Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern

DEPARTMENT OF THE TREASURY

Office of Investment Security

31 CFR Part 850

RIN 1505-AC82

Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern

AGENCY:

Office of Investment Security, Department of the Treasury.

ACTION:

Final rule.

SUMMARY:

This final rule sets forth the regulations that implement Executive Order 14105 of August 9, 2023, “Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern,” which declares a national emergency to address the threat to the United States posed by countries of concern that seek to develop and exploit sensitive technologies or products critical for military, intelligence, surveillance, or cyber-enabled capabilities. The final rule requires United States persons to provide notification to the U.S. Department of the Treasury regarding certain transactions involving persons of a country of concern that are engaged in activities involving certain national security technologies and products that may contribute to the threat to the national security of the United States; and prohibits United States persons from engaging in certain other transactions involving persons of a country of concern that are engaged in activities involving certain other national security technologies and products that pose a particularly acute national security threat to the United States.

DATES:

This final rule is effective on January 2, 2025.

FOR FURTHER INFORMATION CONTACT:

Meena R. Sharma, Director, Office of Investment Security Policy and International Relations, at U.S. Department of the Treasury, 1500 Pennsylvania Avenue NW, Washington, DC 20220; telephone: (202) 622-3425; email:

OIS.Outbound.Regulations@treasury.gov.

SUPPLEMENTARY INFORMATION:

I. Background

A. Outbound Order

On August 9, 2023, the President issued Executive Order 14105 (88 FR 54867), “Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern” (the Outbound Order), pursuant to his authority under the Constitution and the laws of the United States, including the International Emergency Economic Powers Act (IEEPA), the National Emergencies Act (NEA), and section 301 of title 3, United States Code (U.S.C.). In the Outbound Order, the President found that the advancement by countries of concern in sensitive technologies and products critical for the military, intelligence, surveillance, or cyber-enabled capabilities of such countries constitutes a threat to the national security of the United States, which has its source in whole or substantial part outside the United States, and that certain U.S. investments risk exacerbating this threat. In response, the President declared a national emergency to deal with this threat. On August 6, 2024, the President continued the national emergency (89 FR 65163) declared in the Outbound Order.

The Outbound Order identifies three sectors of national security technologies and products to be covered by the program: semiconductors and microelectronics, quantum information technologies, and artificial intelligence. As described in the Outbound Order, countries of concern are exploiting or have the ability to exploit certain U.S. outbound investments, including certain intangible benefits that often accompany U.S. investments and that help companies succeed. In an Annex to the Outbound Order, the President identified one country, the People's Republic of China (PRC), along with the Special Administrative Region of Hong Kong (Hong Kong) and the Special Administrative Region of Macau (Macau), as a country of concern. The President may modify the Annex to the Outbound Order and update the list of countries of concern.

Advanced technologies and products that are increasingly developed and financed by the private sector form the basis of next-generation military, intelligence, surveillance, or cyber-enabled capabilities. As stated in the Outbound Order, advancements in sensitive technologies and products in the areas of semiconductors and microelectronics, quantum information technologies, and artificial intelligence will accelerate the development of advanced computational capabilities that will enable new applications that pose significant national security risks, such as the development of more sophisticated weapons systems, breaking of cryptographic codes, and other applications that could provide a country of concern with military advantages. The potential military, intelligence, surveillance, or cyber-enabled applications of these technologies and products pose risks to U.S. national security, particularly when developed in or by a country of concern in which the government seeks to (1) direct entities to obtain technologies to achieve national security objectives and (2) compel public or private entities to share or transfer these technologies to the government's military, intelligence, surveillance, or security apparatuses.

U.S. investments are often more valuable than their capital alone, because they can also include the transfer of intangible benefits. Intangible benefits that often accompany U.S. investments and help companies succeed include: enhanced standing and prominence, managerial assistance, access to investment and talent networks, market access, and enhanced access to additional financing. Certain investments by United States persons into a country of concern can be exploited to accelerate the development of sensitive technologies or products—including military, intelligence, surveillance, or cyber-enabled capabilities—in ways that negatively impact the national security of the United States. Such investments, therefore, risk exacerbating this threat to U.S. national security.

The Outbound Order outlines two primary components that serve distinct but related objectives with respect to the relevant technologies and products. The first component requires notification to the Secretary of the Treasury (the Secretary) regarding certain types of investments by a United States person in a

covered foreign person

engaged in

covered activities

pertaining to specified categories of technologies and products. The second component requires the Secretary to prohibit certain types of investment by a United States person in a

covered foreign person

engaged in

covered activities

pertaining to other specified categories of advanced technologies and products. Both components focus on investments that could enhance a country of concern's military, intelligence, surveillance, or cyber-enabled capabilities through the advancement of technologies and products in particularly sensitive areas.

The Outbound Order directs the Secretary, in consultation with the Secretary of Commerce and, as appropriate, the heads of other relevant agencies, to issue, subject to public notice and comment, regulations that, among other things, require

U.S. persons

to submit information to the

U.S. Department of the Treasury (Treasury Department) regarding

notifiable transactions

and prohibit

U.S. persons

from engaging in

prohibited transactions.

Under section 10(a) of the Outbound Order, the President authorizes the Secretary to promulgate rules and regulations, including elaborating upon the definitions contained in the Outbound Order. The Secretary's promulgation of regulations under the Outbound Order is consistent with the President's authority to “issue such regulations, including regulations prescribing definitions, as may be necessary for the exercise” of authorities granted under IEEPA (50 U.S.C. 1704) and the President's authority to designate and empower the head of any department or agency in the executive branch to perform any function which is vested in the President by law (3 U.S.C. 301).

The Outbound Order instructs the Secretary to identify in such regulations categories of

notifiable transactions

that involve covered national security technologies and products that the Secretary, in consultation with the Secretary of Commerce and, as appropriate, the heads of other relevant agencies, determines may contribute to the threat to the national security of the United States identified in the Outbound Order. The Outbound Order also instructs the Secretary to identify categories of

prohibited transactions

that involve technologies and products that the Secretary, in consultation with the Secretary of Commerce and, as appropriate, the heads of other relevant agencies, determines pose a particularly acute national security threat to the United States. Consistent with the Outbound Order, the Secretary may exempt from the notification requirement or prohibition any transaction determined by the Secretary, in consultation with the heads of relevant agencies, as appropriate, to be in the national interest of the United States. Additionally, the Outbound Order requires the Secretary to investigate, in consultation with the heads of relevant agencies, as appropriate, violations of the Outbound Order or the regulations and pursue civil penalties for such violations.

B. Advance Notice of Proposed Rulemaking

Concurrent with the issuance of the Outbound Order, on August 9, 2023, the Treasury Department issued an Advance Notice of Proposed Rulemaking, 88 FR 54961 (published August 14, 2023) (ANPRM), to provide transparency and clarity about the intended scope of the program and solicit early stakeholder participation in the rulemaking process. The ANPRM outlined key concepts under consideration and sought public comment on a range of topics related to the implementation of the Outbound Order.

The Treasury Department received 60 comment letters in response to the ANRPM, many from business associations that represented a wide variety of stakeholders across industries as well as from individuals and companies in the financial services, legal, and technology sectors. (The comments to the ANPRM are available on the public rulemaking docket at

https://www.regulations.gov

(Docket TREAS-DO-2023-0009)). In general, the comments focused on enhancing the clarity of the scope of the program and the definitions under consideration, aligning the program where possible with other relevant U.S. Government programs, and supporting program development in a targeted manner to reduce unintended consequences for U.S. competitiveness. The Treasury Department considered each comment in developing the Notice of Proposed Rulemaking discussed in the next section.

C. Notice of Proposed Rulemaking

On June 21, 2024, the Treasury Department issued a Notice of Proposed Rulemaking, 89 FR 55846 (published July 5, 2024) (Proposed Rule), setting forth the full proposed regulations for implementing the Outbound Order. The Proposed Rule built on the ANPRM and reflected the Treasury Department's consideration of comments received in response to the ANPRM. The Proposed Rule included the full draft regulations and explanatory discussion regarding the intent of the proposal. It also solicited additional comments from the public.

Obligations on U.S. Persons

The Proposed Rule would have placed obligations on

U.S. persons,

including a notification requirement for certain transactions and prohibition of certain other transactions. A

U.S. person

was defined to include any United States citizen or lawful permanent resident, as well as any entity organized under the laws of the United States or any jurisdiction within the United States, including any foreign branch of any such entity, and any person in the United States.

Knowledge Standard

The obligations of a

U.S. person

under the Proposed Rule would have applied if such person had knowledge of relevant facts or circumstances related to a transaction. Under the proposed standard, a

U.S. person

may have been assessed to have had knowledge if the

U.S. person

possessed actual knowledge that a fact or circumstance existed or was substantially certain to occur, if the

U.S. person

possessed an awareness of a high probability of a fact or circumstance's existence or future occurrence, or if the

U.S. person

could have possessed such information through a “reasonable and diligent inquiry.” To provide clarity, the Proposed Rule listed factors that the Treasury Department would consider in assessing whether a

U.S. person

undertook a “reasonable and diligent inquiry.” Such factors reflected information that should have been ascertainable and/or contractual assurances that should have been obtainable through reasonable due diligence.

Specific Categories of Covered Transaction

The Proposed Rule would have applied to certain transactions by

U.S. persons,

including the acquisition of an equity interest or

contingent equity interest;

certain debt financing convertible to an equity interest or that afforded certain rights to the lender; the conversion of a

contingent equity interest;

a greenfield investment or other corporate expansion; a joint venture; and certain investments as a limited partner or equivalent (LP) in a non-

U.S. person

pooled investment fund.

Involving a Covered Foreign Person

The Proposed Rule would have applied to certain transactions by a

U.S. person

that also involved a

covered foreign person

—that is, a

person of a country of concern

engaged in a

covered activity

related to defined subsets of technologies and products or a

person

that had a specified relationship with such a person. Under the Proposed Rule,

a person of a country of concern

included an individual who is a citizen or permanent resident of a

country of concern

(and not a U.S. citizen or permanent resident of the United States); an entity organized under the laws of a

country of concern,

or headquartered in, incorporated in, or with a principal place of business in a

country of concern;

the government of a

country of concern;

or an entity that is directly or indirectly owned 50 percent or more by any persons in any of the aforementioned categories. Additionally, the Proposed Rule would have applied to certain transactions involving an entity that had a voting interest, board seat, or equity interest in a

covered foreign person

where more

than 50 percent of one of several key financial metrics of the entity was attributable to such

covered foreign person.

Excepted Transaction

The Proposed Rule would have excepted certain types of transactions from coverage, provided that such transactions did not afford a

U.S. person

certain rights that were not standard minority shareholder protections. These included: investments in publicly traded securities, certain LP investments, buyouts of

country of concern

ownership; intracompany transactions; investments made pursuant to pre-Outbound Order binding commitments; certain syndicated debt financings; and certain transactions involving a person of a country or territory outside of the United States based on a determination by the Secretary.

National Interest Exemption

Under the Proposed Rule, a

U.S. person

could have sought an exemption from the application of the prohibition or notification requirement on the basis that a transaction was in the national interest of the United States.

Notification Requirement

A

U.S. person

subject to the notification requirement under the Proposed Rule would have been required to file a notification form with the Treasury Department that included information related to the transaction such as details about the

U.S. person,

the

covered transaction,

relevant national security technologies and products, and the

covered foreign person.

The Proposed Rule would have required that such notification be filed no later than 30 days after a transaction is completed or, where a

U.S. person

acquires actual knowledge after the completion date of a transaction that the transaction would have been a

covered transaction

if such knowledge had been possessed at the time of the transaction, no later than 30 days after the

U.S. person'

s acquisition of such knowledge.

National Security Technologies and Products

The Proposed Rule identified the subsets of national security technologies and products identified in the Outbound Order that would have been subject to the Proposed Rule.

•

Semiconductors and microelectronics. Covered transactions

related to electronic design automation software; certain fabrication and advanced packaging tools; the design, fabrication, or packaging of certain advanced integrated circuits; and supercomputers would have been prohibited.

Covered transactions

related to the design, fabrication, or packaging of integrated circuits not otherwise covered by the

prohibited transaction

definition would have been subject to the notification requirement.

•

Quantum information technologies. Covered transactions

related to the development of quantum computers and production of critical components; the development or production of certain quantum sensing platforms; and the development or production of quantum networking and quantum communication systems would have been prohibited.

•

Artificial intelligence (AI) systems. Covered transactions

related to the development of any

AI system

designed to be exclusively used for, or intended to be used for, certain end uses would have been prohibited. The Proposed Rule also included proposed alternatives for a prohibition on

covered transactions

related to the development of any

AI system

that was trained using a specified quantity of computing power, and trained using a specified quantity of computing power using primarily biological sequence data.

Covered transactions

related to the development of any

AI system

not otherwise covered by the

prohibited transaction

definition, where such

AI system

was designed or intended to be used for certain end uses or was trained using a specified quantity of computing power (set below the levels in the

prohibited transaction

definition), would have been subject to the notification requirement.

Violations

The Proposed Rule outlined the penalty and disclosure framework for violations. A violation would have been subject to civil and criminal penalties as set forth in IEEPA. In the event of a violation, the Treasury Department would have been authorized to impose civil penalties and could also have referred criminal violations to the Attorney General. The Secretary also could have taken any action authorized under IEEPA to nullify, void, or otherwise require divestment of any

prohibited transaction.

The Proposed Rule would have provided a process for a

U.S. person

to submit a voluntary self-disclosure if they believed their conduct may have resulted in a violation of any part of the Proposed Rule. Such self-disclosure would have been taken into consideration during the Treasury Department's determination of the appropriate response to the self-disclosed violation.

II. Overview of Comments on the Proposed Rule

The public was given an opportunity to comment on the Proposed Rule, and comments were due by August 4, 2024. The public comments received are available on the rulemaking docket at

https://www.regulations.gov

(Docket TREAS-DO-2024-0012). The Treasury Department received over 40 comment letters in response to the Proposed Rule reflecting a range of views. The Treasury Department considered each comment before issuing this final rule (Final Rule). Discussed below are the comments received and the Treasury Department's responses in consideration of the comments.

