At a time when technological power and economic security are more intertwined than ever, the United States has refined its efforts to restrict foreign investment. As we have blogged about since 2022, over the past two years there have been efforts to restrict foreign investment on national security grounds. These efforts have been undertaken both by legislation from Congress and by executive order from the White House.
On August 9, 2023, the Biden Administration issued Executive Order 14105, which restricts U.S. investment in certain national security technologies and products in Countries of Concern (defined as China, including Hong Kong and Macau).
On Friday, June 21, the Treasury Department released a Notice of Proposed Rulemaking (NPRM) setting out proposed foreign investment regulations.
Proposed Regulation
The NPRM marks an important step in U.S. policy to regulate foreign investment in critical technologies to protect them from foreign adversaries. Key elements of the NPRM include:
- Prohibited investmentsThe proposed restrictions would prohibit U.S. persons from engaging in certain transactions involving countries of concern, including:
- Semiconductors and Microelectronics: Transactions relating to electronic design automation software, certain manufacturing and advanced packaging tools, the design, manufacture, or packaging of certain advanced integrated circuits, and supercomputers.
- Quantum Information Technology: Transactions relating to the development and manufacture of critical components for quantum computers, the development or manufacture of certain quantum sensing platforms, and the development or manufacture of quantum networks and quantum communication systems.
- AI Systems: Transactions relating to the development of AI systems designed to:
- Used exclusively for military purposes or intended for military purposes (for exampleweapons targeting, target identification, combat simulation, control of military vehicles or weapons, military decision-making, weapons design, or logistics and maintenance of combat systems).
- is used or intended to be used solely for government intelligence or mass surveillance end uses (for exampletext, voice, or video mining, image recognition, location tracking, or covert eavesdropping devices) or
- Trained using a certain level of computing power (for exampleinteger or floating point arithmetic). Treasury is considering three potential alternatives for the level of computational arithmetic: 10^24, 10^25, or 10^26, but for use primarily with biological sequence data, the levels of computational arithmetic being considered are 10^23, 10^24, or 10^25.
- Notification Requirements: The proposed regulations would require U.S. persons involved in covered transactions to provide notice to the U.S. Treasury:
- Semiconductors and Microelectronics: Transactions relating to the design, manufacture, or packaging of integrated circuits not included in the definition of prohibited transactions.
- AI Systems: Transactions involving the development of AI systems not subject to the prohibitions above, where such AI systems are designed or intended to:
- The ultimate goal of government intelligence and large-scale surveillance (for examplethrough text, voice, or video mining, image recognition, location tracking, or covert eavesdropping devices) or military end uses (for exampleweapons targeting, target identification, combat simulation, control of military vehicles or weapons, military decision-making, weapons design, or logistics and maintenance of combat systems).
- Used for cybersecurity applications, digital forensic tools, penetration testing tools, or to control robotic systems.
- Trained using a certain level of computing power (for exampleinteger or floating point arithmetic). Here, the Treasury Department is considering three potential alternatives for the level of computational arithmetic: 10^23, 10^24, or 10^25.
- Notification timing: The proposed regulations provide that the notice must be filed within 30 days after the closing of the transaction, unless the U.S. person has actual knowledge after the closing date that the transaction would have been a covered transaction if the U.S. person had that knowledge at the time of the transaction, in which case the notice must be filed within 30 days after the U.S. person gained that knowledge.
- Restrictions on eligible foreign nationalsThe proposed restrictions would apply to transactions with covered foreign persons for a subset of the technologies and products listed above. Persons of countries of concern are defined to include:
- Individuals who are nationals or permanent residents of a country of concern (but are not U.S. nationals or permanent residents)
- An entity organized under the laws of the country of concern and having its head office, incorporation or principal place of business in the country of concern.
- the government of the country of concern, or
- An entity that is majority owned, directly or indirectly, by an individual or entity falling within any of the preceding categories.
