Treasury Department Issues Final Rule Regulating Outbound Investment to Protect National Security

On October 28, 2024, the U.S. Department of Treasury (“Treasury”) issued a final rule regulating U.S. outbound investment (the “Final Rule”).[1] The Final Rule specifically targets U.S. investment in Chinese companies engaged in activities related to semiconductors and microelectronics, quantum information technologies and certain AI systems. The rule prohibits U.S. persons from engaging in certain Covered Transactions and requires those persons to notify Treasury of other Covered Transactions involving these technologies.[2] The Final Rule will become effective on January 2, 2025.

As discussed in our previous memorandum, the Final Rule implements President Biden’s August 2023 executive order on “Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern” (the “Outbound Order”). The President found in the Outbound Order “that the advancement by countries of concern in sensitive technologies and products critical for the military, intelligence, surveillance, or cyber-enabled capabilities of such countries constitutes an unusual and extraordinary threat to the national security of the United States.”[3] (emphasis added). According to Treasury, the Final Rule helps address this threat by “tak[ing] targeted and concrete measures to ensure that U.S. investment is not exploited to advance the development of key technologies by those who may use them to threaten our national security.”[4]

Key Takeaways

• High Fence, Small Yard. The Final Rule creates a “high fence” around a relatively “small yard” of important, advanced technologies. Transactions that do not involve semiconductor, quantum or AI businesses are not subject to the Final Rule.
• Uncertain but Broad Scope. Unlike U.S. sanctions programs that list designated individuals and entities, the Final Rule does not define who are the “Covered Foreign Persons.” It requires U.S. companies and individuals to undertake a “reasonable and diligent inquiry” to determine whether a transaction is covered under the rule. To assess whether a “reasonable and diligent inquiry” occurred, Treasury will consider “the totality of relevant facts and circumstances,” including the U.S. person’s efforts to obtain available nonpublic information on the counterparty or target and review that information for consistency with any available public information about the counterparty or target. Treasury may also consider “the presence or absence of warning signs,” such as the counterparty’s or target’s evasive responses or a refusal to provide certain information.
• No Country Off Limits. Given the breadth of relevant definitions, the Final Rule may apply to transactions in any country, if there is a sufficient nexus between a U.S. person and a covered foreign person. For instance, the Final Rule obligates U.S. persons to ensure that subsidiaries in third countries do not engage in Covered Transactions. Further, the Final Rule could also apply to transactions between a U.S. person and entities that are either directly or indirectly controlled by Chinese nationals or entities, but are located outside of China, such as companies that are incorporated or headquartered in countries other than China but have significant ownership or control by Chinese entities or individuals., meaning U.S. persons’ due diligence obligations extend beyond investments directly into China.

