EO 14105 and “Reverse” CFIUS

Executive Order 14105, “Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern,”  presents a notable change in national security law in the United States. Rather than regulating inbound investments into the United States, the United States has become the first country in the world to control outbound investment into China. The restrictions have the most effect on entities involved with (1) semiconductors and microelectronics, (2) quantum information technologies and (3) artificial intelligence (AI). With the final rule issued by the United States Department of the Treasury on Oct. 28, 2024, to implement EO 14105, it is an opportune time to discuss the meaning, the scope and some of the effects of these new regulations.

How Does the Final Rule Work?

What Does It Do?

• The final rule prohibits or requires notification for certain types of transactions (each a “covered transaction”) undertaken by U.S. persons involving—directly or indirectly—Chinese or Chinese-controlled entities engaged in certain specified activities related to (1) semiconductors and microelectronics, (2) quantum information technologies and (3) AI. In a nutshell, the final rule prohibits or requires notification of: 

• Failure to comply results in civil money penalties of up to $368,136 or twice the value of the relevant transaction.
• Criminal violations of the final rule may be referred to the Department of Justice for prosecution. 

Who Is Covered?

• U.S. persons involved in a transaction with foreign entities from a country of concern.

Broad Scope

• The final rule applies not just to transactions undertaken by U.S. individuals and companies but also to transactions undertaken by non-U.S. entities that involve certain “U.S. persons.” For this reason, non-U.S. companies will need to make hard decisions on how or even whether to involve U.S. persons in decision-making related to investments.

Who Has the Compliance Responsibility?

• The relevant U.S. person possesses the obligation to comply with the final rule, not the foreign entities.
  

What Can Be Done?

• The final rule prohibits U.S. persons from “knowingly directing” any non-U.S. person to undertake a transaction that would be prohibited if undertaken by a U.S. person. A U.S. person knowingly directs a transaction when the U.S. person has authority, individually or as part of a group, to make or substantially participate in decisions on behalf of a non-U.S. person, and exercises that authority to direct, order, decide upon or approve a transaction. This authority exists when a U.S. person is an officer or director or otherwise acts as an executive for a non-U.S. person.
• However, a U.S. person can recuse himself or herself from certain activities to avoid liability for knowingly directing a transaction.

Who Is a Covered Foreign Person?

• While covered foreign persons can include persons from any country of concern, this will usually involve Chinese and Chinese-owned entities.
• It is also notable that a foreign entity will be covered by the final rule if it devotes more than 50% of its revenue or net income from, or devotes more than 50% of its capital expenditure or operating expenses to, covered activities related to (1) semiconductors and microelectronics, (2) quantum information technologies and (3) AI.
• The final rule also covers entities from countries of concern participating in joint ventures involving covered activities.

What Is a ‘Covered Transaction’?

Types of covered transactions:

• Acquisition of an equity interest or contingent equity interest in a person that the U.S. person knows at the time of the acquisition is a covered foreign person.
• Atypical loans or a similar debt financing arrangement to a person that the U.S. person knows at the time of the provision is a covered foreign person, where the arrangement will afford the U.S. person an interest in profits of the covered foreign person, the right to appoint members of the board of directors of the covered foreign person, or other comparable financial or governance rights.
• Conversion of a contingent equity interest into an equity interest in a person that the U.S. person knows at the time of the conversion is a covered foreign person, where the contingent equity interest was acquired by the U.S. person on or after Jan. 2, 2025.
• Acquisition, leasing or other development of operations, land, property or other assets in a country of concern that the U.S. person knows at the time of such acquisition, leasing or other development will result in, or that the U.S. person plans to result in, an entity that will be covered by the final rule.

In summary, the final rule applies to “greenfield” investments involving a covered foreign person, “brownfield” investments involving engagement of a person from a country of concern in a covered activity, and joint ventures.

• A greenfield investment refers to a type of foreign direct investment wherein a company establishes operations in a foreign country by constructing new facilities such as a sales office, a manufacturing facility or something similar.
• By way of comparison, a brownfield investment often refers to a foreign company’s direct investment in a country via the redevelopment of existing properties. 

What Are the Exemptions?

The final rule lists 10 categories of exempted transactions:

1. An investment in a publicly traded security.
2. An investment in a security issued by a registered investment company, such as an index fund, mutual fund or exchange-traded fund.
3. An investment of a certain size by a U.S. limited partnership in a pooled investment fund.
4. An investment in a derivative, so long as such derivative does not confer the right to acquire equity or any assets in or of a covered foreign person.
5. A full buyout of all interests of any person of a country of concern in an entity, such that, after the transaction, the entity is not a covered foreign person.
6. Most intracompany transactions between a U.S. person parent and its controlled foreign entity. This is true so long as the transaction either does not alter covered activities or does not create new covered activities.
7. Fulfillment of a U.S. person’s binding, uncalled capital commitment that existed prior to the final rule.
8. The acquisition of a voting interest in a covered foreign person upon default or other condition involving a loan.
9. The receipt of employment compensation by an individual in the form of stock or stock options.
10. Certain transactions with or involving a person of another country that has been designated as having sufficient outbound investment controls. No such country has been designated yet.

Can Parties Request a Waiver or Prior Authorization for a Covered Transaction?

The final rule affirms that a U.S. person could still seek a “national interest exemption” for a covered transaction on a case-by-case basis.

Which Transactions Can Be Prohibited?

• The final rule requires U.S. persons to prevent their controlled foreign entities from engaging in prohibited transactions.

Which Transactions Require Notice?

• The final rule requires U.S. persons to submit notifications to Treasury when their controlled foreign subsidiaries undertake notifiable transactions. 
• Notifications must be submitted no later than 30 days following the completion date of the transaction. The notification must include information about the U.S. person, the covered foreign person and the transaction.