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The U.S. Department of the Treasury (“Treasury”) recently issued a Notice of Proposed Rulemaking (“<a href="https://home.treasury.gov/system/files/206/NPRM%20-%20Provisions%20Pertaining%20to%20U.S.%20Investments%20in%20Certain%20National%20Security%20Technologies%20and%20Products%20in%20Countries%20of%20Concern.pdf">NPRM</a>”), setting the stage for regulation of certain U.S. outbound investment in China and China-linked companies. This NPRM is the latest phase of Treasury’s rulemaking on outbound investment, following Executive Order (“EO”) <a href="https://home.treasury.gov/system/files/206/Executive%20Order%2014105%20August%209%2C%202023.pdf">14105</a> and an Advanced Notice of Proposed Rulemaking (“<a href="https://home.treasury.gov/system/files/206/Provisions%20Pertaining%20to%20U.S.%20Investments%20in%20Certain%20National%20Security%20Technologies%20and%20Products%20in%20Countries%20of%20Concern.pdf">ANPRM</a>”) that was the subject of a previous <a href="/news-and-events/10-key-takeaways-biden-administration-sets-the-stage-for-regulation-of-u-s-investments-in-china/" id="26576">Blank Rome client alert</a>. The NPRM presents draft regulations on this topic for the first time. The period for public comment on the NPRM closes on August 4, 2024.

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Treasury’s June 21, 2024, NPRM seeks to regulate certain U.S. investment in China and China-linked companies based on concerns that U.S. capital and associated “intangible benefits”—such as managerial assistance, enhanced standing, and access to talent networks—could aid China in developing technologies that threaten U.S. national security. The NPRM would apply to “covered transactions;”&nbsp;i.e., those in which a U.S. person or U.S.-owned investor has “knowledge” that the Chinese or China-linked investment target has certain connections with semiconductors, artificial intelligence (“AI”), or quantum technologies that would be subject to a notification requirement or prohibited outright. For further information, see Treasury’s&nbsp;<a href="https://home.treasury.gov/system/files/206/Treasury%20Outbound%20NPRM%20Fact%20Sheet%20FAQ%20-%206.21.2024.pdf">Fact Sheet</a>.

It is important to note that the NPRM is still just a proposal, with no final rule yet on the horizon. Treasury may not issue final regulations for months and perhaps not until next year, and it should be noted that a change in presidential administrations (if one occurs) could delay a final rule and its implementation.

The NPRM contains the following key elements:

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Application to U.S. persons / U.S.-owned entities: The NPRM would apply to U.S. persons—defined as U.S. citizens, U.S. permanent residents, persons located in the United States, and U.S.-incorporated entities and their non-U.S. branches—as well as any non-U.S. entity of which a U.S. person is a “parent” (known as a “controlled foreign entity”).

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Knowledge standard / diligence expectation: The NPRM would apply to transactions in which the investor knows or reasonably should have known, through a “reasonable and diligent inquiry,” that the investment target is a “covered foreign person.”

Specific categories of covered transactions: A “covered transaction” is any transaction that a U.S. person knows involves a “covered foreign person” and includes the following:

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Covered activities: The NPRM identifies a “covered activity” to mean any activity defined as a “notifiable transaction” or “prohibited transaction.”

Countries of concern: As identified in an Annex to EO 14105, the President has designated the People’s Republic of China as a “country of concern,” along with Hong Kong and Macau.

Person of a country of concern: The NPRM expansively defines a “person of a country of concern” to include a range of Chinese persons and China-linked entities outside of China, including:

Covered foreign persons: A “covered foreign person” is defined as:

Excepted transactions: Per Treasury’s <a href="https://home.treasury.gov/system/files/206/Treasury%20Outbound%20NPRM%20Fact%20Sheet%20FAQ%20-%206.21.2024.pdf">Fact Sheet</a>, the NPRM proposes excepting several types of transactions from the rules’ coverage, to include:

National interest exemption: Under the proposed rule, a U.S. person may seek a “national interest” exemption determination for transactions that are “in the national interest of the United States.” Treasury anticipates detailing the process and required information for an exemption at a later date.

