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A Fresh Take

Insights on M&A, litigation, and corporate governance in the US.

| 13 minutes read

President Biden Issues Outbound Investment Restrictions Executive Order – Small Yard, High Fence?

On Wednesday, August 9, 2023, President Biden issued Executive Order 14105, Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern (the “Order”), which prohibits investments by U.S. persons in Chinese companies or Chinese-owned companies involved with certain technologies and creates a notification requirement for others. Simultaneously, the Department of the Treasury (“Treasury”) published an advance notice of proposed rulemaking (“ANPRM”) to seek public comment on future regulations to operationalize the Order.  

Though the outbound investment program applies to any U.S. person, its principal targets are venture capital firms, private equity firms, venture capital arms of strategic companies, and strategic companies seeking joint ventures in China (often to gain market access).

Below we first provide a high-level summary of the measures and expected impact on investors, followed by a more in-depth explanation of the background of the Order and the details of the Order and ANPRM. 

High-Level Summary, Takeaways, and Action Items

  • This is not the sweeping “reverse CFIUS” that some policy makers have sought and many in industry have feared. 
    • It is focused on China. While the program could be expanded to include other countries of concern or technologies, it is not a generally applicable regime. It has elements intended to prevent workarounds, including investments by entities outside the United States controlled by U.S. persons and investment in 50%+ Chinese-owned companies outside of China.
    • It is focused on transactions that could advance the development of technologies in China that have military, intelligence, and surveillance value. It does not seek to address U.S. supply chain integrity or assurance of U.S. domestic critical capabilities, two areas that some have argued could be advanced through outbound investment controls.
    • It is currently contemplated to cover a narrow set of technology areas (described below), rather than the full scope of technologies that have national security relevance (e.g., biotech, telecom, batteries).
    • It covers only transactions involving the creation or acquisition of an ownership interest in an entity: equity, convertible debt, joint ventures, and greenfield. Contracts, IP licensing, and bank loans are not covered.
    • The concern being addressed relates to what some have called “smart capital,” which is investment that brings to the recipient management expertise, reputation enhancement, access to talent networks, market access, and enhanced access to financing that help startups get off the ground and scale up. As such, it does not capture many forms of purely passive investment (public shares, ETFs, mutual funds, limited partner (“LP”) fund investments below a de minimis threshold, provided in each case there are no special rights), ordinary course commercial transactions, and intra-company transfers from U.S. parent companies to their Chinese subsidiaries.
    • It provides that covered transactions are either prohibited or must be notified to the government. It does not involve a licensing or screening system. It is not retroactive. Moving forward, however, violations may be subject to civil and criminal penalties.
  • This will have the greatest impact in the semiconductor sector. The ultimate impact in other areas may be less significant.
    • It would near shut down U.S. investment in China in the semiconductor design software and manufacturing equipment spaces and in fabrication and packaging of advanced semiconductors. It also makes all other IC design, fabrication, and packaging notifiable, which may have a significant chilling effect on investment in the Chinese semiconductor industry generally.
    • It would near shut down U.S. investment in China in the quantum computer and supercomputer space. However, this is a narrower field and one that was already widely understood to be highly sensitive in its entirety.
    • The most surprising news is that it may only have limited impact in the artificial intelligence space. Here the prohibition is focused on military, intelligence, and mass-surveillance end uses. The ANPRM suggests that Treasury is considering whether the criterion should be “exclusive” use or “primary” use for such sensitive purposes; the latter would likely have some degree of chilling effect on some commercial applications as well. Even the areas where notification is proposed are relatively limited. 
    • Beyond these industries, the impact is more one of precedent and risk of future expansion of covered technologies, as some U.S. policy makers are already advocating.
  • The full story is not yet written, however, so the pressures on U.S. activities in China are likely to continue to intensify.
    • The Treasury ANPRM asks for input over the next 45 days. Some contemplated elements could fall away, and some additional limitations could be added before regulations are finalized.
    • As Treasury has stated that it will publish draft regulations which also would be subject to public comment, it is likely that the rules would not be effective before early next year, though it is possible that external factors could push that schedule well into next year.
    • Congress is still seized with this issue, but there are highly varied views among Members. The Senate has already overwhelmingly passed at least a very broad notification requirement, but it remains to be seen whether the House will act and whether political events could allow for even tougher legislation in the next year.
    • The narrow nature of the expected program is likely intended in part to increase the chances of broader international adoption of parallel restrictions. This is on the G7 agenda, and the EU has also confirmed that it is examining outbound investment controls. 
  • There are steps that companies can take now to prepare for the finalization of rules.
    • Companies should size up any investments that may not be closed until next year against the potential rules. The ANPRM is ambiguous as to whether a transaction that has been signed but not closed before the effective date of the regulations would be prohibited.
    • Transactions that are completed starting this week could be subject in the future to a notification requirement, even if not prohibition. Therefore, investors should consider whether future government scrutiny of current transactions would affect their interest in the transaction. 
    • Companies making investments now that may involve follow-on investments in the future should evaluate the potential for the rules to apply to those follow-on investments. If follow-on investments and capital calls can be declined without penalty, the investor may be obligated not to make the follow-on investment. 
    • U.S. investors in non-U.S. funds should consider whether they should include language that allows them to be excused from future fund investments in China that could conflict with the prohibitions under the rules. The ANPRM does not specify the threshold above which an investment as an LP would no longer be viewed as an exempt investment.
    • Companies and investors may consider submitting comments on the Treasury ANPRM. The 45-day comment period affords private parties an opportunity to submit input and raise potential issues the U.S. government should consider as it finalizes the new regulations.

