On June 21, 2024, the U.S. Department of the Treasury issued proposed regulations in a Notice of Proposed Rulemaking (the “NPRM”) to implement Executive Order (“E.O.”) 14105, which addresses U.S. investments in certain national security technologies and products in “countries of concern.” Consistent with the E.O., the proposed regulations focus on advanced semiconductors and microelectronics, quantum computing and related technologies, and specific types of artificial intelligence, which the U.S. considers to have national security significance. The “countries of concern” are the People’s Republic of China (“PRC”) as well as the Special Administrative Regions of Hong Kong and Macau.

The proposed regulations, when implemented, will establish an outbound investment control and review program similar in certain respects to the inbound foreign investment regime currently overseen by the Committee on Foreign Investment in the United States (“CFIUS”). They would regulate transactions that may pose a threat to U.S. national security by enhancing the military, intelligence, surveillance, or cyber-enabled capabilities of countries of concern. If enacted as proposed, the regulations would prohibit certain foreign investment transactions by U.S. persons, while requiring U.S. persons to notify the Department of the Treasury of other transactions, absent an applicable exemption. While foreign entities, including subsidiaries of U.S. companies, would not be directly subject to the proposed rule’s requirements, U.S. persons owning or controlling those entities have certain responsibilities with respect to their activities. We summarize the proposed regulations below.

Who is affected?

U.S. persons and their controlled foreign entities.

The regulations would apply to “U.S. persons,” defined as U.S. citizens and permanent residents, any entity organized under U.S. law, and any foreign branch of such an entity. The regulations would also require a U.S. person to take “all reasonable steps” to prohibit and prevent any transaction by its “controlled foreign entity” that would be a prohibited transaction 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. A “controlled foreign entity” includes not only subsidiaries controlled by a majority of voting interest or board votes, but also a foreign entity where the U.S. person is a general partner, managing member, or equivalent of the entity or, if the entity is a pooled investment fund, is an investment adviser to any such fund.

Covered foreign persons.

“Covered foreign persons” include “persons from a country of concern”¹ that engage in a “covered activity,” as well as certain persons who are significantly financially connected to such entities.² “Covered activity” under the rule includes any of the activities outlined in the definitions of notifiable transactions or prohibited transactions, as described below, and there are circumstances where a foreign person of a country of concern could be considered a “covered foreign person” based on known future activity.

What types of transactions would be subject to the rule?

The proposed rule adopts the term “covered transaction” from the CFIUS regulations to describe transactions that would be subject to the rule’s prohibitions or notice requirements. Covered transactions include those in which a U.S. person engages in the following activities, directly or indirectly:

• Acquisitions of ownership interests in a person that the U.S. person knows at the time of the acquisition is a “covered foreign person”;
• Certain debt financing to a person that a U.S. person knows at the time of the provision is a “covered foreign person”;
• The conversion of a contingent equity interest in a person that the U.S. person knows at the time of the conversion is a “covered foreign person”;
• A greenfield investment or other corporate expansion in a country of concern that at the time of investment, the U.S. person knows will, or intends to, result in the establishment of a “covered foreign person” or newly engaging in activity subject to the regulations;
• Entrance into a joint venture, wherever located, that is formed with a person of a country of concern and that the subject U.S. person knows at the time of entrance into the joint venture will engage in or the U.S. person intends to engage in a covered activity; and
• Investments as a limited partner in certain foreign investment funds if the U.S. persons knows at the time likely will invest in a person of a country of concern that is in the semiconductors and microelectronics, quantum information technologies, or artificial intelligence sectors, and such fund undertakes a transaction that would be a covered transaction if undertaken by a U.S. person.

What transactions would be prohibited?

Prohibited transactions are covered transactions involving covered foreign persons engaged in activities that pose a particularly acute national security threat. Broadly, these include certain activities relating to:

• Software for electronic design automation;
• Integrated circuit manufacturing equipment;
• Equipment for performing volume advance packaging;
• Extreme ultraviolet lithography fabrication equipment;
• Advanced integrated circuit design, fabrication, and packaging;
• Supercomputers;
• Quantum computers and components;
• Quantum sensors intended for use in military, government intelligence, or mass-surveillance end uses;
• Quantum networking and quantum communications systems for certain end uses;
• Certain AI system development for military, government intelligence, or mass-surveillance end uses; and
• Certain AI system training.

The rule identifies certain technical specifications and/or capabilities for each of the above categories of technologies and products to fall within the scope of a prohibited transaction.

Further to the above, even if a covered transaction would ordinarily only be subject to a notification requirement under the regulations, the involvement of certain persons designated or subject to certain U.S. sanctions or export control lists (in particular, the Bureau of Industry and Security (“BIS”) Entity List or Military End User List, "military intelligence end-users” pursuant to 15 C.F.R. § 744.22(f)(2), the Office of Foreign Assets Control’s (“OFAC”) List of Specially Designated Nationals and Blocked Persons (“SDN List”), and persons blocked under OFAC’s 50 Percent Rule, Persons on the Non-SDN Chinese Military-Industrial Complex Companies List, and foreign terrorist organizations designated under 8 U.S.C. 1189) would render the transaction prohibited.

