Tech & Sourcing @ Morgan Lewis


The Biden administration issued a long-anticipated executive order on August 9 regarding US outbound investment in select technology and products with national security applications produced by “countries of concern.” Executive Order 14105 (EO) was released in conjunction with a corresponding Advanced Notice of Proposed Rulemaking (ANPRM) from the US Department of the Treasury (Treasury). Both these developments, while not yet effective, are critical to technology companies and investors, and the coming months will reveal the extent of the impact and the direction Treasury takes with its proposed regulations.

Inbound investments in technology have long been monitored by the US government through the Committee on Foreign Investment in the United States (CFIUS). However, an increased focus on the extensive loss of technology to countries of concern as well as ties between national and economic security led to the US government’s conclusion that investment in countries of concern presents another type of national security risk that needs to be addressed. The EO and ANPRM describe anticipated limits on the funding of indigenous development in three covered technologies in countries of concern, which is currently defined to include the People’s Republic of China, the Special Administrative Region of Hong Kong, and the Special Administrative Region of Macau.

Although the EO and ANPRM are not immediately effective, they provide a roadmap of the government’s current thinking on outbound investment—and reveal that the government’s approach remains a work in process with fundamental questions that aim at the heart of potential concerns for investors. In this blog post, we discuss the potential scope of the EO and ANPRM, including the covered technologies targeted (and not targeted), exceptions, and other issues relevant to investors.

How broadly will the regulations likely be scoped?

As described in the EO, identified countries of concern are ones “engaged in comprehensive, long-term strategies that direct, facilitate, or otherwise support advancements in sensitive technologies and products that are critical to such countries’ military, intelligence, surveillance, or cyber-enabled capabilities” Although the People’s Republic of China, the Special Administrative Region of Hong Kong, and the Special Administrative Region of Macau, are the only countries and regions mentioned in the EO, others could potentially be added later.

The EO also identifies three types of “sensitive technologies” that may be prohibited or subject to a notification requirement under this program: semiconductors and microelectronics; quantum information technologies; and artificial intelligence (AI).

The ANPRM seeks public input on a number of issues, including the subsets of sensitive technologies and products enumerated in the EO that would be subject to the proposed rules. Key areas where public input is sought include the following:

  • Semiconductors and microelectronics: Treasury is considering prohibiting certain advanced semiconductor and microelectronics investments, while allowing other investments into these technologies contingent on the parties’ notification. Specifically, Treasury may prohibit US persons from investing in activities involving software for electronic design automation for integrated circuit (IC) design, front-end semiconductor fabrication equipment used for volume fabrication of ICs, advanced IC design, and fabrication for ICs that meet specified criteria, advanced IC packaging, and supercomputers. Additionally, Treasury is considering a notification requirement for investments involving IC design, fabrication, or packaging that do not fall within the scope of prohibited transactions.
  • Quantum information technologies: Treasury intends to prohibit investments related to quantum computers and components; quantum sensors designed to be used for military, intelligence, or surveillance end uses; and quantum networking and communications systems designed for secure communications.
  • AI systems: Treasury is considering requiring notification of investments in AI software designed to be exclusively used for military, government intelligence, or mass-surveillance end uses, while imposing a notification requirement for investments in AI software designed to be exclusively used for cybersecurity, digital forensics, penetration testing, control of robotic systems, surreptitious listening, non-cooperative location tracking, or facial recognition purposes.

The proposed regime is binary, in the sense that transactions will either be prohibited or not, or subject to notification requirements or not. The ANPRM states that Treasury is not contemplating a CFIUS-like system of case-by-case reviews and determinations. Given that Treasury already runs a case-by-case review process under CFIUS, it remains an open question whether it will reconsider its initial statement regarding no case-by-case reviews for outbound investment, especially if companies, investors, and other interested parties (collectively, investors) provide comments regarding the scope of liability that applies for decisions that will be made by investors and not the US government.

