The only thing truly certain about the proposed U.S. outbound investment regulatory regime is that a lot of uncertainty remains. But industry responses garnered during the comment period may, at least partly, foretell the likely scope and scale of the final regulations.
On Aug. 9, 2023, U.S. President Joe Biden issued an executive order (E.O.) declaring a “national emergency” to defend against “countries of concern” that seek to exploit U.S. outbound investments for the development of certain advanced technologies and products that threaten U.S. national security. China, including the regions of Hong Kong and Macau, is the only “country of concern” mentioned.
The E.O. directed the U.S. Department of Treasury to issue implementing regulations that will either entirely prohibit certain outbound investments or permit with notification others regarding certain technologies and products that may “significantly advance” China’s “military, intelligence, surveillance, or cyber-enabled capabilities.”
Treasury that same day issued a thorough Advance Notice of Proposed Rulemaking (ANPRM), seeking public comment on 83 questions about the regulation’s proposed scope and scale. Once finalized, the regulations portend to significantly impact any U.S. investments in Chinese companies that have touchpoints in semiconductors and microelectronics, quantum information technologies, and artificial intelligence (AI) systems.
The comment period generated 61 responses from a wide range of companies, financial institutions, trade groups, law firms, and more. Collectively, commenters expressed questions, comments, and concerns on three key areas: a need for further clarity around several key terms, a narrowing of the regulation’s scope, and broader exemptions to prevent the unintended capture of non-targeted sectors. Those comments are analyzed in more detail below.
AMBIGUOUS KEY TERMS
Broadly, “U.S. persons” would be prohibited from engaging in transactions with a “covered foreign person” who is engaged in activities involving national security technologies and products.”
Both the E.O. and ANPRM propose to define “U.S. person” as “any United States citizen, lawful permanent resident, entity organized under the laws of the United States or any jurisdiction within the United States, including any foreign branches of any such entity, and any person in the United States.”
Several commenters, in response, asked for clarity around many of the key terms, including “U.S. person” and “covered foreign person.” The Semiconductor Industry Association (SIA), for example, commented that it would help to clarify that the “U.S. person” definition “does not cover foreign-owned entities or persons that are already subject to review by the Committee on Foreign Investment in the United States (CFIUS).”
SIA also asked for clarity around how dual citizens will be handled, and whether the requirements in the E.O. stop applying when a foreign national who travels to the United States has left the United States.
In another comment letter, the National Association of Manufacturers (NAM) encouraged Treasury to align the “U.S. person” definition with that used for export controls. “One definition across regulations will help compliance teams in implementing the program,” NAM commented.
DUE DILIGENCE CONCERNS
The proposed “covered foreign person” definition also elicited several comments, questions, and concerns, particularly around due diligence obligations. Treasury proposes to define a “covered foreign person” as a “person of a country of concern” that is either engaged in or that a U.S. 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.”
Many commenters expressed the general concern that the type of financial information that would be necessary to obtain to make a “covered foreign person” determination – such as access to Chinese banking and ownership information – is not readily available and difficult to obtain. Practically speaking, companies would have to conduct extensive due diligence to satisfy the “knows or should know” standard, and in some circumstances, might not be able to make such a determination at all.
SIA commented that the knowledge standard “would penalize companies who have conducted good faith due diligence based on all relevant information available to them.” Several asked Treasury to allow U.S. persons to rely, instead, on diligence responses and representations and warranties from the prospective investee.
A comment letter from law firm Akin encouraged Treasury “to publish guidance that describes relevant due diligence steps and red flags to assist U.S. persons seeking to comply with any knowledge standard included in the regulations.” It cited as an example the U.S. Department of Commerce’s “Know Your Customer Guidance.”
‘KNOWLEDGE STANDARD’ TOO BROAD
Under the ANPRM’s scope, a U.S. person would “need to know, or reasonably should know,” based on a “reasonable and appropriate amount of due diligence, that it is undertaking a transaction involving a covered foreign person and that the transaction is a covered transaction.” Treasury further noted that awareness is “inferred from a person’s willful avoidance of facts.”
The proposed “knowledge standard” garnered significant comments, with many expressing concerns over the difficulty that companies often face in obtaining certain information from a diligence standpoint on overseas companies. For this reason, many commenters requested that Treasury rely on an “actual knowledge,” rather than “constructive knowledge,” standard.
SCOPE OF AI AND QUANTUM TECHNOLOGIES
Other industry commenters expressed concerns that the proposed definition around “AI system” and quantum technologies, such as “quantum computers and components,” are too broad and generally could potentially sweep in technologies designed for non-military, commercial uses.
Some commenters suggested ways that Treasury can avoid this confusion. For example, concerning the list of end uses for which certain AI systems would require notification, the SIA suggested incorporating the qualifying language “with dual-use application” to ensure that notification requirements do not apply to “robotic systems,” for example, used for non-military purposes.
The Advanced Medical Technology Association similarly expressed concern in a comment letter that the “proposed scoping for transactions subject to notification under AI systems could unintentionally cover certain technologies designed for commercial medical uses with no military applications.”
To avoid any confusion, many commenters agreed with Treasury that the final regulations should apply to technologies and systems “exclusively used,” rather than “primarily used,” for military or surveillance applications.
OTHER EXEMPTIONS SOUGHT
Treasury also proposes to create an exception for certain investments “made as a limited partner into a venture capital fund, private equity fund, fund of funds, or other pooled investment funds.” Some commenters in the financial services industry asked Treasury to expand the scope of the proposed exceptions further.
For example, a comment letter from SIFMA recommended that the final regulation exempt “transactions that result in the U.S. person holding 10 percent or less of the equity interest and voting interest in a covered foreign person,” and that are “solely for the purpose of passive investment.” SIFMA further suggested that the final regulation make clear that compliance obligations with any prohibition or notification requirement under the E.O., including liability for non-compliance, reside solely with the entity or individual undertaking the covered transaction.
SIFMA stressed that the obligation should not extend to third parties otherwise involved in the transaction, “for example, as an advisor, underwriter, source of debt financing, sponsor, arranger, issuer, or in any other capacity as a U.S. financial institution acting in an intermediary or other capacity.”
HARMONY WITH EXISTING MECHANISMS
Some commenters asked that the final regulations align with existing national security mechanisms, such as the proposed CHIPS Act’s “guardrails” for the semiconductor sector. “In particular, administrative requirements such as reporting and recordkeeping should be harmonized,” SIA wrote in its comment letter.
Many commenters agreed that harmony with existing national security mechanisms will help U.S. companies ensure compliance with the regulations, minimize administrative burdens and help to prevent further supply chain disruptions overall.
PROACTIVE COMPLIANCE MEASURES
Although the U.S. outbound investment regulatory regime will not apply retroactively, Treasury did state that,
“after the effective date of the regulations, it may request information about transactions by U.S. persons that were completed or agreed to after the date of the issuance of the order to better inform the development and implementation of the program.”
Implementation of the final regulations is likely at least a year away, but prudent companies and their counsel should begin the due diligence process now of scrutinizing and reviewing any investments with China to identify any transactions that potentially fall under the regulation’s scope. It’s also a good idea to document such transactions now in preparation for what’s to come if Treasury, as it has indicated, issues a request for informationonce the regulations come into force. ACI will be holding its 10th National Conference on CFIUS on April 11–12 in Arlington, VA that will feature top government leaders in the CFIUS space. For more information, please visit:www.AmericanConference.com/CFIUS
