What Happened

On October 28, 2024, the US Department of Treasury (Treasury) Office of Investment Security issued its final rule (Outbound Investment Rules) to implement Executive Order 14105 (the Outbound Investment Order), which directed Treasury to regulate certain US investments into China’s semiconductors and microelectronics, quantum information technologies and artificial intelligence sectors. The Outbound Investment Rules follow Treasury’s June 2024 Notice of Proposed Rulemaking (NPRM) and August 2023 Advanced Notice of Proposed Rulemaking (ANPRM) on outbound investments in China, and will go into effect on January 2, 2025.

The Bottom Line

The Outbound Investment Rules generally track the rules proposed in the NPRM and establish a new national security program to be implemented and administered by Treasury to regulate US outbound investment. Companies with investments, or planning to invest, in China, particularly in the tech sector, should review the Outbound Investment Rules to understand changing compliance obligations with respect to US outbound investment. Companies should carefully diligence investments in China, or in businesses that are located outside of China but have Chinese ownership or otherwise have significant financial ties to China, for compliance with the Outbound Investment Rules.

The Full Story

On August 9, 2023, President Biden issued the Outbound Investment Order directing Treasury, in consultation with other federal agencies, to regulate certain US investments into China’s semiconductors and microelectronics, quantum information technologies and artificial intelligence sectors. Treasury simultaneously released its ANPRM seeking public comment related to the implementation of the Outbound Investment Order. Our coverage of the Outbound Investment Order and the ANPRM, including our summary of the proposed rules, is available here. On June 21, 2024, Treasury issued the NPRM, providing further detail on key concepts and aspects of the proposed regulations to implement the Outbound Investment Order. Our coverage of the NPRM is available here.

As discussed in our earlier client alerts regarding the proposed outbound investment regime, the Outbound Investment Order directs Treasury to regulate two classes of covered transactions: (1) “notifiable transactions” for which US persons must provide notice to Treasury and (2) “prohibited transactions” from which US persons are prohibited from undertaking. 

The regulations established by the Outbound Investment Rules do not entail a case-by-case review by Treasury of covered transactions or any other transactions prior to completion, or establish a licensing or clearance process where a US person would (or could) seek prior authorization for a covered transaction. Rather, the relevant US person undertaking a transaction would have the obligation to determine whether the given transaction is prohibited, permissible but subject to notification or not covered at all by the rules because either it is an excepted transaction or it is not within the authority set forth under the Outbound Investment Rules. This compliance framework is similar to the framework for US sanctions compliance in that the Outbound Investment Rules establish broad diligence obligations on the part of US persons and Treasury will not review and provide clearance for proposed investments in China. Unlike the framework for US sanctions, however, the Outbound Investment Rules do not establish a formal licensing process for Treasury to authorize otherwise prohibited transactions (although the rules authorize the Secretary of the Treasury, in consultation with certain other department heads, to grant certain national interest exemptions).

Key provisions in the Outbound Investment Rules include the following:

Obligations for US Persons

The Outbound Investment Rules place obligations on US persons for transactions undertaken after January 2, 2025. Under the rules, a US person includes any United States citizen or lawful permanent resident, as well as 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.

Knowledge Standard

As expected from the ANPRM and NPRM, the Outbound Investment Rules establish a knowledge standard that includes constructive knowledge. "Knowledge" is defined as actual (conscious) knowledge at the specified time as well as (1) what the US person should have known at such time, based on information publicly available or available through reasonable and appropriate due diligence, and/or (2) knowledge that a fact or circumstance exists or is substantially certain to occur, an awareness of a high probability of a fact or circumstance’s existence or future occurrence or reason to know of a fact or circumstance’s existence. As discussed further below, "knowledge" by a US person that a transaction was a covered transaction involving a covered foreign person would trigger an obligation to notify Treasury after completion (if the transaction was notifiable) or to refrain from undertaking the transaction (if it was prohibited).

Treasury’s assessment as to whether, at the time of a given transaction, a US person has or had knowledge of a given fact or circumstance will be made based on information a US person had or could have had through a reasonable and diligent inquiry. Treasury has explicitly acknowledged the challenges of conducting due diligence in foreign jurisdictions, including China. Although the Outbound Investment Rules do not establish safe harbor if a US person takes specific due diligence steps, the Outbound Investment Rule does set forth an illustrative list of factors that Treasury will consider in assessing whether a US person has undertaken a “reasonable and diligent inquiry” with respect to a particular transaction:

1. the inquiry a US person has made regarding an investment transaction counterparty, including questions asked as of the time of the transaction;
2. the sufficiency of the contractual representations or warranties the US person has obtained or attempted to obtain from the investment target or transaction counterparty;
3. the efforts by the US person to obtain and consider available non-public information;
4. available public information and the efforts undertaken by the US person to obtain and consider such information;
5. whether the US person purposefully avoided learning or seeking relevant information;
6. the presence or absence of warning signs, which may include evasive responses or non-responses from an investment target or transaction counterparty; and
7. the use of available public and commercial databases to identify and verify relevant information of an investment target or transaction counterparty.

