2) for AI systems, covered transactions related to the development of any AI system designed to be exclusively used for, or intended to be used for, certain end uses; (3) for quantum information technologies, covered transactions related to the development of quantum computers and production of critical components; the development or production of certain quantum sensing platforms; and the development or production of quantum networking and quantum communication systems. The Treasury has determined that these activities “pose a particularly acute national security threat to the United States.”
Excepted Outbound Investment Transactions
The proposed rule does propose to accept certain types of transactions provided that such transactions do not afford a U.S. person certain rights that are not standard minority shareholder protections. While each transaction would require a close review for an exception, they would include:
(i) investment in a publicly traded security; (ii) investment of a certain size made as a limited partner or equivalent in a venture capital fund, private equity fund, mutual fund, exchange-traded fund, or other pooled investment fund;
(iii) full buyouts of all country of concern ownership interests of an entity; (iv) an intracompany transaction between a U.S. parent and a majority-controlled subsidiary to support ongoing operations or other non-covered activities; (v) a transaction fulfilling a binding, uncalled, capital commitment entered into prior to August 9, 2023;
(vi) certain syndicated debt financing; and (vii) certain third country measures when the Treasury determines that the country or territory is addressing national security concerns posed by outbound investment and the transaction is of a type for which associated national security concerns are likely to be adequately addressed by the actions of that country or territory.
In addition, the proposed rule would allow a U.S. person to seek an exemption from the application of the prohibition or notification requirements on the basis that a transaction is in the national interest of the United States. This exemption would be applied on a case-by-case basis and only in “exceptional circumstances.”
Penalties
The proposed rule includes provisions for civil and criminal penalties in the event of any violations. It also would allow the Treasury to nullify, void, or require divestment of any prohibited transaction. Voluntary self-disclosure would be permitted under the proposed rule if a U.S. person believes their conduct may have violated any part of the proposed rule.
Conclusion
Since the issuance of the EO in August 2023, the Treasury has clearly stated that any final rule it issues will be narrowly targeted and will not prohibit all investment activity in countries of concern. Any final rule the department proposes is intended to target certain types of investments in entities from countries of concern, particularly those related to sensitive technologies and products critical for military, intelligence, surveillance, or cyber-enabled capabilities. The Treasury states that it continues to support “an open investment environment where consistent with the protection of U.S. national security.”
These proposed rules are detailed, lengthy, and complex, and this bulletin provides only an overview of the major provisions and definitions of the proposed implementing text for outbound investments in certain national security technologies and products in countries of concern. U.S. persons potentially affected by this proposed rule must review its scope and impact on their investment activities.
This proposed rule will be followed by final implementing regulations, which will establish the program’s effective date.
Request for Comments The Treasury will seek comments on “any and all aspects of the proposed rule,” but has listed 25 specific questions on which it seeks feedback and, if available, empirical data or other specific information. Of particular interest may be questions that seek input on certain thresholds for the covered technologies/products involved that the Treasury could use in determining whether a covered transaction would be notifiable or prohibited. Another area where the Treasury seeks specific input concerns the potential application of the “knowledge standard” for relevant facts or circumstances related to a transaction. Written comments on the proposed rule must be submitted by August 4, 2024.
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