Navigating the U.S. Treasury Department’s “Outbound Investment Rule”: International Compliance Challenges and Strategies

Abstract

On January 2, 2025, a new U.S. Treasury Department regulation, (“Outbound Investment Rule”), will go into effect. It will require U.S. persons to navigate complex compliance requirements when investing in specific technologies within designated “countries of concern,” primarily China (including Hong Kong and Macau). This article explores the regulation’s implications, the compliance landscape for international businesses, and discusses the legal foundations. It examines the rule’s specific requirements, including prohibited and notifiable transactions, due diligence standards, and the repercussions for non-compliance, with a focus on practical compliance strategies for international stakeholders.

Introduction: Background and Regulatory Context

In recent years, U.S. outbound investments in sensitive technologies have raised national security concerns, particularly regarding investments in countries where technological advancements may enable military, surveillance, or cyber capabilities detrimental to U.S. interests. Recognizing the risks associated with such investments, the U.S. government has enacted regulatory measures under Executive Order 14105, empowering the Department of the Treasury to oversee and control U.S. investments in certain foreign entities. This rule, codified in 31 C.F.R. Part 850, focuses on mitigating risks posed by investments in semiconductors, quantum information technologies, and artificial intelligence (AI).

These areas are critical to national security due to their potential applications in developing advanced computational, surveillance, and military systems. The rule intends to curb U.S. financial support that could accelerate the development of such technologies in designated foreign entities, specifically within the People’s Republic of China, Hong Kong, and Macau.

Legal Foundations: Authority and Scope

The Treasury Department’s regulatory authority is derived from the International Emergency Economic Powers Act (IEEPA), which grants the President the power to address national security threats originating outside the U.S., provided a national emergency is declared. The National Emergencies Act (NEA) and Section 301 of Title 3 of the U.S. Code further empower the President and the Secretary of the Treasury to establish regulations that safeguard U.S. interests against foreign threats.

In Executive Order 14105, issued on August 9, 2023, the President declared a national emergency, citing the risks posed by investments in certain technologies within countries deemed adversarial. This Executive Order authorizes the Department of the Treasury to control outbound investments by U.S. persons that may involve foreign entities engaged in developing sensitive technologies. Importantly, this Outbound Investment Rule requires U.S. persons to submit transaction notifications or, in some cases, prohibits transactions outright, depending on the assessed risk level of the transaction.

Outbound Investment Rule Overview

Under the Outbound Investment Rule, certain outbound investments by U.S. persons, or those directed by them, will either be prohibited or subject to notification requirements. If a “U.S. person” engages in a “covered transaction” with a “covered foreign person,” the transaction will either be subject to notification or prohibited, depending on the activities involved. Treasury will also require U.S. persons to (i) Take steps to ensure controlled non-U.S. entities do not engage in transactions that would be prohibited if done by a U.S. person; (ii) Prevent “knowingly directing” transactions by non-U.S. persons.

• “U.S. person” means 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.
• “Covered Transaction” A “covered transaction” includes various activities, such as:
  • Acquisitions of equity interests or contingent equity interests.
  • Debt financing convertible to equity or affording certain rights to the lender.
  • Conversion of a contingent equity interest.
  • Greenfield investments or other corporate expansions.
  • Joint ventures.
  • Limited partner investments in a non-U.S. pooled investment fund.
• “Covered Foreign Person” means either (i) a person of a country of concern engaged in covered activity or (ii) a party that has some control over a covered foreign person and meets certain economic parameters in relation to that holding.

Compliance Requirements and Obligations for U.S. and International Investors

The Outbound Investment Rule introduces significant compliance obligations that impact a wide range of transactions, including acquisitions, joint ventures, and certain financing arrangements.

The key obligation is to establish “knowledge” of relevant facts and circumstances at the time of an inquiry, meaning the U.S. person conducted a “reasonable and diligent inquiry” to determine whether their investments are classified as covered transactions. This involves thorough verification of transaction details, understanding the structure and ultimate ownership of foreign entities, and ensuring contractual safeguards where feasible. Importantly, due diligence in this context extends beyond financial assessments and requires detailed scrutiny of potential technology transfers and the role of the foreign entity.