Companies, including those believing that an investment or loan is purely a domestic transaction or otherwise does not involve China should consider appropriate diligence steps and utilizing contractual representations and warranties to address compliance with the new Outbound Investment Rules.

Covered Transaction

As expected from the ANPRM and NPRM, the Outbound Investment Rules apply to certain categories of transactions by US persons. Specifically, a US person’s direct or indirect (1) acquisition of an equity interest or contingent equity interest in a covered foreign person; (2) provision of a loan or similar debt financing to a covered foreign person where such debt financing has economic and governance rights characteristic of an equity investment rather than a loan; (3) conversion of a contingent equity interest into an equity interest in a covered foreign person; (4) greenfield investments that could result in the establishment of a covered foreign person or engaging in a covered activity; (5) establishment of a joint venture, wherever located, that is formed with a covered foreign person or could result in the establishment of a covered foreign person; or (6) acquisition of a limited partner or equivalent interest in a venture capital fund, private equity fund, fund of funds or other pooled investment fund to invest in China, in each case subject to the US persons knowledge that the investment target or counterparty is a covered foreign person or otherwise engages in covered activity (see description of the knowledge standard above).

Covered Foreign Persons

As expected from the ANPRM and NPRM with some adjustments in scope, the Outbound Investment Rules apply to certain transactions by a US person that involve a “covered foreign person”—that is, a person of a country of concern that is engaged in a covered activity related to defined sub-sets of technologies and products (i.e., the “national security technologies and products” described below) or a person that has a voting or equity interest, board seat or certain powers with respect to such a person of a country of concern (i.e., China) where more than 50% of one of several key financial metrics of the person is attributable to one or more such persons of a country of concern. A person of a country of concern includes an individual who is a citizen or permanent resident of a country of concern (and not a citizen or permanent resident of the United States); an entity that is organized under the laws of, headquartered in, incorporated in or with a principal place of business in a country of concern; the government of a country of concern or a person acting for or on behalf of the government of a country of concern; or an entity that is directly or indirectly at least 50 percent-owned by any persons or entities in any of the aforementioned categories.

Exceptions

The NPRM requested comments on Treasury’s proposed exceptions that would carve-out certain types of transactions from a “covered transaction.” The Outbound Investment Rules except certain types of transactions from coverage, provided that such transactions do not afford a US person rights that are not standard minority shareholder protections. Excepted transactions include those for publicly traded securities, LP investments below certain thresholds or with certain commitments (i.e., $2,000,000 or less or if the US person has received a contractual assurance that its capital will not be used by the fund to engage in what would be a prohibited or notifiable transaction), investments in certain derivatives, full buy-outs (i.e., such that the entity does not constitute a covered foreign person following the transaction), intracompany transactions, equity-based compensation, certain national security circumstances, certain syndicated debt financing and grandfathered transactions for binding capital commitments entered into prior to January 2, 2025.

Notification Obligation

Outbound Investment Rules require that notification of “notifiable transactions” be filed no later than 30 days after the relevant covered transaction is completed or the US person’s acquisition of actual knowledge after the completion date of a transaction that the transaction would have been a covered transaction if such knowledge had been possessed at the time of the transaction.

Covered Activities

Consistent with the ANPRM and NPRM with some adjustments in scope, Outbound Investment Rules identify the sub-sets of national security technologies and products that are subject to the new rules (Covered Activities):

• Semiconductors and microelectronics:
  • Prohibited transactions: Covered transactions related to certain electronic design automation software; certain fabrication or advanced packaging tools; the design or fabrication of certain advanced integrated circuits; advanced packaging techniques for integrated circuits; and supercomputers.
  • Notifiable transactions: Covered transactions related to the design, fabrication or packaging of integrated circuits that are not otherwise a prohibited transaction.
• Quantum information technologies:
  • Prohibited transactions: Covered transactions related to the development of quantum computers or production of any critical components required to produce a quantum computer; the development or production of certain quantum sensing platforms; and the development or production of certain quantum networks or quantum communication systems.
• Artificial intelligence (AI) systems:
  • Prohibited transactions: 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 are prohibited. In addition, covered transactions related to the development of any AI system that is trained using a quantity of computing power greater than 10ˆ25 computational operations or trained using primarily biological sequence data and a quantity of computing power greater than 10ˆ24 computational operations.
  • Notifiable transactions: Covered transactions related to the development of any AI system that are not otherwise a prohibited transaction, where such AI system is: designed or intended to be used for certain end uses or applications or trained using a quantity of computing power greater than 10ˆ23 computational operations.

Penalties for Violations

Violations of the Outbound Investment Rules are subject to civil and criminal penalties. Under the International Emergency Economic Powers Act (IEEPA), as of the issuance of the Outbound Investment Rules, the maximum civil penalty for a violation is the greater of $368,136 (as adjusted annually for inflation) or twice the value of the transaction that is the basis for the violation. Treasury can also take any action authorized under IEEPA to nullify, void or otherwise require divestment of any prohibited transaction.

Treasury encourages voluntary self-disclosure by US persons that believe that they may have violated the Outbound Investment Rules and will take into account such self-disclosure during Treasury’s determination of the appropriate enforcement response to the self-disclosed violation.