III. Discussion of the Final Rule

A. Scope and Objective of the Final Rule

The preamble to the Proposed Rule noted that its focus was on the types of U.S. investments that presented a likelihood of conveying both capital and intangible benefits that could be exploited by countries of concern to accelerate the development of sensitive technologies or products in ways that negatively impact the national security of the United States. With an interest in minimizing unintended consequences and addressing the national security risks posed by countries of concern developing technologies that are critical to the next generation of military, intelligence, surveillance, or cyber-enabled capabilities, the Proposed Rule included detailed definitions and descriptions of terms and elements to appropriately scope coverage and facilitate compliance by United States persons. At the same time, the Proposed Rule sought to avoid loopholes that could have undermined the national security objectives of the Outbound Order.

Several commenters noted their support for the overall goals of the Outbound Order and Proposed Rule. One commenter commended the Treasury Department for taking action to stop U.S. investment in entities backed by the Chinese Communist Party that threaten U.S. national security. Another commenter endorsed U.S. Government efforts to ensure entities that pose national security threats are denied access to all U.S. investors and U.S. capital markets. Several commenters expressed support for the Treasury Department's goal of restricting investment that would accelerate the development of military, intelligence, surveillance, and cyber-enabled capabilities in countries of concern. Another commenter emphasized the importance and difficulty of countering

the undesired transfer of emerging technologies. One commenter commended the Treasury Department's recognition that U.S. leadership in emerging technologies is critical to long-term U.S. interests, while another noted that maintaining a healthy U.S. semiconductor industry is an essential component to protecting national security.

Several commenters noted the importance of balancing the protection of national security with the maintenance of economic competitiveness and an open investment policy. One commenter stated that a well-designed rule would have actionable requirements that achieve the Treasury Department's goals while mitigating unintended consequences.

Several commenters highlighted the importance of clarity in the Proposed Rule, especially in the definitions, or requested further clarification. Other commenters requested that the rule be no more burdensome than necessary to achieve its aims. One commenter encouraged the Treasury Department to be mindful of the implications of the U.S. Supreme Court decision in

Loper-Bright

v.

Raimondo,

144 S. Ct. 2244 (2024), particularly related to implementation of broad authorities and industry's reliance on a stable, clear, and predictable regulatory environment.

One commenter highlighted a think tank report about outbound investment that encouraged authorities to target the highest risk transactions and recommended establishing a rule that is proportionate, easy to understand, nonduplicative of existing tools, and that enables dialogue with allies about adopting similar regimes.

Other commenters expressed the view that the Proposed Rule was too broad or not designed to address the threat identified in the Outbound Order. Some commenters requested the notification requirement be removed from the rule, with one commenter expressing the view that the notification requirement would not address the threat identified in the Outbound Order. One commenter asserted that the investment restriction in the Proposed Rule was based on misconceptions and assumptions about the PRC government and PRC businesses that are not supported by evidence. Another commenter asserted that the Proposed Rule represents a departure from the United States' traditional support for free and open capital flows. Another commenter characterized the Proposed Rule as unreasonable and contrary to principles of free and fair trade. The commenter alleged that the Proposed Rule would obstruct opportunities for PRC companies, limit the innovation capacity of the United States, and destroy the global industrial supply chain. Another commenter expressed concern that the Proposed Rule is overly broad and that it underestimates the potential negative impacts on investment managers.

In response to these comments, the Treasury Department notes that the United States has long maintained an open investment policy and supported cross-border investment where consistent with U.S. national security interests. In developing the Final Rule, the Treasury Department has sought to maintain the goals of both open investment and protection of national security by focusing on U.S. investments that present a likelihood of conveying both capital and intangible benefits that can be exploited to accelerate the development of sensitive technologies or products critical for military, intelligence, surveillance, or cyber-enabled capabilities of countries of concern in ways that threaten the national security of the United States.

The Treasury Department also recognizes the potential for unintended consequences that may arise under the Final Rule and has sought to further minimize the impact of those consequences, including through changes to the definitions of

covered transaction

and

excepted transaction

in the Final Rule that are described below. The Treasury Department made these changes to provide additional clarity, improve administrability, and facilitate compliance by

U.S. persons,

while also cognizant of the need to close loopholes that could undermine the national security objectives of the Outbound Order. In addition, as discussed further below, the Treasury Department anticipates providing additional information on its Outbound Investment Security Program website to facilitate compliance by

U.S. persons.

Similar to the Proposed Rule, the Final Rule seeks to complement existing authorities and tools of the U.S. Government, such as export controls and inbound investment reviews. The Final Rule addresses the complex and evolving national security threat identified in the Outbound Order.

The Treasury Department also notes that the Final Rule is based on the President's finding in the Outbound Order that

countries of concern

are “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.” The President's finding also notes that “[a]s part of this strategy of advancing the development of these sensitive technologies and products,

countries of concern

are exploiting or have the ability to exploit certain United States outbound investments, including certain intangible benefits that often accompany United States investments and that help companies succeed.” The Treasury Department assesses that the requirements of the Final Rule are narrowly scoped to focus on a limited subset of investment activity and to avoid unintended impacts in broader sectors of the U.S. or global economies. The Treasury Department also notes that imposing targeted measures to address acute national security risks is consistent with trade and investment agreements to which the United States is a party. The Treasury Department further notes that the two components of the program—that is, requiring notification of certain transactions and prohibiting other transactions—helps limit the impact on market participants while providing the Treasury Department with visibility into the volume and nature of

U.S. person covered transactions

and informing future policy development and decisions. Finally, regarding the potential unintended impact on asset managers, the Treasury Department notes that some modifications made to the Final Rule are specifically intended to limit the applicability to certain routine cross-border financial activity that the Treasury Department has determined is unlikely to result in the transfer of intangible benefits along with capital that can be exploited to threaten U.S. national security.

B. Statutory Authority

As described above, the Outbound Order was issued by the President pursuant to his authority under the Constitution and the laws of the United States, including IEEPA, the NEA, and section 301 of title 3, U.S.C. The Outbound Order directs the Secretary, in consultation with the Secretary of Commerce and, as appropriate, the heads of other relevant agencies, to issue, subject to public notice and comment, regulations that, among other things, require

U.S. persons

to submit information to the Treasury Department regarding

notifiable transactions

and prohibit

U.S. persons

from engaging in

prohibited transactions.

Under section 10(a) of the Outbound Order, the President authorizes the Secretary to promulgate rules and regulations, including elaborating upon the definitions contained in the Outbound

Order. The Secretary's issuance of the Proposed Rule and this Final Rule under the Outbound Order is consistent with the President's authority to “issue such regulations, including regulations prescribing definitions, as may be necessary for the exercise” of authorities granted under IEEPA (50 U.S.C. 1704) and the President's authority to designate and empower the head of any department or agency in the executive branch to perform any function which is vested in the President by law (3 U.S.C. 301).

One commenter raised questions about whether the Treasury Department had appropriate authority to issue and administer the rule. The commenter noted that Congress did not explicitly authorize the Assistant Secretary of the Treasury for Investment Security to oversee an outbound investment program in the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA; Subtitle A of Title XVII of Pub. L. 115-232, 132 Stat. 2173), the legislation that established the position of Assistant Secretary of the Treasury for Investment Security. The commenter noted that the establishment of the Outbound Investment Security Program would mean that the Assistant Secretary's duties would no longer be principally related to the Committee on Foreign Investment in the United States (CFIUS) as FIRRMA requires. The commenter also asserted that personnel hired under FIRRMA's hiring authority likewise must have CFIUS-related work as their primary responsibility, which in the commenter's view, does not encompass the rulemaking to implement the Outbound Order. The commenter also expressed the view that IEEPA could not be a source of authority for the Proposed Rule. The commenter expressed that in practice, the Proposed Rule sought to regulate access to expertise and professional networks, and that this was “sharing of information” that could not be prohibited under IEEPA unless such information was subject to espionage or export control laws.

The Treasury Department appreciates these comments and the opportunity to respond to the legal points they raise. IEEPA (50 U.S.C. 1701

et seq.

) authorizes the President to deal with any unusual and extraordinary threat, which has its source in whole or substantial part outside the United States, to the national security, foreign policy, or economy of the United States, if the President declares a national emergency with respect to such threat. Nothing in FIRRMA limits the President's authority under IEEPA. As described in more detail above, consistent with the framework of the NEA and IEEPA, the President declared a national emergency in the Outbound Order and directed the Secretary to issue regulations to address that emergency. As noted, the Secretary's promulgation of regulations under the Outbound Order is consistent with the President's authority to “issue such regulations, including regulations prescribing definitions, as may be necessary for the exercise” of authorities granted under IEEPA (50 U.S.C. 1704) and the President's authority to designate and empower the head of any department or agency in the executive branch to perform any function which is vested in the President by law (3 U.S.C. 301).

As directed by the President, the Final Rule addresses the declared national emergency and threat to national security by prohibiting certain transactions and requiring notification of certain other transactions by

U.S. persons

involving subsets of sensitive technologies and products critical for military, intelligence, surveillance, or cyber-enable capabilities of

countries of concern.

The commenter states that a provision of IEEPA exempting from regulation “the importation from any country, or the exportation to any country . . . of any information or informational materials” (50 U.S.C. 1702(b)(3)) forecloses the Treasury Department from issuing the rule under IEEPA. Consistent with the statute, neither the Proposed Rule nor the Final Rule regulates the export of “information or informational materials.” Section 850.503 of the Final Rule explicitly provides that conduct referred to in 50 U.S.C. 1702(b) shall not be regulated or prohibited, directly or indirectly, by this part. Instead, the Proposed Rule would have regulated, and the Final Rule will regulate,

covered transactions.

Consistent with the national emergency framework described above, IEEPA unambiguously authorizes the President to, among other things, “regulate . . . transactions involving[ ] any property in which any foreign country or a national thereof has any interest by any person, or with respect to any property, subject to the jurisdiction of the United States” (50 U.S.C. 1702(a)(1)(B)), and the Outbound Order, ANPRM, Proposed Rule, and Final Rule rely on this authority. The existence of a

covered transaction

is a fundamental prerequisite for the application of the notification requirement and prohibitions under the Proposed Rule or Final Rule, and the concept of a

covered transaction

has been crafted in a manner consistent with both section 1702(b) of IEEPA and section 850.503 of the Final Rule.

Notifiable transactions

and

prohibited transactions

are each defined as

covered transactions

in which the relevant

covered foreign person

undertakes (or in certain instances, the

U.S. person

knows will or plans to undertake) specified

covered activities.

The types of transactions that may constitute a

covered transaction

are the acquisition of an equity interest or

contingent equity interest;

certain debt financing that affords certain rights to the lender; the conversion of a

contingent equity interest;

a greenfield investment or other corporate expansion; a joint venture; and certain investments as an LP in a non-

U.S. person

pooled investment fund. Granting access to expertise or professional networks via a

U.S. person

is not a

covered transaction,

and thus is not subject to regulation under the Final Rule.

The commenter observes that the duties of the Assistant Secretary of the Treasury for Investment Security, as defined in 50 U.S.C. 4565(k)(4)(A)(ii)(II), must be “principally related to [CFIUS].” The Final Rule and the establishment of the Outbound Investment Security Program within the Treasury Department's Office of Investment Security are consistent with this requirement. Taking into account factors such as budget, personnel, and allocation of time, the Assistant Secretary for Investment Security's duties, and those of relevant Treasury Department staff, will remain principally related to CFIUS, even with the Outbound Investment Security Program coming under the Assistant Secretary's purview.

C. Summary of Comments to the Proposed Rule and Changes From the Proposed Rule

The discussion below summarizes comments submitted to the Proposed Rule and the Treasury Department's responses to those comments. For provisions that are not discussed below, the Treasury Department did not receive any substantive comments on those provisions and is implementing them in the Final Rule without substantive change from the Proposed Rule.

Subpart A—General

§ 850.101—Scope

Section 850.101 of the Proposed Rule outlined the scope of the Proposed Rule. Section 850.101(a) explained that the Proposed Rule implemented the Outbound Order, and § 850.101(b), (c), and (d) discussed at a high level certain key terms and requirements in the

Proposed Rule, namely

covered transactions

and

excepted transactions,

along with

notifiable

and

prohibited transactions

and the requirements for

U.S. persons

and

controlled foreign entities

regarding

notifiable

and

prohibited transactions.

Section 850.101(e) described requirements in the Outbound Order for the Secretary to communicate with Congress and the public with respect to implementation of the Outbound Order and consult with specified departments and agencies on various aspects of the Outbound Order and regulations.

The Treasury Department did not receive any comments on § 850.101 of the Proposed Rule. The Final Rule adopts § 850.101 in a form nearly identical to that in the Proposed Rule but makes some non-substantive edits to the structure of paragraphs (c) and (d) to clarify the requirements applicable to the Secretary's determination with respect to

covered activities.

§ 850.104—Knowledge Standard

Under § 850.104 of the Proposed Rule, certain provisions, including in the definition of

covered transaction,

would have applied only if a

U.S. person knew

of a relevant fact or circumstance. The definition of

knowledge

in the Proposed Rule at § 850.216 included the following: actual knowledge that a fact or circumstance existed or was substantially certain to occur, an awareness of a high probability of a fact or circumstance's existence or future occurrence, or reason to know of a fact or circumstance's existence. The definition of

covered transaction

in the Proposed Rule at § 850.210 generally would have required the

U.S. person

to

know

(or in some circumstances, to intend) at the time of a transaction that the transaction involved a

covered foreign person,

would have resulted in the establishment of a

covered foreign person

(in the case of a greenfield, brownfield, or a joint venture investment), or would have resulted in a

person of a country of concern'

s engagement in a new

covered activity

(in the case of a business pivot). The Proposed Rule noted that the Treasury Department was not proposing to hold a

U.S. person

liable for a transaction that had all of the other attributes of a

covered transaction

but that the

U.S. person

did not

know

at the time (which would have included not having “reason to know” at the time) was involved with or would have resulted in a

covered foreign person.

