On Aug. 9, 2023, President Biden signed an executive order (EO) that creates a policy to report and, in some cases, restrict outbound investments in national security technologies and products from the United States into countries of concern, including the People’s Republic of China (PRC). It declares a national emergency regarding the technological advancement of these countries and lays out the actions the United States will take to protect its national security. The order is designed to ensure American resources are not used by such countries to advance technologies critical to their military, intelligence, surveillance and cyber-enabled capabilities. Three national security technology and product sectors are directly identified in the EO: semiconductors and microelectronics, quantum information technologies and artificial intelligence (AI) capabilities. The EO designates the Treasury Department as the lead agency for the administration and implementation of the program. Accordingly, the Treasury Department issued an Advanced Notice of Proposed Rulemaking (ANPRM) in conjunction with the EO that provides clarification on the scope and implementation plan for the national security program. Specifically, the ANPRM names which sub-technologies from countries of concern are being considered for U.S. investment prohibition or notification requirements.
For those in the semiconductor sector, the Treasury Department is considering prohibiting U.S. investments in Chinese entities engaged in the development of electronic design automation software or semiconductor manufacturing equipment; the design, fabrication or packaging of advanced integrated circuits; and the installation or sale of supercomputers. The Treasury Department is also considering requiring notification for U.S. investments in Chinese entities engaged in the design, fabrication and packaging of less advanced integrated circuits. In the quantum computing space, the Treasury Department is looking to prohibit U.S. investments in Chinese entities that are producing quantum computers and their components, developing quantum sensors and communication systems. The Treasury Department explicitly noted they are looking for public input on prohibiting U.S. investment in Chinese entities engaged in activities related to artificial intelligence (AI) systems with specific end uses, among other AI-systems-related definitions and requirements.
Importantly, the EO is not a final rule, and it does not have any immediate impacts beyond the opportunity for the public to submit comments to help inform the Treasury Department’s rulemaking process. Until the legislative and regulatory processes are complete, it is unclear the EO’s direct impact on the global competitiveness of the United States in the identified national security technology sectors. While stronger than the outbound investment amendment to the NDAA that was overwhelmingly adopted on July 25 by the Senate, the EO notably uses weak language and holds off on explicitly defining key elements of the rule.
Executive Order Overview
- Notifiable and Prohibited Transactions: The EO instructs the Secretary of the Treasury to issue regulations that “require United States persons to provide notification of information relative to certain transactions involving covered foreign persons (notifiable transactions) and that prohibit United States persons from engaging in certain other transactions involving covered foreign persons (prohibited transactions).” This is in addition to developing guidelines for U.S. persons to notify the Treasury Department of transactions involving national security technologies and products identified by the secretary. The EO also instructs the Secretary of the Treasury to issue regulations that prohibit transactions involving national security technologies and products identified by the Secretary of the Treasury. The EO identifies prohibited transactions as those that “pose a particularly acute national security threat because of their potential to significantly advance the military, intelligence, surveillance or cyber-enabled capabilities of countries of concern.”
- Covered National Security Technologies: The EO identifies three national security technologies, including “semiconductors and microelectronics, quantum information technologies and artificial intelligence sectors that are critical for the military, intelligence, surveillance and cyber-enabled capabilities of a country of concern.” The EO instructs the Secretary of the Treasury, in consultation with other relevant agency heads, to “assess whether to amend the regulations, including whether to adjust the definition of ‘covered national security technologies and products’” and whether “to add or remove technologies and products” in the three national security technology categories.
- Countries of Concern: In the annex to the EO, China is identified as a country of concern. The Special Administrative Region of Hong Kong and Macau are also listed.
- Enforcement Authority: The EO vests the authority to investigate violations of the rule with the Secretary of the Treasury, including the ability to “refer potential criminal violations of this order or the regulations issued under this order to the Attorney General.”
- Person of a Country of Concern: The EO identifies a “person of a country of concern” as: (1) “any individual that is not a United States person and is a citizen or permanent resident of a country of concern,” (2) “any entity organized under the laws of a country of concern or with a principal place of business in a country of concern,” (3) “the government of each country of concern, including any political subdivision, political party, agency or instrumentality thereof, or any person owned, controlled, or directed by or acting on behalf of the government of such country of concern,” or (4) “any entity owned by a person identified” in the previous subsections.
