With Focus on Tech Sector and China, Treasury Publishes Proposed Outbound Investment Restrictions

The U.S. Department of the Treasury proposed regulations on June 21, 2024, that would prohibit certain outbound investments by U.S. persons in Chinese companies focused on semiconductors and microelectronics, quantum computing and information technologies, and artificial intelligence. 

The proposal would also require U.S. persons to notify Treasury of other types of outbound investment.  The proposed rule would implement President Biden’s August 9, 2023, Executive Order 14105, discussed in our prior alert.  

The proposal does not impose any immediate legal requirements.  Treasury is seeking public comments by August 4, 2024.  It is unlikely that Treasury will issue a final rule before the fourth quarter of this year.  

Apart from foreign policy-based sanctions, the proposal departs from a long-standing U.S. policy of open and unqualified environment for such investment.  As most recently stated by Treasury, the new policy is that the United States supports “an open investment environment where consistent with the protection of U.S. national security.”

At a Glance:  Key Points From the Proposed Rule

The proposed rule would: 

• Prohibit U.S. persons from knowingly engaging in investment transactions involving individuals and entities with ties to China (including Macau and Hong Kong), with limited exceptions.  The prohibition would apply to investments related to activities in the semiconductor and microelectronics, quantum computing and information technologies and AI sectors.  It would require U.S. persons to take steps to prohibit and prevent foreign entities they control from engaging in such transactions.
• Require U.S. persons to notify Treasury within 30 days of completing certain investment transactions involving specified activities by individuals and entities with ties to China.
• Exclude from its requirements investment transactions in publicly traded securities or securities issued by investment companies and certain other types of investments.

The proposed rule would not establish a process for the U.S. government to review or license transactions.  But the U.S. government would be able to nullify, void or otherwise require divestment of any prohibited transaction.  

Treasury’s proposal also includes a process for voluntarily disclosing potential violations and provides for civil and criminal penalties on persons who violate the rule.

Who Is Covered by the Proposed Rule?

The proposed rule would apply to activities of “U.S. persons.”  A “U.S. person” would be any U.S. citizen, lawful permanent resident, entity organized under U.S. law or any person in the United States.  A foreign parent or foreign employer of a U.S. person would not be a U.S. person simply because it has an affiliate or employees in the United States.

Under the proposed rule, U.S. persons would have to take reasonable steps to ensure that their “controlled foreign entities” (e.g., subsidiaries) forgo transactions that would be prohibited if executed by a U.S. person.  A U.S. person would also be required to notify authorities of a transaction by its controlled foreign entity that would be a notifiable transaction if executed by a U.S. person.

What Transactions Are Covered by the Proposed Rule?

The proposed rule would pertain to activities of U.S. persons and controlled foreign entities with respect to “covered transactions” involving “covered foreign persons.”

“Covered transactions” would include certain investment and similar transactions if a U.S. person has knowledge of the involvement of a “covered foreign person.”  This would include acquisitions of equity interests or contingent equity interests in covered foreign persons, certain debt financings, conversions of equity interests or debt to equity interests, greenfield or brownfield investments that are intended to result in establishing covered foreign persons or covered activities, certain joint ventures and certain limited partnership investments.

A “covered foreign person” would include:

• A person of a country of concern (China) engaging in a “covered activity;” or 
• A person who (i) directly or indirectly holds any voting interest or equity interest in or power to direct one or more covered foreign person(s) and (ii) either:
  • Derives more than 50 percent of its revenue or net income from the covered foreign person(s); or
  • Incurs more than 50 percent of its capital expenditure or operating expenses through the covered foreign person(s).  This could include, for example, a U.S. entity that has a subsidiary in China.

A person of a country of concern would include:

• An individual who is a citizen or permanent resident of China and is neither a U.S. citizen nor permanent resident of the United States;
• An entity that has its principal place of business in, headquarters in or that is incorporated in or organized under the laws of China;
• The Chinese government or any person acting for or on behalf of the Chinese government;
• An entity in which the Chinese government holds, directly or indirectly, 50 percent or more of the outstanding voting interest, voting power of the board or equity interest or that otherwise has the power to direct or control; or
• An entity in which one or more persons identified above, 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.

“Covered activities” would include activities associated with “prohibited transactions” or “notifiable transactions” (discussed in greater detail below).  

Prohibited and Notifiable Transactions

Prohibited transactions would be covered transactions that are not notifiable or excepted transactions (discussed below) in which a covered foreign person or a joint venture between a U.S. person and a Chinese person engages in an activity listed in the prohibited transactions column of the table above.  The proposed rule would also prohibit U.S. persons’ covered transactions involving a covered foreign person included on any U.S. government blacklist performing any of the activities listed in the table above.  

Notifiable transactions would be covered transactions that are not prohibited or excepted transactions in which a covered foreign person or a joint venture between a U.S. person and a Chinese person engages in an activity listed in the notifiable transactions column of the table above.  U.S. persons involved in notifiable transactions would be required to notify Treasury of each such transaction within 30 days of the transaction’s completion.

A U.S. person who discovers, after completing a transaction, that it was covered would have 30 days to notify Treasury.

After a notification, Treasury would be authorized to contact the U.S. person with questions or document requests related to the transaction or compliance with the rule. 

Knowledge Requirement

A transaction that otherwise has the attributes of a covered transaction (i.e., either a prohibited transaction or a notifiable transaction) generally would be treated as covered only if the U.S. person involved in the transaction has knowledge at the time of the transaction that it involves or would result in the establishment of a covered foreign person (or would result in a Chinese person’s engagement in a new covered activity).  The proposal includes detailed provisions on the meaning of the applicable “knowledge” standard.  

A U.S. person would be required to perform reasonable and appropriate diligence to determine whether a transaction is covered.  If, however, a U.S. person undertakes a reasonable and diligent inquiry and still does not know that a transaction is covered, Treasury ordinarily would not conclude that the person knew the transaction was covered.  

Excepted Transactions

The proposed rule would except certain types of transactions from the rule, including:

• Binding commitments consummated prior to the Executive Order:  A transaction made pursuant to a binding, uncalled, capital commitment entered into before August 9, 2023.
• Publicly traded securities:  An investment by a U.S. person in any publicly traded security or a security issued by certain types of investment and business development companies.
• Certain limited partner investments:  An investment below certain thresholds by a U.S. limited partner in a pooled investment fund.
• Full buyouts of Chinese ownership:  A U.S. person’s full buyout of all interests of any person of a country of concern in 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. person parent and its subsidiary to support ongoing operations.
• Certain syndicated debt financings:  A U.S. person that is a passive member of a lending syndicate who acquires a voting interest in a covered foreign person upon default of a loan.
• Third country measures:  A transaction involving a person of a foreign country or territory if the Treasury Secretary determines that the country or territory adequately addresses national security concerns posed by the outbound investment.
• National interest transactions:  A transaction the Treasury Secretary determines to be in the national interest of the United States.