The U.S. Department of the Treasury has recently announced final regulations to implement Executive Order 14105 of August 9, 2023, which was intended to address the advancement by the People's Republic of China and other countries of concern in sensitive technologies critical for military, intelligence, surveillance or cyber-enabled capabilities. The final rule, which will be administered by the newly created Office of Global Transactions in the Treasury's Office of Investment Security and will become effective on January 2, 2025, could have significant implications for U.S. companies that are expanding or plan to expand operations in the Chinese market, as well as on investments and joint ventures in the artificial intelligence, quantum information technologies, semiconductors and microelectronics industries.
Background on EO 14105 and Previous Rulemaking Notices
The final rule builds on the advance notice of proposed rulemaking issued by Treasury in August 2023 (discussed in our previous Alert) and the proposed rule issued by Treasury in June 2024 (discussed in our previous Alert), and provides the operative regulations and an explanatory discussion regarding the final rule's intent and application. As detailed in our previous Alerts, EO 14105 directed the Secretary of the Treasury to establish an Outbound Investment Security Program that:
- Prohibits U.S. persons from engaging in certain transactions with persons of a country of concern involving certain technologies and products that pose a particularly acute national security threat to the United States; and
- Requires U.S. persons to notify Treasury of certain other transactions with persons of a country of concern involving certain technologies and products that may contribute to the threat to the national security of the United States.
In an annex to EO 14015, President Joe Biden identified the People's Republic of China, along with the special administrative regions of Hong Kong and Macau, as a country of concern. The three categories of national security technologies and products covered by the Outbound Investment Security Program are:
- Semiconductors and microelectronics;
- Quantum information technologies; and
- Artificial intelligence.
The final rule provides details on the subsets of technologies and products within these sectors and implements a new program that will help address the advancement of key technologies and products by countries of concern that may use them to threaten U.S. national security.
The Final Rule
The final rule applies to certain transactions by a U.S. 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 subsets of technologies and products 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 where more than 50 percent 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 U.S. 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.
The final rule defines key terms and provides detail on various aspects of the program's implementation, including the following.
Obligations of a U.S. Person Regarding a Covered Transaction
The final rule places obligations on U.S. persons, including prohibition of certain transactions and a notification requirement for certain other transactions. A U.S. 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.
Categories of Covered Transactions and Excepted Transactions
The final rule applies to certain transactions by U.S. persons, including the acquisition of an equity interest or contingent equity interest; certain debt financing that affords certain rights to the lender; the conversion of a contingent equity interest; a greenfield investment or other corporate expansion; entrance into a joint venture; and certain investments as a limited partner or equivalent (LP) in a non-U.S. person pooled investment fund.
The final rule makes exceptions for certain types of transactions in some cases, provided that such transactions do not afford a U.S. person certain rights that are not standard minority shareholder protections. Some of these excepted transactions include:
Publicly Traded Securities
An investment by a U.S. person in a publicly traded security or a security issued by a registered investment company, such as an index fund, mutual fund or exchange-traded fund.
Certain LP Investments
A U.S. person's investment made as an LP in a venture capital fund, private equity fund, fund of funds or other pooled investment fund, if such investment is $2 million or less or if the U.S. 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.
Derivatives
A U.S. person's investment in certain derivative securities.
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 does not constitute a covered foreign person following the transaction.
Intracompany Transactions
An intracompany transaction between a U.S. person and its controlled foreign entity to support operations that are not covered activities or to maintain ongoing operations with respect to covered activities that the controlled foreign entity was engaged in prior to January 2, 2025.
Certain Pre-Final Rule Binding Commitments
A transaction fulfilling a binding, uncalled capital commitment entered into prior to January 2, 2025.
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 is not the syndication agent.
Equity-Based Compensation
A U.S. person's receipt of employment compensation in the form of an award or grant of equity or an option to purchase equity in a covered foreign person or the exercise of such option.
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 related to 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.
Information That a U.S. Person Is Required to Provide to Treasury as Part of a Notification
A U.S. person subject to the notification requirement is required to file a notification form with Treasury that includes information related to the transaction, such as details about the U.S. person, the covered foreign person, the covered transaction and the relevant national security technologies and products. The final rule requires that a notification 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 date a transaction is completed that it 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.