- United States Person: The EO defines a U.S. person as “any United States citizen, lawful permanent resident, entity organized under the laws of the United States or any jurisdiction within the United States, including any foreign branches of such entity and any person in the United States.”
ANPRM Overview
On top of the EO the Treasury Department released an Advance Notice of Proposed Rulemaking (ANPRM). The Treasury Department identified the purpose of the ANPRM as to “provide transparency and clarity about the intended scope of the program and solicit input from the public on the implementation of the EO and the scope of the program before it goes into effect.” An overview of key elements of the ANPRM follows.
- S. Persons: The ANPRM clarifies that U.S. persons will be expected to adhere to the rule regardless of their location. It also says that the Secretary of the Treasury may “place obligations on U.S. persons with respect to foreign entities they control and in certain situations where U.S. persons knowingly direct transactions by non-U.S. persons.”
- Covered Transactions: The ANPRM explains the EO’s intention is to “focus on U.S. persons undertaking certain types of transactions that could convey intangible benefits.” These types of transactions are identified as the acquisition of equity interests, greenfield investments, joint ventures and certain debt financing that are convertible to equity. However, the Treasury Department is taking a “deliberate approach to excepted transactions” and is considering excepting intracompany transfers of funds.
- Foreign Persons: The ANPRM clarifies the EO is intended to apply to “entities that are engaged in activities related to defined sub-sets of technologies and products, and that are organized under the laws of a country of concern, have a principal place of business in a country or concern or are majority-owned by country of concern individuals or entities.”
- Potential Exceptions: The ANPRM says the Treasury Department is considering implementing an exception for “passive and other investments that may pose a lower likelihood of conveying intangible benefits or in an effort to minimize unintended consequences.” As an example, the ANPRM mentions an exception for “U.S. investments into securities, index funds, mutual funds, exchange-traded funds, certain investments made as a limited partner, committed but uncalled capital investments and intracompany transfers of funds from a U.S. parent company into its subsidiary.”
- Semiconductors and Microelectronics: The ANPRM mentions that requiring the notification of U.S. investments in Chinese entities “engaged in the design, fabrication and packaging of less advanced integrated circuits” is under consideration by the Treasury Department. The ANPRM outlines the following as potentially prohibited under the rule: (1) “the development of electronic design automation software or semiconductor manufacturing equipment,” (2) “the design, fabrication or packaging of advanced integrated circuits” and (3) “the installation or sale of supercomputers.”
- Quantum Information Technologies: The ANPRM clarifies that notification requirements for any quantum information technologies are not under consideration by the Treasury Department. But the ANPRM identifies the following as potentially prohibited under the rule: (1) Chinese “entities engaged in the production of quantum computers and certain components,” (2) “the development of certain quantum sensors” and (3) “the development of quantum networking and quantum communication systems.”
- Certain AI Systems: The ANPRM says the Treasury Department is considering notification requirements for U.S. investment in Chinese “entities engaged in activities related to software that incorporates an AI system and is designed for certain end-uses that may have military or intelligence applications and pose a national security risk.” The Treasury Department is seeking public comment on prohibition on U.S. investment in Chinese AI, which is detailed in the “Next Steps” section of this alert.
The Executive Order vs. the NDAA Amendment
On July 25, the Senate voted to adopt the outbound-investment-focused amendment to the National Defense Authorization Act (NDAA) filed by Sens. John Cornyn (R-TX) and Bob Casey (D-PA). The amendment only requires U.S. persons to notify the Treasury Department of investments in certain advanced technology sectors in China and does not prohibit or allow for the blocking of any transactions. Even though the amendment was adopted 91-6, it may face challenges during the conference process as some House Republicans will only support an outbound investment amendment that allows for investments to be blocked and for entities to be sanctioned.
The most significant difference between the EO and the Cornyn-Casey amendment is that the EO allows for the prohibition of certain investments by U.S. persons in a country of concern. On the other hand, the Cornyn-Casey amendment only requires U.S. persons to notify the Treasury Secretary of such investments with the power of the Treasury Secretary to prohibit transactions being extremely limited. Additionally, the Cornyn-Casey amendment covers a broader range of national critical capabilities sectors, including hypersonics, satellite-based communications and network laser scanning systems with dual-use applications. The EO is more narrowly tailored to technology sectors that specifically affect U.S. national security. However, it can be expected that technologies targeted by the EO will evolve as discussions continue.
