US Department of the Treasury Issues Final Rule to Regulate Outbound Investments

On October 28, 2024, the US Department of the Treasury (“Treasury”) issued a Final Rule to require the notification or prohibition of certain outbound investments and other transactions by US persons involving persons of countries of concern, and certain subsidiaries or parents thereof, engaged in activities involving three sensitive sectors: (1) semiconductors and microelectronics, (2) quantum information technologies, and (3) certain artificial intelligence (“AI”) systems. The Final Rule’s requirements will go into effect on January 2, 2025.

The Final Rule considered public comments offered to the August 9, 2023 Advance Notice of Proposed Rulemaking (ANPRM) and June 21, 2024 Notice of Proposed Rulemaking (NPRM) and implements Executive Order 14105 (the “Outbound Order”), which was issued on August 9, 2023. As defined in the Outbound Order, only China, including the regions of Macau and Hong Kong, has been designated a “country of concern.”  

Scope

As a threshold matter, the Final Rule’s requirements apply to US persons, including United States citizens and lawful permanent residents, and any person in the US. The requirements also apply to entities organized under US law, and any foreign branches of those entities.

The Final Rule also requires US. persons to take all reasonable steps to prevent transactions by “controlled foreign entities” that would be prohibited if engaged in by US persons. Under the Final Rule, “controlled foreign entities” include any entities, wherever incorporated or organized, of which a US person is a parent. US persons are also prohibited from knowingly directing a transaction by a non-US person that the US person knows at the time of the transaction would be prohibited if engaged in by a US person. The Final Rule provides specificity as to the recusals needed in order to avoid that knowing direction by a US person.

Additionally, the Final Rule contains a knowledge standard, including for the determination of whether a transaction qualifies as a “covered transaction.” Thus, many of the Final Rule’s requirements apply to US persons who have one of the following types of “knowledge:” (1) actual knowledge that a fact or circumstance exists or is substantially certain to occur, (2) an awareness of a high probability of a fact’s or circumstance’s existence or future occurrence, or (3) reason to know of a fact’s or circumstance’s existence. Moreover, a US person who fails to conduct a “reasonable and diligent inquiry by the time of a transaction may be assessed to have had…reason to know of a given fact or circumstance.” If, post-transaction, a US person acquires actual knowledge of a fact or circumstance that, if known at the time of the transaction, would have made the transaction a covered transaction, that person must submit a notification within 30 calendar days.

Covered Transactions and Exceptions

The Final Rule’s requirements apply to “covered transactions,” which are a US person’s direct or indirect:

• Acquisition of an equity interest or contingent equity interest in a person that the US person knows at the time of the acquisition is a covered foreign person.
• Provision of a loan or a similar debt financing arrangement to a person that the US person knows at the time of the provision is a covered foreign person, where such debt financing affords or will afford the US person certain equity-like rights in the covered foreign person.
• Conversion of a contingent equity interest into an equity interest in a person that the US person knows at the time of the conversion is a covered foreign person, where the contingent equity interest was acquired by the US person on or after January 2, 2025 (as a result, the acquisition of a contingent equity interest in a covered foreign person may be a covered transaction both at the time of acquisition and at the time of conversion).
• The acquisition, leasing, or other development of operations, land, property, or other assets in a country of concern (i.e., a greenfield or brownfield investment) that the US person knows at the time will result in, or that the US person plans to result in:
• The establishment of a covered foreign person; or
• The engagement of a person of a country of concern in a covered activity.
• The entrance into a joint venture, wherever located, that is formed with a person of a country of concern, and where the US person knows at the time of entrance that the joint venture will engage, or plans to engage, in a covered activity.
• The acquisition of a limited partner or equivalent interest in a venture capital fund, private equity fund, or similar fund that a US person knows at the time of the acquisition likely will invest in a person of a country of concern that is in one of the sensitive sectors described above, and that fund undertakes a transaction that would be a covered transaction if undertaken by a US person.

The Final Rule provides a list of transactions that are specifically excepted from the definition of “covered transactions,” as follows:

• An investment by a US person:
  • In any publicly traded “security”;
  • In a security issued by any “investment company”;
  • Made as a limited partner or equivalent in a venture capital fund, private equity fund, or similar fund where: (A) the limited partner’s or equivalent’s committed capital is not more than $2,000,000, aggregated across any investment and co-investment vehicles of the fund; or (B) the limited partner or equivalent has secured a binding contractual assurance that its capital in the fund will not be used to engage in a transaction that would be a prohibited transaction or notifiable transaction, as applicable, if engaged in by a US person; or
  • In a derivative, so long as such derivative does not confer the right to acquire equity, any rights associated with equity, or any assets in or of a covered foreign person.

Such investments will only qualify as excepted if they do not afford the US person any rights beyond standard minority shareholder protections with respect to the covered foreign person. The Final Rule includes a non-exclusive list of example minority shareholder protections.