As discussed in the Proposed Rule, if a

U.S. person

failed to conduct a “reasonable and diligent inquiry” at the time of a transaction and undertook the transaction where a particular fact or circumstance indicative of a

covered transaction

was present, the Treasury Department might have found in the course of determining compliance with the Proposed Rule that the

U.S. person

had reason to know of such fact or circumstance (and therefore, for purposes of the Proposed Rule,

knew

). To provide further clarity, the Proposed Rule, in § 850.216, included some of the factors that the Treasury Department would have considered in assessing whether a

U.S. person

undertook such an inquiry, as applicable. These included efforts to obtain contractual assurances and information that should have been obtainable through a reasonable transactional due diligence process with respect to the determination of a transaction's status as a

covered transaction

or relevant entity's status as a

covered foreign person.

The Treasury Department received comments on several aspects of § 850.104 of the Proposed Rule. In response, the Treasury Department has made changes to clarify this provision in the Final Rule and discusses other issues below.

Commenters sought clarification or guidance on how the Treasury Department will evaluate the sufficiency of a

U.S. person'

s due diligence as part of determining whether a “reasonable and diligent inquiry” occurred, citing potential obstacles to conducting due diligence in the PRC. Several commenters asked that the Treasury Department explicitly acknowledge the challenges of conducting due diligence in foreign jurisdictions and provide specific due diligence guidance, include language in the rule that makes clear that it will evaluate a

U.S. person'

s due diligence efforts based on the totality of the facts and circumstances, and/or provide a safe harbor from enforcement if the

U.S. person

takes specific due diligence steps, such as soliciting or securing representations and warranties or using representative due diligence questions that some commenters requested be provided by the Treasury Department. A few commenters suggested that, with respect to the language in the Proposed Rule regarding a “relevant counterparty,” a

U.S. person'

s due diligence obligations should be limited to obtaining certain representations and warranties in the relevant investment agreement.

As in the Proposed Rule, § 850.104(c) of the Final Rule sets forth an illustrative list of factors that the Treasury Department will consider in assessing whether a

U.S. person

has undertaken a “reasonable and diligent inquiry” with respect to a particular transaction. The Treasury Department recognizes that some of the considerations in 850.104(c) may be inapplicable to a given transaction. In response to comments seeking clarity regarding how the Treasury Department will evaluate the sufficiency of a

U.S. person'

s due diligence, the Treasury Department has added a new paragraph (d) to § 850.104 of the Final Rule to clarify that the Treasury Department's assessment of whether a

U.S. person

has undertaken a “reasonable and diligent inquiry” will be made based on a consideration of the totality of relevant facts and circumstances. This new language accounts for the circumstance where a

U.S. person

may face obstacles to conducting due diligence, while preserving the necessary flexibility to consider the individual facts and circumstances of a transaction when assessing whether a “reasonable and diligent inquiry” has occurred.

The Treasury Department declines to include a safe harbor provision or to prescribe specific due diligence obligations in the Final Rule. Rather, the Final Rule is designed to address the fact-specific and individualized nature of each transaction by offering an illustrative list of considerations at § 850.104(c), in combination with § 850.104(d), as described above.

One commenter stated that the Treasury Department should not consider an entity's refusal to make representations or warranties to be a warning sign, by itself, while another commenter stated that they did not believe they would be able to credibly assess information received from an investment target for warning signs. Given the variety of forms a warning sign could take, the Final Rule does not prescribe what a warning sign or red flag would be, but § 850.104(d) addresses commenter concerns by stating that the totality of the relevant facts and circumstances shall be considered in determining if the

U.S. person

has undertaken a “reasonable and diligent inquiry.” If, for example, a

U.S. person

is unable to obtain certain information from a transaction counterparty, or unable to obtain relevant representations or warranties, the presence or absence of other relevant factors may be relevant to the consideration of whether, in totality, the

U.S. person

undertook a “reasonable and diligent inquiry.”

Commenters also requested clarification that a

U.S. person

will not be held responsible for an investment target's provision of false or inaccurate information or failure to provide information, or at least will have safe

harbor for good faith reliance on the information provided absent warning signs or contradictory information. Another commenter noted that

U.S. persons

would have to rely on unverified responses from prospective portfolio companies because much of the information would be in the exclusive possession of the target company and may be proprietary.

The Treasury Department acknowledges that in certain instances, information required to assess whether a transaction is a

covered transaction

may be difficult to ascertain. In such circumstances, and in the absence of warning signs, a

U.S. person

may wish to obtain representations or warranties from the relevant transaction counterparty regarding pertinent information such as the investment target or counterparty's ownership, investments, and activities.

Multiple commenters sought clarification regarding how the Treasury Department will evaluate a

U.S. person'

s efforts to obtain information in the context of an assessment of a “reasonable and diligent inquiry.” One commenter asked that the Treasury Department not evaluate a

U.S. person'

s efforts to obtain non-publicly available information, but merely assess whether they evaluated what was in their possession. The commenter stated that it would be sufficient for the Treasury Department to make clear that this factor, and others, would be evaluated in light of the totality of the facts and circumstances, including the sophistication of the

U.S. person.

One commenter asked for clarification regarding the degree of effort that a

U.S. person

must exert to obtain non-publicly available information. Another questioned what “available” means—whether it refers to information in the

U.S. person'

s possession, information that the

U.S. person

could obtain in the normal course of business, or information that must be sought. A few commenters indicated that they did not believe they would be able to review all publicly available information about a target due to the voluminous amount of public information often available regarding a target, much of it not in English, and the timeframes on which many venture capital deals occur. One commenter asked whether a risk-based approach was sufficient. Another commenter asked for clarification that only

U.S. persons

who are party to

covered transactions

are obligated to conduct the required “reasonable and diligent inquiry.”

Other commenters sought information about the degree to which a

U.S. person

must access commercially available databases, while another commenter requested guidance regarding which sources for non-publicly available information a

U.S. person

should review. Another commenter suggested that, in absence of specific guidance, the Treasury Department include a safe harbor for good faith reliance on a reasonable interpretation of the rule's requirements.

Under the Final Rule, a

U.S. person

is responsible for

knowledge

the

U.S. person

had or could have had through a “reasonable and diligent inquiry.” The Treasury Department expects a

U.S. person

to make a reasonable effort, taking into account the context of a given transaction and any warning signs, among other factors.

The Final Rule adopts, with minor changes, the text of § 850.104(c)(3) and (4) from the Proposed Rule regarding “available non-public information” and “available public information” as well as a

U.S. person'

s efforts to obtain it. The text of § 850.104(c)(3) now refers to the “efforts,” rather than effort, of the

U.S. person,

for consistency with § 850.104(c)(4). Both sub-paragraphs now focus on the efforts of the

U.S. person

“as of”—instead of “at”—the time of the transaction. The Treasury Department assesses that the phrase “as of” better describes the process of due diligence leading up to and including the time of the transaction. Sections 850.104(c)(3) and 850.104(c)(4) have been further revised to describe efforts by the

U.S. person

to “obtain and consider” available non-public and public information, respectively, clarifying that the

U.S. person'

s evaluation or assessment of the available public and non-public information is relevant. The Treasury Department assesses that the language in § 850.104(c) is otherwise sufficiently clear on its face, particularly in combination with the added § 850.104(d) that, as discussed above, explains that the “the totality of the relevant facts and circumstances” should be considered. Limiting consideration only to the information already in a

U.S. person'

s possession, as one commenter requested, could incentivize purposeful blindness and is inconsistent with the intent of the Final Rule to require reasonable “inquiry” where certain relevant facts may not already be known to the

U.S. person.

At the same time, § 850.104(c) of the Final Rule does not require a

U.S. person

to obtain and consider “all” publicly available information, and this is clear from the fact that the word “all” is not included in this paragraph. Instead, the expectation is that a

U.S. person

undertake a reasonable and diligent approach to gathering and assessing information. The practical implication of such an approach may mean that, for example, a

U.S. person

investor is generally expected to view a transaction counterparty's responses or statements in light of other information contained in commercially available information sources in addition to information that is freely available to the general public. Such diligence is commonplace when investors are considering a transaction—such as when conducting diligence with respect to risks related to sanctions, bribery and corruption, or litigation exposure.

The Final Rule also includes a related technical edit to § 850.104(c)(7), adding “available” before “public and commercial databases.” This edit is being made to clarify the scope of databases that may be reviewed and to be consistent with how other sources of information in § 850.104(c) are qualified with “available.” It is not intended to affect the substance of the requirement.

One commenter requested that the Treasury Department identify specific standards or considerations for what constitutes a “reasonable and diligent inquiry” for an LP in an investment fund where the LP cannot reasonably know the specific targets of the fund. Another commenter asked that the Treasury Department publish a list of

covered foreign persons

to supplement—not replace—

U.S. person

due diligence efforts.

The Treasury Department notes that the foregoing discussion of the knowledge standard and a “reasonable and diligent inquiry” is generally applicable to an investment by a

U.S. person

and, like the Final Rule's approach to

knowledge

generally, is intended to account for a variety of situations and transaction structures. This also applies in the context of a

U.S. person

LP's investment into a non-U.S. pooled investment fund. The Treasury Department declines to prescribe, in the Final Rule, particular assurances for an LP to seek from the manager of a fund or specific standards or considerations in situations where a

U.S. person

LP does not

know

a fund's specific investment targets at the time of the

U.S. person

LP's investment. As discussed further in the discussion of the definition of an

excepted transaction

below, the Treasury Department has determined to except

U.S. person

LP investments into funds if the

U.S. person

has obtained a binding contractual assurance that its capital in the fund will not be used to engage in a transaction that would be a

notifiable transaction

or a

prohibited transaction,

as applicable, if engaged in by a

U.S.

person.

Consistent with the Treasury Department's approach to the knowledge standard, the Treasury Department does not specify the particular language of such a binding contractual assurance. The Treasury Department also declines to provide a list of

covered foreign persons

in § 850.104 or elsewhere for the reasons set forth in the discussion of the definition of

covered foreign person

below.

One commenter requested the reference to legal counsel in § 850.104(c)(5) be deleted, arguing that it would permit an inappropriate imputation of knowledge to the

U.S. person.

In response and for consistency throughout § 850.104(c), the Treasury Department has removed the references to “legal counsel” from § 850.104(c)(1) and (5) of the Final Rule. Under the Final Rule, a

U.S. person

is responsible for information such person

knew

or should have known, following a “reasonable and diligent inquiry,” although the Treasury Department notes that due diligence may be conducted on behalf of a

U.S. person

by the

U.S. person'

s legal counsel or other representative.

A number of commenters requested clarification regarding the definition of “relevant counterparty” in § 850.104(c), stating that if the term were to include other investors of the relevant fund or other owners of the target portfolio company, then the necessary due diligence would be unduly burdensome. As such, one commenter asked that the term be defined to mean a party to the transaction, while others requested limiting the required diligence to parties participating in the transaction.

In response, the Treasury Department has adopted the suggestion made by commenters and modified § 850.104(c) to refer to “an investment target or other relevant transaction counterparty (such as a joint venture partner)” where applicable. This change is intended to clarify that as a general matter, the Treasury Department does not expect diligence to be conducted on

persons

who are not parties to the transaction. However, inquiries related to non-parties, such as beneficial owners or downstream entities that are not technically parties to the transaction, may be necessary to determine, for example, whether a party to a transaction is a

person of a country of concern

or a

covered foreign person.

Further, the Treasury Department believes the language regarding a “reasonable and diligent inquiry” is clear, as written, in referring to a

U.S. person

that is party to a transaction, rather than unrelated

U.S. persons.

Commenters expressed similar views with respect to the feasibility of conducting due diligence to determine whether the criteria for a

person of a country of concern

is met. Some commenters expressed concern that the definition would require due diligence with respect to all investments. One commenter requested a standard with specific factors for investments in private equity or venture capital funds, such as researching past investments, engaging with the general partner, and reviewing a fund's prospectus. Another commenter recommended that the rule include factors for identifying a

person of a country of concern,

as well as language deeming an inquiry reasonable and diligent, “if and only if, based on these factors, it will typically be adequate to correctly identify persons of concern.”

Given the wide variety of possible transaction structures and for the reasons stated above, the Treasury Department declines to adopt prescriptive diligence standards as they relate to particular transaction structures or the application of a particular definition in the Final Rule. Instead, the knowledge standard discussed in the Final Rule, the specific factors enumerated in § 850.104(c), and the consideration of the totality of relevant facts and circumstances described in § 850.104(d) explain the obligations and expectations regarding due diligence under the Final Rule.

Knowledge Standard—Final Rule Summary

The Final Rule specifies that certain provisions, including § 850.210, which defines

covered transaction,

will apply only if a

U.S. person

has

knowledge

of the relevant facts or circumstances at the time of a transaction. The definition of

knowledge

set out in § 850.216 includes any of the following: actual knowledge that a fact or circumstance exists or is substantially certain to occur, an awareness of a high probability of a fact or circumstance's existence or future occurrence, or reason to know of a fact or circumstance's existence.

The definition of

covered transaction

requires the

U.S. person

to

know

at the time of a transaction that the transaction involves a

covered foreign person,

will result or is planned to result in the establishment of a

covered foreign person

(in the case of a greenfield, brownfield, or joint venture investment), or will result or is planned to result in a

person of a country of concern'

s engagement in a

covered activity

(in the case of a brownfield investment). The Treasury Department will not consider a transaction that has all of the other attributes of a

covered transaction

but that the

U.S. person

does not

know

at the time of the transaction (which includes not having “reason to know” at the time of the transaction) involves or will result in a

covered foreign person

to be a

covered transaction

subject to the notification requirement or prohibition, as applicable. The Treasury Department notes, however, that if the

U.S. person

subsequently acquires actual knowledge of a fact or circumstance that, if known at the time of the transaction, would have caused the transaction to be a

covered transaction,

the

U.S. person

is required to notify the Treasury Department pursuant to § 850.403 of the Final Rule. If a

U.S. person

fails to conduct a “reasonable and diligent inquiry” at the time of a transaction and undertakes the transaction where a particular fact or circumstance indicative of a

covered transaction

is present, the Treasury Department may find in the course of determining compliance with the Final Rule that the

U.S. person

had reason to know (and therefore, for purposes of the proposed rule,

knew

) of such fact or circumstance. To provide clarity, § 805.104 of the Final Rule includes some of the factors that the Treasury Department will consider in assessing whether a

U.S. person

undertook such an inquiry. That inquiry will be based on a consideration of the totality of the facts and circumstances. These include efforts to obtain information and contractual assurances that should be obtainable through a reasonable transactional due diligence process with respect to the determination of a transaction's status as a

covered transaction

or relevant entity's status as a

covered foreign person.

