On October 28, 2024, the U.S. Department of the Treasury issued its long-awaited final rule (Final Rule) implementing an outbound investment security program. Stemming from Executive Order 14105 (Outbound Order), the new program targets U.S. investment in China, Hong Kong, and Macau related to a defined set of technologies and products that pose an acute national security threat to the United States.
The Final Rule identifies both prohibited transactions and transactions that require a U.S. person to notify Treasury. The Final Rule will become effective on January 2, 2025. The newly created Office of Global Transactions within Treasury's Office of Investment Security will administer the outbound investment program.
Background on the Outbound Order
The Outbound Order declared a national emergency to address the threat posed to the United States by China, Hong Kong, and Macau's advancement in "sensitive technologies and products in the semiconductors and microelectronics, quantum information technologies, and artificial intelligence sectors" that are critical for military, intelligence, surveillance, or cyber-enabled capabilities, which is being further exacerbated by U.S. investments. The Outbound Order further directed the Treasury Secretary to issue regulations creating an outbound investment security program.
Overview of Final Rule
The Final Rule builds on Treasury's August 2023 Advance Notice of Proposed Rulemaking and July 2024 Notice of Proposed Rulemaking.
Key elements of the Final Rule are outlined below:
- Requirements for U.S. Persons. The Final Rule creates requirements for U.S. persons, which include U.S. citizen; lawful permanent resident; entity organized under the laws of the United States or any jurisdiction within the U.S., including any foreign branch of any such entity; or any person in the U.S.
- Knowledge Standard. These obligations apply if the U.S. person has knowledge of relevant facts or circumstances about a transaction. Knowledge includes (1) actual knowledge that a fact or circumstance exists or is substantially certain to occur; (2) an awareness of a high probability of a fact or circumstance's existence or future occurrence; or (3) reason to know of a fact or circumstance's existence. In assessing whether a U.S. person had knowledge, Treasury will consider information a U.S. person had or could have had through a reasonable and diligent inquiry.
- Covered Foreign Persons. The term covered foreign person means a person of a country of concern that engages in a covered activity; or a person that has a board seat, voting or equity interest, or certain contractual powers with respect to such a person of a country of concern where more than 50% of one of a few important financial metrics of the person is attributable to one or more such persons of a country of concern.1
- Covered Transactions. The Final Rule covers
transactions where a U.S. person directly or
indirectly:2
- Acquires an equity interest3 or contingent equity interest in a covered foreign person.
- Provides certain loan or similar debt financing arrangements to a covered foreign person.
- Converts a contingent equity interest acquired on or after January 2, 2025, into an equity interest in a covered foreign person.
- Acquires, leases, or develops operations, land, property, or other assets in China, Hong Kong, or Macau that the U.S. person knows will result in, or the U.S. person plans to result in (1) the establishment of a foreign covered person or (2) the engagement of a person of a country of concern in a covered activity.4
- Enters into a joint venture anywhere in the world that is formed with a person of a country of concern if the U.S. person knows the joint venture will engage, or plans to engage, in a covered activity.
- Acquires a limited partner or equivalent interest in a venture capital fund, private equity fund, fund of funds, or other pooled investment fund (where the fund is not a U.S. person) that the U.S. person knows likely will invest in a person of a country of concern that is in the semiconductor and microelectronics, quantum information technology, or artificial intelligence sectors, and such fund undertakes a transaction that would be a covered transaction if undertaken by a U.S. person.
- Prohibited Transactions. A covered transaction
is prohibited if the relevant foreign person or joint venture:
- Develops or produces any electronic design automation software for the design of integrated circuits or advanced packaging.
- Develops or produces certain (1) front-end semiconductor fabrication equipment; (2) equipment for performing volume advanced packaging; or (3) certain items designed exclusively for use in or with extreme ultraviolet lithography fabrication equipment.
- Designs any integrated circuit that meets or exceeds certain performance or operational parameters.
- Fabricates (1) certain logic integrated circuits; (2) certain NOT-AND (NAND) memory integrated circuits; (3) certain dynamic random-access memory (DRAM) integrated circuits; (4) integrated circuits manufactured from a gallium-based compound semiconductor; (5) integrated circuits using graphene transistors or carbon nanotubes; or (6) certain integrated circuits designed to meet specific operational parameters.
- Packages any integrated circuits using advanced packaging techniques.
- Develops, installs, sells, or produces certain supercomputers.
- Develops a quantum computer or produces any of the critical components required to produce a quantum computer.
- Develops or produces any quantum sensing platform designed for, or which the relevant covered foreign person intends to be used for, any military, government intelligence, or mass-surveillance end use.
- Develops or produces any quantum network or quantum communication system designed for, or which the relevant covered foreign person intends to be used for certain end uses, including any military, government intelligence, or mass-surveillance end use.
- Develops any AI system that is designed to be exclusively used for, or which the relevant covered foreign person intends to be used for, any (1) military end use or (2) government intelligence or mass-surveillance end use.
- Develops any AI system that is trained using certain quantities of computing power.
- Meets certain conditions because of its relationship to one or more covered foreign persons engaged in any covered activity described in the preceding bullets.
