Outbound Investment Review Program – Themes from Industry Comments

As discussed in our September 2023 Lawfare article, the Biden administration’s first-of-its-kind outbound investment review program seeks to limit outbound investments by U.S. investors in Chinese developers of certain sensitive technologies. The Biden administration issued an Advance Notice of Proposed Rulemaking (ANPRM) that included a long list of questions for the public.  Such broad public solicitation highlights the administration’s more cautious approach and its reliance on the private sector to ensure it is appropriately tailored to not hinder U.S. innovation and technological superiority.

The period for responding to the ANPRM ended on September 28, 2023, and generated 61 comments. The comments highlighted two major issues with the ANPRM.  First, the scope of transactions covered by the ANPRM is unclear—which transactions would be prohibited and what level of due diligence would be required to satisfy the program’s requirements. Second, the definitions of the covered technologies are broad and potentially unworkable in the areas the program seeks to regulate—semiconductors, quantum computers, and AI systems (“Covered Technologies”).  Although the Biden administration will seek to address these issues when it publishes the regulations next year, they are likely to remain areas of concern as the program becomes operational.

Covered Transactions

The most prominent concern expressed by commenters related to the scope of transactions covered by the ANPRM. The ANPRM stated that the program would “prohibit certain types of investment by United States persons into certain entities located in or subject to the jurisdiction of a country of concern . . . with capabilities or activities related to defined technologies and products.” Many comments concerned the definition of a “U.S. Person;” the inclusion of transactions “knowingly directed” by U.S. persons; and the lack of clarity surrounding the required level of due diligence of affected parties.

“U.S. Person”

Commenters questioned the scope of the term “U.S. Person” as extended to foreign nationals in the United States. For example, commenters observed that “U.S. Person” is currently defined to include “any person in the United States,” regardless of citizenship.  One commenter argued that this formulation does not “translate well to the outbound investment context where both U.S. and foreign senior executives may transit in and out of the United States and could be subject to the requirements of the program, simply by virtue of the timing of their investment decisions relative to the time of travel.” The comments also noted that the broad definition of “U.S. Person” makes it possible for an individual to be both a “U.S. Person” and a “covered foreign person,” putting them in an “uncertain and possibly irresolvable regulatory status.”

“Knowingly Directed”

Interested parties were particularly apprehensive about one specific application of the outbound investment program. The ANPRM states “the Secretary [of the Treasury] may prohibit United States persons from knowingly directing transactions if such transactions would be prohibited transactions pursuant to this order if engaged in by a United States person.”  The Treasury Department is considering defining “knowingly” to mean that the “U.S. person had actual knowledge, or should have known, about the conduct, the circumstance, or the result.” This “knowingly directed” standard is broad and could be difficult to comply with, prompting many questions from commenters, including:

• At what point in a transaction is a U.S. person considered to have “directed” it?   
• Who is responsible for determining whether a U.S. person “knowingly directed” a transaction, the individual or the corporate employer? 
• Who has the obligation to notify the government?  

Other commenters were worried that the proposed definition could “cast a shadow” on informal discussions between international partners, “for fear of [these discussions] being deemed ‘knowingly directing’ a transaction toward the foreign team by the U.S. team.”

Proposed potential solutions included implementing an advisory opinion process and adopting an authorization or licensing process to authorize otherwise prohibited transactions.

Required Due Diligence

There was also concern about the lack of clarity about the level of due diligence Treasury expects firms to undertake in evaluating transactions for compliance with the proposed rule. As currently constructed, the ANPRM indicates that for a transaction to be covered:

a U.S. person would need to know, or reasonably should know based on publicly available information and other information available through a reasonable and appropriate amount of due diligence, that it is undertaking a transaction involving a covered foreign person and that the transaction is a covered transaction.

The ANPRM does not clarify what is deemed “reasonable and appropriate” in terms of the level of diligence required. Moreover, “reasonable and appropriate” diligence will vary depending on the nature of the transaction and an investor’s ability to conduct thorough due diligence. As with other language in the ANPRM, commenters requested that Treasury more concretely and objectively clarify what is needed to comply with the proposed order.

Covered Technologies

The outbound investment program would prohibit, or require notification of, investments in certain entities engaged in the development of three advanced technologies:

(1) semiconductors and microelectronics, (2) quantum information technologies, and (3) AI systems. The ANPRM has defined these technologies with varying degrees of specificity and solicited feedback from interested parties to clarify what technologies may be covered. Comments submitted to Treasury criticized the breadth of the technological definitions in all three areas.

Semiconductors and Microelectronics: Inconsistency with Existing Regulatory Frameworks

Commenters were critical of specific elements of each definition. One technology advocacy group pointed out potential inconsistencies between the outbound investment program and existing treatment of semiconductors and microelectronics, such as in the Department of Commerce’s Export Administration Regulations (EAR). The group asserted that:

Any new regulations established by the Treasury Department in response to the Order should be made entirely consistent with existing EAR.  The EAR are already closely followed by companies working in this sector.  Creating a separate set of rules potentially differing would create confusion, which is expensive for companies seeking compliance.

This concern was common among the commenters, especially considering the growing importance of foreign semiconductor investment, the unknown impact of the ANPRM on the industry, and the complexity of the existing regulatory framework.

Quantum Computers: Inclusion of “Components” in Coverage

Commenters also highlighted the ANPRM’s inclusion of “components” in covering “Quantum Computers and Components.” Many were concerned that the inclusion of “components” expands “the scope of the proposed rules to cover any piece of hardware that might go into a quantum computer now or at any time in the future. That is, lasers, cables, semiconductor devices, diagnostics, and classical computer interfaces are seemingly covered by this wording.”  Recommendations included narrowing the definition to “integrated components essential to scaling quantum computers.”

AI Systems: Overbreadth and Civilian Technology Impact

Finally, interested parties questioned the definition of “AI systems,” which the ANPRM states covers any “engineered or machine-based system that can, for a given set of objectives, generate outputs such as predictions, recommendations, or decisions influencing real or virtual environments.” Treasury indicated that technologies in this category would be in scope if they were “exclusively” or “primarily” used “for military, government intelligence or mass-surveillance end uses.”

The breadth of this definition drew a slew of criticism, despite the government’s language indicating only technologies with certain end uses would be in scope. Commenters argued that most AI systems are covered by this broad definition and the program will have adverse effects on basic systems that have dual uses, both civilian and military. Commenters posit that such a broad definition could be read to cover basic laptops and gaming systems, a traditional calculator, or nearly any type of software used for civil purposes, if it could also be used in military applications. The issue of civilian product coverage was common across all three covered technologies.

Conclusion

The comments to the ANPRM illustrate the rawness of the Outbound Investment Program.  The volume and breadth of comments demonstrate that Treasury will benefit from refining and narrowing the scope of covered transactions and the description of covered technologies. As currently structured, the program will be difficult to comply with and challenging to enforce uniformly. Collectively, these issues and challenges suggest that implementation of the program will be delayed for some time.