Accordingly, the Final Rule adds a new provision clarifying that an assessment of whether a

U.S. person

has undertaken a “reasonable and diligent inquiry” will be made based on a consideration of the totality of relevant facts and circumstances.

If a

U.S. person

has undertaken a “reasonable and diligent inquiry” and still does not have

knowledge

of a fact or circumstance relevant to whether a transaction involves or will result in a

covered foreign person

in a way that will render the transaction a

covered transaction,

the knowledge requirements in § 850.210 are not met.

The Treasury Department anticipates making additional information available on its Outbound Investment Security Program website regarding topics such as the application of the knowledge standard.

Subpart B—Definitions

§ 850.202—AI System

As discussed in the Proposed Rule, the U.S. Government is concerned with the development of

AI systems

that enable the military modernization of

countries of concern

—including weapons, intelligence, and surveillance capabilities—and those that have applications in areas such as cybersecurity and robotics. Additionally, the U.S. Government is concerned with software and hardware, among other things, that incorporate such

AI systems.

The policy objective of the definition is to cover U.S. investment into entities that develop

AI systems

with applications that pose, or have the potential to pose, significant national security risks, without broadly capturing investments into entities that develop

AI systems

intended only for consumer applications or other civilian end uses with no potential national security consequences. To address these concerns, the Proposed Rule included a notification requirement and a prohibition with respect to investments into entities engaged in certain

covered activities

involving

AI systems.

Under the Proposed Rule,

AI system

was defined in § 850.202(a) as a machine-based system with certain specified functions and characteristics. Section 850.202(b) of the Proposed Rule included within the definition of the term any data system, software, hardware, application, tool, or utility that operated in whole or in part using such a machine-based system. As noted in the Proposed Rule, this definition combined the definitions of “artificial intelligence” and “AI system” from Executive Order 14110, “Safe, Secure, and Trustworthy Development and Use of Artificial Intelligence” issued on October 30, 2023 (the AI Order).

Several commenters expressed concern about the breadth of the definition in the Proposed Rule. One commenter argued that the definition did not differentiate products that pose a national security risk from those that do not. Others requested the removal of § 850.202(b) from the definition of

AI system,

noting that its inclusion would cover products, services, or applications that incorporate AI for internal or commercial use, which may not pose national security risks. Commenters cited the recent practice among technology firms to leverage, rather than develop, AI by incorporating AI capability into existing systems. Commenters suggested narrowing the definition of

AI system

to limit the impact on such firms and also make the rule more administrable. One commenter requested that

AI systems

for medical use be excluded from the definition.

The Final Rule makes clarifying edits to the definition of

AI system

at § 850.202(a) by moving the clause “uses data inputs to” from (a) to (a)(1) in order to be consistent with the definition in the AI Order, and adjusts the first word at the beginning of each of (a)(2) and (a)(3) accordingly. Otherwise, the Final Rule adopts the text of § 850.202 from the Proposed Rule. The Treasury Department considered the comments requesting a narrower definition of

AI system

and the Final Rule adopts the text of § 850.202 from the Proposed Rule. However, in response to the comments, the Final Rule adds two notes to each of §§ 850.217 and 850.224. Note 2 clarifies how

AI systems

defined at § 850.202(b) are implicated by the criteria of

notifiable

and

prohibited transactions.

The Treasury Department notes that the scope of the

AI systems

definition is intentional, since a

covered transaction

involving an

AI system,

whether that system is an AI model or machine-based system described at § 850.202(a) or a system operating in whole or in part using a system described at § 850.202(a), that meets one or more of the listed end-use or computing power thresholds could contribute to the advancement of military, intelligence, surveillance, or cyber-enabled capabilities by a

country of concern.

While the scope of

AI systems

as defined at § 850.202(b) may implicate a range of persons who use third-party AI models or machine-based systems in a data system, software, hardware, application, tool, or utility, the Treasury Department notes that such persons would be implicated by the Final Rule only to the extent they

develop

the

AI system

defined at § 850.202(b) by engaging in the activities enumerated in § 850.211, such as design or substantive modification, with respect to the relevant third-party AI model or machine-based system being used. For example, a

person

engaging in substantive modifications of a third-party AI model that is being used by a data system, software, hardware, application, tool, or utility to operate in whole or in part, such as removing security measures or safeguards of the third-party AI model, would be

developing

an

AI system.

The addition of Note 2 clarifies this point, consistent with the definition for

develop

at § 850.211. The Final Rule also adds a Note 3 to each of §§ 850.217 and 850.224 to provide a carve-out for customizing, configuring, or fine-tuning a third-party AI model or machine-based system that is being used by a data system, software, hardware, application, tool, or utility to operate in whole or in part, where such customization, configuration, or fine-tuning of the third-party AI model or machine-based system is strictly for a

person'

s own internal, non-commercial use. Such activity would not itself trigger the notification requirements or prohibition delineated in § 850.217 or § 850.224, respectively, for

covered transactions

involving

AI systems,

unless it has government intelligence, mass-surveillance, or military end use, or is for digital forensics tools, penetration testing tools, or the control of robotic systems.

One commenter requested that the Treasury Department clarify that the computing power thresholds for a

notifiable transaction

or

prohibited transaction

involving an

AI system

pertain to the combined computing power required to train a given

AI system,

including computing power used to train relevant sub-models or generate inputs to inform such an

AI system.

The purpose of this clarification would be to prevent undercounting of computing power for an

AI system

where a

covered foreign person

may develop an AI system by combining smaller models or the learnings of other models. The same commenter also requested clarification regarding whether different versions of an

AI system

would be considered one system or multiple

AI systems,

and if adaptations of an

AI system

would be considered a new or distinct

AI system.

The Treasury Department notes that the computing power thresholds refer to the aggregate or combined computing power required to train a given

AI system.

For example, the computing power required to train an

AI system

that is a combination of smaller, pre-trained AI models would be the summation of computing power required to train and combine each component model of the

AI system.

Similarly, developing an AI model based on the transfer of knowledge from one model to another would include the computing power required to train both models. The Treasury Department intends

persons

employing techniques to develop

AI systems

that are derived from, or are a combination of, other

AI systems

to evaluate the aggregate computing power required for training when assessing whether the

AI system

meets the criteria set forth in §§ 850.217(d)(3) and 850.224(k). For the purposes of assessing whether an

AI system

has any of the end-use applications set forth in §§ 850.217(d) and 850.224(j), the Treasury Department

notes that different versions of an

AI system,

including adaptations, derivatives, subsequent generations, or successor systems, should be assessed as distinct

AI systems

since the designed end-use or capabilities of a successor system could vary from a prior version.

One commenter stated the Treasury Department would need to hire technical staff to monitor changes in the AI marketplace and suggested the Treasury Department leverage technical talent at other U.S. Government agencies if the roles cannot be maintained within the Treasury Department. In response to this comment, the Treasury Department notes that the Outbound Order directs the Treasury Department to consult with relevant U.S. Government agencies on the implications for military, intelligence, surveillance, or cyber-enabled capabilities of covered national security technologies and products and potential covered national security technologies and products. The Treasury Department has leveraged the expertise of other U.S. Government agencies through the rulemaking process and will continue to do so in the implementation and administration of the Final Rule.

§ 850.205—Contingent Equity Interest

The Proposed Rule defined a

contingent equity interest

as a financial instrument that “currently does not constitute an equity interest but is convertible into, or provides the right to acquire, an equity interest upon the occurrence of a contingency or defined event.” While the Treasury Department did not receive any comments to the Proposed Rule's definition of

contingent equity interest,

there were several comments that sought additional clarity on what types of contingent or convertible equity interests would be included in the definition of

covered transaction

at § 850.210(a)(1) and (3) of the Proposed Rule (defining

covered transactions

involving the acquisition or conversion of a

contingent equity interest

).

In response to these comments, the Final Rule modifies the definition of

contingent equity interest

at § 850.205 of the Proposed Rule. The definition of

contingent equity interest

in the Final Rule refers to a “financial interest,” rather than a “financial instrument” as in the Proposed Rule. As described below in the discussion to § 850.210 of the Final Rule, this change is intended to more accurately reflect the Treasury Department's intent to cover the acquisition or conversion of interests that are convertible into an equity interest, or provide the right to acquire equity interests. The definition of

contingent equity interest

in the Final Rule also clarifies that debt can constitute a financial interest that is convertible into, or provides the right to acquire, an equity interest.

§ 850.206—Controlled Foreign Entity

The Proposed Rule defined

controlled foreign entity

as an entity incorporated in, or organized under the law of, a country other than the United States of which a

U.S. person

was a

parent.

Section 850.219 of the Proposed Rule defined

parent

as a

U.S. person

that directly or indirectly held more than 50 percent of the outstanding voting interest or voting power of the board of the entity; was a general partner, managing member, or equivalent of the entity; or, if the entity was a pooled investment fund, was an investment adviser to any such fund. Section 850.302 of the Proposed Rule would have placed obligations on a

U.S. person

to take all reasonable steps to prohibit and prevent its

controlled foreign entity

from undertaking a transaction that would have been a

prohibited transaction

if undertaken by a

U.S. person,

and § 850.402 would have required a

U.S. person

to notify the Treasury Department if its

controlled foreign entity

undertook a transaction that would have been a

notifiable transaction

if undertaken by a

U.S. person.

The Treasury Department proposed defining

controlled foreign entity

using a bright line so that a

U.S. person

could easily ascertain whether an entity was its

controlled foreign entity.

The Treasury Department invited comments regarding this definition, including considerations with respect to the definition's inclusion of entities established outside of the United States.

The Treasury Department received several comments on the definition of

controlled foreign entity.

After considering these comments, the Final Rule adopts § 850.206 as in the Proposed Rule without changes.

One commenter expressed support for the 50 percent threshold set forth in the definition of

parent

in § 850.219 of the Proposed Rule (and referred to in the definition of

controlled foreign entity

in § 850.206(a)) because it would provide a bright line framework to assist industry in complying with the rule's requirements. The Treasury Department notes that paragraph 850.206(b) of the Proposed Rule delineated how the holdings of voting interest or voting power of the board of a subsidiary would have been attributed to the

parent.

Where the relationship between one entity and another would have been that of

parent

and subsidiary, attribution would have been full. Where the relationship between an entity and another entity would have not been that of

parent

and subsidiary (

i.e.,

because the holdings of voting interest or voting power of the board of the first entity in the second entity would be 50 percent or less), then the indirect downstream holdings of voting interest or voting power of the board would have been attributed proportionately to the first entity.

Another commenter stated that the Proposed Rule's definition of

controlled foreign entity

applied the 50 percent threshold to voting interest, which the commenter argued “deviates significantly from ANPRM, which had proposed basing the 50% calculation on revenue, income, expenditure and operating expense.” The commenter questioned whether a

U.S. person

with a 51 percent voting interest would be able to prevent its

controlled foreign entity

from entering into a

prohibited transaction

and suggested that the requirement would “impose an unrealistic knowledge standard” on the

U.S. person,

particularly in certain roles such as an investment adviser. This commenter appears to have conflated the ANPRM's discussion of the term

controlled foreign entity

with its discussion of the term

covered foreign person,

a distinct term with a distinct definition, where revenue, income, expenditure, and operating expenses were discussed as part of the definition in the ANPRM and the NPRM. (See more below regarding the definition of

covered foreign person.

) Additionally, with a threshold above 50 percent of the “outstanding voting interest” or “voting power of the board” of an entity, it is reasonable to expect the

U.S. person parent

to have the power to influence the compliance infrastructure of its subsidiary. For a non-U.S. pooled investment fund of which a

U.S. person

is an adviser (meaning again that the

U.S. person

is a

parent

and the fund is its

controlled foreign entity

), investment advisers often manage the investment portfolios of such pooled investment funds.

Commenters requested that the Treasury Department clarify that the

U.S. person parent

under 850.206(a) must be the ultimate parent entity and not an intermediary

U.S. person

without ultimate decision-making authority. In response, the Treasury Department has added a note (Note 1) to the definition of

parent

at § 850.219 of the Final Rule to clarify that a

U.S. person

that meets the definitional requirements of

parent

under § 850.219 constitutes a

parent,

including a

U.S. person

that is an

intermediate entity. Further information on the definition of

parent

is below in the discussion of § 850.219.

Controlled Foreign Entity—Final Rule Summary

The Final Rule defines

controlled foreign entity

as an entity incorporated in, or otherwise organized under the laws of, a country other than the United States of which a

U.S. person

is a

parent.

Section 850.219 of the Final Rule defines

parent

as a

U.S. person

that directly or indirectly holds more than 50 percent of the outstanding voting interest or voting power of the board of the entity; is a general partner, managing member, or equivalent of the entity; or, if the entity is a pooled investment fund, is an investment adviser to any such fund.

In determining whether a

U.S. person

indirectly holds voting interest or voting power of the board via a tiered ownership structure for purposes of this section of the Final Rule, where the relationship between an entity and another entity is that of a

parent

and subsidiary, the voting interest or voting power of the board of a subsidiary will be fully attributed to the

parent.

By contrast, if an entity holds 50 percent or less of another entity's voting interest or voting power of the board—that is, if the relationship is not a

parent

-subsidiary relationship—then the indirect downstream holdings of voting interest or voting power of the board, as applicable, attributed to the first entity will be determined proportionately.

If a

U.S. person

holds both direct and indirect holdings in the same entity, the direct and indirect holdings of the

U.S. person'

s voting interest or voting power of the board, as applicable, will be aggregated. For the avoidance of doubt, each of these metrics (voting interest or voting power of the board) will be evaluated independently from the other. For example, if an entity has 20 percent of its voting interest and 15 percent of its voting power of the board each held by a

U.S. person,

these percentages will not be combined to equal 35 percent.

