President Biden Signs Executive Order on Outbound Investment

Key Points

• On August 9, 2023, President Biden issued a long-anticipated Executive Order on outbound investment aimed at addressing concerns related to China’s advancement in sensitive technologies critical for military, intelligence, surveillance, or cyber-enabled capabilities.
• The EO directs the U.S. Department of the Treasury to begin a rulemaking process that will result in both prohibitions and notification requirements on specific types of investments by U.S. persons in China or in certain Chinese-affiliated entities that develop or produce semiconductors, quantum computers, and artificial intelligence applications. These new restrictions will not take effect until the end of the rulemaking process, which Treasury anticipates could take a year.
• On the same day, Treasury published an Advance Notice of Proposed Rulemaking asking for public comments by September 28, 2023. The ANPRM includes proposed scoping provisions and definitions. Treasury states that the ANPRM focuses on more active—rather than passive— investment for both the prohibitions and notifications. Based on the ANPRM, a range of transactions through third counties could be covered. U.S. persons and funds investing in these technology sectors will need to undertake robust due diligence to comply with this new authority.
• Treasury asked the public to submit comments  about what the impact of the regulations would be to their business activities and investments. Treasury also asked specific questions for the public to answer. Such comments could have a significant influence on how Treasury drafts the final regulations.
• The EO’s impact on existing legislative proposals, including a provision in the Senate-passed National Defense Authorization Act, is unclear. While many Members of Congress responded positively to the Administration’s EO, many also encouraged the Administration to go further in restricting U.S. investment in China.

Background and Purpose

The U.S. government has been considering regulating outbound investment for several years. During the debate concerning reform of inbound foreign investment review and export controls in 2017 and 2018, Congress considered adding provisions for the review of certain outbound investments. These provisions were dropped in the final versions of the legislation (the Foreign Investment Risk Review Modernization Act of 2018 and the Export Control Reform Act), which strengthened the authority of the Committee on Foreign Investment in the United States (CFIUS) and authorized enhanced export controls to address concerns relating to U.S. companies aiding China in the development of strategically significant "emerging and foundational technologies." Subsequently, through Executive Orders, the Trump and Biden administrations prohibited investment in publicly traded securities of certain identified Chinese Military Industrial Complex (CMIC) companies.

This new Executive Order (EO) addresses what the Administration sees as a continuing gap in its authorities, by prohibiting certain investment by U.S. persons into Chinese companies that could provide intangible benefits, such as managerial assistance and market access, that could in turn enable China’s indigenous development of sensitive technologies. It also requires notification of a broader range of transactions to enable the government to collect information on investment flows and potentially take additional regulatory action in the future. The EO focuses on specified activities with respect to certain technologies and does not establish a list-based approach that identifies companies by name. This sectoral approach will allow the government to capture early-stage investment, as well as investment in mature companies.

Summary of Rule and Status

Although Treasury states explicitly that the Advance Notice of Proposed Rulemaking (ANPRM) does not identify the full scope of approaches that Treasury might take in finalizing regulations to implement the EO, the ANPRM provides extensive insight on key parameters under consideration. In particular, it describes the types of China-related transactions that Treasury is considering prohibiting or requiring be notified to the government if undertaken by a U.S. person. Key parameters include the following:

Covered transactions would include any of the following direct or indirect transactions by a U.S. person:

1. Acquisition of an equity interest or contingent equity interest in a “covered foreign person” (described below);
2. Provision of debt financing to a covered foreign person where such debt financing is convertible to an equity interest;
3. Greenfield investments that could result in the establishment of a covered foreign person; or
4. Establishment of a joint venture, wherever located, that is formed with a covered foreign person or could result in the establishment of a covered foreign person.

U.S. persons subject to the prohibitions and notification requirements would include (i) U.S. citizens and lawful permanent residents, (ii) entities organized under U.S. law or any jurisdiction of the United States (including branches) and (iii) any person in the United States. Treasury is contemplating covering certain “indirect” transactions by U.S. persons to close loopholes that would result from the use of intermediary entities to undertake transactions that would be prohibited if undertaken directly by the U.S. person. Treasury is also considering covering transactions undertaken by entities controlled by U.S. persons (i.e., entities owned, directly or indirectly, by a U.S. person of a 50% or greater interest) or that are directed by U.S. persons, such as where a U.S. citizen serves as an officer of a non-U.S. fund and directs a transaction that would otherwise be prohibited or a U.S. person manages a foreign fund (e.g., general partners).