Notifiable vs. Prohibited Transactions

The Treasury has established prohibitions and notification requirements for U.S. persons undertaking transactions with a covered foreign person engaged in the following activities:

1. Notifiable Transactions

The term notifiable transaction means a covered transaction (that is not a prohibited transaction described in § 850.224) in which the relevant covered foreign person or, with respect to a joint venture:

(a) Designs any integrated circuit;

(b) Fabricates any integrated circuit;

(c) Packages any integrated circuit;

(d) Develops any AI system

(1) Designed to be used for any military end use (e.g., for weapons targeting, target identification, combat simulation, military vehicle or weapons control, military decision-making, weapons design (including chemical, biological, radiological, or nuclear weapons), or combat system logistics and maintenance); or government intelligence or mass-surveillance end use (e.g., through incorporation of features such as mining text, audio, or video; image recognition; location tracking; or surreptitious listening devices);

(2) Intended by the covered foreign person or joint venture to be used for any of the following:

(i) cybersecurity applications;

(ii) digital forensics tools;

(iii) penetration testing tools; or

(iv) the control of robotic systems; or

(3) Trained using a quantity of computing power greater than 10^23 computational operations (e.g., integer or floating-point operations).

For transactions requiring notification, Treasury requires U.S. persons to file through a portal hosted on Treasury’s website no later than 30 days following closing of the transaction. The notification requires information about the parties (both the U.S. person and the covered foreign person), details of the transaction/investment, and the covered national security technologies and products. Treasury will post instructions on how to file a notification its Outbound Investment Security Program website prior to the effective date of the rule (Jan. 2, 2025).

2. Prohibited Transactions

Transactions deemed high-risk are expressly prohibited. This includes investments that could lead to direct or indirect contributions to advanced military, surveillance, or cyber capabilities. “Prohibited transactions” broadly involve transactions that transfer intangible benefits, such as technological expertise, to entities in designated countries.

The term prohibited transaction means a covered transaction in which the relevant covered foreign person or, with respect to a covered transaction described in § 850.210(a)(5), the relevant joint venture:

(a) Develops or produces any electronic design automation software for the design of integrated circuits or advanced packaging;

(b) Develops or produces any:

(1) Front-end semiconductor fabrication equipment designed for performing the volume fabrication of integrated circuits, including equipment used in the production stages from a blank wafer or substrate to a completed wafer or substrate (i.e., the integrated circuits are processed but they are still on the wafer or substrate);

(2) Equipment for performing volume advanced packaging; or

(3) Commodity, material, software, or technology designed exclusively for use in or with extreme ultraviolet lithography fabrication equipment.

(c) Designs any integrated circuit that meets or exceeds the performance parameters in Export Control Classification Number 3A090.a in supplement No. 1 to 15 CFR part 774, or integrated circuits designed for operation at or below 4.5 Kelvin;

(d) Fabricates any of the following:

(1) Logic integrated circuits using a non-planar transistor architecture or with a production technology node of 16/14 nanometers or less, including fully depleted silicon-on-insulator (FDSOI) integrated circuits;

(2) NOT-AND (NAND) memory integrated circuits with 128 layers or more;

(3) Dynamic random-access memory (DRAM) integrated circuits using a technology node of 18 nanometer half-pitch or less;

(4) Integrated circuits manufactured from a gallium-based compound semiconductor;

(5) Integrated circuits using graphene transistors or carbon nanotubes; or

(6) Integrated circuits designed for operation at or below 4.5 Kelvin;

(e) Packages any integrated circuit using advanced packaging techniques;

(f) Develops, installs, sells, or produces any supercomputer enabled by advanced integrated circuits that can provide a theoretical compute capacity of 100 or more double-precision (64-bit) petaflops or 200 or more single-precision (32-bit) petaflops of processing power within a 41,600 cubic foot or smaller envelope;

(g) Develops a quantum computer or produces any of the critical components required to produce a quantum computer such as a dilution refrigerator or two-stage pulse tube cryocooler;

(h) Develops or produces any quantum sensing platform designed for, or which the relevant covered foreign person intends to be used for, any military, government intelligence, or mass surveillance end use;

(i) Develops or produces any quantum network or quantum communication system designed for, or which the relevant covered foreign person intends to be used for:

(1) Networking to scale up the capabilities of quantum computers, such as for the purposes of breaking or compromising encryption;

(2) Secure communications, such as quantum key distribution; or

(3) Any other application that has any military, government intelligence, or mass surveillance end use;

(j) Develops any AI system that is designed to be exclusively used for, or which the relevant covered foreign person intends to be used for, any:

(1) Military end use (e.g., for weapons targeting, target identification, combat simulation, military vehicle or weapon control, military decision-making, weapons design (including chemical, biological, radiological, or nuclear weapons), or combat system logistics and maintenance); or

(2) Government intelligence or mass-surveillance end use (e.g., through incorporation of features such as mining text, audio, or video; image recognition; location tracking; or surreptitious listening devices);