The Knowledge Standard and Expectations for a U.S. Person to Conduct a Reasonable and Diligent Inquiry Prior to Undertaking a Transaction
The obligations of a U.S. person under the final rule apply if such person has knowledge of relevant facts or circumstances related to a transaction. Under the final rule, a U.S. person has knowledge if the U.S. person possesses actual knowledge that a fact or circumstance exists or is substantially certain to occur if the U.S. person possesses an awareness of a high probability of a fact or circumstance's existence or future occurrence, or if the U.S. person could have possessed such information through a reasonable and diligent inquiry. To provide clarity, the final rule includes factors that Treasury will consider in assessing whether a U.S. person undertook a reasonable and diligent inquiry. Such factors incorporate information that should be ascertainable as well as contractual assurances that should be obtainable through reasonable due diligence. The final rule also clarifies that consideration will be given to the totality of the facts and circumstances related to the transaction.
Conduct That Would Be Treated as a Violation of the Final Rule and Applicable Penalties for Such Conduct
Violations are subject to civil and criminal penalties as set forth in the International Emergency Economic Powers Act (IEEPA). In the event of a violation, Treasury is authorized to impose civil penalties and could also refer criminal violations to the U.S. attorney general. Under IEEPA, as of the issuance of the final rule 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.
Technical Specifications for Certain Technologies and Products in the Areas of Semiconductors and Microelectronics, Quantum Information Technologies and Artificial Intelligence
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 are prohibited.
Notifiable transactions: Covered transactions related to the design, fabrication or packaging of integrated circuits not otherwise covered by the prohibited transaction definition are subject to a notification requirement.
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 are prohibited.
Certain Artificial Intelligence 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 10Æ25 computational operations, or trained using primarily biological sequence data and a quantity of computing power greater than 10Æ24 computational operations, are prohibited.
Notifiable transactions: Covered transactions related to the development of any AI system not otherwise covered by the prohibited transaction definition are subject to a notification requirement if they are designed or intended to be used for certain end uses or applications, or trained using a quantity of computing power greater than 10Æ23 computational operations.
Additional information regarding the final rule is available on the U.S. Treasury website.
Congressional Reactions to the Final Rule
U.S. Senator Bob Casey, D-Pa., a lead sponsor of the bipartisan Outbound Investment Transparency Act, has been pushing for additional congressional and executive action in this space. After the announcement of the final rule, Senator Casey issued a statement, noting that "this rule is a good start and I will keep fighting to pass my bipartisan legislation to make permanent an outbound investment screening program." While the Outbound Investment Transparency Act has been added as an amendment to the draft of the Senate version of the FY 2025 National Defense Authorization Act (NDAA), it is unclear as to whether it will be voted on by the Senate during the upcoming lame-duck session of Congress.
There also is support for similar legislation in the House of Representatives. House Speaker Mike Johnson, Foreign Affairs Committee Chairman Michael McCaul and Select Committee on Strategic Competition Between the United States and the Chinese Communist Party Chairman John Moolenaar have expressed a strong desire to address outbound investment in the FY 2025 NDAA. Following the issuance of the final rule, Chairman Moolenaar issued a statement "commending" the regulation but calling for Congress to "build on these rules and address a broader set of technologies and transactions that threaten our national security."
About Duane Morris
Attorneys in the firm's Corporate Practice Group and International Practice Group have considerable experience in assisting clients on a wide range of matters, including assisting in determining the applicability of foreign direct investment control laws that are administered in various jurisdictions (e.g., the United States, United Kingdom and European Union) and performing comprehensive due diligence relating to international M&A transactions.
For More Information
If you have any questions about this Alert, please contact Geoffrey M. Goodale, Hope P. Krebs, Thomas R. Schmuhl, Eduardo Ramos-Gómez, Elizabeth G. Hodgson, Raul Rangel Miguel, Bei Wang, Lauren E. Wyszomierski, any of the attorneys in our International Practice Group or the attorney in the firm with whom you are regularly in contact.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.