The Biden Administration issued the long-anticipated Executive Order (E.O.) on Aug. 9, 2023, requiring notification of, and in some cases prohibiting, U.S. investments in companies engaged in the semiconductors and microelectronics, quantum information technologies and artificial intelligence (AI) sectors if such companies are located in "countries of concern" or are owned by nationals of such "countries of concern." Although the Biden Administration has stated that the E.O. is intended to be narrowly focused on certain types of technology within the covered sectors and signaled that a range of exceptions will be provided, the text of the E.O. is broad, and there are potentially far-reaching implications for companies, businesses and investors worldwide. At this time, the only listed country of concern is China, including Hong Kong and Macau.
The E.O. directs the U.S. Department of the Treasury to issue regulations that 1) prohibit U.S. persons from engaging in certain transactions involving certain technologies and products that pose an acute national security threat to the United States (prohibited transactions) and 2) require U.S. persons to notify the Treasury Department of certain other transactions involving certain technologies and products that may contribute to the threat to the national security of the United States (notifiable transactions). The E.O. focuses on three "covered" sectors: semiconductors and microelectronics, quantum information technologies and AI.
Going forward, U.S. companies will be restricted in their ability to directly or indirectly fuel Chinese efforts to develop sensitive technologies with military, intelligence, surveillance or cyber-enabled capabilities. The E.O. comes amid heightened supply chain pressures, geopolitical tensions and growing national security concerns with China.
Scope of the E.O. and ANPRM
The E.O. provides for the establishment of a new and targeted national security program to be implemented and administered by the Treasury Department in consultation with other relevant executive departments and agencies. Although "countries of concern" are cited throughout the E.O., an annex defines those countries – initially – as only China, including Hong Kong and Macau.
As an initial step, concurrent with the issuance of the E.O., the Treasury Department issued an Advance Notice of Proposed Rulemaking (ANPRM)1 with a 45-day public comment period ending Sept. 28, 2023, to seek input from the industry on the intended scope and implementation of the program. The ANPRM does not itself implement the E.O. and is not draft regulatory text. The ANPRM will be followed by draft regulations at a later stage in the process.
The E.O. and ANPRM:
- prohibit U.S. persons from undertaking particular transactions involving certain entities located in or subject to the jurisdiction of a country of concern, as well as certain other entities owned by persons of a country of concern engaged in activities related to defined subsets of technologies and products
- require notification (proposed by Treasury to be due within 30 days after closing a covered transaction) from U.S. persons regarding a broader set of transactions involving certain entities located in or subject to the jurisdiction of a country of concern, as well as certain other entities owned by persons of a country of concern, engaged in activities related to other defined technologies and products
According to the ANPRM, U.S. investment in semiconductors and AI likely will be divided into "notifiable transactions" and "prohibited transactions" based on the nature and capability of the technology, and all covered quantum computing transactions will be prohibited.
Through the ANPRM, the Treasury Department seeks input from the industry regarding how to regulate each subset of transactions and, more important, how to define the industry sectors and products that will fall into each bucket. Although the investment prohibitions and notification requirements are intended to be forward-looking, the ANPRM states that the Treasury Department may request information about transactions that are completed prior to the regulations' effective date "to better inform the development and implementation of the [outbound investment] program."
The E.O. provides the authority for the Treasury Department to order divestment of prohibited transactions and to pursue civil penalties for violations of its implementing regulations. The ANPRM indicates that civil penalties will attach for 1) failure to timely notify a transaction, 2) undertaking a prohibited transaction or 3) making material misstatements in, or material omissions from, information filed with the Treasury Department.
The Long Road to Outbound Investment Screening
The E.O. is historically significant in that it introduces a mandatory screening of U.S. outbound investments. Although "countries of concern" are referenced throughout the E.O., the only identified country – China – is not surprising. And although this comes under the rubric of outbound investments and has been dubbed the "outbound CFIUS" in reference to the Committee on Foreign Investment in the United States (CFIUS), which screens investments in the U.S., the new outbound investment screening regime is more akin to an economic sanctions program. Similar to other economic sanctions programs administered by the Treasury Department's Office of Foreign Assets Control (OFAC), the E.O. is issued under the authority of the International Emergency Economic Powers Act (IEEPA), National Emergencies Act (NEA), and Section 301 of Title 3, U.S. Code, on the basis of national security.
The E.O. was long anticipated and carefully coordinated with U.S. allies, and it is expected that the United Kingdom, countries in the European Union (EU) and other like-minded nations will implement similar outbound investment screening regimes over time. And although the White House acted first, there are several competing legislative proposals on the same topic, some of which may become law before the final rules are issued implementing the E.O. Several examples include:
- Sens. Bob Casey (D-Pa.) and John Cornyn (R-Texas) proposed the National Critical Capabilities Defense Act (NCCDA) to cover investments that could potentially provide certain "countries of concern" with "national critical capabilities." The proposed legislation listed China, Russia, Iran, North Korea, Cuba and Venezuela as countries of concern and targeted the semiconductor, manufacturing minerals, pharmaceuticals, AI and quantum technology, and large-capacity batteries sectors.