Section 850.206 should be read in connection with §§ 850.302 and 850.402, which place obligations on a

U.S. person

to take all reasonable steps to prohibit and prevent its

controlled foreign entity

from undertaking a transaction that would be a

prohibited transaction

if undertaken by a

U.S. person,

and to notify the Treasury Department if the

controlled foreign entity

undertakes a transaction that would be a

notifiable transaction

if undertaken by a

U.S. person,

respectively.

§ 850.208—Covered Activity

The Proposed Rule identified activities that would provide the relevant nexus between the

covered foreign person

and the covered national security technologies and products described in the Outbound Order. The Outbound Order defines the term “covered national security technologies and products” to mean sensitive technologies and products in the semiconductors and microelectronics, quantum information technologies, and AI sectors that are critical for the military, intelligence, surveillance, or cyber-enabled capabilities of a

country of concern,

as determined by the Secretary in consultation with the Secretary of Commerce and, as appropriate, the heads of other relevant agencies. The Outbound Order further states that, where applicable, “covered national security technologies and products” may be limited by reference to certain end uses of those technologies or products.

The three primary definitions in the Proposed Rule implementing the term “covered national security technologies and products” were

covered activity, notifiable transaction,

and

prohibited transaction.

The term

covered activity

meant, in the context of a particular transaction, any of the activities referred to in the definition of

notifiable transaction

in § 850.217 or

prohibited transaction

in § 850.224.

The definitions of

notifiable transaction

and

prohibited transaction

in the Proposed Rule identified specific

covered activities

relevant to the technologies or products within each category. Some such

covered activities

related to semiconductors and microelectronics technology, equipment, and capabilities that enabled the production and certain uses of integrated circuits that underpin current and future military innovations that improved the speed and accuracy of military decision-making, planning, and logistics, among other things; as well as that enabled mass surveillance or other cyber-enabled capabilities. The Proposed Rule also addressed

covered activities

related to quantum information technologies and products that enabled capabilities that could have compromised encryption and other cybersecurity controls and jeopardize military communications, among other things. In the case of a quantum sensing platform or quantum network, the end-use provision would have avoided covering use cases in strictly civilian fields. Finally, the Proposed Rule addressed

covered activities

related to certain

AI systems

with applications that posed or had the potential to pose significant national security risks. The Proposed Rule did not seek to broadly capture

AI systems

intended only for commercial applications or other civilian end-uses that did not have potential national security consequences.

The Treasury Department received several comments related to the definition of

covered activity

that focused on certain aspects of the definitions of

notifiable transaction

and

prohibited transaction.

Those comments are discussed in the sections below on

notifiable transaction

and

prohibited transaction.

In the Final Rule, the Treasury Department adopts § 850.208 without change from the Proposed Rule. C

overed activity

means, in the context of a particular transaction, any of those activities included in the definition of

notifiable transaction

in § 850.217 or

prohibited transaction

in § 850.224. The term

covered activity

encompasses technologies and products that may contribute to the threat to the national security of the United States by cross-referencing the definition of

notifiable transaction

and also incorporates those technologies and products that pose a particularly acute national security threat by cross-referencing the definition of

prohibited transaction.

The scope of

notifiable transaction

and the scope of

prohibited transaction

are intended to be distinct and not overlap. The Treasury Department intends the notification requirement to increase the U.S. Government's visibility into

U.S. person

transactions involving the relevant technologies and products and expects that these notifications will be helpful in highlighting aggregate sector trends and related capital flows as well as informing future policy development. The prohibitions are tailored restrictions on specific, identified areas to prevent

U.S. persons

from investing in the development of technologies and products that pose a particularly acute national security threat. Both the specific

covered activities

as well as the technical descriptions in the Final Rule were scoped with these objectives in mind.

§ 850.209—Covered Foreign Person

The Outbound Order requires the Treasury Department to prohibit or require notification of certain transactions involving a

covered foreign person

and defines the term as “a person of a country of concern who or that is engaged in activities, as identified in the regulations issued under [the Outbound Order], involving one or more covered national security

technologies and products.” The definition of

covered foreign person

in the Proposed Rule described three sets of circumstances that would have caused a

person

to be a

covered foreign person:

• A

person of a country of concern

that engages in a

covered activity

(§ 850.209(a)(1));

• Any person that has a particular relationship with a

person of a country of concern

that engages in a

covered activity

—

i.e.,

where (1) the person holds a specific interest in such

person of a country of concern,

such as a voting interest, board seat, equity interest, or the power to direct or cause the direction of the management or policies of the

person of a country of concern

through contractual arrangement(s) (including, for the avoidance of doubt, any contractual arrangement with respect to a variable interest entity); and if there is such an interest, (2) more than 50 percent of the first person's revenue, net income, capital expenditure, or operating expenses is attributable to such

person of a country of concern,

individually or in the aggregate (§ 850.209(a)(2)); or

• A

person of a country of concern

that participates in a joint venture with a

U.S. person

if such joint venture engages or intends to engage in a

covered activity

(§ 850.209(a)(3)).

One commenter stated that the definition of a

covered foreign person

in § 850.209(a)(1) would impact a broad range of businesses and activities because the definition of “national security technologies and products” in the Proposed Rule was “obscure.” The Treasury Department notes that “national security technologies and products” was not a defined term in the Proposed Rule, although the Outbound Order does refer to “covered national security technologies and products” as noted above in the discussion of § 850.208. The Outbound Order directs the Treasury Department to issue regulations that identify categories of

notifiable transactions

as well as categories of

prohibited transactions

that involve “covered national security technologies and products.” Both the Proposed Rule and this Final Rule define

notifiable transaction

and

prohibited transaction,

and the definition of a

covered activity

in § 850.208 of the Final Rule specifies that it refers to “any of the activities referred to” in those definitions. The commenter did not offer concrete suggestions regarding where or how any of the foregoing defined terms could be modified.

Covered Foreign Person—“Engages In”

A number of commenters suggested that the term “engages in,” as used in § 850.209(a)(1) of the Proposed Rule to connect a

person of a country of concern

to a

covered activity,

should be further defined or clarified. One commenter stated that without further clarification, “engages in” could include ancillary activities such as the ownership of intellectual property, the direction of other companies' or entities' activities, or involvement in

covered activities

by an affiliate of the investment target. Another commenter requested clearer criteria linked to financial or business activities to avoid overbreadth.

As used in § 850.209(a)(1), the function of “engages in” is simply intended to provide a link between the

person of a country of concern

and the specified activities described in detail in §§ 850.217 (

notifiable transaction

) and 850.224 (

prohibited transaction

) (which, taken together, comprise the definition of

covered activity

in § 850.208). In other words, the language “engages in” is a succinct way to capture the activities described in §§ 850.217 and 850.224, such as designs, fabricates, packages, develops, and produces, among other things. The Treasury Department therefore considers the criteria for a

covered activity

to be sufficiently clear given the specificity with which the enumerated

covered activities

are described in relevant part in §§ 850.217 and 850.224 of the Final Rule. Similarly, various ancillary activities noted by commenters in response to this provision, as well as in response to the definition of

covered transaction

in § 850.210 (see the discussion of

covered transaction

below), would not be within the scope of the Final Rule if they do not meet the criteria set forth in the definition of a

covered transaction

(including the terms used in that definition).

One commenter asked that the rule distinguish between activities that are legitimately part of a

person of a country of concern'

s normal operations and those activities that might be conducted by individual employees or without the guidance or supervision of a

person of a country of concern'

s management. One commenter asked that the Treasury Department clarify that an entity must directly implement the

covered activity.

Regarding the distinction that one commenter raised between a

covered activity

that is

known

to a

person of a country of concern

investment target and employee-level activity that is not authorized by or not

known

to an investment target's management, under the Final Rule, whether or not a transaction is a

covered transaction

depends in part on whether the

U.S. person knows,

based on a reasonable and diligent inquiry, that the investment target or relevant transaction counterparty (such as a joint venture) is a

covered foreign person.

It may be the case that if the investment target itself was unaware that its employees were engaging in a

covered activity,

the

U.S. person

would not have reason to

know

that the investment target was engaging in a

covered activity,

particularly if no other information was available to indicate the presence of such activity. In response to one commenter's question about whether an entity must “directly implement” a

covered activity,

absent other facts (such as an intent to evade the Final Rule), to be assessed to be “engaging in” a

covered activity,

a

person of a country of concern

would need to perform one of the specific actions set forth in either § 850.217 or § 850.224. To be assessed to be “engaging in” a

covered activity

described in § 850.217(a), for example, would require that the relevant

person of a country of concern

itself

designs

the integrated circuit, as described in that paragraph.

One commenter suggested that a

person of a country of concern

should be considered to “engage” in a

covered activity

only if it either conducts or participates in a

covered activity

or has a “demonstrated business objective” to conduct or participate in a

covered activity.

The Treasury Department declines to make the changes suggested in this comment. The use of the language “conducts or participates” in place of “engages in” is not necessary given the Treasury Department's explanation of the role of “engages in” above, and the use of two verbs instead of one could introduce ambiguity. Regarding a “demonstrated business objective,” under the Final Rule, a

U.S. person

is responsible for information such person

knew

or should have known, following its own “reasonable and diligent inquiry,” as to whether a

person of a country of concern

“engages in” a

covered activity.

While such inquiry may take into account any “demonstrated business objectives,” identification of a “demonstrated business objective” is not necessary for a

person of a country of concern

to “engage” in a

covered activity,

nor is the identification of such an objective necessarily part of a “reasonable and diligent inquiry.” In addition, and independently, the Treasury Department believes that a

person of a country of concern

“engaging in” a

covered activity

raises national security

concerns regardless of whether such activity comprises a “business objective” at that time. For example, early-stage entities may develop certain technologies that are not yet part of a “business objective,” but might become so later. In addition, and independently, a “demonstrated business objective” can frequently refer to future intent, while “engages in” as used in § 850.209(a)(1) refers to the underlying activities of an investment target at the time of the

covered transaction,

although this does not remove from coverage certain transactions intended to evade the Final Rule, such a

covered foreign person'

s raising capital from a

U.S. person

investor for the specific purpose of “engaging in” a

covered activity.

(See further discussion of this issue below.)

Commenters asked about the temporal aspects of “engages in.” One recommended that “engages in” require that engagement in a

covered activity

be “active and ongoing,” while another commenter asked whether past activity, ceased at the time of a transaction, would be covered. One suggested a definition of “engages in” to address both their questions about the temporal scope of “engages in” as well as their requested inclusion of a de minimis threshold (discussed further below), which would define “engages in” as: “(a) conducts or participates in a covered activity or (b) has a demonstrated business objective to conduct or participate in a covered activity.”

The Treasury Department has determined not to change § 850.209(a)(1) in the Final Rule. The Treasury Department notes that in the context of § 850.209(a)(1), “engages in,” which is phrased in the present tense, refers to a

person

performing the specific actions described in detail in §§ 850.217 and 850.224 at the time of a transaction, and does not have retroactive applicability. A

person of a country of concern

“engaging in” the

covered activity

described in § 850.217(a), for example, would require that the

person of a country of concern

itself

designs

the integrated circuit, as described in that paragraph, at the time of a

covered transaction.

While the use of the present tense of the verb “engages” is deliberate, a

person of a country of concern

cannot avoid application of the Final Rule simply by ceasing the

covered activity

during fundraising only to resume the

covered activity

following the fundraising (see § 850.604). Nor does the present tense remove from coverage a

person of a country of concern

that, for example, is raising capital from a

U.S. person

investor for the specific purpose of “engaging in” a

covered activity.

In other words, “engages in” refers to an attribute of an entity's business, not a condition that it be continuously occupied with a particular activity.

Several commenters requested that the Treasury Department consider a de minimis activity threshold in the definition of a

covered foreign person

as it relates to their “engagement” in a

covered activity,

below which the definition of

covered foreign person

would not apply. Several commenters stated that compliance challenges could arise without such a threshold, including ambiguity in the definition of

covered foreign person.

One commenter noted that such a threshold would be necessary to avoid unintended consequences for transactions that have no nexus to national security because the

covered activity

“engaged in” by the investment target may be unrelated to the transaction itself.

The Treasury Department declines to institute a de minimis exception with respect to the “engages in” language of § 850.209(a)(1). Setting a de minimis threshold based on the level of activity involving a covered technology or product would be challenging from a regulatory and administrative perspective and would likely introduce ambiguity. In response to comments regarding ambiguity in the Proposed Rule's formulation (which has been adopted without changes in the Final Rule), the Treasury Department reiterates that any amount of a

covered activity

by a

person of a country of concern

is sufficient for such person to be defined as a

covered foreign person

in the Final Rule. This is because the Treasury Department has determined that national security concerns arise in the context of any amount of such activity by a

person of a country of concern,

particularly in the context of early-stage companies and/or emerging technologies, the rapid expansion of which could be significantly aided by the intangible benefits provided by a

U.S. person

investor. Regarding one commenter's contention that without a de minimis threshold transactions that lack a national security nexus but where the transaction counterparty undertakes de minimis

covered activities

completely unrelated to the transaction would be prohibited, the commenter does not provide a specific suggestion for how a de minimis threshold would be defined or operationalized, or how the Treasury Department could ascertain that a transaction is “completely unrelated” to the

covered activity

given that intangible benefits often accompany investments by

U.S. persons

that help companies succeed, and there is no apparent mechanism by which the company-wide benefits conferred by a

U.S. person

could be relegated only to those operations of an investment target that do not raise national security concerns. However, the definitions of

covered activities

in §§ 850.217 and 850.224 are narrow and precise, and in the context of § 850.209(a)(1) they apply directly to a given

person of a country of concern

and not to an investment target's holding companies or other members of a corporate group.

Section 850.209(a)(2)

Commenters made suggestions related to the scope of § 850.209(a)(2) or requested clarification of this paragraph's application. Commenters discussed the costs related to conducting due diligence to determine whether § 850.209(a)(2) applies to a person receiving investment from a

U.S. person.

One commenter noted that a

U.S. person

may need to rely on an investment target to supply the information required to determine the applicability of § 850.209(a)(2). The Treasury Department has provided further information in the discussion of the knowledge standard (see discussion under Subpart A above) to address a “reasonable and diligent inquiry” in situations where a

U.S. person

may have no source other than an investment target to supply information necessary to determine the applicability of the Final Rule.

