In an era where technological prowess and economic security are more entangled than ever, the United States has refined its approach towards restricting outbound investments. As we have been blogging since 2022, the past two years have seen efforts to restrict outbound investments for national security reasons. Those efforts come both from Congress through legislation and the White House through Executive Order.

On August 9, 2023, the Biden Administration issued Executive Order 14105 to restrict U.S. investments in certain national security technologies and products in countries of concern (defined as China, including Hong Kong and Macau).

Now, on Friday, June 21, the Department of Treasury published a Notice of Proposed Rulemaking (NPRM) providing the proposed outbound investment regulations.

The Proposed Regulations

The NPRM represents a critical step in U.S. policy to regulate outbound investments to protect critical technologies from foreign adversaries. The key elements from the NPRM are as follows:

• Prohibited Investments: The proposed regulations would prohibit U.S. persons from engaging in certain transactions involving countries of concern as follows:
  • Semiconductors and microelectronics: Transactions related 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: Transactions related to the development of quantum computers and production of critical components; the development or production of certain quantum sensing platforms; and the development or production of quantum networking and quantum communication systems.
  • AI systems: Transactions related to the development of any AI system designed to:
    • be exclusively used for, or intended to be used for military end use (e.g., for weapons targeting, target identification, combat simulation, military vehicle or weapon control, military decision-making, weapons design, or combat system logistics and maintenance);
    • be exclusively used for, or intended to be used for government intelligence or mass surveillance end use (e.g., through mining text, audio, or video; image recognition; location tracking; or surreptitious listening devices); or
    • be trained using a quantity of computing power greater than a certain level of computational operations (e.g., integer or floating-point operations). The Treasury Department is considering three potential alternatives for the level of computational operations: 10^24, 10^25, or 10^26, but in cases using primarily biological sequence data the level of computation operations being considered is 10^23, 10^24, or 10^25.
• Notification Requirements: The proposed regulations would require U.S. persons involved in covered transactions to provide notification to the U.S. Department of Treasury as follows:
  • Semiconductors and microelectronics: Transactions related to the design, fabrication, or packaging of integrated circuits not otherwise covered by the prohibited transaction definition.
  • AI systems: Transactions related to the development of any AI system not covered by the above prohibition, where such AI system is designed or intended to:
    • be used for any government intelligence or mass-surveillance end use (e.g., through mining text, audio, or video; image recognition; location tracking; or surreptitious listening devices) or military end use (e.g., for weapons targeting, target identification, combat simulation, military vehicle or weapons control, military decision-making, weapons design, or combat system logistics and maintenance);
    • be used for cybersecurity applications, digital forensics tools, and penetration testing tools, or the control of robotic systems; or
    • be trained using a quantity of computing power greater than a certain level of computational operations (e.g., integer or floating-point operations). Here, the Treasury Department is considering three potential alternatives for the level of computational operations: 10^23, 10^24, or 10^25.
• Notification Timing: The proposed regulations provide that notification must be filed no later than 30 days after a transaction is completed or, where a U.S. person acquires 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, no later than 30 days after the U.S. person’s acquisition of such knowledge.
• Restrictions on Covered Foreign Persons: The proposed regulations would apply to transactions with covered foreign persons for the above sub-set of technologies and products. A person of a country of concern is defined as including:
  • an individual who is a citizen or permanent resident of a country of concern (and not a U.S. citizen or permanent resident of the United States);
  • an entity that is organized under the laws of a country of concern, headquartered in, incorporated in, or with a principal place of business in a country of concern;
  • the government of a country of concern; or
  • an entity that is directly or indirectly majority-owned by any persons or entities in any of the aforementioned categories.

Thus, the proposed regulations cover certain acquisitions of an equity or contingent equity interest, debt financing convertible to an equity interested, conversion of a contingent equity interest or convertible debt, and greenfield, brownfield, or a joint venture investments. Additionally, the proposed rule would include certain transactions involving an entity than has a voting interest, board seat, or equity interest in a covered foreign person where more than fifty percent (50%) of one of several key financial metrics of the entity is attributable to such covered foreign person.

• Requirements on U.S. Persons: The NPRM is limited to U.S. persons. A U.S. person would include 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: The proposed regulations include a ‘knowledge standard’ to determine the extent of a U.S. person’s awareness of their investment’s impact on national security technologies. The standard is thus a U.S. person would need to know, or reasonably should know, based on information publicly available or or available through reasonable and appropriate due diligence, that it is undertaking a transaction involving a covered foreign person and that the transaction is a covered transaction. The standard ensures investors cannot plead ignorance of their investment’s potential consequences.
• National Interest Exemption: The proposed regulations allow for a national interest exemption to permit certain transactions that might otherwise be restricted if determined to serve the U.S. national interest. The proposed regulations set forth the procedures for a U.S. person to seek a national security exemption from the notification and prohibition requirements.
• Excepted Transactions: Certain transactions may be excepted based on criteria such as the nature of the investment or the relationship with the foreign entity, aiming to balance national security concerns with the need for international cooperation and innovation.
  • Publicly traded securities: An investment by a U.S. person in a publicly traded security or a security issued by an investment company, such as an index fund, mutual fund, or exchange-traded fund;
  • Certain LP investments: A U.S. person’s investment of a certain size made as a limited partner or equivalent in a venture capital fund, private equity fund, fund of funds, or other pooled investment fund;
  • Buyouts of country of concern ownership: A U.S. person’s full buyout of all country of concern ownership of an entity, such that the entity would not constitute a covered foreign person following the transaction;
  • Intracompany transactions: An intracompany transaction between a U.S. parent and a majority-controlled subsidiary to support ongoing operations or other non-covered activities;
  • Pre-Outbound Order binding commitments: A transaction fulfilling a binding, uncalled, capital commitment entered into prior to August 9, 2023;
  • Certain syndicated debt financings: Where the U.S. person, as a member of a lending syndicate, acquires a voting interest in a covered foreign person upon default and the U.S. person cannot initiate any action vis-à-vis the debtor and does not have a lead role in the syndicate;
  • Third country measures: Certain transactions involving a person of a country or territory outside of the United States may be excepted transactions where the Secretary of the Treasury determines that the country or territory is addressing national security concerns posed by outbound investment and the transaction is of a type for which associated national security concerns are likely to be adequately addressed by the actions of that country or territory.
• Violations, Divestment, and VSDs: The NPRM outlines penalties for violations of the regulations, including fines, civil penalties, referral of criminal violations, and potential restrictions on future investments. Additionally, divestment may be required in cases where investments are made in violation of the rules. The proposed regulations also provide a process for a U.S. person to submit a voluntary self-disclosure if they believe their conduct may have resulted in a violation of any part of the regulations.
• Comment Request and Effective Date: The Department of the Treasury is seeking comments from the public on the NPRM by August 4, 2024. Importantly, as of now, the proposed regulations have no set effective date, which should allow time for thorough review and consideration of the feedback received.

Impact on Businesses and Strategic Technologies

For businesses, especially operating in semiconductors, AI, and quantum computing, the NPRM’s implications are significant. Companies may need to reevaluate their international investment strategies, enhance due diligence in deals, and prepare for a more complex regulatory environment. Strategies may include early engagement with legal advisors, developing compliance mechanisms, and monitoring regulatory developments. Adapting to this regulatory framework requires businesses to be informed and adaptable.

Conclusion

The NPRM by the Department of the Treasury marks a significant step. As regulations are finalized, businesses, particularly in critical technology sectors, must prepare to account for these restrictions in future covered investments. We will continue to provide insights on navigating the complexities of the outbound investment restrictions.

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