Key Aspects of the Final Rule

• To whom does the Final Rule apply?
  • U.S. Persons Are Broadly Defined. U.S. persons, wherever they are located, will be required to adhere to the prohibitions and the notification requirements in the Final Rule. “U.S. persons” are defined broadly to include “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 branch of any such entity, or any person in the United States.”
  • Executives and Directors of Non-U.S. Companies Are Potentially Implicated. While the Final Rule would not apply to non-U.S. entities, a “U.S. person” would be prohibited “from knowingly directing a transaction” of a non-U.S company. To “knowingly direct,” the U.S. person must both “have authority to make or substantially participate in decisions on behalf of the non-U.S. person and exercise that authority to direct, order, decide upon, or approve a transaction.” The Final Rule specifies that a U.S. person must recuse itself from specific activities, including participation in formal approval and decision-making processes, reviewing and signing relevant transaction documents and engaging in negotiations with the investment target, to avoid being considered as “knowingly directing” a transaction.
  • Controlled Foreign Entities Are Also Potentially Implicated. U.S. persons are required to “take all reasonable steps to prohibit and prevent” a controlled foreign entity from engaging in a transaction that would be prohibited if undertaken by a U.S. person, and in addition report to Treasury any notifiable transaction by the controlled foreign entity. A “controlled foreign entity” is one in which a U.S. person directly or indirectly controls a majority of the voting interest, acts as the general partner or managing member or acts as an investment advisor to a pooled investment fund.[5]
• What transactions are covered?
  • Covered Transactions. The Final Rule is applicable to certain transactions by U.S. persons that involve Covered Foreign Persons (“Covered Transactions”). Covered Transactions include “the acquisition of an equity interest or contingent equity interest; certain debt financing that affords certain rights to the lender; the conversion of a contingent equity interest; a greenfield investment or other corporate expansion; entrance into a joint venture; and certain investments as a limited partner or equivalent (LP) in a non-U.S. person pooled investment fund.”[6]
  • Covered Foreign Persons. Covered Foreign Persons are individuals or entities associated with a Country of Concern (presently China, Hong Kong and Macau) that are engaged in covered activities.[7]
  • Covered Activities. Covered activities include, for example, research, development and manufacturing involving covered national security technologies and products. An investment in a Covered Foreign Person is within the purview of the Final Rule if the Covered Foreign Person is engaged in any covered activity, regardless of whether the investment itself directly involves the technology associated with those covered activities.
  • Transactions Outside a Country of Concern. A transaction can be covered even if it is an investment or joint venture outside a Country of Concern.
    • An entity outside a country of concern can be considered a covered foreign person if it “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 any person or persons” from which it derives significant financial benefits, such as more than 50% of its revenue, net income, capital expenditure or operating expenses.
    • A joint venture outside a country of concern can be a covered transaction if it involves a covered foreign person and the joint venture engages or plans to engage in a covered activity.
    • Notably, the use of intermediaries does not exempt a transaction from being a covered transaction, if the transaction otherwise meets the criteria of involving a covered foreign person.[8]
• Which transactions are prohibited and which require notification under the Final Rule?
  • Prohibition: The categories of prohibited transactions is relatively narrow, focusing on specific activities and relationships that pose acute national security risks.
  • Notification: The notification obligation applies broadly to a wide range of transactions involving Covered Foreign Persons and requires detailed information to be submitted to the Treasury. This includes information on the nature of the transaction, the parties involved and the relevant national security technologies and products. [9]
  • The table below defines the types of activities that are covered by the prohibition and the notification requirement:

What types of transactions are excepted from the Final Rule’s coverage?

The Final Rule carves out specified categories of transactions:[1]

• Investments in any publicly traded security. The exception applies to pre-IPO investing, including with respect to the acquisition of pre-public shares that might be obtained in connection with certain underwriting activities.
• Securities issued by an investment company. This exception applies to the sale of securities issued by an investment company, as defined in Section 3(a)(1) of the Investment Company Act of 1940, that is registered with the SEC. This includes index funds, mutual funds and exchange-traded funds.
• Certain limited partner investments. This exception applies to investments made by a U.S. person as an LP or equivalent in a venture capital fund, private equity fund, fund of funds or other pooled investment fund; provided that certain conditions are met.
• Buyouts of country of concern ownership. This exception applies to the acquisition by a U.S. person of all equity or other interests in an entity held by one or more persons of a country of concern; provided that, following the acquisition, the entity does not constitute a covered foreign person. This exception aims to “eliminate the likelihood that intangible benefits of a U.S. person could transfer to a covered foreign person.”[2]
• Intracompany transactions. This exception applies to transactions between a U.S. person and its controlled foreign entity that support operations not classified as covered activities or that maintain covered activities in which the controlled foreign entity was engaged prior to January 2, 2025. This exception is designed to “avoid unintended interference with the ongoing operations of a U.S. person’s controlled foreign entity, even if that entity meets the definition of a covered foreign person.”[3]
• Pre-outbound order binding commitments. This exception applies to transactions made in fulfillment of a binding capital commitment entered into prior to January 2, 2025.
• Certain syndicated debt financing. This exception applies to the “acquisition of a voting interest in a covered foreign person upon default or other condition involving a loan, where the loan was made by a lending syndicate and a U.S. person participated passively in the syndicate.”
• Exemptions issued by Treasury. Under the Final Rule, Treasury can issue exemptions (i) where the Secretary of the Treasury determines that the country or territory is addressing national security concerns related to outbound investment and the transaction is of a type for which associated national security concerns are likely to be adequately addressed by the actions of that country or territory or (ii) where the Secretary of the Treasury determines that there is a “national interest.”