Several commenters requested that the Treasury Department clarify whether an investment in a

parent

or holding company would be defined as an indirect

covered transaction

only when a downstream entity meets one of the thresholds set forth in § 850.209(a)(2) and further requested that the Treasury Department provide additional guidance as to how certain transactions, such as acquisitions through special purpose vehicles, would be treated under the rule. These commenters also requested that the Treasury Department clarify that if the acquisition of a company that is not a

person of a country of concern

does not meet the thresholds in § 850.209(a)(2), then both the direct acquisition of the company and the indirect acquisition of its interest in its subsidiary are not

covered transactions.

One such commenter wrote that § 850.209(a)(2) would be “meaningless” unless the definition of an indirect

covered transaction

was clarified to exclude investments into targets that have subsidiaries that fall short of the financial thresholds specified in § 850.209(a)(2)(i) through (iv) because,

for example, “investing in a parent company outside a country of concern would be `indirectly' investing in any of its subsidiaries that was a covered company, even if such a subsidiary only accounted for 1 percent of its revenues and expenses.”

The Treasury Department notes that the bright-line criteria set forth in § 850.209(a)(2) are for purposes of determining whether a

person

is a

covered foreign person

but are not intended to exclude the possibility that other transactions involving intermediary entities could be a

covered transaction

under § 850.210, and therefore the Treasury Department declines to categorically exclude from coverage any and all indirect transactions through

persons

falling outside of § 850.209(a)(2). As explained in the Proposed Rule and as further addressed in the Final Rule (see Note 1 to § 850.210), the definition of

covered transaction

includes indirect transactions, including when a

U.S. person

uses an intermediary entity or acquisition vehicle to engage in a transaction that would be a

covered transaction

if engaged in directly by the

U.S. person.

See the discussion of § 850.210 (

covered transaction

) below for additional discussion of an “indirect”

covered transaction.

Furthermore, meaningful distinctions exist between the scope of § 850.209(a)(2) and an indirect

covered transaction

under § 850.210(a) in both the Proposed Rule and in the Final Rule. Section 850.209(a)(2) defines certain investment targets, wherever located, as

covered foreign persons

given the significance of their financial ties with one or more

covered foreign persons.

In such a case, absent an exception, a

U.S. person'

s acquisition of an equity interest in such entity is a

covered transaction.

One commenter requested clarification as to whether the application of § 850.209(a)(2) “goes through the group or the portfolio company” as well as guidance as to the treatment of subsidiaries and affiliates of the company in which a

U.S. person

invests. Because this comment lacks specific information about the relationship between and among a “group,” a “portfolio company,” or “subsidiaries and affiliates,” the Treasury Department is unable to provide the specific information requested beyond the bright-line definitions provided in the Final Rule. As to the general topic of a

U.S. person

investment into a “group” but not a portfolio company, various parts of the Final Rule, including but not limited to § 850.209(a)(2), specify those scenarios in which an investment could be a

covered transaction

even if the immediate investment target is not itself a

person of a country of concern

engaged in a

covered activity.

One commenter asked whether, if a

U.S. person

owns an entity in a

country of concern

that is engaged in a covered national security technology or product, the

U.S. person

as well as the entity in a

country of concern

would be a

covered foreign person

and whether “the 50% rule described in the [Proposed Rule]” would be applicable. This query contains insufficient information about the relationships between and among the

U.S. person,

the other entity, and a

country of concern

—for example, information that would aid determination of whether an entity “in” a

country of concern

would meet the definition of a

person of a country of concern,

and information that would aid determination of whether the

U.S. person'

s relationship with the former entity would meet the definition of a

controlled foreign entity

in § 850.206—for the Treasury Department to provide specific guidance on the hypothetical given. However, as a general matter, § 850.209(a)(2) could apply to a

U.S. person

entity that meets the criteria in that provision regarding interest in, and financial metrics attributable to, a

covered foreign person.

Two commenters requested additional guidance regarding how the financial metrics cited in the Proposed Rule,

i.e.,

revenue and operating expenses, are calculated for the purposes of the application of § 850.209(a)(2). The Treasury Department notes that Section 850.209(b) refers to an “audited financial statement,” and the Treasury Department anticipates that such statements, which typically include those financial metrics covered by § 850.209(a)(2), will have been prepared in accordance with the applicable accounting rules and conventions of the relevant jurisdiction. (The Treasury Department also notes that § 850.209(b) provides for alternatives in the event an audited financial statement is unavailable.)

Several commenters suggested that the Treasury Department attribute the requirement in § 850.209(a)(2) to a single entity, rather than aggregating among entities, or provide clarification for how aggregation would be applied. Additionally, commenters requested that the rule institute a de minimis threshold for a person's vested interest in a

covered foreign person

that would narrow the scope of § 850.209(a)(2). Suggested approaches included de minimis thresholds for a

covered activity

(discussed above in connection with § 850.209(a)(1)) or a de minimis threshold connected to the investment target's ownership interest in a

covered foreign person.

One commenter suggested excluding from such calculations entities in which a

U.S. person

owns less than 10 percent of the outstanding voting power or equity because a transaction counterparty's finances may aggregate revenues or expenses across a substantial number of unrelated companies and assets, while another suggested that any voting or equity interest under 25 percent held by an entity be excluded from the calculations under § 850.209(a)(2). One commenter suggested that as an alternative, the Treasury Department could draw on certain definitions from the CFIUS regulations related to controlling transactions and certain non-controlling, non-passive investments to more clearly explain when a

person

that is not a

covered foreign person

would have a requisite interest in a

covered foreign person

to qualify under this provision.

In response to the comments, the Treasury Department has modified § 850.209(a)(2) of the Final Rule to note that for the purposes of calculating whether one or more

persons of a country of concern

engaged in a

covered activity

exceed the financial thresholds enumerated in § 850.209(a)(2)(i) through (iv), only those

persons of a country of concern

engaged in a

covered activity

in which the relevant person directly or indirectly holds an interest specified in (a)(2) will be considered. Such an interest as specified in § 850.209(a)(2) is any of the following: a board seat on, a voting or equity interest (other than through securities or interests that would satisfy the conditions in § 850.501(a) if held by a

U.S. person

) in, or any contractual power to direct or cause the direction of the management or policies of such

person of a country of concern

engaged in a

covered activity.

In response to comments on considerations for a

U.S. person

conducting due diligence to assess the application of § 850.209(a)(2), the Final Rule includes in the aggregation calculations of the financial thresholds in § 850.209(a)(2)(i) through (iv) only those

persons of a country of concern

(engaged in a

covered activity

) that account for at least $50,000 (or equivalent) of the relevant financial metric of the

U.S. person'

s investment target or relevant counterparty (such as a JV partner). The $50,000 and above threshold for inclusion in the calculation for any given financial metric is intended to ensure there is a meaningful financial relationship between the investment target and a

person

of a

country of concern

and that

de minimis contributions to any of the financial metrics are not required to be included, to address commenter's stated concerns about the diligence burden of the calculations required by § 850.209(a)(2)(i) through (iv).

For example, if an investment target holds a board seat on a

person of a country of concern

engaged in a

covered activity

and such

person of a country of concern

contributed $100,000 to the investment target's revenue for the most recent year, this contribution will be included in determining whether the 50 percent threshold in § 850.209(a)(2)(i) is exceeded. However, if an investment target holds a board seat on a

person of a country of concern

engaged in a

covered activity

and such

person of a country of concern

contributed $25,000 to the investment target's revenue for the most recent year, this contribution will not be included in determining whether the 50 percent threshold in § 850.209(a)(2)(i) is exceeded. Each metric will be evaluated independently in applying this rule. For example, if an investment target holds a board seat on a

person of a country of concern

engaged in a

covered activity

and such

person of a country of concern

engaged in a

covered activity

contributed $25,000 of the investment target's revenue for the most recent year and accounted for $100,000 of the investment target's capital expenditure for the most recent year, the revenue contribution will not be considered for purposes of applying § 850.209(a)(2)(i) but the capital expenditure allocation will be considered for purposes of applying § 850.209(a)(2)(iii).

The Treasury Department determines that the above change will make necessary information easier for a

U.S. person

to ascertain, and addresses issues raised by commenters regarding due diligence considerations. Such minimum financial thresholds on which contributions are to be included in the aggregations may reduce the number of

persons of a country of concern

engaged in a

covered activity

that must be considered for the purposes of aggregating across such

persons of a country of concern

with respect to a given financial metric calculation, and, consistent with the intent of the provision to capture investment targets or transaction counterparties with substantial ties to

persons of a country of concern

engaged in

covered activities,

such thresholds help ensure that only significant financial ties are included.

The Treasury Department declines to adopt a de minimis threshold, as suggested by some commenters, for an investment target or transaction counterparty's equity or voting interest in a

person of a country of concern

engaged in a

covered activity.

Thresholds such as 10 percent or 25 percent, as suggested by some commenters, could exclude downstream investments in a

covered foreign person

with which the immediate investment target has a significant relationship. A minimum financial threshold, rather than excluding entities based on an investment threshold, addresses this issue, and additionally and independently, such a financial threshold is comparatively difficult to manipulate for the purpose of avoiding or evading this provision. The Treasury Department also declines to incorporate the suggested definitions from the CFIUS regulations given the differences in these programs. For example, the concept of “control” in the CFIUS context is a heavily fact dependent determination that is assessed by CFIUS for every transaction filed with CFIUS, whereas the Treasury Department uses a threshold approach in § 850.209(a)(2) for ease of administrability for transaction parties who will be determining coverage under this rule themselves.

One commenter requested that for the purposes of determining

covered foreign person

status under § 850.209(a)(2), a person who receives more than 50 percent of revenue or net income from publicly traded securities, or index funds, mutual funds, exchange-traded funds, or similar instruments (including associated derivatives) should be excepted. The Treasury Department views the likelihood of a

U.S. person

transferring intangible benefits in such a situation where an investment target's only relationship with a

person of a country of concern

engaged in a

covered activity

is the holding of certain securities identified in the exception set forth in § 850.501(a) to be similar to the situation where a

U.S. person

directly acquires or holds such securities. The Treasury Department has therefore modified § 850.209(a)(2) in the Final Rule to specify that, for purposes of determining whether an entity holds an equity or voting interest within the meaning of § 850.209(a)(2), the holding of securities or interests that would satisfy the conditions in § 850.501(a) if held by a

U.S. person

will not be included.

The Treasury Department has made additional changes to § 850.209(a)(2) to reflect comments and enhance clarity. These include the removal of an explicit reference to “one or more contractual arrangements, including, for the avoidance of doubt, variable interest entities” from the Proposed Rule, which modified the reference to a person's having “any power to direct or cause the direction of the management or policies of” a

person of a country of concern

engaged in a

covered activity.

This change is to enhance readability and is not intended to alter the meaning of this provision. The Treasury Department emphasizes that “contractual power to direct or cause the direction of the management or policies” can be granted through variable interest entities.

As modified in the Final Rule, § 850.209(a)(2) continues to focus on the significance of the financial relationship between an investment target and one or more

covered foreign persons

while addressing commenter concerns related to diligence of the downstream entities' activities. In setting the relevant threshold for financial metrics between the investment target and

persons of a country of concern

engaged in a

covered activity

at more than 50 percent, the Treasury Department expects that through a “reasonable and diligent inquiry” a

U.S. person

will be able to determine whether a potential investment target meets the applicable conditions. The Treasury Department understands that multiple entities may need to be considered in this aggregation, but investment targets with significant financial ties with downstream entities, as demonstrated by meeting any of the thresholds in 850.209(a)(2)(i)-(iv), should be able to answer questions from a

U.S. person

investor during due diligence about the application of § 850.209(a)(2), and/or to provide relevant representations and warranties. The Treasury Department has also made additional changes to § 850.209(a)(2) for clarity; no additional substantive changes were intended.

One commenter suggested that § 850.209(a)(2) consider only consolidated revenue and net income because, among other things, they are easier to obtain in the ordinary course of business than the other metrics. The Treasury Department declines to adopt this change because information about capital expenditure and operating expenses should generally be available. In addition, and independently, considerations related to the ease of obtaining this information are outweighed by the national security concerns that would be implicated by not covering an entity under § 850.209(a)(2) that incurs more than 50 percent of its capital expenditure or operating expenses through a

covered foreign person.

In addition, and independently, the Treasury Department wishes to address situations in which a

U.S. person

is investing in an intermediate entity that acts as a vehicle for investment into early-stage

companies engaged in capital-intensive

covered activities.

Such companies may generate little or no revenue or income in their early stages, and yet the Final Rule is designed to prevent the transfer of

U.S. person

intangible benefits to such investment targets given the significance of the financial ties that do exist between the

U.S. person

and the

person of a country of concern

engaged in a

covered activity.

One commenter suggested that the Final Rule “harmonize” the thresholds in § 850.209(a)(2) with other parts of the rule, such as the threshold for determining control in the case of a

controlled foreign entity,

in order to avoid confusion. The Treasury Department has set bright-line thresholds in various provisions in the Final Rule and each threshold set forth in the Final Rule serves a distinct function and is underpinned by distinct considerations, such that adjusting them to be identical would not serve the policy goals of the Final Rule.

One commenter stated that this provision aligned with the policy goals of the Proposed Rule and suggested that because the thresholds in 850.209(a)(2) are based on the most recent available financial statement,

U.S. persons

should have a grace period to reduce their financial ties with

covered foreign persons.

Because the analysis to determine the application of § 850.209(a)(2) must occur at the time of a transaction, the Treasury Department does not determine that a grace period is necessary; if a transaction would be a

prohibited transaction,

it should not be entered into, while an investment that is permitted at the time of the transaction does not need to be divested later due merely to post-transaction changes in an investment target's finances or activities of which the

U.S. person

did not have

knowledge

at the time of the investment. In addition, and independently, an entity into which

U.S. person

investment may be a

covered transaction

under § 850.209(a)(2) that wishes not to meet the criteria of § 850.209(a)(2) can take as little or as much time as it needs to reduce its underlying exposure to relevant

covered foreign person

(s), obviating the need for a set grace period.