(k) Develops any AI system that is trained using a quantity of computing power greater than: (1) 10^25 computational operations (e.g., integer or floating-point operations); or (2) 10^24 computational operations (e.g., integer or floating-point operations) using primarily biological sequence data;

(l) Meets the conditions set forth in § 850.209(a)(2) because of its relationship to one or more covered foreign persons engaged in any covered activity described in any of paragraphs (a) through (k) of this section; or

(m) Engages in a covered activity, whether referenced in this section or § 850.217 and is:

(1) Included on the Bureau of Industry and Security’s Entity List (15 CFR part 744,  supplement no. 4);

(2) Included on the Bureau of Industry and Security’s Military End User List (15 CFR part 744, supplement no. 7);

(3) Meets the definition of “Military Intelligence End-User” by the Bureau of Industry and Security in 15 CFR 744.22(f)(2);

(4) Included on the Treasury’s list of Specially Designated Nationals and Blocked Persons (SDN List), or is an entity in which one or more individuals or entities included on the SDN List, individually or in the aggregate, directly or indirectly, own a 50 percent or greater interest;

(5) Included on the Treasury’s list of Non-SDN Chinese Military Industrial Complex Companies (NS–CMIC List); or (6) Designated as a foreign terrorist organization by the Secretary of State under 8 U.S.C. 1189.

Penalties and Enforcement Actions

Violations of the Outbound Investment Rule (including attempts or conspiracies to violate) may result in:

• Civil penalties: Up to $368,136 or twice the transaction amount.
• Criminal penalties: Fines up to $1 million and imprisonment for up to 20 years.

The Treasury also reserves the right to nullify, void, or compel divestment of prohibited transactions entered into after the effective date if deemed necessary.

International Compliance Challenges

The rule poses unique compliance challenges for foreign investors and U.S.-based multinational corporations with global operations, especially those with interests in China. These challenges include:

• Due Diligence Constraints: The expectation of a “reasonable and diligent inquiry” often requires access to non-public information about foreign counterparties. This can be particularly challenging in jurisdictions where public information may be limited, incomplete, or politically sensitive. U.S. persons investing through foreign branches or subsidiaries may also face challenges in assessing the compliance risk of each transaction, given the potential lack of transparency around the end-use of the technology.
• Cross-Border Coordination and Compliance: Multinational corporations must establish cohesive compliance frameworks across various jurisdictions. This includes training regional compliance teams to recognize red flags and enforce due diligence practices that align with U.S. regulatory expectations. Furthermore, coordinating with legal counsel across borders is essential to prevent inadvertent violations of the outbound investment rule.

Compliance Strategies for International Stakeholders

Foreign investors and U.S.-based multinationals can adopt the following strategies to manage compliance risks effectively:

• Enhanced Due Diligence and Contractual Safeguards: Implement robust due diligence frameworks to assess potential risks. Consider including contractual clauses requiring foreign entities to disclose any links to covered activities.
• Collaboration with Legal and Compliance Experts: Partner with legal counsel familiar with U.S. export control laws and foreign investment restrictions to interpret the rule’s scope and ensure compliance.
• Regional Compliance Training Programs: Train regional compliance teams on the outbound investment rule and its requirements.
• Compliance Monitoring Systems: Establish monitoring systems to track international transactions, allowing compliance teams to detect prohibited transactions early.
• Voluntary Disclosure Programs: Self-disclosure of unintentional violations can potentially mitigate penalties.

Conclusion

The Treasury’s Outbound Investment Rule introduces a stringent compliance landscape for U.S. investors in designated foreign entities, emphasizing the need for vigilance, transparency, and proactive risk management. International stakeholders, particularly those with investments in China, must adapt to this evolving regulatory environment by implementing comprehensive compliance frameworks and engaging in robust due diligence practices.

While the rule reflects broader geopolitical concerns about technology transfer and national security, it also signals a fundamental shift in global investment patterns. Through effective compliance management, international investors can navigate these challenges and contribute to a secure and resilient international investment ecosystem.

Ivan Komaritsky is a regulatory compliance, corporate crime and litigation attorney.  He advises clients with respect to the Foreign Corrupt Practices Act (FCPA) compliance, the Committee on Foreign Investment in the United States (CFIUS) regulations, and US economic sanctions and embargoes (OFAC regulations). Ivan also represents clients in white collar crime investigations and commercial litigation matters. Mr. Komaritsky guides clients on developing and implementing multinational compliance programs and policies to address risks of corruption, fraud, embezzlement, and violation of OFAC/sanctions legislation.