What type of due diligence into transactions does the Final Rule require?

• Reasonable and Diligent Inquiry. The Final Rule requires investors to undertake a “reasonable and diligent inquiry” to determine whether a transaction is a covered transaction, evaluated based on the totality of relevant facts and circumstances.[4]Such an inquiry is expected to involve several steps, including: inquiring with “investment targets or other relevant transaction counterpart[ies] (such as a joint venture partner)” to ascertain the status of the transaction and the counterparty; making efforts “to obtain and consider available non-public information”; reviewing “available public information” for consistency; avoiding purposeful blindness; identifying “warning signs” such as “evasive responses or non-responses” or “a refusal to provide information, contractual representations, or warranties”; using “available public and commercial databases [to] verify relevant information”; and conducting “periodic training and internal reporting requirements” with respect to compliance with the Final Rule.[5]
• Contractual Provisions. The Final Rule requires U.S. persons to confirm that no contractual provisions associated with the covered transaction enable restricted activities. The rule also requires investors to obtain or attempt to obtain contractual representations or warranties from the investment target or counterparty regarding the transaction’s status and the counterparty’s status as a covered foreign person. Specifically, for limited partner investments, the Final Rule requires investors to secure binding contractual assurances that their capital will not be used to engage in transactions that would be prohibited or notifiable if engaged in by a U.S. person, obtained prior to the investment.[6]

Does the Final Rule contain any continuing, post-transaction obligations?

• Documentation and recordkeeping. The Final Rule will require any U.S. person that files a notification with Treasury to maintain a copy of the notification and supporting documentation for 10 years from the date of the notification. If the U.S. person did not provide the information required, they must provide a “sufficient explanation” for why the information could not be obtained and describe the steps taken to try to obtain it.[7]
• Post-transaction monitoring. There is no requirement for ongoing monitoring after a transaction occurs, although the rule does require a U.S. person to notify Treasury within 30 days if it acquires actual knowledge post-transaction of facts that would have made the transaction a Covered Transaction.[8]

What constitutes a violation of the Final Rule and what are the penalties?

Violations of the Final Rule include: taking action prohibited under the Final Rule; failing to take action required by the Final Rule; making “materially false or misleading” representations to Treasury when submitting any information required by the Final Rule; and taking any action that evades or avoids or has the purpose of evading or avoiding any of the prohibitions of the Final Rule.

• Knowledge Requirement. The Final Rule makes clear that its knowledge requirement is integral to determining whether a U.S. person is complying with the regulations, particularly in identifying covered transactions. The knowledge standard is defined as “actual knowledge, awareness of a high probability, or reason to know of a fact or circumstance’s existence.”[9] This requirement is closely tied to the due diligence requirement that a U.S. person must conduct a “reasonable and diligent inquiry” to ascertain relevant facts or circumstances, discussed above. Failure to conduct such an inquiry may result in the U.S. person being deemed to have had reason to know of the relevant facts, thereby meeting the knowledge requirement.
• Civil and Criminal Penalties. A violation of the Final Rule is subject to civil penalties up to $368,136, or an amount that is twice the amount of the transaction that is the basis of the violation, whichever is greater. Any person whose violation is willful is also subject to criminal penalties of up to $1,000,000 and imprisonment of up to 20 years.[10] Treasury is authorized to impose such civil penalties and refer criminal violations to the Department of Justice.
• Divestment. Treasury will be empowered to take action to “nullify, void, or otherwise compel divestment of any prohibited transaction entered into after the effective date” of the Final Rule, which is January 2, 2025.
• Voluntary Self-Disclosures. If a U.S. person elects to disclose voluntarily an actual or possible violation of the Final Rule to Treasury, then Treasury may “take such disclosure into account as a mitigating factor in determining the appropriate response, including the potential imposition of penalties, if [Treasury] determines that there was, in fact, a violation.”[11]

Have other countries recently taken similar action on outbound investment?