Thus, the proposed regulations cover certain acquisitions of equity or conditional equity interests, debt financings convertible into equity interests, conversions of conditional equity interests or convertible debt, and greenfield, brownfield, or joint venture investments.In addition, the proposed rules include certain transactions involving entities in which a covered foreign person has voting power, director voting power, or an equity interest, where 50% or more of one of several key financial metrics of the entity is attributable to the covered foreign person.
- Requirements for US persons: The NPRM is limited to U.S. persons, which includes U.S. citizens or lawful permanent residents, any entity organized under U.S. law or jurisdiction within the United States (including any foreign branch of such an entity), and any person within the United States.
- Knowledge Standards: The proposed regulations include a “knowledge standard” to determine the extent to which a U.S. person is aware of the impact of an investment on national security technology. Thus, this standard means that a U.S. person must know, or reasonably should know, based on publicly available information or information available through reasonable and appropriate due diligence, that a transaction involving a covered foreign person is a covered transaction. This standard precludes an investor from claiming that they were unaware of the potential consequences of their investment.
- National Interest Exemption: The proposed regulations allow national interest exemptions to permit certain transactions that might otherwise be restricted if they are determined to be in the national interest of the U.S. The proposed regulations establish procedures for U.S. persons to seek national security exemptions from the notification and prohibition requirements.
- Exceptions to this rule: Aiming to balance national security concerns with the need for international cooperation and innovation, certain transactions may be exempted based on criteria such as the nature of the investment and its relationship to a foreign entity.
- Publicly Traded Securities: An investment by a U.S. person in publicly traded securities or securities issued by an investment company (such as an index fund, mutual fund or exchange-traded fund).
- Certain LP Investments: Investments of a certain size made by U.S. persons as limited partners or equivalent in venture capital funds, private equity funds, funds of funds, or other pooled investment funds.
- Acquisition of Country of Concern Ownership: A U.S. person acquires outright all of an entity’s Country of Concern ownership interests, such that the entity is no longer a covered foreign person after the transaction.
- Intercompany transactions: Intercompany transactions between a U.S. parent and a majority-controlled subsidiary in support of ongoing operations or other uncovered activities.
- Binding Commitments Prior to Outbound Orders: Transactions that fulfill binding uncalled capital commitments entered into before August 9, 2023.
- Certain syndicated debt financings: Where a U.S. person, as a member of a financing syndicate, acquires the voting power of a covered foreign person in the event of default and cannot take any action against the debtor, and does not play a leading role in the syndicate.
- Third Country Measures: Certain transactions involving persons in a country or region other than the United States may be excepted transactions if the Secretary of the Treasury determines that the country or region is addressing national security concerns raised by foreign investment and that the transaction is of a type that makes it likely that the relevant national security concerns will be adequately addressed by actions of that country or region.
- Violation, Divestment, VSD: The NPRM outlines penalties for violations of the rules, including monetary fines, civil penalties, criminal charges, and potential restrictions on future investments. Additionally, any investments made in violation of the rules may result in divestment requirements. The proposed rules also provide for a process for U.S. persons to voluntarily submit self-disclosures if they believe their actions may have led to a violation of any of the rules.
- Request for Comments and Effective Date: The Department is seeking public comment on the NPRM by August 4, 2024. Importantly, no effective date has been set for the proposed regulations at this time, allowing time for thorough consideration of any feedback received.
Business and Strategic Technology Impact
The impact of the NPRM will be significant, especially for companies operating in the semiconductor, AI, and quantum computing sectors. Companies may need to reevaluate their international investment strategies, strengthen due diligence in transactions, and prepare for a more complex regulatory environment. Strategies include engaging with legal counsel early, developing compliance mechanisms, and monitoring regulatory developments. Adjusting to this regulatory framework will require companies to be savvy and adaptive.
Conclusion
The Treasury NPRM is an important step. As the regulations are finalized, companies, especially those in critical technology sectors, should prepare to consider these restrictions in future covered investments. We will continue to provide insights on how to navigate the complexities of the foreign investment restrictions.