Notifiable and prohibited transactions:

Notably, the NPRM provides that the rules do “not entail a case-by-case review by the Department of the Treasury of covered transactions or any other transactions, nor does it establish a licensing process where a U.S. person would seek prior authorization for a covered transaction.” Rather, the NPRM requires U.S. persons to determine whether certain transactions are “prohibited, permissible but subject to notification, or not covered by the rule.”

As identified, above, the NPRM pertains to three types of technologies subject to investment prohibition or notification. Specifically, this includes:

Semiconductors/Microelectronics

Prohibition: Electronic design operation software; certain front-end semiconductor fabrication equipment; certain volume advanced packaging equipment; design, fabrication, and packaging of certain advanced integrated circuits; supercomputers enabled by certain advanced integrated circuits

Notification: Integrated circuit design, fabrication, and packaging not otherwise covered by the prohibited transaction definition

Quantum Information Technologies

Prohibition: Development of a quantum computer; production of any critical elements required to produce a quantum computer; development or production of certain quantum sensing platforms; development or production of certain quantum network or quantum communication systems

Prohibition: Certain AI systems designed to be exclusively used for, or which the relevant covered foreign person intends to be used for, any military, government intelligence, or mass-surveillance end uses

Notification: Development of AI systems not otherwise covered by the prohibited transaction definition that are designed for any (i) military, government intelligence, or mass-surveillance end users; (ii) end users who intend to use the systems for certain applications; and (iii) trained using a specified quantity of computing power

Violations of the NPRM are subject to civil and criminal penalties under the International Economic Emergency Powers Act (“IEEPA”). Violations of IEEPA are punishable by civil penalties of up to the greater of ~$368,000 (annually adjusted for inflation) or twice the value of the transaction at issue, and criminal penalties of up to $1 million and/or 20 years’ imprisonment. In addition, Treasury may force the divestment of a prohibited investment. Notably, the NPRM would authorize any person who has violated the regulations to submit to Treasury a voluntary self-disclosure.

The NPRM is an essential step towards regulating outbound U.S. investments with a link to Chinese technology development, which has been proposed in various forms for years. The following are particularly notable regarding the NPRM:

The focus is on integrated circuits, AI, and quantum—three technologies that are at the apex of U.S. national security concerns. The NPRM is not intended to cover all investments with a China nexus.

Where an investment presents a link with the above technologies, the scope of the NPRM is quite broad, applying to:

The effect of this is that, where an investment could even tangentially involve one of the technologies at issue, U.S. and U.S.-owned investors may need to conduct extensive diligence, covering multiple degrees of separation, to assess whether the transaction is prohibited or notifiable.

The NPRM reinforces this through the knowledge standard, which imputes to investors what they should have known through a “reasonable and diligent inquiry.”

Violations of the NPRM would be subject to potentially significant IEEPA penalties and, for prohibited transactions, unwinding of the transaction.

The NPRM is still just a proposal as of this time, and industry comments and presidential politics are likely to impact the content and timing of any final rule.

For more information or assistance, contact <a href="/people/anthony-rapa/" id="18891">Anthony Rapa</a>, <a href="/people/brendan-s-saslow/" id="18841">Brendan S. Saslow</a>, <a href="/people/patrick-f-collins/" id="18900">Patrick F. Collins</a>, <a href="/people/rachel-d-evans/" id="18789">Rachel D. Evans</a>, or another member of Blank Rome’s <a href="/services-and-industries/international-trade/" id="18498">International Trade</a> group.

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© 2024 Blank Rome LLP. All rights reserved. Please contact Blank Rome for permission to reprint. Notice: The purpose of this update is to identify select developments that may be of interest to readers. The information contained herein is abridged and summarized from various sources, the accuracy and completeness of which cannot be assured. This update should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.

Outbound and Down: Key Takeaways from Treasury’s NPRM

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Outbound and Down: Key Takeaways from Treasury’s NPRM

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