Background and Context – U.S. Outbound Investment Policy with Respect to China

Over the years, concern has been growing in the United States that both private investments by U.S. investors in China and the rendering of certain services to Chinese companies is enabling China to get ahead of the United States or to undermine the American interest in certain critical areas.

Considered a piece of unfinished business since the Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”) did not include provisions covering U.S. person contribution of technology and assistance to foreign persons through foreign joint ventures, the U.S. government considered what – if anything – to do about this concern. Focus initially was on using export controls and limited sanctions to begin to address this risk. In 2020, President Trump issued, and President Biden subsequently amended in 2021, an executive order prohibiting the trading in securities of certain companies determined to be tied to China’s military-industrial complex. In 2022, the Department of Commerce’s dual-use export control agency promulgated a sweeping set of export controls targeting export of advanced semiconductors and use of U.S. origin technology to advance the Chinese advanced computing and artificial intelligence capabilities. 

Within the past two years, however, there was an increasing view in Washington that some effort was necessary to more directly address outbound investment.

The National Critical Capabilities Defense Act (“NCCDA”), introduced in Congress in 2021 would have established a true “reverse CFIUS” screening mechanism covering investment in a very broad range of technologies and activities in China, seeking to address technology transfer, supply integrity, and U.S. domestic critical capability concerns. That legislation met with opposition within Congress and the private sector and soft opposition from the Administration and the NCCDA and its variants (including one introduced in the House this year) have not gained traction. More recently, the Senate overwhelmingly passed the Outbound Investment Transparency Act (“OITA”) as an amendment to the National Defense Authorization Act. However, it remains unclear whether even the OITA, which is limited to a broad reporting requirement with no prohibition element, will find the necessary reception in the House.

The Biden Administration for over a year has been publicly discussing its work to develop narrowly-scoped restrictions on U.S. investments in China in the form of an executive order. There reportedly was vigorous debate within the Executive Branch over whether the program should be limited to a reporting requirement or whether it should provide for prohibition and mitigation authority. Though an executive order was expected to have been issued as early as one year ago, the timeline was continually pushed out, potentially because of Congressional concern, the desire to gather input from stakeholders, and concern that introduction of such a measure could be a significant irritant in already tense relations with China. The Administration, however, has consistently described its intent as being to issue a narrowly tailored order to protect emerging and foundational technologies critical to U.S. national security, using what Administration officials have referred to as a “small yard and high fence” approach.