- Engages in a covered activity and (1) is included on the Entity List; (2) is included on the Military End User List; (3) meets the definition of a "Military Intelligence End-User" under the Export Administration Regulations; (4) is included on the Specially Designated Nationals and Blocked Persons (SDN List), or is an entity in which one or more individuals or entities included on the SDN List, individually or in the aggregate, directly or indirectly, own a 50 percent or greater interest; (5) is included on the Non-SDN Chinese Military-Industrial Complex Companies (NS–CMIC List); or (6) is designated as a foreign terrorist organization.
- Notifiable Transactions. A covered transaction
that is not otherwise prohibited requires notification to Treasury
if the relevant covered foreign person or joint venture:
- Designs, fabricates, or packages integrated circuits that are not covered by the corresponding prohibition above.
- Develops certain AI systems that are not otherwise covered by the corresponding prohibition above and that are (1) designed to be used for any military or government intelligence or mass-surveillance end use; (2) intended to be used for (a) cybersecurity applications, (b) digital forensics tools, (c) penetration testing tools, or (d) the control of robotic systems; or (3) trained using a certain quantity of computing power.
A U.S. person subject to the notification requirement must file a notification form with Treasury that includes information related to the transaction (e.g., details about the U.S. person, the covered foreign person, the covered transaction, and the national security technologies and products). This must be filed no later than 30 days after the relevant covered transaction is completed or, where a U.S. person acquires actual knowledge after the completion date of a transaction.
- Exceptions. The Final Rule outlines certain excepted transactions, including certain (1) investments in securities, derivatives, or funds; (2) buyouts; (3) intracompany transactions; (4) transactions pursuant to binding commitments entered into ahead of the Final Rule; (5) syndicated debt financing arrangements; (6) equity-based compensation; and (6) transactions involving certain third countries.
- Exemptions. The Final Rule also allows for a U.S. person to seek an exemption based on the national interest of the United States. Such exemptions will be determined based on the consideration of the totality of the relevant facts and circumstances.
- Violations and Penalties. Violations are subject to civil and criminal penalties under the International Emergency Economic Powers Act (IEEPA). Currently, the maximum civil penalty for a violation is the greater of $368,136 (adjusted annually for inflation) or twice the value of the transaction that is the basis for the violation. Under IEEPA, Treasury can also take any authorized action to nullify, void, or otherwise require divestment of any prohibited transaction. Self-disclosure will also be taken into consideration in Treasury's determination of the appropriate resolution.
Footnotes
1. "Person of a country of concern" means "(a) Any individual that: (1) Is a citizen or permanent resident of a country of concern; (2) Is not a U.S. citizen; and (3) Is not a permanent resident of the United States; (b) An entity with a principal place of business in, headquartered in, or incorporated in or otherwise organized under the laws of, a country of concern; (c) The government of a country of concern, including any political subdivision, political party, agency, or instrumentality thereof; any person acting for or on behalf of the government of a country of concern; or any entity with respect to which the government of a country of concern holds individually or in the aggregate, directly or indirectly, 50 percent or more of the entity's outstanding voting interest, voting power of the board, or equity interest, or otherwise possesses the power to direct or cause the direction of the management and policies of such entity (whether through the ownership of voting securities, by contract, or otherwise); (d) Any entity in which one or more persons identified in paragraph (a), (b), or (c) of this section, individually or in the aggregate, directly or indirectly, holds at least 50 percent of any of the following interests of such entity: outstanding voting interest, voting power of the board, or equity interest; or (e) Any entity in which one or more persons identified in paragraph (d) of this section, individually or in the aggregate, directly or indirectly, holds at least 50 percent of any of the following interests of such entity: outstanding voting interest, voting power of the board, or equity interest. See § 850.221.
2. Note 1 to § 850.210: An indirect covered transaction includes a U.S. person's use of an intermediary to engage in a transaction that would be a covered transaction if engaged in directly by a U.S. person. However, for purposes of § 850.210(a)(1), a U.S. person is not considered to have acquired an indirect equity interest or contingent equity interest in a covered foreign person when the U.S. person acquires a limited partner or equivalent interest in a venture capital fund, private equity fund, fund of funds, or other pooled investment fund and that fund then acquires an equity interest or contingent equity interest in a covered foreign person. (A U.S. person's acquisition of a limited partner or equivalent interest in a non-U.S. person venture capital fund, private equity fund, fund of funds, or other pooled investment fund may, however, be a covered transaction under § 850.210(a)(6).)
3. Note 2 to § 850.210: Neither the issuance of a secured loan or similar debt financing for which equity is pledged as collateral, nor the acquisition of such secured debt on the secondary market, is an acquisition of an equity interest. However, foreclosure on collateral where the debtholder takes possession of the pledged equity is an acquisition of an equity interest; provided that such an acquisition is not a covered transaction where the equity was pledged prior to January 2, 2025, or where the U.S. person did not know at the time of issuing or acquiring the debt that the pledged equity was in a covered foreign person.
4. "Covered activity" means, in the context of a particular transaction, any of the activities referred to in the definition of notifiable transaction in § 850.217 or prohibited transaction in § 850.224. See § 850.208.
This article is presented for informational purposes only and is not intended to constitute legal advice.