Introduction to the Outbound Investment Security Program
On June 21, 2024, the U.S. Department of the Treasury (Treasury) issued a Notice of Proposed Rulemaking (NPRM), a significant step in implementing Executive Order 14105. This initiative establishes the Outbound Investment Security Program, a national security measure targeting investments in specific technology sectors by U.S. persons in countries of concern, primarily the People’s Republic of China, including Hong Kong and Macau.
Understanding the Outbound Investment Security Program
The Outbound Investment Security Program aims to monitor and restrict investments in key technology sectors—semiconductors/microelectronics, quantum information technology, and artificial intelligence (AI). Unlike the “reverse CFIUS” program, this program’s targeted approach and lack of a review process emphasize its distinct nature.
Due Diligence Requirements
The NPRM introduces comprehensive rules necessitating businesses to conduct diligent inquiries to determine applicability. Non-compliance or insufficient diligence can result in severe penalties, including forced divestment, civil fines, and criminal penalties, such as up to 20 years of imprisonment.
Public Comment and Feedback
The NPRM is currently open for public comment, with Treasury seeking input on various elements, including transaction coverage, key term definitions, notification protocols, and enforcement mechanisms. Although the final rule will take some time to be enacted, businesses, especially private equity and venture capital firms, should prepare their diligence plans accordingly.
Identifying Covered Transactions
Unlike the case-by-case reviews by the Committee on Foreign Investment in the United States (CFIUS), the Outbound Investment Security Program requires notification or prohibits specific “covered transactions” in the targeted sectors. A transaction qualifies as covered if a U.S. person, directly or indirectly:
- Acquires equity or contingent equity in a covered foreign person.
- Provides convertible debt financing or gains management rights in a covered foreign person.
- Converts debt or contingent equity to equity in a covered foreign person.
- Engages in greenfield investments or operations in a country of concern.
- Enters a joint venture in a country of concern involving covered activities.
- Invests in funds likely to invest in targeted technology sectors in a country of concern.
Knowledge Standards and Due Diligence
The NPRM specifies that certain provisions apply only if a U.S. person is aware of relevant facts, defined as actual knowledge, awareness of a high probability, or reason to know. Treasury will evaluate the diligence of inquiries based on factors such as:
- The depth of inquiry into investment targets or counterparties.
- Contractual representations and warranties obtained.
- Efforts to acquire non-public and public information.
- Avoidance of relevant information.
- Presence of warning signs.
- Use of public and commercial databases for verification.
Penalties for Non-Compliance
Violations of the NPRM can result in significant penalties, including civil fines under the International Emergency Economic Powers Act (IEEPA) and criminal penalties for willful violations, which can include fines up to USD $1,000,000 and up to 20 years of imprisonment. Additional penalties under other laws, such as property forfeiture and penalties for false statements, may also apply.
Preparing for Compliance
Businesses must develop robust diligence plans to comply with the final rule. This involves screening transaction partners, understanding their organizational structures, and addressing key jurisdictional questions. Thorough documentation of inquiries and adherence to Treasury’s factors are critical for compliance.
Conclusion
As the NPRM undergoes the comment period, its core intent remains clear: businesses must conduct thorough diligence inquiries to ensure compliance with the Outbound Investment Security Program. For assistance in preparing your business, contact us to speak with an expert.