- More recently, there is strong bipartisan support for an outbound investment screening regime in the National Defense Authorization Act (NDAA) for Fiscal Year 2024. The Senate overwhelmingly backed a provision to target outbound investments in certain "covered sectors." The provision, if enacted into law, would require any U.S. person or company intending to engage in a "covered activity" regarding "countries of concern" to submit a written notification to the Secretary of the Treasury. This provision was passed by the Senate on July 25, 2023, just two weeks before the issuance of the E.O.
Key Points and Takeaways
There is considerable ambiguity in the E.O., so industry input in shaping the implementing regulations will be essential. The ANPRM presents an important vehicle for businesses to engage with the Treasury Department to develop the contours of the future program. There are several key takeaways for both U.S. and foreign businesses to consider.
- The public is invited to offer comments, including providing data and other information, that may be useful to inform the development of the program. Specifically, the ANPRM provides initial details on key terms and aspects of the program's implementation. Among other things, the Treasury Department seeks input on the subsets of national security technologies and products related to semiconductors, quantum information technology and AI systems described in the ANPRM.
- Extensive interagency and international ally and partner consultations are ongoing. The E.O. requires extensive U.S. interagency coordination on implementation, as well as consultations with partners and allies. International efforts to align policies have been underway for months – including a statement in the communique from the G7 Summit in May 2023 announcing the countries would "de-risk, not decouple" economic engagement with China. The interagency collaboration is key to ensuring that the equities of different agencies – often with competing agendas – are incorporated in the final rules. And consultations with partners and allies are key to ensuring U.S. restrictions with respect to China are harmonized internationally with like-minded countries in order to avoid creating an unlevel playing field for U.S. businesses and creating a weaker global security architecture.
- There is potential for global reach involving a range of non-U.S. investors. The program anticipates that U.S. persons, wherever located, will be responsible for adhering to the prohibition and notification requirements. A U.S. person includes any U.S. 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. Under the E.O., the Secretary of the Treasury may also place certain obligations on U.S. persons with respect to foreign entities that they control and in certain situations where U.S. persons knowingly direct transactions by non-U.S. persons. This has the potential to impact non-U.S. businesses including, according to the ANPRM, 1) U.S. persons who manage a foreign fund, 2) U.S. person officers, senior managers or equivalent senior-level employees at a foreign fund that undertakes a transaction at that U.S. person's direction and 3) U.S. person venture partners who launch a foreign fund. The program will also impose obligations on U.S. persons who "control" (i.e., own, directly or indirectly, a 50 percent or greater interest) a foreign entity to notify the U.S. government of notifiable transactions and take "all reasonable steps" to prevent prohibited transactions undertaken by the controlled foreign entity – a potentially hefty compliance burden on U.S. person parents.
- Specific categories of covered transactions are targeted for regulations. The program is anticipated to focus on U.S. persons undertaking certain types of transactions that could convey intangible benefits, specifically 1) acquisition of equity interests (e.g., via mergers and acquisitions (M&A), private equity, venture capital and other arrangements), 2) greenfield investments, 3) joint ventures and 4) certain convertible debt financing.
- Covered foreign persons could potentially include U.S. and foreign (non-Chinese) entities. The restrictions are anticipated to apply to investments in entities engaged in the targeted sectors and organized under the laws of a country of concern, with a principal place of business in a country of concern, or majority-owned by country of concern individuals or entities. This final prong means that U.S. or foreign subsidiaries of companies organized in a country of concern (currently, only China) could be subject to restrictions.
- Certain types of transactions may be excluded from the regulations. The Treasury Department may create exceptions for certain passive or other investments that pose a lower likelihood of conveying intangible benefits in an effort to minimize unintended consequences. For example, the Treasury Department is considering excepting certain U.S. investments into publicly traded securities, index funds, mutual funds, exchange-traded funds, certain investments made as a limited partner, committed but uncalled capital investments and intracompany transfers of funds from a U.S. parent company to its subsidiary. The scope and nature of each of these potential exceptions is under consideration as detailed in the ANPRM. The definition of "covered transaction" in the ANPRM is also expected to exclude certain enumerated activities, including university-to-university research collaborations, procurement of inputs for covered national security technologies, intellectual property licensing arrangements and certain activities secondary to a covered transaction (e.g., bank lending; the processing, clearing or sending of payments by a bank; underwriting services and prime brokerage).
U.S. and foreign businesses are encouraged to actively engage in the comment process if they anticipate that the E.O. and subsequent regulatory framework may impact their operations. Like CFIUS today, the outbound screening mechanism is anticipated to be here for the long haul, and moving early to influence the scope of coverage and structure of the process is key to ensuring the final rules are properly tailored to protect national security while avoiding unnecessary burdens on global companies or unintended consequences for cross-border dealmakers.
1 Note: The link directs to the unpublished Federal Register publication. It is expected that the ANPRM will be published in the Federal Register on Aug. 14, 2023.