Treasury Publishes Proposed Rule to Implement Outbound Investment Program

On June 21, 2024, the U.S. Department of the Treasury issued a notice of proposed rulemaking (“NPRM”) to implement the China-focused outbound investment program introduced by Executive Order 14105 (the “Outbound EO”) of August 9, 2023. The NPRM, which is not a final rule, builds upon the advance notice of proposed rulemaking published by the Treasury Department in conjunction with the Outbound EO.

The NPRM would impose notification requirements—and, in some cases, prohibitions—with respect to certain U.S. investments concerning China that involve semiconductors and microelectronics, quantum information technologies, or artificial intelligence.

1. Who Would Be Required to Comply?

The Outbound EO’s restrictions and requirements would apply to “U.S. persons,” defined by the NPRM as follows:

• Any United States citizen, lawful permanent resident, entity organized under the laws of the United States or any jurisdiction within the United States (including any foreign branch of any such entity), or any person in the United States.

U.S. persons’ obligations under the NPRM would extend to the activities of their “controlled foreign entities”:

• The term “controlled foreign entity” would mean any entity incorporated in, or otherwise organized under the laws of, a country other than the United States of which a U.S. person is a direct or indirect parent (i.e., investment adviser, general partner, or holder of more than a 50% outstanding voting interest or voting power of the board).

Specifically, a U.S. person would be required to take “all reasonable steps” to prohibit and prevent a controlled foreign entity from engaging in a transaction that would be prohibited if undertaken by a U.S. person, and to notify the Department of the Treasury if the controlled foreign entity undertakes a transaction that would be a notifiable transaction if undertaken by a U.S. person.

2. What Transactions Would Be In Scope?

The NPRM would regulate “covered transactions,” defined broadly to include several types of equity and non-equity investments in “covered foreign persons.”

A. Covered Foreign Persons

The term “covered foreign person” would include, inter alia, (1) a “person of a country of concern” (i.e., China, inclusive of Hong Kong and Macau) engaged in a “covered activity”; and (2) a person that directly or indirectly derives more than 50% of its revenue/income from, or incurs more than 50% of its capex/operating expenses through, any person of a country of concern engaged in a covered activity (e.g., a parent company with Chinese subsidiaries).

1. Person of a Country of Concern

The NPRM would define “person of a country of concern” broadly and, consequently, the NPRM’s prohibitions and requirements would capture entities both within and outside of China:

• 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 (inclusive of any political subdivision, agency or instrumentality thereof, or other subordinate entity, as well as a person acting on behalf of a government of a county of concern);
• Any entity that is 50% or more owned, individually or in the aggregate, by one or more of the foregoing; and
• Any entity in which one or more of the foregoing holds, individually or in the aggregate, at least 50% of the outstanding voting interest, voting power of the board, or equity interest.

2. Covered Activity

The term “covered activity” would encompass any activity that is prohibited or notifiable under the Outbound EO, which the NPRM would define as follows:

Sector	Prohibited Transactions	Notifiable Transactions
Semiconductors and Microelectronics	Entities engaged in the development or production of any electronic design automation software for the design of integrated circuits or advanced packaging. Entities that develop or produce (1) front-end semiconductor fabrication equipment designed for performing volume fabrication of integrated circuits; (2) equipment for performing volume advanced packaging; or (3) commodity, material, software, or technology designed exclusively for use in or with extreme ultraviolet lithography fabrication equipment. Entities that design integrated circuits that meet or exceed specified performance parameters or that are designed for operation at certain temperatures. Entities that fabricate integrated circuits that meet specified criteria. Entities that package integrated circuits using advanced packaging techniques. Entities that design, sell, or produce supercomputers enabled by advanced integrated circuits that can perform at certain thresholds.	Entities engaged in the design, fabrication, or packaging of any integrated circuit that does not meet the parameters necessary to trigger a prohibition.
Quantum Information Technologies “Quantum computer” is defined as “a computer that performs computations that harness the collective properties of quantum states, such as superposition, interference, or entanglement.”	Entities engaged in the development of quantum computers or the critical components required to produce quantum computers, such as dilution refrigerators or two-stage pulse tube cryocoolers. Entities engaged in the development or production of quantum sensing platforms designed for, or intended to be used for, military, government intelligence, or mass-surveillance end uses. Entities engaged in the development or production of quantum networks or communication systems designed for, or intended to be used for, networking to scale up capabilities of quantum computers, secure communications, or any other application that has any military, government intelligence, or mass-surveillance end use.	None.
Artificial Intelligence “AI system” is defined broadly as either (1) a machine-based system that can, for a given set of human-defined objectives, make predictions, recommendations, or decisions influencing real or virtual environments; or (2) any data system, software, hardware, application, tool, or utility that operates in whole or in part using such a system.	Entities engaged in the development of AI systems exclusively designed for, or intended to be used for, military, government intelligence, or mass surveillance end uses. Entities engaged in AI systems trained using a to-be-determined quantity of computing power.	Entities engaged in the development of AI systems that are designed for military, government intelligence, or mass surveillance end uses (but not exclusively). Entities engaged in the development of AI systems intended to be used for cybersecurity applications, digital forensics tools, penetration testing tools, or the control of robotics systems. Entities engaged in AI systems trained using a to-be-determined quantity of computing power (i.e., at a threshold lower than that for prohibited transactions).
Other Categories of Transactions	Entities engaged in covered activities (i.e., notifiable activities) that are subject to certain sanctions, export restrictions, or designations imposed by the Office of Foreign Assets Control, the U.S. Department of Commerce’s Bureau of Industry and Security, or the U.S. Department of State.	None.