Covered foreign persons would be scoped through a two-step definition:

1. A “person of a country of concern” would include: (i) citizens and permanent residents of China who are not U.S. persons, (ii) entities organized or with a principal place of business in China, (iii) the Chinese government and persons controlled by or acting on behalf of the government, and (iv) entities that are at least 50% owned by persons under (i) – (iii).
2. A “covered foreign person” in turn would be defined to include (a) a person of a country of concern that is engaged in (or a U.S. person knows or should know will be engaged in) activities involving “covered national security technologies or products” (described below) or (b) a person whose direct or indirect subsidiaries or branches are referenced in (a) and which, individually or in the aggregate, comprise more than 50% of that person’s consolidated revenue, net income, capital expenditure or operating expense. Consequently, subsidiaries, and some parents, of Chinese companies in third countries would be captured as covered foreign persons.

Covered national security technologies and products would be defined based on a description of the technology and the relevant activities, capabilities or end uses. Depending on the specific technology or product, a covered transaction may be either prohibited or require notification. Based on the ANPRM, this would include:

• Semiconductors and microelectronics: Prohibition on transactions with covered foreign persons engaged in activities involving certain (i) technologies that enable advanced integrated circuits (ICs) (e.g., electronic design automation (EDA) tools for IC design, front-end semiconductor equipment exclusively for volume fabrication); (ii) advanced IC design and production (e.g., design for 3A090 chips, advanced nodes production, certain special production process (e.g., gallium-based compound IC manufacturing), certain IC packaging that support 3D integration; and (iii) installation or sale to third-party customers of certain supercomputers; and a notification requirement where the covered foreign person is engaged in activities involving the design, fabrication, and packaging of ICs not covered by the prohibitions. The prohibitions cover a broader span of the semiconductor supply chain than the October 7, 2022, export control rules.
• Quantum information technologies: Prohibition on covered transactions with covered foreign persons engaged in activities involving (i) the production of a quantum computer, dilution refrigerator or two-stage pulse tube cryocoolers; (ii) the development of a quantum sensing platform designed to be exclusively used (or potentially just primarily used) for military end uses, government intelligence or mass-surveillance end uses; and (iii) the development of a quantum network or quantum communication system designed to be exclusively used (or potentially just primarily used) for secure communications, such as quantum key distribution (including quantum cryptography); and no notification requirement.
• Artificial intelligence (AI) systems: Prohibition on covered transactions with covered foreign persons engaged in the development of software that incorporates an AI system and is designed to be exclusively used (or potentially just primarily used) for military, government intelligence or mass-surveillance end uses; and a notification requirement for covered foreign persons engaged in the development of software that incorporates an AI system and is designed to be exclusively used for (or potentially just primarily used) for cybersecurity applications, digital forensics tools and penetration testing tools; the control of robotic systems (which is not defined and in particular could cover many commercial applications); certain surreptitious listening devices; non-cooperative location tracking; or facial recognition.

Penalties could be assessed up to the maximum allowable under the International Emergency Economic Powers Act, which is currently $356,579 per violation. This could include both civil and criminal penalties.

Next Steps

Timing. Treasury asks 83 specific questions in the ANPRM, including how significant the anticipated costs and burdens of compliance might be. After reviewing comments, Treasury will most likely publish draft regulations with another comment period of 30 days before it issues final regulations. This new program therefore will not become effective until 2024, potentially well into the year. It will be evaluated within one year of the effective date of the regulations, and annually thereafter, to determine if modifications should be made.

Congressional Reaction. The interplay between the EO and congressional efforts on outbound investments is unclear. As described in a recent Akin client alert, the Senate recently passed a measure as part of the National Defense Authorization Act (NDAA) that would require notification of certain transactions in China in a somewhat similar fashion as the EO. However, a few notable differences are that (i) the Senate provision covers more types of transactions (including more passive investments) than the EO; (ii) the Senate provision covers more sectors (including hypersonics, satellite-based communications and networked laser scanning systems); and (iii) the Senate provision is notification only and does not prohibit any transactions.

Many members of Congress indicated support for the EO, but also characterized it as a first step, with some indicating that more needs to be done. For example, Sen. Bob Casey (D-PA), one of the lead proponents of outbound investment screening in the Senate, indicated that Congress should still codify the Senate approach as part of the NDAA. China Select Committee Chairman Mike Gallagher (R-WI) indicated that the EO has too many loopholes and does not adequately cover passive investment while House Financial Services Ranking Member Waters (D-CA) suggested that the EO should be broadened to address supply chain issues, passive investment and apply retroactively. On the other hand, House Financial Services Chairman Patrick McHenry (R-NC) complimented the EO for its narrow scoping, but also indicated it would be better to focus on strengthening existing sanctions measures instead of creating a new mechanism to address concerns about investment in China. This suggests that the NDAA Conference will be fluid and that Congress could go in multiple directions, such as codifying the Senate-passed measure, passing a different measure or taking no action at all.