U.S. persons are prohibited from engaging in or completing any prohibited transaction, unless they obtain an exemption from the Secretary of the Treasury. The Secretary of the Treasury may grant an exemption on a case-by-case basis, if the Secretary determines that the transaction is in the national interest of the United States.

Borrowing a concept from OFAC’s anti-facilitation rules, the regulations would also prohibit U.S. persons from knowingly directing a transaction by a non-U.S. person that would be prohibited under the regulations if engaged in by a U.S. person. Knowing direction is defined as having the “authority, individually or as part of a group, to make or substantially participate in decisions on behalf of a non-U.S. person, and exercises that authority to direct, order, decide upon, or approve a transaction.” This “authority exist when a U.S. person is an officer, director, or senior advisor, or otherwise possesses senior-level authority at a non-U.S. person.”

What transactions would require notification?

Notifiable transactions generally involve a less-sensitive subset of the broad three categories of technologies and products subject to the regulations. These are:

• Designing, fabricating, or packaging certain integrated circuits for which transactions involving U.S. persons are not otherwise prohibited;
• Developing certain AI systems not covered by the prohibited transaction definition and meeting certain criteria.³

U.S. persons must submit a written notice to the Department of the Treasury no later than 30 days after completion of the transaction if the U.S. person undertakes a notifiable transaction or if its controlled foreign entity engages in a transaction that would be notifiable if engaged in by the U.S. person. The regulations would also impose an ongoing notification requirement where the U.S. person acquires actual knowledge after the completion date of a transaction that the transaction would have been a covered transaction. Such notice would be required no later than 30 days after acquiring such knowledge. The proposed regulations specify the type of information required as part of a notice, which includes information on the parties, the transaction, and the activities at issue.

Excepted transactions

The NPRM would except certain transactions from the prohibition and notification requirements. Excepted transactions include investments in publicly traded securities, securities issued by investment companies, limited partner investments in pooled funds under certain thresholds, full buyouts of interests held by persons of a country of concern, intracompany transactions supporting non-covered activities, transactions made pursuant to binding capital commitments entered into before August 9, 2023, acquisitions upon default involving loans made by a syndicate of banks; and certain transactions that occur in a country or territory outside the United States that has been designated by the Secretary. The proposed regulations outline specific conditions for each category of excepted transaction to apply.

Would the rule be retroactive?

Treasury evidently does not intend for the prohibition and notification requirements in the proposed rule to apply retroactively. However, the NPRM states that Treasury may, after the effective date of the regulations, request information about transactions by U.S. persons that were completed or agreed to after the issuance of E.O. 14105, i.e., August 9, 2023, to aid in the development and implementation of the rule.

Penalties

The regulations also outline penalties for violating the notification or prohibition requirements. Violations of the proposed regulations may result in civil and criminal penalties under the International Emergency Economic Powers Act (“IEEPA”). Civil penalties are currently $368,136 per violation (subject to an annual adjustment for inflation). If a violation is willful, meaning the U.S. person knowingly or intentionally violated the rule, the maximum civil penalties applicable is $1,000,000 per violation. Where the violator is an individual, the individual may also face criminal prosecution and up to 20 years of imprisonment. Additionally, the proposed rule allows the Secretary of the Treasury to order a U.S. person to divest a covered transaction if it is deemed necessary to protect U.S. national security.

Public comment

The Treasury Department is seeking public comment on the proposed rule until August 4, 2024. This feedback will be used to refine the final regulations before they are issued and go into effect.

1. The rule defines “persons of a country of concern” as individuals that are citizens or residents of countries of concern and do not hold US citizenship or residency; (2) entities with a principal place of business in, headquartered in, or incorporated in or otherwise organized under the laws of, a country of concern; (3) the government of a country of concern; (4) any person acting for or on behalf of the government of such country of concern; or (5) any entity with respect to which the government of such country of concern holds 50 percent or more of the entity’s outstanding voting interest, voting power of the board, or equity interest, or otherwise controls; and (d) any entity in which one or more persons identified above holds at least a 50% interest.↩
2. Such persons would be defined to include those who directly or indirectly (1) hold any voting interest, board seat, or equity interest in a person of country of concern engaged in covered activity, or (2) have the power to direct or influence the management or policies of such a person through contractual arrangements, including variable interest entities, and who, based on relevant financial statements: (i) Derives more than 50% of their revenue from persons in (a), (ii) Derives more than 50% of their net income from persons in (a), (iii) Incurs more than 50% of their capital expenditure through persons in (a), or (iv) Incurs more than 50% of their operating expenses through persons in (a).↩
3. The proposed rule contains three alternative formulations of this provision, on which comments are invited.↩