B. Covered Transactions

The term “covered transaction” would include equity investments as well as (1) non-equity investments that confer rights characteristic of an equity investment; and (2) certain limited partnership investments:

• Acquisition of equity interest or contingent equity interest: Acquisition of an equity interest or a contingent equity interest (or interest equivalent to an equity or contingent equity interest) in a person that the U.S. person knows is a covered foreign person;
• Convertible debt; debt with special rights: Provision of a loan or similar debt financing to a person that the U.S. person knows is a covered foreign person, if the debt financing is (1) convertible into an equity interest; or (2) will afford the U.S. person the right to make management decisions with respect to the covered foreign person or appoint board directors (or equivalent);
• Conversion of contingent interest or convertible debt: Conversion of a contingent equity interest or debt into an equity interest in a person that the U.S. person knows is a covered foreign person;
• Greenfield or brownfield investment: Acquisition, leasing, or other development of operations, land, property, or other assets in a country of concern, where the U.S. person knows will, or intends to, result in (1) the establishment of a covered foreign person; or (2) the engagement of a covered foreign person in new covered activity.
• Joint venture investment: Entrance into a joint venture, wherever located, with a person in a country of concern, where the U.S. person knows that the joint venture will, or intends for the joint venture to, engage in covered activity; and
• Certain limited partner investments in non-U.S. funds: Acquisition of a limited partner or equivalent interest in a non-U.S. fund (including venture capital funds, private equity funds, funds of funds, and other pooled investment funds), where (1) the U.S. investor knows the fund will likely invest in a person of a country of concern that is in the semiconductors and microelectronics, quantum information technologies, or artificial intelligence sector, and (2) such fund undertakes a transaction that would be a covered transaction if undertaken by a U.S. person. While a limited partner may not know how a third party-managed fund will deploy its capital, the NPRM posits that it is possible for a limited partner to know, through reasonable and diligent inquiry, where a pooled fund is likely to invest in terms of geography and sector.

Importantly, the NPRM contemplates certain exemptions from the definition of covered investment, including for:

• Publicly traded securities: Acquisition of publicly traded securities or securities issued by any “investment company” as defined in the Investment Company Act of 1940 (e.g., index fund, mutual fund, or exchange traded fund), if such transaction does not afford the U.S. person rights beyond standard minority shareholder protections;
• Certain limited partner investments: Certain limited partner investments in pooled investment funds, for which the Treasury Department is contemplating alternative exemptions:
  • Alternative 1: An investment by a limited partner in a fund where the limited partner (1) is not responsible for any debts or financial obligations beyond its investment; (2) cannot influence the fund’s investment decisions; (3) cannot participate in decisions made by the general partner; (4) does not possess unilateral rights with respect to appointment, removal, or compensation of the general partner; (5) cannot influence the decisions of any covered foreign person in which the fund invests; and (6) either possesses a 50% or lesser interest in the fund or has secured a contractual commitment providing that the fund will not cause the limited partner to participate indirectly in a prohibited transaction (the NPRM notes that participation on a limited partner advisory committee would not constitute having the ability to undertake the actions in (1)-(5) if the committee does not have the ability to approve or control decisions of the fund or general partner).
  • Alternative 2: An investment by a limited partner in a fund where the limited partner’s total committed capital is $1,000,000 or less, and the investment does not afford the limited partner any rights beyond standard minority shareholder protections.
• Buyouts of country of concern ownership: A buyout of all of the ownership of a person of a country of concern in an entity, such that the entity post-transaction is no longer a covered foreign person;
• Intracompany transactions: An intercompany transaction between a U.S. person and its controlled foreign entity that supports ongoing operations or other activities, provided these activities do not involve the establishment of new covered foreign persons, the establishment of a joint venture with a covered foreign person, or the entry into covered activity; and
• Certain syndicated debt financings: A syndicated debt financing, where the U.S. person lender (1) cannot on its own initiate any action vis-à-vis the debtor; and (2) does not have a lead role in the syndicate.
• Pre-Outbound EO binding commitments: A transaction fulfilling a binding, uncalled capital commitment entered into prior to August 9, 2023 (i.e., the date of publication of the Outbound EO).