• The complete buyout of all of a person of a country of concern’s interests.
• Certain intracompany transfers, specifically, a transaction that otherwise would be a covered transaction between a US person and its controlled foreign entity and either supports operations that are not covered activities or maintains covered activities that the controlled foreign entity was engaged in prior to January 2, 2025.
• A transaction made after January 2, 2025, pursuant to a binding, uncalled capital commitment entered into before January 2, 2025.
• The acquisition of a voting interest in a covered foreign person by a US person upon default or other condition involving a loan or a similar financing arrangement, where the loan was made by a syndicate of banks in a loan participation, and the US person lender(s) in the syndicate cannot act on its own with respect to the debtor and is not the syndication agent.
• An individual’s employment compensation in the form of stock or stock options.
• Certain transactions with or involving a person of a country or territory outside of the United States that Treasury has designated as qualifying for to-be-developed criteria related to outbound investment regulation.
• transaction for which the US Government grants an exemption on the basis that the transaction is in the US national interest.

Covered Foreign Persons and Persons of a Country of Concern

As defined in the Final Rule, a “covered foreign person” is:

• A person of a country of concern that engages in a covered activity; or
• A person that directly or indirectly holds a board seat on, a voting or equity interest in, or any contractual power to direct or cause the direction of the management or policies of such persons, and through which it derives more than 50%of its annual revenue or annual net income, or incurs more than 50% of its annual capital expenditure or operating expenses, in each case based on certain aggregation and monetary thresholds.

Thus, the definition of a “covered foreign person” includes both (1) a person of a country of concern engaged in a covered activity; and (2) other persons with the specified relationships with persons of a country of concern engaged in a covered activity. This definition provides a broad reach to the Final Rule, with an application not just to entities located in the “countries of concern” specified above.

Finally, the Final Rule provides a definition of “person of a country of concern” that, again, is not just limited to entities located in the “countries of concern” specified above. The term includes:

• Any individual who is a citizen or permanent resident of a country of concern, and is not a US citizen or permanent resident of the United States.
• An entity with a principal place of business in, headquartered in, or incorporated in or otherwise organized under the laws of, a country of concern.
• The government of a country of concern; any person acting for or on behalf of that government; or any entity, wherever located, with respect to which that government holds, individually or in the aggregate, directly or indirectly, 50% or more of the outstanding voting interests, voting power of the board, or equity interest, or otherwise possesses the power to direct or cause the direction of the management and policies.
• Any entity, wherever located, in which one or more persons identified above individually or in the aggregate, directly or indirectly, holds at least 50% of the outstanding voting interests, voting power of the board, or equity interests.

Prohibited and Notifiable Transactions

The Final Rule sets out prohibitions and notification requirements for covered transactions involving the activities in the three sensitive sectors identified above (and spelled out in detail below). Notifications must be filed no more than 30 days after the covered transaction or 30 days after the US person acquires actual knowledge that the transaction would have been covered at the time of the transaction.

Semiconductors and Microelectronics

The Final Rule prohibits certain covered transactions related to the development, production, design, fabrication, packaging, installation, or sale of:

• Certain electronic design automation software.
• Certain fabrication or advanced packaging equipment or items designed exclusively for use in or with ultraviolet lithography fabrication equipment.
• Integrated circuits based on certain technical, performance, or design parameters.
• Certain supercomputers enabled by advanced integrated circuits that provide certain compute capacities.

The scope of notifiable transactions involving the semiconductor and microelectronics industry is broad and includes covered transactions in which the relevant covered foreign person or joint venture designs, fabricates, or packages any other integrated circuit not described above.

Quantum Information Technologies

The Final Rule prohibits certain covered transactions related to:

• The development of quantum computers or production of any critical components required to produce a quantum computer.
• The development or production of certain quantum sensing platforms designed or military, government intelligence, or mass surveillance end uses.
• The development or production of certain quantum networks or quantum communication systems.

The Final Rule does not provide a category of notifiable covered transactions involving quantum information technologies.

AI Systems

The Final Rule defines the term “AI system” to mean:

• A machine-based system that can, for a given set of human-defined objectives, make predictions, recommendations, or decisions influencing real or virtual environments—i.e., a system that:
• Uses data inputs to perceive real and virtual environments;
• Abstracts such perceptions into models through automated or algorithmic statistical analysis; and
• Uses model inference to make a classification, prediction, recommendation, or decision.
• Any data system, software, hardware, application, tool, or utility that operates in whole or in part using a system described above.

With respect to these AI systems, the Final Rule prohibits certain covered transactions related to:

• The development of any AI system designed to be exclusively used for, or intended to be used for, certain end uses (including military end uses and government intelligence or mass-surveillance end uses); or
• The development of any AI system that is trained using specified thresholds of computing power.

With respect to notifiable transactions and AI systems, the Final Rule requires notification of certain covered transactions related to the development of any AI system not otherwise covered by the prohibited transaction definition, where that AI system is:

• Designed or intended to be used for certain end uses or applications; or
• Trained using a specified threshold of computing power.

Analysis

The Final Rule is the culmination of years of effort in the regulation of US outbound investment in sensitive sectors. Moreover, in many instances the Final Rule covers a broad scope of transactions. Thus, parties to potential transactions should carefully consider the regulations and implement procedures to evaluate potential tripwires. Significant civil ($368,136 or twice the amount of the transaction that is the basis of the violation) and criminal ($1 million and up to 20 years imprisonment) penalties for violations will serve as potent enforcement tools; the Final Rule also provides Treasury with the authority to require divestment of any prohibited transactions. Due diligence and advice of counsel prior to consummating a transaction will be critical to avoiding penalties and other consequences.