Many are breathing a sigh of relief, given that the Order is far narrower than other proposals, such as the NCCDA. Others in Washington and beyond will be disappointed that the Order and regulations do not go far enough, and the issue will likely remain a potential subject of legislation, though the Order will likely reduce the sense of urgency in that regard.

Scope and Details of the Order

The Order invokes the President’s authority pursuant to the International Emergency Economic Powers Act (“IEEPA”). As required under IEEPA, the Order declares an emergency “to deal with the threat of advancement by countries of concern in sensitive technologies and products critical to the military, intelligence, surveillance, or cyber-enabled capabilities of such countries.”

The Order itself speaks in broad terms about how to deal with the threat presented by this advancement, but the program envisioned has a narrow focus. It specifies that transactions involving one of three “covered national security technologies and products” is subject to notification or prohibition: “semiconductors and microelectronics, quantum information technologies, and artificial intelligence capabilities that are critical for the military, intelligence, surveillance, or cyber-enabled capabilities of a country of concern.” The Order delegates to Treasury the decision of which particular types of transactions should be prohibited. These will be defined in rules disseminated for public comment, as previewed in the ANPRM.

Under the Order, going forward, outbound transactions can be categorized as one of three types:

  1. Prohibited transactions: These are “covered transactions” which Treasury has specified by regulation are prohibited on the basis of the target company involvement in specified covered technologies. The Order does not provide for any generally applicable licensing or mitigation authority to allow transactions to proceed.
  2. Notifiable transactions
    • These are covered transactions that Treasury has not specified for prohibition.
    • There is no case-by-case review for these transactions; assuming the investor has correctly categorized the transaction as notifiable, the Order gives Treasury no authority to take any action or mitigate any risk with respect to such notified transactions.  
  3. All other transactions: If a transaction does not involve “covered national security technologies,” or does not involve China, or is not performed by a U.S. person or with a covered foreign person, there is no notification requirement and no prohibition.

Details of ANPRM

Treasury’s ANPRM serves as an early prompt for comment for rules that, although likely already in the works at Treasury, have not yet been released in draft form. The ANPRM seeks public feedback on specific issues, indicating that Treasury’s draft rules are well along but open to modification. Below are some of the key provisions:

  • Transaction forms. The ANPRM’s definition of “covered transaction” captures a range of transactions similar to those covered by the U.S. government’s inbound investment body, the Committee on Foreign Investment in the United States (“CFIUS”). Covered transactions include:
    • Both passive and active equity investments in a covered foreign person; 
    • Establishment of a new local subsidiary, a joint venture with a local partner, and greenfield investments (often outside the jurisdiction of CFIUS);
    • Debt financing that is convertible to equity rights in a covered foreign person; and
    • Board representation (including observer) rights.

Notable exceptions to the coverage definition include (i) purchases of publicly traded securities and publicly traded funds; (ii) intra-company transfers; (iii) acquisitions of a covered foreign person’s entire interest in an entity or assets outside China; and (iv) acquisitions of LP interests in a private equity or venture capital fund, in each case where the investor does not have rights that go beyond standard minority investor protections (i.e., no board or observer seat or involvement in decision making) and where any LP investment does not exceed a de minimis threshold to be specified in the regulations.

  • Covered foreign persons include any entity organized or with principal place of business in a country of concern, an entity whose equity securities are principally traded in a country of concern, and any entity (regardless of location) 50%+ owned by either of the foregoing. The only country of concern specified is China (including Hong Kong and Macau).

Though there is some ambiguous language in the ANPRM, this definition would not appear to apply to a non-Chinese company with a Chinese subsidiary or office, unless its Chinese operations account for a majority of consolidated revenue, net income, capital expenditures, or operating expenses.