3. When Would This Apply?

A. Knowledge

The NPRM’s prohibitions and notification requirements would be triggered when a U.S. person knows that a prospective transaction—whether undertaken by the U.S. person or its controlled foreign entity—is a covered transaction:

• Consistent with other regulatory regimes, the NPRM’s definition of knowledge encompasses both actual and constructive knowledge (i.e., whether the U.S. person should have known or had a high probability of awareness through a reasonable and diligent inquiry). The NPRM states that both the scope of pre-acquisition due diligence and contractual representations obtained by a U.S. person may be relevant to determining whether a U.S. person has undertaken a reasonable and diligent inquiry.
• U.S. persons that acquire actual knowledge of a covered transaction post-completion must provide notice of the covered transaction within 30 days of learning of the covered transaction.
• The NPRM contemplates that limited partners’ knowledge generally would be assessed at the time of investment into a third party-managed fund, as opposed to each individual investment by the fund.

B. Notifiable Transaction Reporting

Where a covered transaction is notifiable (versus prohibited), notification must be submitted within 30 days after completion. Under the NPRM, notices of covered transaction must include, inter alia:

• The contact information of a representative of the U.S. person filing the notification, who can communicate with Treasury regarding the filing;
• A description of the U.S. person (including its place of incorporation, principal place of business, and ownership);
• Post-transaction organizational charts of the U.S. person and covered foreign person;
• A description of the commercial rationale for the transaction;
• A description of why the U.S. person determined the transaction is notifiable;
• The status of the transaction (including actual or expected completion date);
• The total transaction value in U.S. dollars;
• The aggregate equity interest, voting interest, and board seats of the U.S. person in the covered foreign person;
• Information about the covered foreign person (including its place of incorporation, principal place of business, ownership, officers, and directors);
• Identification and description of each of the covered activity or activities undertaken by the covered foreign person that makes the transaction a covered transaction, as well as a brief description of the known end use(s) and end user(s) of the covered foreign person’s technology, products, or services; and
• Where the notice is submitted more than 30 days post-closing, a description of why the U.S. person lacked sufficient to knowledge to timely submit (including a description of any pre-transaction diligence conducted).

Upon receipt of a notified transaction, Treasury may submit questions or document requests, with which the U.S. person must comply within the Treasury-specified timeframe. Information received by Treasury would be treated as confidential, subject to certain limited exceptions.

4. Would the NPRM Establish a Reverse CFIUS Regime?

No. The Outbound EO does not establish a review or licensing approval regime for covered transactions similar to the Committee on Foreign Investment in the United States (CFIUS) process. The NPRM contemplates that, in exceptional circumstances, parties to a covered transaction may apply to the Treasury Department to seek an exemption to the Outbound EO’s requirements for a covered transaction that is in the national interest of the United States.

5. What If I Do Not Comply?

Under the NPRM, failure to comply with a prohibition or notification requirement could result in (1) civil liability of the statutory maximum (currently $368,136, adjusted regularly for inflation) or twice the value of the transaction, whichever is greater; or (2) criminal liability of up to $1,000,000 and imprisonment of up to 20 years per violation, if a breach is committed willfully. In addition to statutory penalties, the NPRM would accord Treasury the authority to nullify, void, or compel the divestment of prohibited transactions (although, depending on the facts, Treasury may face practical limitations in attempting to exercise this authority).

6. What’s Next?

The NPRM is not a final rule, and the Treasury Department is soliciting public comments through August 4, 2024. Thereafter, the Treasury Department is expected to publish a final set of implementing regulations; however, there is no specified timeline for those regulations to take effect.

Ropes & Gray is carefully monitoring developments with respect to the outbound investment program. We will provide further updates as more information becomes available. In the meantime, do not hesitate to reach out our international risk team with any questions.