Commenters also raised suggestions relating to the time at which a determination of the applicability of § 850.209(a)(2) is made. One commenter noted that the financials of a given target company could change over time, which could complicate compliance for investors that wish to participate in multiple funding rounds and could “have a dramatic chilling effect.” The commenter also suggested exempting subsequent funding rounds from the notification requirements absent a material change or allowing an amendment of a prior notification. In response to this comment, the Treasury Department clarifies that because the analysis to determine the application of § 850.209(a)(2) must occur at the time of a transaction using the information set forth in § 850.209(b), in the context of a single investment, fluctuations in an investment target's finances prior or subsequent to the relevant time period are not relevant to the operation of § 850.209(a)(2). With respect to

notifiable transactions,

the Treasury Department is interested in understanding the volume and nature of investments involving the identified technologies and products and therefore exempting or excepting subsequent funding rounds from the notification requirement will not serve the objectives of the Outbound Order. As discussed more below (see

content of notifications

), the Treasury Department is exploring the ability to allow follow-on notifications involving the same

U.S. person

and

covered foreign person

to be able to incorporate information from a prior notification within the electronic system for submission of notifications.

The Treasury Department declines to create an exemption or exception for a transaction simply because it is part of a subsequent funding round, in § 850.209(a)(2) or elsewhere. Such an exception or exemption could reduce U.S. Government visibility into certain follow-on investments and open a loophole by permitting investments that would otherwise be

prohibited transactions.

One commenter suggested that the measurements set forth in § 850.209(a)(2) be applied at the time of final closing in the case of a closed-end fund, but at the time of an investment by a

U.S. person

in the case of an open-end fund. Due to the ambiguities such an approach might introduce, as well as the potential for evasion or avoidance that such a differentiated approach could create, the Treasury Department declines to adopt this suggested change in the Final Rule.

One commenter requested that the Treasury Department consider making

U.S. person

transactions in entities meeting the criteria of § 850.209(a)(2) notifiable only, even in cases where an underlying entity is engaged in a

covered activity

enumerated in § 850.224 and a prohibition would therefore otherwise apply. The Treasury Department declines to adopt this suggestion, as doing so would open a significant loophole whereby the intercession of an intermediate entity could, in certain circumstances, be used to convert an otherwise

prohibited transaction

into a

notifiable transaction,

undermining the national security objectives that motivate prohibition of certain transactions.

One commenter suggested striking § 850.209(a)(2) in its entirety. Among the reasons given for this suggestion is that a

U.S. person

scoped in as a

covered foreign person

by this prong may itself not be directly engaging in a

covered activity,

and because this coverage could have adverse effects on U.S. companies, including those with important commercial sales relationships or technology licensing agreements with a

person of a country of concern

that is engaged in a

covered activity.

This commenter suggested replacing the Proposed Rule's § 850.209(a)(2) language with the following: “(2) Any entity in which a foreign national, foreign government, foreign entity, or another covered foreign person holds a 50% ownership interest and engages in a covered activity.” In response to this comment, the Treasury Department notes that in order for a

U.S. person

to be scoped in as a

covered foreign person

under § 850.209(a)(2), the

U.S. person

would first have to have a specified relationship with a person of a country of concern that is engaged in a covered activity and second, also be significantly financially connected, as discussed above. The mere fact that a U.S. company has commercial sales relationships or technology licensing agreements, without more, is unlikely to meet the criteria. However, where the criteria under § 850.209(a)(2) is met even in the case of a

U.S. person,

there is a policy desire to address that situation given there is a meaningful relationship with, one or more

persons of a country of control

engaged in

covered activities.

This approach addresses both the potential for evasion and accounts for the range of geographic and organizational structures commonly used by multinational firms to manage their business activities. As one commenter stated, “most investments are made through holding companies and not directly in operating companies,” underscoring the importance of retaining this provision. Further, the alternate definition for § 850.209(a)(2) suggested by the commenter referring to,

e.g.,

a “foreign national” or “foreign person,” could regulate transactions that involve a

person

of a third country but do not involve a

person

with any relationship to a

person of a country of concern

and therefore exceeds the authorities granted

to the Treasury Department by the Outbound Order.

Commenters noted the potential extraterritorial application of § 850.209(a)(2). One commenter stated that a third-country entity “should not be regarded as the same as a person of a country of concern.” Another commenter stated that including entities incorporated outside of a

country of concern

but that have subsidiaries in a

country of concern

could limit investments that draw manufacturers of semiconductor components and suppliers away from the PRC market, negatively impacting U.S. competitive and national security interests. The Treasury Department assesses that certain transactions with an entity that is not a

person of country of concern

engaged in a

covered activity

but nevertheless has an interest in, as well as a significant financial relationship with, a

person of country of concern

engaged in a

covered activity,

have a similar potential of exacerbating the threat identified in the Outbound Order as do transactions with

persons of a country of concern

engaged in a

covered activity,

and notes that § 850.209(a)(2) addresses a common transaction structure whereby investments are made into

parent

companies or holding companies. In addition, and independently, § 850.209(a)(2) does not, in fact, treat non-

country of concern

entities the same as

country of concern

entities, because an entity that is not a

person of a country of concern,

and engages in a

covered activity,

would not be a

covered foreign person

under § 850.209(a)(1) of the Final Rule, whereas a

person of a country of concern

would be.

One commenter stated that § 850.209(a)(2) may prevent a

U.S. person

from making investments in the national security interest of the United States, and multiple commenters suggested the Treasury Department may wish to create a licensing regime to facilitate the approval of investments where appropriate. In response, the Treasury Department notes that a

U.S. person

could seek a national interest exemption from the notification requirement or prohibition set out in the Final Rule by following the process described in § 850.502 and further discussed below. The Treasury Department anticipates that this exemption of a

covered transaction

where in the national interest would be granted by the Secretary in exceptional circumstances, unlike a licensing regime which is typically more frequent.

The Final Rule also makes changes to § 850.209(b), which establishes how a person's revenue, net income, capital expenditure, and operating expenses are to be ascertained. One commenter suggested that where an annual financial statement is unavailable, a

U.S. person

could be permitted to rely on independent appraisals or good faith estimates. The Treasury Department has adopted language similar to this suggestion in § 850.209(b)(1) of the Final Rule, as it pragmatically addresses situations in which no financial statement is available. Under § 850.209(b)(1) of the Final Rule, for purposes of identifying any of a person's overall revenue, net income, capital expenditure, operating expenses, and the relevant contributions of one or more

covered foreign persons,

calculations are to be based on an audited financial statement from the most recent year. If an audited financial statement is not available, the most recent unaudited financial statement is to be used instead. If no financial statement is available, an independent appraisal is to be used instead. If no independent appraisal is available, a good-faith estimate is to be used instead.

This provision is intended to apply independently to the ascertainment of each metric or figure. For example, if overall revenue is available in an audited financial statement from the most recent year, but the specific contributions of

persons of a country of concern

engaged in a

covered activity

are only available via good-faith estimates, then an audited financial statement is to be used to calculate overall revenue, but a good-faith estimate is to be used to calculate the individual revenue contributions of such

persons of a country of concern

engaged in a

covered activity.

The Final Rule also adds § 850.209(b)(2) to address the calculation of exchange rates for the purpose of determining whether the contribution of a

person of a country of concern

engaged in a

covered activity

falls beneath the $50,000 (or equivalent) threshold in cases where the relevant amounts were not in U.S. dollars or where a financial statement did not already convert such figures into U.S. dollar equivalent. In such cases, the most recent published rate of exchange available on the Department of the Treasury's website is to be used instead. Such rates are published quarterly and are not spot exchange rates.

Finally, the Final Rule adds a Note 1 to § 850.209 to clarify that references in that section to revenue, net income, capital expenditure, or operating expenses refer to overall revenue, net income, capital expenditure, or operating expenses, as applicable, without subtracting amounts attributable to a

person of a country of concern

engaged in a

covered activity

of less than $50,000 (or equivalent).

A number of commenters requested the Treasury Department reconsider its decision in the Proposed Rule not to issue a list of entities that are

covered foreign persons.

The Treasury Department has further considered these commenter requests and declines to issue such a list in the Final Rule. Compiling and then publishing a list of

covered foreign persons

would be challenging given that any such list would likely be subject to frequent change and likely underinclusive, which would undermine the national security goals of the Outbound Order. For example, such a list may not capture early-stage companies that would meet the definition of a

covered foreign person

but may not have come to the attention of the Treasury Department. Even if such a list were illustrative or non-exhaustive, market actors may incorrectly determine that entities not listed are therefore not

covered foreign persons

and may decline to undertake the “reasonable and diligent inquiry” described in the Final Rule. Another independent reason for this decision is that providing a list of

covered foreign persons

could also result in attempts to evade the Final Rule through corporate restructuring, creating a greater enforcement burden, undermining the national security goals of the Outbound Order, and adding the burden of maintaining such a list. Additionally, a list of entities may be misleading, because some investments in a given entity may be permitted (

e.g.,

a purchase of a small number of publicly traded shares in such entity) while another investment in the same entity (

e.g.,

a controlling stake) may be prohibited. Finally, the Treasury Department has determined that in the case of early-stage companies, market actors making investments have access to more detailed and up to date information than the U.S. Government and are therefore in a better position to determine whether a transaction is covered under the Final Rule, including whether any

covered foreign person

is involved.

Covered Foreign Person—Final Rule Summary

The definition of

covered foreign person

in the Final Rule describes three sets of circumstances that will cause a

person

to be a

covered foreign person.

First, under § 850.209(a)(1), a

person

is a

covered foreign person

if it is a

person of a country of concern

that is engaged in a

covered activity.

Second, under § 850.209(a)(2), a person is a

covered foreign person

even

if it is not itself a

person of a country of concern

or engaged in a

covered activity

but has a particular relationship with a

person of a country of concern

that is engaged in a

covered activity.

The relationship must meet two conditions. First, the relevant person must hold a specified interest in a

person of a country of concern

that engages in a

covered activity.

That interest can take the form of a voting interest or equity interest (other than through securities or interests that would satisfy the conditions in § 850.501(a) if held by a

U.S. person

), board seat (voting or observer), or the contractual power to direct or cause the direction of the management or policies of the

person of a country of concern

(this could occur, for example, through any contractual arrangement with respect to a variable interest entity). Second, if there is such an interest, then more than 50 percent of the first person's revenue, net income, capital expenditure, or operating expenses need to be attributable to the

person of a country of concern

for § 850.209(a)(2) to apply. The first person also meets this condition if the person holds a specified interest in more than one

person of a country of concern

engaged in a

covered activity,

and more than 50 percent of the first person's revenue, net income, capital expenditure, or operating expenses is attributable to such

persons of a country of concern,

in aggregate. However, any contributions of less than $50,000 (or equivalent) to any given financial metric from any given

person of a country of concern

engaged in a

covered activity

are not included in the relevant calculations as they relate to contributions from such persons toward the relevant 50 percent thresholds.

Relatedly, the Treasury Department intends the threshold of more than 50 percent of any of the financial metrics to be evaluated independently, not in combination. For example, assuming no other relevant circumstances, if a

person

holds a specified interest in a

person of a country of concern

and such

person of a country of concern

represents 20 percent of the first person's revenue and 31 percent of its capital expenditure, these metrics will be evaluated independently and not combined to equal 51 percent.

Under § 850.209(a)(2), the Treasury Department intends to capture those entities that, while not directly engaged in a

covered activity

themselves, are significantly financially connected to entities that are engaged in a

covered activity.

The Treasury Department considers that if more than 50 percent of an investment target's revenue, net income, capital expenditure, or operating expense is attributable to one or more

persons of a country of concern

that are engaged in a

covered activity,

the intangible benefits associated with a

U.S. person'

s investment in the target are likely to be conveyed to such

persons of a country of concern.

Accordingly, the Treasury Department considers that the investment target itself shall be treated as a

covered foreign person.

Moreover, in setting the threshold for financial metrics between the investment target and

persons of a country of concern

engaged in a

covered activity

at more than 50 percent, the Treasury Department expects that through a “reasonable and diligent inquiry” a

U.S. person

will be able to determine whether a potential investment target meets the applicable conditions.

Lastly, under § 850.209(a)(3), a

person of a country of concern

will be a

covered foreign person

by virtue of its participation in a joint venture with a

U.S. person

if such joint venture is engaged in a

covered activity.

That is, even though the

person of a country of concern

may not be engaged in a

covered activity

itself, the fact of its participation in a joint venture that is engaged in a

covered activity

would cause the person to be a

covered foreign person.

Consistent with the policy objectives of the Outbound Order, this approach seeks to focus on transactions where there is a likelihood of the transfer of intangible benefits from a

U.S. person

to a

person of a country of concern

in connection with a

covered activity.

§ 850.210—Covered Transaction

The Proposed Rule defined a

covered transaction

to include a

U.S. person'

s direct or indirect:

Acquisition of an equity interest or

contingent equity interest,

or their equivalent, in a

covered foreign person;

Provision of debt financing convertible to an equity interest in a

covered foreign person

or provision of debt financing that affords the lender certain management or governance rights in a

covered foreign person;

Conversion of a

contingent equity interest

or convertible debt in a

covered foreign person;

Greenfield investment or certain other corporate expansions that either will establish a

covered foreign person,

or will cause an existing

person of a country of concern

to engage in a

covered activity;

Entrance into a joint venture, wherever located, with a

person of a country of concern

where the joint venture will undertake a

covered activity;

and

Investment as an LP into a non-

U.S. person

pooled investment fund that invests in a

covered foreign person.

Importantly, for each of the above transaction types, the Proposed Rule included a specific requirement for what a

U.S. person

would have needed to know or intend for a transaction to be a

covered transaction.

As set forth in the Proposed Rule, a transaction that otherwise had the attributes of a

covered transaction

ordinarily would have been treated as a

covered transaction

only if the relevant

U.S. person knew

at the time of the transaction that the transaction involved, or would have resulted in the establishment of, a

covered foreign person

(or would have resulted in a

person of a country of concern'

s engagement in a new

covered activity

).

