On June 21, 2024, the US Department of the Treasury (Treasury) released proposed new federal regulations (Proposed Rules) that, if implemented, would prohibit or require notification of a broad range of outbound investment transactions in three national security-related business sectors involving countries of concern, including most notably China.¹

The Proposed Rules flow from and implement the August 9, 2023 Executive Order 14105, on “Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern” (the Order), which was concurrently issued with a notice of advance proposed rulemaking (ANPRM) that outlined concepts regarding the proposed regulations and solicited feedback from stakeholders.

Overall, the Proposed Rules set forth, for public notice and comment by August 4, 2024, a series of outbound investment restrictions that apply broadly to a wide range of transactions but in a narrowly circumscribed set of business areas with a national security nexus – semiconductors and microelectronics, quantum information technologies, and certain artificial intelligence systems (AI) – involving China, Hong Kong or Macao. The breadth of the restricted transactions, in the form of either a prohibition or notification, is achieved through a number of techniques. These include coverage of a broad range of investment transactions, expansive definitions of covered US persons and foreign persons engaged in the relevant sectors, a broad definition of the requisite “knowledge” that US investors must have to be caught under the Proposed Rules, and robust anti-circumvention measures.

Such a broad and expansive program will likely have a chilling effect not only on specific covered transactions in the relevant business sectors in countries of concern, but also in a broader range of transactions in these sectors – as potential investors undoubtedly will limit their investments to avoid liability risk. This regulatory approach thus would effectively achieve the purpose of Treasury’s long-awaited “Outbound Investment Security Program” – namely, to curb investments with a “likelihood of conveying both capital and intangible benefits that can be exploited to accelerate the development of sensitive technologies or products critical for military, intelligence, surveillance, or cyber-enabled capabilities of … countries [of concern] in ways that negatively impact the national security of the United States.”²

The summary below highlights, for prospective investors, certain notable aspects of the Proposed Rules that are worth considering.

Covered Transactions and Persons

Covered Transactions. Overall, the Proposed Rules would create a program that would apply to a number of different types of transactions (Covered Transactions). Specifically, the Proposed Rules would broadly cover:

• acquisitions of an equity interest or contingent equity interest;
• certain debt financing that is convertible to an equity interest or that affords the lender certain rights;
• the conversion of a contingent equity interest or of debt to an equity interest;
• a greenfield investment or other corporate expansion;
• joint ventures; and
• certain investments as a limited partner (LP) or equivalent in a non-US person pooled investment fund.

As expected, the Proposed Rules include a number of “Excepted Transactions,” so long as such transactions do not afford a US person certain rights that are not standard minority shareholder protections (see below).

US Persons and Covered Foreign Persons. The Proposed Rules would apply to Covered Transactions by “US Persons” that involve “Covered Foreign Persons.”

US Persons would include: any United States citizen or lawful permanent resident; 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; and any person in the United States.

Further, as discussed below, the Proposed Rules also have some extraterritorial reach through covering situations where such US persons do not take sufficient steps to stop controlled subsidiaries from engaging in Covered Transactions or direct other third parties to engage in such transactions.

Covered Foreign Persons would include: a person of a “Country of Concern” that engages in a “Covered Activity;” and a person that directly or indirectly holds any voting interest, board seat, or equity interest in any such person, or holds any power to direct or cause the direction of the management or policies of any such person through contractual arrangements, and where more than 50% of one of the specified financial metrics of the entity is attributable to such person.

Thus, the Proposed Rules covers a broad range of foreign parties that have activities in the relevant covered sectors.

Notifiable Transactions, Prohibited Transactions and Excepted Transactions

The Proposed Rules would place obligations on US Persons, including a notification requirement for one category of Covered Transactions (Notifiable Transactions) and a prohibition on another class of Covered Transactions (Prohibited Transactions). Whether a transaction is a Prohibited Transaction or a Notifiable Transaction depends on the Covered Activity in which the Covered Foreign Person is engaged:

• Prohibited Transactions:
  • Semiconductors and Microelectronics: Covered Transactions relating to electronic design automation software; certain fabrication and advanced packaging tools; the design, fabrication, or packaging of certain advanced integrated circuits; and supercomputers.
  • Quantum Information Technologies: Covered Transactions relating to the development of quantum computers and production of critical components; and the development or production of certain quantum sensing platforms and quantum networking and quantum communications systems.
  • Certain AI Systems: Covered Transactions relating to the development of AI systems designed exclusively for or intended for specified end uses.