• United Kingdom. In the United Kingdom, the National Security and Investment Act 2021 (“NSIA”) covers foreign investment into the United Kingdom.[12] Earlier this year, the U.K. government confirmed in guidance that it considers the NSIA to extend to outbound investment as well. [13] The new U.K. government has recently published its Green Paper on Industrial Strategy, calling for a reduction in regulatory red tape around investment. However, the Green Paper is largely silent on the NSIA, and the government has not yet given any indication how it intends to use its NSIA enforcement powers whether in relation to inwards, domestic or outbound investment.[14]
• European Union. In January 2024, the EU Commission’s Directorate General for Trade published a White Paper[15] addressing outbound investment controls as a measure to protect EU economic security. The paper focuses on the concern that outbound investment could result in technology and know-how leakage that is not adequately protected through the export controls regime.

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[1] These bullets synthesize these categories of transactions. The specific text of each exemption is set forth in 31 CFR § 850.501.

[2] See Final Rule at 152.

[3] See Id. at 153.

[4] See 31 CFR § 850.104(d).

[5] See 31 CFR §§ 850.104(c), 850.302(b).

[6] See 31 CFR § 850.501(a)(1)(iii).

[7] See 31 CFR §§ 850.405(c) (d).

[8] See 31 CFR § 850.403.

[9] See 31 CFR § 850.216.

[10] See Section 206 of the International Emergency Economic Powers Act, as amended (50 U.S.C. 1705).

[11] See 31 CFR § 850.704. See also Final Rule at 173.

[12] Paul, Weiss, UK NSIA Investment Controls: Insights for Dealmakers from the Latest Data (Sep. 25, 2024), available here.

[13] UK Cabinet Office guidance, How the National Security and Investment Act could affect people or acquisitions outside the UK (updated May 21, 2024), available here.

[14] See Nicole Kar, Global Co-Chair of the Paul, Weiss Antitrust Practice, to the Financial Times, Labour cannot ignore national security in its pitch to investors (Oct. 22, 2024) , available here.

[15] European Commission, White Paper on Outbound Investments (Jan. 24, 2024) (COM(2024) 24 final), available here.

[1] Treasury Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern (Oct. 28, 2024), available here.  The Final Rule completes Treasury’s implementation of President Biden’s August 2023 Executive Order on “Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern,” available here.

[2] We previously addressed Treasury’s Advanced Notice and Notice of Public Rulemaking. See Paul, Weiss, President Biden Issues Executive Order Creating Unprecedented Outbound Investment Review Prohibitions Targeting China (Aug. 10, 2023), available here;  Paul, Weiss, Treasury Issues Notice of Proposed Rulemaking to Restrict U.S. Outbound Investment in National Security Technologies (Jun. 26, 2024), available here; see also Treasury, Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern (Jun. 21, 2024), available here.

[3] Outbound Order, available here. That order defined “countries of concern” as the People’s Republic of China, including Hong Kong and Macau.

[4] Treasury, Press Release: Treasury Issues Regulations to Implement Executive Order Addressing U.S. Investments in Certain National Security Technologies and Products in Countries of Concern (Oct. 28, 2024), available here. The ”Outbound Investment Security Program” will be administered by the Office of Global Transactions, which is a newly created office within Treasury’s Office of Investment Security.

[5] See 31 CFR § 850.206.

[6] See 31 CFR § 850.210(a)

[7] Covered foreign person also includes a person that has a voting or equity interest, board seat or other authorities concerning a person of a country of concern with more than 50% of certain financial metrics. See 31 CFR § 850.209.

[8] See 31 CFR §§§ 850.209(a)(2), 850.209(a)(3) and 850.210(a)(5). See also Note 1 to § 850.210.

[9] See Annex: National Security Technologies and Products, infra.