U.S. Treasury Department Issues Proposed Rulemaking for Forthcoming Outbound Investment Program

Background
On August 9, 2023, President Biden signed Executive Order (EO) 14105 titled "Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern." This new EO marked the conclusion of extensive deliberations by the Biden Administration on outbound investment regulations and initiated a 45-day comment period to establish a new regulatory framework for reviewing outbound investments in foreign countries of concern. Our prior alerts on this subject are available here and here.

As was the case with the prior ANPRM, the new NPRM sets out to accomplish two objectives in the regulations, including:

• a requirement that U.S. persons provide notification regarding certain transactions involving national security technologies and products that may contribute to a threat to the national security of the United States (notifiable transactions); and
• the prohibition of U.S. persons from engaging in certain other transactions involving national security technologies and products that pose a particularly acute national security threat to the United States (prohibited transactions).

Similar to the ANPRM, the NPRM requires notification or prohibits certain transactions by a U.S. person with a “covered foreign person” from a “country of concern” involved in “covered activities” related to “covered national security technologies and products.” Importantly, the NPRM is a set of draft regulations. Neither the Biden administration nor the Treasury Department has specified a timeline for the implementation of final regulations.

Covered Foreign Persons
The EO requires that the Treasury Department prohibit or require notification of certain transactions involving covered foreign persons. The NPRM broadens the definition of “covered foreign person” to include:

• a person of a country of concern (i.e., China, Macau or Hong Kong) that engages in a covered activity; or
• a person who is not a person of a country of concern, but:
• holds a specified interest in the person of a country of concern in the form of a voting interest, board seat (voting or observer), equity interest, or the power to direct or cause the direction of the management or policies of the person of a country of concern; and
• more than 50% of the person’s revenue, net income, capital expenditure, or operating expenses that are attributable to the person of a country of concern, and that person must be engaged in a covered activity.

Covered Activities
The “covered activities” contemplated for regulation include those involving certain technologies and products that may contribute to U.S. national security threats. Please see this chart of "covered activities."

Key Changes from the Prior ANPRM
There are a number of key differences between the August 2023 ANPRM and the June 21, 2024, NPRM, including:

• a broadened scope of AI systems covered by the rule. The NPRM adds a computational power threshold trigger for an AI system to be a covered activity, in addition to the end-use trigger for both notifiable and prohibited transactions. The NPRM notes that the computation threshold is still being determined and that after a final rule is issued, the Treasury Department may periodically adjust the computation threshold to ensure it adequately addresses threats to national security;
• clarification of the scope of the prohibition on U.S. persons “knowingly directing” certain transactions. A U.S. person “knowingly directs” a transaction when they have authority to make or substantially participate in decisions on behalf of a non-U.S. person and exercise that authority to direct, order, decide upon or approve a transaction that would be a prohibited transaction if engaged in by a U.S. person. Such authority exists when a U.S. person is an officer, director, senior advisor or person who otherwise possesses senior-level authority, but would not necessarily apply to ordinary third-party services, such as banking services or routine administrative work by a U.S. person who lacks substantial involvement in an investment decision;

• expansion of the Knowledge Standard. Under the proposed standard, a U.S. person may be found to have knowledge if the U.S. person: (1) possesses actual knowledge that a fact or circumstance exists or is substantially certain to occur; (2) possesses an awareness of a high probability of a fact or circumstance’s existence or future occurrence; or (3) could have possessed such information through a reasonable and diligent inquiry. Treasury will take into consideration adequate due diligence on a transaction to determine whether a U.S. person had in fact “knowledge”;
• notification of post-transaction knowledge. A U.S. person must also notify the Treasury Department if the U.S. person acquires actual knowledge following the completion date of a transaction that the transaction would have been a covered transaction if the U.S. person had known of relevant facts or circumstances as of the completion date. Notification must be made “promptly,” but no later than 30 days following acquisition of knowledge; and

• clarification of the scope of limited partnership (LP) investments that would be covered by the proposed rule and those that would be excepted. At the outset, the proposed rule sets out that a “covered transaction” includes investment by a limited partner in an investment fund that then invests into a covered foreign person.

The NPRM prohibits investments into a non-U.S. person pooled fund where the U.S. person knows at the time of the investment that the pooled fund is likely to invest in a person of a country of concern engaged in one of the covered technologies. The NPRM notes that knowledge is determined through “reasonable and diligent inquiry” into the likely geography and sectors of the pooled fund’s potential investments. In examples provided by the NPRM, “reason to know” can be determined, for example, by a history of investments in a covered country. Importantly, the prohibition on the LP investment is triggered only when the pooled investment fund undertakes a transaction that would be a covered transaction if made by a U.S. person.

The proposed rule also provides two potential alternatives for defining exceptions to the general prohibition on U.S. persons investing into a pooled fund that invests into a covered foreign person.

• Option 1: A U.S. person’s investment in a pooled fund would be excepted if the U.S. person’s rights are consistent with a passive investment and; the U.S. person’s committed capital does not exceed 50% of the fund’s total assets. If the U.S. person’s capital exceeds 50%, then they must secure a binding agreement that the pooled fund will not engage in a prohibited transaction.
• Option 2: A U.S. person’s investment would be excepted if their committed capital is less than $1 million.

The NPRM is soliciting comments specifically on both the scope of prohibited LP investments and the preferred alternative for exceptions for LP transactions.

Looking Forward
The NRPM asks for stakeholder comments in several areas, including the compliance and diligence burdens imposed by the rule, scope of “covered activities,” and the breadth of the rule, among other things. U.S. persons considering investments or other transactions involving China or with Chinese counterparties should review whether the relevant technologies and products at issue will be covered by the outbound investment program. Comments will be accepted on the NPRM until August 4, 2024.