• Notifiable Transactions:
  • Semiconductor and Microelectronics: Covered Transactions relating to the design, fabrication, or packaging or integrated circuits not covered by Prohibited Transactions.
  • Certain Artificial Intelligence (AI) Systems: Covered Transactions relating to the development of any AI system not covered by Prohibited Transactions, where such AI system is designed or intended for certain end uses or is trained using certain levels of computing power.

If a Covered Transaction is a Notifiable Transaction, the US person would be required to file a notification including various transaction details, with Treasury. With respect to timing, as currently drafted, the Proposed Rules would require the notification to be filed no later than 30 days after a transaction is completed. In the event a US person acquires actual knowledge after the completion date of a transaction that such transaction would have been a covered transaction if the US person had such knowledge at the time of the transaction, the notification would need to be filed no later than 30 days after the US person’s acquisition of said knowledge.

• Excepted Transactions: Among the types of transactions Treasury has proposed would be excluded from the application of the Proposed Rules are the following:
  • investments in publicly traded securities;
  • certain LP investments;
  • buyouts of country of concern ownership;
  • intracompany transactions;
  • pre-Outbound Order binding commitments;
  • certain syndicated debt financings; and
  • certain transactions involving a third country that has adequate controls in place to address national security concerns posed by outbound investment.

In addition, a US person could seek an exemption from the prohibition or notification requirement on the grounds that a transaction serves the national interest of the United States.

A Broad Knowledge Standard

Notably, the Proposed Rules place obligations on a US person if such person has actual or constructive “knowledge” of relevant facts or circumstances related to the transaction in question. As drafted, the Proposed Rule’s definition of “knowledge” tracks the broad “knowledge” standard in the Export Administration Regulations (EAR), covering not only actual knowledge that a fact or circumstance exists or is substantially certain to occur or an awareness of a high probability of a fact or circumstance’s existence or future occurrence, but also the “reason to know” of a fact or circumstance’s existence.

Notably, Treasury’s assessment as to whether, at the time of the transaction, a US person has or had knowledge of a given fact or circumstance will be made based on information that person had or could have had through a reasonable and diligent inquiry. Therefore, by failing to conduct a reasonable and diligent inquiry at the time of a given transaction, a US person may be determined to have had reason to know of a given fact or circumstance, including facts or circumstances that would cause the transaction to be a covered transaction.

The Proposed Rules include a number of steps that US persons may take to conduct “reasonable and diligent inquiry.”

Evasion and Anti-Circumvention, and Extraterritorial Application to Certain Foreign Parties

Like many regulatory programs, the Proposed Rules include provisions making evasion a violation. However, the Proposed Rules notably go further and prohibit, and require notice of, a range of extraterritorial “transactions” involving certain types of US person’s engagement with foreign entities with respect to such covered transactions:

• Prohibited Transactions:
• Controlled Foreign Entities. US persons must take all reasonable steps to prohibit and prevent any transaction by its “controlled foreign entity” that would be a Prohibited Transaction if engaged in by a US person.
• Knowingly Directing. US persons are prohibited from knowingly directing a transaction by non-US persons that the US persons know at the time of the transaction would be a prohibited transaction if engaged in by a US person.

• Notifiable Transactions:
  • Controlled Foreign Entities. US persons must file a notification with Treasury with respect to any transaction by a “controlled foreign entity” of that US person that would be a Notifiable Transaction if engaged in by a US person.

Under the Proposed Rules, a Controlled Foreign Entity is any entity incorporated in, or otherwise organized under the laws of, a country other than the United States of which a US person is a parent (with the Proposed Rules outlining certain rules when determining whether an entity is a parent of another entity in a tiered ownership structure).

In short, the Proposed Rules have broad extraterritorial effect and US persons cannot “bury their heads in the sand” with respect to the investments of their controlled entities or other covered third country investments they knowingly direct.

Conclusion

In sum, as currently drafted, the Proposed Rules paint the picture of a broad and complex program that would place considerable and, in some cases, unclear obligations on US persons that will have a chilling effect on investments in the select areas subject to the program. We expect Treasury, in finalizing the Proposed Rules, will carefully consider public and stakeholder feedback after the close of the comment period on August 4. While some adjustments may be made, we expect that Treasury will maintain the breadth of the program’s coverage of outbound investments in order to achieve the program’s national security goals.

1 The Proposed Rules were published in the Federal Register on July 5, 2024. See Provisions Pertaining to US Investments in Certain National Security Technologies and Products in Countries of Concern, 89 Fed. Reg. 55846 (July 5, 2024).

2 89 Fed. Reg. at 55847.

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