  • Definitions of covered national security technologies are elaborated in the ANPRM as follows:
Advanced semiconductors and microelectronics(i) The development of electronic design automation software for integrated circuit design or semiconductor manufacturing equipment; (ii) the design, fabrication, or packaging of certain advanced integrated circuits; and (iii) he installation or sale of certain supercomputers.The design, fabrication, and packaging of less advanced integrated circuits.
Artificial intelligence systemsThere is no specific prohibition contemplated in the ANPRM, but they are contemplating a prohibition where it is primarily or exclusively for military, intelligence, or surveillance end use.Activities related to software that incorporates an artificial intelligence system and is [exclusively or primarily] designed for cybersecurity applications, digital forensics tools, and penetration testing tools; the control of robotic systems; surreptitious listening devices that can intercept live conversations without the consent of the parties involved; non-cooperative location tracking (including international mobile subscriber identity (IMSI) catchers and automatic license plate readers); or facial recognition.
Quantum information science and technology

The production of quantum computers and certain components; (ii) the development of certain quantum sensors; and (iii) the development of quantum networking and quantum communication systems

Here, Treasury is most concerned with quantum technologies “that enable capabilities that could compromise encryption and other cybersecurity controls and jeopardize military communications, among other things.” 

There is no separate set of quantum technologies being considered for notification only, which indicates high sensitivity.

For each of the three technology groups listed above, Treasury has posed a list of specific questions aimed at clarifying the draft rule before it is published. Depending on the amount and character of feedback received by Treasury in the next 45 days, the definitions may expand or contract to cover the technologies Treasury and the consulting agencies view to be most sensitive to national security.

  • U.S. persons include U.S. citizens, legal permanent residents, and entities organized in the United States, as well as their foreign branches. A U.S. company would also be responsible for notifying transaction of its 50%+ foreign subsidiaries if they would have been notifiable if undertaken by a U.S. person. It would also be responsible for taking steps to prevent such subsidiaries for engaging in any transactions that would be prohibited if undertaken by a U.S. person. The ANPRM, in this regard, is narrower than the reach of the CHIPS and Science Act of 2022, which applies outbound investment restrictions to the parent and affiliate companies of a recipients of CHIPS Act funding regardless of citizenship.

Enforcement and Penalties

The Order tasks Treasury with investigating suspected violations of the Order and pursuing civil penalties, and the Order explicitly prohibits “any conspiracy formed to violate” the Order or implementing regulations. Criminal penalties are also authorized as a general matter under IEEPA; Treasury may refer potential criminal violations to the Department of Justice. 

There is no stated mechanism for consulting with Treasury or any other government party as to whether a transaction is notifiable or prohibited. Although the proposed rules may be sufficiently clear from Treasury’s perspective, an investor faced with ambiguity may also be obligated to choose between notifying the transaction and potentially facing a penalty, or to treat the transaction as prohibited and not proceed at all. Although this may comport with a general intention of the Biden Administration to deter U.S. investments into China in these high sensitivity areas, investors may prefer a mechanism to seek certainty ex ante with Treasury.

Similar Restrictions May Follow from Allies

The conversation, and now action, on outbound investment in the United States are prompting careful consideration of similar measures in other friendly nations. For example, in January 2023 the Netherlands and Japan joined the United States to extend export controls on certain high-technology semiconductor fabrication technology to cover exports to China. Shortly thereafter, EU President Ursula von der Leyen remarked that the EU is “reflecting on if and how” to implement outbound investment controls. And more recently, the G7 Leaders’ Statement on Economic Resilience and Economic Security promised “clarity to the private sector” on the G7 Leaders’ outbound investment control priorities. Indeed, Treasury’s Fact Sheet states that the Order and ANPRM “reflect discussions with the G7 and other ally and partner engagements.”

Please feel free to get in touch with us if you would like to further discuss the Order and ANPRM and how the outbound investment program may affect your company.


cfius, national security, m&a, private equity, venture capital, foreign investment