The Biden Administration has issued its long-awaited Executive Order on Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern (“EO”), which will create a new “outbound investment” review regime and impose compliance obligations for investors in certain high-technology industries focused on China after regulations are issued at a future date.
The EO, the first step in the creation of an outbound investment review regime, declares a “national emergency” to address threats posed by “countries of concern” that are pursuing advancements “in sensitive technologies and products critical for the military, intelligence, surveillance, or cyber-enabled capabilities.” It singles out the People’s Republic of China (“PRC” or “China”), and its Special Administrative Regions of Macau and Hong Kong, as the only countries of concern. Simultaneously with the issuance of the EO, the Treasury Department released an Advanced Notice of Proposed Rulemaking (“ANPRM”) that announces the Department’s intention to establish new regulations to implement the EO, as well as a detailed Fact Sheet.
The ANPRM poses 83 detailed questions for stakeholders to address in public comments due by September 28. Although the precise contours and definitions of the outbound investment regime remain to be fleshed out through this rule-making process, the coming rules controlling certain outbound investment from the United States to China may have a dramatic impact on multinational firms that invest in Chinese companies engaged in activities involving semiconductors and microelectronics, quantum information technologies, and artificial intelligence that are “critical” for China’s “military, intelligence, surveillance, or cyber-enabled capabilities.”
Administration Briefing on the EO
In a briefing just prior to the release, U.S. government officials described the Administration’s intentions and the related next steps:
- The proposed regulations are intended to be narrowly tailored in scope, draw bright line rules, and to be easy for companies to implement and agencies to enforce. They are intended to follow the “small yard, high fence” approach described by National Security Advisor Jake Sullivan in an October 2022 speech: “Chokepoints for foundational technologies have to be inside that yard, and the fence has to be high—because our strategic competitors should not be able to exploit American and allied technologies to undermine American and allied security.”
- The regime is intended to cover transfers of both financial and “intangible” capital to Chinese entities, which contribute to China’s ability to create technologies indigenously that have “new applications that pose significant national security risks, such as the development of more sophisticated weapons systems, breaking of cryptographic codes, and other applications that could provide these countries with military advantages.”
- The Treasury Department’s Investment Security unit, in consultation with the Department of Commerce’s International Trade Administration, will lead the regulatory process. Treasury’s Investment Security unit has begun to assemble a team to focus on the outbound investment program.
- The rules are not intended to cover passive investments or otherwise stymie international trade and investment in China writ large. The Administration insists that its economic policy towards China is one of “de-risking,” not decoupling.
- The Administration is eager to receive feedback from industry, stakeholders, Congress, and allies during the ANPRM phase – especially on the definition of artificial intelligence systems.
- The Administration is working with Congress and allies – especially in the G7 and European Union – to align interests to ensure the outbound investment program’s maximum effectiveness.
- The Administration views this regulatory process as a complement to the U.S. Senate’s recent legislation on outbound investment, which was included in the Senate version of the National Defense Authorization Act (“NDAA”) for Fiscal Year 2024 (passed in July). The NDAA provision would require U.S. companies to report certain investments in high-tech sectors in “countries of concern” to the federal government. The Administration plans to coordinate with Congress this fall, as the Senate and the House of Representatives work to move the outbound investment legislation forward in conference.
Key Provisions of the EO and Rulemaking Process
The EO and ANPRM set forth two types of contemplated regulatory requirements:
1) Potential prohibitions on undertaking transactions where investments “pose a particularly acute national security threat because of their potential to significantly advance the military, intelligence, surveillance, or cyber-enabled capabilities of” the PRC; and
2) Potential notification requirements to the U.S. Secretary of the Treasury for investments in less-restricted types of technologies.
The ANPRM states that “[t]he focus of both components is on investments that could enhance a country of concern’s military, intelligence, surveillance, or cyber-enabled capabilities through the advancement of technologies and products in particularly sensitive areas.” (ANPRM at 6).
Although public comments will likely shape the draft regulations, the EO and ANPRM have revealed the Administration’s views on several fundamental concepts:
- Focus on China. In an Annex, the EO identifies the PRC, and its Special Administrative Regions of Hong Kong and Macau, as the only “country of concern.”