Broadly speaking, the EO is a stronger but more narrowly tailored version of the Cornyn-Casey amendment. For instance, Rep. Mike Gallagher (R-WI), Chair of the Select Committee on the CCP, wrote a letter to the Biden administration before they released the EO on August 9 calling for President Biden to “meet the moment with urgency, clarity and breadth required to address the serious national security issues we face.” Rep. Gallagher specifically provided the Biden administration with five considerations: (1) restrict both private and public investments, (2) “restrict U.S. capital from flowing into organizations connected to the CCP’s genocide, the CCP’s technological rise and the Chinese military,” (3) hold Chinese companies to the same “due diligence standards as American companies,” (4) avoid the creation of a “case-by-case screening process” and (5) “consult with allies and partners before implementing new restrictions and urge them to adopt parallel restrictions on investing in China.”
Relation to Semiconductor Export Controls
On Oct. 7, 2022, the Bureau of Industry and Security (BIS) issued an interim final rule, Implementation of Additional Export Controls: Certain Advanced Computing and Semiconductor Manufacturing Items; Supercomputer and Semiconductor End Use; Entity List Modification. The rule implemented export controls specifically focused on “advanced computing integration circuits (ICs), computer commodities that contain such ICs and certain semiconductor manufacturing items.” On Oct. 13, BIS published an additional rule that added export controls on “certain advanced computing manufacturing chips (chips, advanced computing chips, integrated circuits), transactions for supercomputer end uses and transactions involving certain entities on the Entity List.” The BIS also added export controls “on certain semiconductor manufacturing items and transactions for certain IC production end uses.”
The Treasury Department said the EO serves as a complementary measure to the Biden administration’s October export controls by ensuring that U.S. investments in these advanced technology sectors do not “accelerate the indigenization of these technologies” in China and effectively “undermine the effectiveness of our existing export controls.”
Next Steps and Brownstein’s Take
President Biden’s outbound investment EO is not a final rule and the ANPRM does not implement the program but provides an overview of the direction the Treasury Department is headed in terms of the rulemaking process. Industry stakeholders can inform the Treasury Department’s draft legislation through a public comment period that will last 45 days from the publication of the ANPRM in the Federal Register. All stakeholders involved should look to get involved as soon as possible as industry members will be required to determine the status of their investments, which could leave them vulnerable to force divestments and legal penalties from the Treasury Department.
Industry leaders in AI, in particular, have the opportunity to input on: (1) “how to shape a prohibition on U.S. investments in PRC entities engaged in a narrow set of activities related to software that incorporates an AI system and is designed for particular end uses with national security implications” and (2) provide “feedback on the definitions” in the AI category and “their potential implications on scope.” Also, current guidance seems to target only military use of AI, but could be expanded in a final rule. Stakeholders with an interest in the semiconductor and quantum computing space also have an opportunity to inform the Treasury Department’s rulemaking process as they are seeking public comment on “related definitions and elements of the program.” It is also worth watching if the additional industries are added to the final rule before publishing, this will likely rely on how much capacity the administration feels it has to enforce the rule.
The timing of the EO is also of note. The Biden administration has recently claimed to be pursuing a “thaw” in U.S.-China relations following a series of diplomatic setbacks. This rhetoric has been enforced with visits from top administration officials including Treasury Secretary Janet Yellen, Secretary of State Anthony Blinken, Environmental Envoy John Kerry and, reportedly in the future, Secretary of Commerce Gina Raimondo. Still, China has continued to place restrictions on exports to the United States, most recently cutting shipments of rare earth minerals such as gallium and germanium. Based on this, China’s reaction to a final rule may see the CCP place additional sanctions on organizations that follow the order.
Following the ANPRM, the Treasury Department is expected to release draft legislation. A final rule may take up to a full year to publish and the timeline, as well as enforcement, may be altered by politics surrounding the 2024 election. With the general ambiguity of the rule, industry members have a unique opportunity to shape the final guidelines. Please reach out to the authors of this alert for support in making sure your interests are considered.
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