Biden Administration Issues Draft Regulations for New Outbound Investment Regime

The Biden Administration has moved one step closer to implementing a new outbound investment regulatory regime first announced last year. On June 21st, the Treasury Department issued a Notice of Proposed Rulemaking (“NPRM”) with a full draft of regulations implementing President Biden’s Executive Order 14105 of August 9, 2023 – “Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern” (the “EO”).

Building on an Advanced Notice of Proposed Rulemaking issued concurrent with the Executive Order last August, described in our prior alert (Biden Administration Launches New Regulatory Regime Governing Outbound Investment), the NPRM sets forth details on the types of transactions proposed to be covered by the regulations, the sub-sets of national security technologies and products within scope, and key terms and process requirements. Comments on the NPRM are due by August 4, 2024.

A final rule is expected later this year, which will set an effective date for the implementation of the outbound investment program. Notably, Treasury has said that it is not proposing to apply the new rules retroactively, but may request information from parties to transactions entered into or completed prior to the effective date. Once the regulations are finalized in the coming months, there will be greater clarity as to the breadth and impact of the new outbound investment program.

Summary of NPRM

The U.S. national security concern prompting the regulatory regime governing outbound investment is that “countries of concern” are engaged in strategies to support advancement in sensitive technologies and products critical for military, intelligence, surveillance, and cyber-enabled capabilities that pose a threat to the United States and its allies, and that certain U.S. investments “may accelerate and increase the success of the development” of those technologies. The EO identifies only one “country of concern”—China (including Hong Kong and Macau), and the sensitive technologies and products covered by the outbound investment program are: semiconductors and microelectronics, quantum information technologies, and artificial intelligence (“AI”) sectors.

To address this threat, the EO directs the Secretary of the Treasury to issue regulations (1) to prohibit U.S. persons from engaging in certain transactions involving technologies that pose an acute national security threat to the United States and (2) to require U.S. persons to notify Treasury of certain other transactions involving technologies that may contribute to the threat to U.S. national security. Though sometimes incorrectly referred to as “reverse CFIUS” in the press, the EO does not authorize a screening regime to review and mitigate investments. Rather, transactions within the regulations’ scope are only either prohibited or require notification to Treasury.

Within that broader context, the proposed scope of the outbound investment regulations includes the following key elements:

Application Scope

The outbound investment program rules apply to “U.S. persons” involved in certain types of transactions with “covered foreign persons.”

U.S. persons include: U.S. citizens and lawful permanent residents, wherever located; any individuals in the United States; and any entities organized under the laws of the United States, including their foreign branches. In addition, any foreign entity in which a U.S. person holds more than 50% of the outstanding voting interest or voting power of the board, or is the general partner, managing member or equivalent, would also be subject to the rules applicable to U.S. persons.

A person would be considered a “covered foreign persons” in three circumstances: (1) 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; (2) an entity that has a voting interest, board seat, or equity interest in a covered foreign person where more than 50% of one of several key financial metrics of the entity is attributable to such covered foreign person; and (3) an entity that participates in a joint venture with a U.S. person that engages in activities subject to the prohibition or notification requirements.

The rules set forth Treasury’s expectation that such U.S. persons will undertake reasonable and diligent inquiries of transactions to assess whether they are within the scope of the rules. Violations of the rules can be subject to civil and criminal penalties as set forth under the International Emergency Economic Powers Act, which currently are civil fines up to US$368,136 or twice the amount of the underlying transaction, and criminal fines of up to US$1 million and 20 years’ imprisonment. The Treasury Department would also be authorized to order a divestment of an investment in violation of the rules.

Transaction Scope

Covered Transactions

Under the NPRM, the following transactions by U.S. persons with covered foreign persons would be “covered transactions” subject to the prohibition and notification requirements:

• Acquisition of an equity interest or contingent equity interest in a covered foreign person;
• Provision of debt financing convertible to an equity interest in a covered foreign person or provision of debt financing that affords the lender certain management or governance rights in a covered foreign person;
• Conversion of a contingent equity interest or convertible debt in a covered foreign person;
• Greenfield investment or certain other corporate expansions that either will establish a covered foreign person, or will cause an existing person of a country of concern to pivot into a new covered activity;
• Entry into a joint venture, wherever located, with a person of a country of concern where the joint venture will undertake a covered activity; and
• Investment as a limited partner or equivalent (LP) into a non-U.S. person pooled investment fund that invests in a covered foreign person.

Excepted Transactions

Under the NPRM, the following transactions would fall outside the scope of covered transactions, provided that U.S. persons do not obtain rights that are not standard minority shareholder protections:

• 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 noncovered activities;
• Pre-Executive Order binding commitments: A transaction fulfilling a binding, uncalled, capital commitment entered into prior to August 9, 2023; and
• 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.

Technology Scope

For covered transactions, the prohibition and notification requirements apply only to the following technologies:

• Semiconductors and microelectronics:
  • Prohibited transactions: Covered 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.
  • Notifiable transactions: Covered transactions related to the design, fabrication, or packaging of integrated circuits not otherwise covered by the prohibited transaction definition.
• Quantum information technologies:
  • Prohibited transactions: Covered 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.
• Certain 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. The NPRM also proposes alternatives for a prohibition on covered transactions related to the development of any AI system that is trained using a specified quantity of computing power, and trained using a specified quantity of computing power using primarily biological sequence data.
  • Notifiable transactions: Covered transactions related to the development of any AI system not otherwise covered by the prohibited transaction definition, where such AI system is designed or intended to be used for certain end uses or is trained using a specified quantity of computing power (set below the levels in the prohibited transaction definition).

Implications

The outbound investment program is not intended to impede all U.S. investments in China or impose sector-wide restrictions on U.S. person activities. Instead, consistent with the Biden Administration’s approach in other national security areas related to China of “small yard, high fence,” the outbound investment program is intended to be a narrowly targeted action aimed at complementing existing U.S. export controls and CFIUS’s inbound investment screening tools. In particular, the NPRM indicates the U.S. Government’s particular focus is on preventing Chinese companies from receiving the intangible benefits that often accompany U.S. investments that help companies succeed, including “enhanced standing and prominence, managerial assistance, access to investment and talent networks, market access, and enhanced access to additional financing.”

U.S. persons considering investments or other transactions in China or with Chinese counterparties should review whether there are touchpoints to the technologies and products that will be covered by the outbound investment program. If so, as the effective date of the new regulations has not yet been determined, investors should be mindful that the transactions could be captured by the new rules.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. David J. Ribner, an O’Melveny partner licensed to practice law in the District of Columbia and New York; and Greta L. Nightingale, an O’Melveny partner licensed to practice law in the District of Columbia, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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