- Focus on Three High-Technology Sub-sectors. The rulemaking is intended to narrowly target technologies and products in three high-technology sub-sectors—semiconductors and microelectronics, quantum information technologies, and artificial intelligence— that are “critical” for the “military, intelligence, surveillance, or cyber-enabled capabilities of a country of concern,” with varying degrees of restrictions being contemplated for each:
1) Semiconductors and Microelectronics
Potential prohibition on transactions related to “(i) specific technology, equipment, and capabilities that enable the design and production of advanced integrated circuits or enhance their performance; (ii) advanced integrated circuit design, fabrication, and packaging capabilities; and (iii) the installation or sale to third-party customers of certain supercomputers, which are enabled by advanced integrated circuits.”
Potential notification requirement “for design, fabrication, and packaging of other integrated circuits” which would be intended to “increase the U.S. Government’s visibility into the volume and nature of investments and inform future policy decisions.” (ANPRM at 24).
2) Quantum Information Technologies
Potential prohibition on transactions related to “specific and advanced quantum information technologies and products, or with respect to end uses. In the case of quantum sensors, the end-use provisions seek to distinguish from use cases in civilian fields such as medicine and geology, and in the case of quantum networking systems.” (ANPRM at 28).
3) AI Systems
Definition. Treasury proposed and is seeking comments on a definition of AI systems as “an engineered or machine-based system that can, for a given set of objectives, generate outputs such as predictions, recommendations, or decisions influencing real or virtual environments. AI systems are designed to operate with varying levels of autonomy.”
Potential prohibition on “U.S. investments into covered foreign persons engaged in the development of software that incorporates an AI system and is designed to be exclusively [or primarily] used for military, government intelligence, or mass-surveillance end uses.”
Potential notification requirement for “undertaking a transaction with a covered foreign person engaged in the development of software that incorporates an artificial intelligence system and is designed to be exclusively [or primarily] used for: cybersecurity applications, digital forensics tools, and penetration testing tools; the control of robotic systems; surreptitious listening devices that can intercept live conversations without the consent of the parties involved; non-cooperative location tracking (including international mobile subscriber identity (IMSI) Catchers and automatic license plate readers); or facial recognition.” (ANPRM at 31 – 32).
Carefully developed definitions will be critical to providing clarity on the scope of the prohibitions. Notably, a previous effort by the Committee on Foreign Investment in the United States (“CFIUS”, the inbound U.S. investment review regime) to identify sectors subject to heightened restrictions based on their North American Industry Classification System (“NAICS”) code was abandoned after proving to be unworkable.
- Who Must Comply. The EO would create compliance obligations for, at the least, all “United States persons,” which is defined 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.” As discussed in our prior alert, this definition would likely capture non-US-person-owned/controlled funds or entities that are either registered in the United States or that direct investment operations from the United States.
The EO also appears to advocate for a “facilitation” prohibition—similar to the concept in the Treasury Department’s economic sanctions programs—that would prohibit U.S. persons “from knowingly directing transactions if such transactions would be prohibited transactions pursuant to this order if engaged in by a United States person;” this could create obligations for all natural U.S. persons, wherever located, even if they do not work for a U.S. legal entity. The EO also provides a basis for extending the prohibitions to transactions “by a foreign entity controlled by such United States person”—effectively reaching non-U.S.-registered subsidiaries or funds controlled by a U.S. person.
- Covered Investment Types or Trade Flows. Transactions that the Treasury Department anticipates being covered by the program include “certain acquisitions of equity interests (e.g., mergers and acquisitions, private equity, and venture capital), greenfield, joint ventures, and certain debt financing transactions by United States persons.”
Importantly, carveouts and exceptions may exist for certain passive investments, including “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 ANPRM suggests that “any investment that affords the U.S. person rights beyond those reasonably considered to be standard minority shareholder protections” may not qualify as an excepted transaction. (ANPRM at 17 – 18).
The program intends to grandfather ongoing investments and be prospective rather than retroactive. The ANPRM notes that the Treasury Department “would not use this authority to unwind a transaction that was not prohibited at the time it was completed.” The ANPRM provides a caveat that “the Treasury Department may, after the effective date of the regulations, request information about transactions by United States 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.” (ANPRM at 7 – 8).
- Record-keeping and Penalties. The ANPRM also seeks comments on, among other items, the record-keeping requirements that the Treasury Department should require under the program and the civil penalties it should impose for violations of the program under the International Emergency Economic Powers Act for “(i) material misstatements made in or material omissions from information or documentary material submitted or filed with the Treasury Department; (ii) the undertaking of a prohibited transaction; or (iii) the failure to timely notify a transaction for which notification is required.” (ANPRM at 45 – 46).