Additionally, the two agencies that are principally responsible for the outbound investment regime, Treasury, and the US Department of Commerce, are economically focused, not national-security-focused agencies. Because the US Department of Defense and the intelligence community appear to be relatively absent from this process, it’s unclear at this point what kind of engagement could arise with the agencies that have national security missions during the regulatory stage. How that may color what happens with the impending regulations or result in some changes in scope is yet to be determined.

Are companies and investors outside the three covered technologies safe from the new regulations?

One of the key problems may be the avenue for obtaining guidance from Treasury regarding whether a transaction is subject to prohibitions or notifications. Unless the Treasury regulations are sufficiently clear and focused, investors will need to exercise reasonable judgment when deciding what applies to their outbound investments.

Based on the regulations Treasury has issued in other contexts—for example, CFIUS, sanctions, AML, etc.—the agency tends to draft regulations to maximize the US government’s flexibility when it comes to reviews and enforcement. While CFIUS refers to “controls for export purposes,” we don’t have that clarification or direction in this case. For semiconductors, for instance, there are at least controls from last October, including Export Control Classification Numbers (ECCNs), However, for quantum computing and AI, no such similar targeted export classifications exist yet.

These technologies are basically part of the emerging technologies category identified in various critical and emerging technology strategies published by the current and recently past administrations. Without specified and existing performance parameters for these two categories, foot faults or mistakes deciding whether a technology falls within the categories noted remains a significant concern. While some things will be clear, AI muddies the water, and the agencies will need careful definitions and a process of letting people know if they are in or out of scope.

What is the process for adding additional technologies?

The language of the EO opens the door to the possible expansion of the list of covered technologies that could be subject to reporting requirements and additional restrictions. Non-identified industries should not assume they will be exempt, despite the current tailored scope of covered technologies. Moreover, non-identified industries that are involved in one of the identified industries (for example, a life sciences company that uses AI) might still be covered.

What exceptions will there likely be and how will the exceptions be important to investors?

The ANPRM seeks public input on a number of issues, including the subsets of sensitive technologies and products enumerated in the EO that would be subject to the proposed rules. It also seeks comment on certain proposed exceptions to the new prohibitions and notification requirements.

In particular, Treasury identifies certain transactions that could be carved out from the definition of “covered transaction” because the nature of the investment is passive and therefore presents a lesser national security concern. However, it may be these types of investments that raise concerns, as the US Congress has identified various questions regarding what may be viewed as a passive investment through the issuance of letters to at least four private equity/venture capital funds regarding their specific investments in China.

This congressional interest may or may not affect Treasury’s approach to possible exceptions. If it does not, the guidance included in the ANPRM outlines Treasury’s current thinking. The proposed exceptions include different categories of transactions, including certain types of excepted investments, such as:

  • investments into publicly traded securities;
  • investments into index funds, mutual funds, exchange-traded funds, or similar instruments; and
  • investments made as a limited partner (LP) into a venture capital fund, private equity fund, fund of funds, or other pooled investment funds where the LP’s contribution is passive and below a specified de minimis threshold; this exception, as written, could allow for massive capital flow through pooled funds, unless it is cabined appropriately.

Notably, any such investments that include membership, observer, or nomination rights or other involvement in substantive decision-making of the covered foreign person would not qualify for the exception. Additional proposed exceptions include:

  • certain equity acquisitions;
  • intracompany funds transfers by a US parent to a covered subsidiary; or
  • a binding uncalled capital commitment, where the commitment was entered into before the date of the EO.

A number of significant unknowns remain, and the regulatory process is expected to take months, not weeks. Even with this potential regulatory delay, Treasury and the EO provide sufficient guidance on where the administration sees the risks, the processes under consideration and the key terms that will be more clearly defined in subsequent rulemaking.

Given the potential reach of the regulations and the anticipated uncertainty in some areas due to the government’s standard approach of maximizing its flexibility in the national security space, potentially affected investors and other entities should strongly consider taking advantage of the ANPRM and submitting comments to Treasury to help inform the government’s further consideration of exactly how to scope the regulations.

For more information, including about prohibitions and notification requirements, read our LawFlash: Outbound Investment Review: Little Immediate Effect, but More Is Coming. Comments are due to Treasury by September 28.