Knowledge

for this purpose included both actual knowledge and “reason to know” of the relevant facts or circumstances, as set forth in § 850.216.

Covered Transaction—General Scope

A few commenters expressed the view that the Proposed Rule expanded the scope of transactions that would have been considered

covered transactions

as compared to the ANPRM, with one such commenter noting the inclusion of brownfield investment and joint ventures in particular. The scope of

covered transactions

in the Proposed Rule addressed a set of circumstances in which a

U.S. person

could have provided intangible benefits to a

covered foreign person.

Brownfield investment was included within the scope of the Proposed Rule because the Treasury Department assessed that such an investment, that is, an investment into an existing entity that shifts its operations into a new

covered activity,

risked undermining the national security goals of the Outbound Order. Similar to brownfield investment, a joint venture was included within the scope of

covered transaction

to cover situations in which the transaction structure presented the opportunity and incentive for the transfer of intangible benefits from a

U.S. person

to a

person of a country of concern

through the joint venture.

Acquisition of Equity Interest or Contingent Equity Interest; Conversion of Contingent Equity Interest

The proposed definition of

covered transaction

in the Proposed Rule included the acquisition of an equity interest (or equivalent) in a

covered foreign person

and the acquisition of a

contingent equity interest,

which was defined in 850.205 as a financial instrument that did not constitute an

equity interest at the time of the

covered transaction

but was convertible into, or provided the right to acquire, an equity interest in a

covered foreign person

upon the occurrence of a contingency or defined event.

The proposed definition of

covered transaction

included as a separate basis of coverage the conversion of a

contingent equity interest

or convertible debt in a

person

that the

U.S. person

knew at the time of conversion was a

covered foreign person.

As discussed in the Proposed Rule, with respect to a

notifiable transaction,

the policy objective of including the conversion of a contingent equity or convertible debt in the definition of

covered transaction

was to gain visibility into the circumstances in which contingent interests in a

covered foreign person

would convert. Including the conversion of a

contingent equity interest

or convertible debt in the scope of

covered transaction

would also have addressed circumstances where the investment target or borrower was not a

covered foreign person

at the time of the acquisition of the relevant interest but was a

covered foreign person

at the time of conversion of such interest (

e.g.,

as a result of newly engaging in a

covered activity

or the target's new relationship with a

person of a country of concern

engaged in a

covered activity

).

The Treasury Department received a number of comments in connection with § 850.210(a)(1) and (3) of the Proposed Rule, which covered the acquisition or conversion of a

contingent equity interest.

One commenter indicated that § 850.210(a)(1) of the Proposed Rule, via the coverage of indirect acquisitions, could apply to LP investments into U.S. funds that are not captured by § 850.210(a)(6). The Final Rule clarifies in Note 1 to § 850.210 that for purposes of § 850.210(a)(1), a

U.S. person

is not considered to have indirectly acquired an equity interest or

contingent equity interest

in a

covered foreign person

when the

U.S. person

acquires an LP interest in a venture capital fund, private equity fund, fund of funds, or other pooled investment fund and that fund then acquires an equity interest or

contingent equity interest

in a

covered foreign person.

Accordingly, absent other facts (such as an intent to evade this rule), a

U.S. person

LP's investment into a

U.S. person

pooled investment fund would not itself be assessed to be a

covered transaction.

The

U.S. person

pooled investment fund's transaction with or involving a

covered foreign person

is, however, covered by this rule if such a transaction meets the definition of a

covered transaction,

and hence the

U.S. person

pooled investment fund is responsible for making any required notification and for refraining from engaging in any

prohibited transaction.

The Treasury Department further clarifies that § 850.210(a)(6), and not § 850.210(a)(1), describes the types of investment made as an LP in a pooled investment fund that are defined as a

covered transaction,

namely acquisitions of an LP interest in a venture capital fund, private equity fund, fund of funds, or other pooled investment fund where the fund is not a

U.S. person

and where the other criteria set out in § 850.210(a)(6) are met.

Several commenters requested that the Treasury Department either delete or clarify the phrase “interest equivalent to an equity or

contingent equity interest.”

In response, the Treasury Department is removing references to an “interest equivalent to an equity or

contingent equity interest”

from § 850.210(a)(1) and (3) of the Final Rule.

One commenter stated that the Treasury Department should revise the definition of a

covered transaction

such that it does not include a transaction whereby a

U.S. person

underwriter of an initial public offering (IPO) takes a “short-term residual position in the issuer's shares in the event of a shortfall in demand” where the issuer is a

covered foreign person

or otherwise takes possession of the shares of a

covered foreign person

as a market-maker in connection with an IPO. (Other commenters requested that similar transactions be

excepted transactions

in the rule; see also discussion of an

excepted transaction

below.) In response to this comment, the Treasury Department emphasizes that a

U.S. person'

s acquisition of an equity interest in a

covered foreign person

that is not yet publicly traded for the purpose of facilitating an IPO, such as a purchase with the intent to create a market for the security or to resell the security on a secondary market (

e.g.,

as part of an underwriting arrangement), is a

covered transaction.

The Treasury Department declines to modify the definition of

covered transaction

to exclude such fact patterns, which combine the acquisition of an equity interest with the transfer of intangible benefits, including enhanced standing and prominence, managerial assistance, access to investment and talent networks, market access, and enhanced access to additional financing. However, absent additional facts, the provision of a service ancillary to an IPO that does not include the acquisition of an equity interest (or other interests set forth in the definition of § 850.210) is not a

covered transaction.

The Treasury Department is modifying the definition of

contingent equity interest

at § 850.205 of the Final Rule, which is referenced in § 850.210(a)(1) and (3). (See discussion above under

Contingent equity interest.

) The definition of

contingent equity interest

in the Final Rule refers to a “financial interest,” rather than a “financial instrument” as in the Proposed Rule. This change is intended to more accurately reflect the Treasury Department's intent to cover the acquisition or conversion of interests that are convertible into an equity interest or provide the right to acquire equity interests. The definition of

contingent equity interest

in the Final Rule also clarifies that debt can constitute a financial interest that is convertible into, or provides the right to acquire, an equity interest. Because the definition of a

contingent equity interest

now explicitly refers to debt, the reference to the “conversion of debt to an equity interest” has been removed from § 850.210(a)(3) of the Final Rule. Accordingly, to avoid duplication, the Final Rule deletes § 850.210(a)(2)(i) (

i.e.,

the reference to the provision of debt financing that is convertible to an equity interest, as was included in the Proposed Rule) since such a transaction is now covered in the Final Rule by § 850.210(a)(1) as an acquisition of a

contingent equity interest.

Several commenters stated that the rule should not apply to convertible debt financing more broadly or, in the alternative, should include a safe harbor for any debt financing provided prior to the effective date of the rule. One commenter recommended that debt financing should be a

covered transaction

only if the borrower/recipient receives proceeds from the transaction or if the debt automatically converts upon the occurrence of a specific event. One commenter indicated appreciation for the Proposed Rule's clarity that the acquisition of a

contingent equity interest

and subsequent conversion of that interest are separate

covered transactions.

Another commenter highlighted that because the acquisition of a

contingent equity interest

and the conversion of that interest are each a

covered transaction,

a

U.S. person

investor may find itself unable to convert its interest if an investment target that is a

person of a country of concern

begins engaging in a

covered activity

described in § 850.224 (which defines a

prohibited transaction

) after the interest was initially acquired, such that the conversion would now be prohibited.

Another commenter asserted that covering both the acquisition and the conversion of a contingent interest would have a chilling effect on acquisitions of contingent equity that would be

notifiable transactions,

as a

U.S. person

investor would be uncertain whether it would be able to convert its interest in cases in which the

covered foreign person

investment target subsequently pivots to a

covered activity.

The commenter also noted that venture capital firms generally begin providing non-monetary benefits as soon as they acquire a

contingent equity interest

and thus, any conversion would not trigger the provision of additional intangible benefits. For these reasons, the commenter requested that the Treasury Department provide a safe harbor (or, in the alternative, a licensing regime) that would permit conversion of a

contingent equity interest

provided that, at the time the contingent interest was acquired, the

U.S. person

did not have

knowledge

that the target intended to engage in

covered activities

that would make conversion of the instrument prohibited.

The Treasury Department recognizes that the activities of an investment target in which a

U.S. person

holds a

contingent equity interest

could change during the period between a

U.S. person'

s acquisition and conversion thereof, and that this could cause a

U.S. person

either to decide not to enter into an investment or to be unable to convert an existing contingent interest. To avoid a situation in which a

U.S. person

is prohibited from converting a

contingent equity interest

that was obtained prior to the effective date of the Final Rule, the Final Rule provides in § 850.210(a)(3) that conversion of a

contingent equity interest

into an equity interest in a person that the

U.S. person knows

at the time of conversion is a

covered foreign person

is a

covered transaction

only where the

contingent equity interest

was acquired by the

U.S. person

on or after the effective date of the Final Rule. Permitting a

U.S. person

to acquire an equity interest in a

covered foreign person

engaged in one of the specific

covered activities

described in the definition of a

prohibited transaction

as a result of converting a

contingent equity interest

acquired on or after the effective date of the Final Rule would create a significant loophole that could be exploited and would run counter to the goals of the Outbound Order. Like a

U.S. person

that has obtained an equity interest directly, a

U.S. person

that has obtained an equity interest as a result of converting a

contingent equity interest

is positioned to provide intangible benefits that often accompany investments by

U.S. person

s and that help companies succeed. Given this outcome, neither a safe harbor beyond the cutoff date for acquisitions specified above and in the Final Rule nor a licensing regime would be appropriate. The Treasury Department also recognizes that an investor that acquires a

contingent equity interest

in an investment target may be able to obtain contractual assurances from the investment target as to the nature of its future activities, addressing a situation where the activities of the investment target change such that the

U.S. person

would be unable to convert its interest and the target could obtain a windfall. In response to one commenter's contention that venture capital firms generally begin providing non-monetary benefits as soon as they acquire a

contingent equity interest,

even if this statement is descriptively correct as it relates to some investments, it does not mean that the Final Rule should not also cover conversions of contingent interests given the direct channel for the transfer of intangible benefits that such conversions establish between a

U.S. person

and a

covered foreign person

in many transaction structures. Accordingly, the Treasury Department declines to adopt such a recommendation.

Provision of Debt Financing

The Proposed Rule provided that a

U.S. person'

s provision of a loan or similar debt financing arrangement to a

person

that the

U.S. person

knew at the time of the provision was a

covered foreign person

would have been a

covered transaction

when the debt financing was convertible to an equity interest or afforded or would have afforded the

U.S. person

the right to make management decisions with respect to or on behalf of the

covered foreign person

or the right to appoint members of the board of directors (or equivalent) of the

covered foreign person.

The intent of this provision was to capture lending by a

U.S. person

lender only where such lending involved the acquisition of equity or equity-like rights by the

U.S. person

lender with respect to a

covered foreign person.

The Proposed Rule explained that while the issuance of debt secured by equity in a

covered foreign person

would not, absent other circumstances, have been a

covered transaction,

foreclosure on collateral that constituted an equity interest in a

covered foreign person

would have constituted the acquisition of an equity interest under the Proposed Rule and would have been a

covered transaction.

Several commenters provided input on § 850.210(a)(2) of the Proposed Rule. Several commenters focused on a scenario whereby a

U.S. person

lender issues debt for which equity is pledged as collateral and forecloses on that collateral at some subsequent point. Some commenters urged that the rule not apply to either debt financing secured by equity or to foreclosure on such equity. One commenter requested the Final Rule permit U.S. lenders to foreclose on or restructure existing debt that may be otherwise prohibited if the lender provides a notification under the program and attempts to divest as soon as practicable. One commenter suggested that the Treasury Department clarify that a loan or similar debt financing that is secured using equity held as collateral not be considered “convertible to an equity interest” under § 850.210(a)(2)(i). One commenter indicated appreciation for the Proposed Rule's clarity that foreclosure on equity in a

covered foreign person

that secures debt would have been a

covered transaction.

A few commenters recommended that the Treasury Department make explicit in the rule that foreclosure on equity used as collateral for debt is not a

covered transaction.

One commenter noted that the Proposed Rule could have limited the ability of

U.S. persons

to create supplier relationships with counterparts in whom investment was not otherwise prohibited by the Proposed Rule—

e.g.,

where convertible equity interests were used for purposes of commercial risk mitigation—and requested that supply contracts secured through convertible equity interests be carved out of the rule.

Other commenters requested that the rule not apply to secondary debt market transactions involving debt secured by equity. A few commenters highlighted that purchasers in the debt market do not have access to diligence materials or the power to negotiate representations from the underlying issuer, while another commenter stated that secondary debt market transactions should be carved out because the borrower would not receive any proceeds from that secondary transaction.

Commenters also discussed the description in § 850.210(a)(2)(ii) of the Proposed Rule regarding a lender's ability to make management decisions. Several commenters argued that when a lender seeks to restructure a delinquent loan, for example to change the borrower's management or appoint a

board member, such actions should not be considered a

covered transaction.

Another commenter sought clarification regarding the phrase “make management decisions” and inquired as to whether this language would encompass standard debt covenants. The commenter asked that either such covenants be carved out of the rule or that the rule provide further clarity with respect to what activities constitute “mak[ing] management decisions.” In response to the above comments, the Final Rule contains changes to § 850.210(a)(2) as well as to Note 2 to § 850.210. Note 2 to § 850.210 of the Final Rule clarifies that neither the issuance of debt financing secured by equity collateral nor the acquisition of such secured debt on the secondary market is an “acquisition of an equity or

contingent equity interest”

and hence will not, absent other facts, constitute a

covered transaction.

That note also further clarifies, however, that foreclosure on collateral where the debtholder takes possession of the pledged equity does constitute an acquisition of an equity interest. This is so because where a

U.S. person

obtains an equity interest in a

covered foreign person,

whether as a result of the conversion of a convertible interest or foreclosure on collateral that was pledged as security, the

U.S. person

assumes the position of an equity holder in the

covered foreign person

and therefore has the opportunity and incentive to provide the types of intangible benefits that the Outbound Order and this rule are intended to address.

As such, foreclosure on equity taken as collateral continues to be considered an acquisition of equity for purposes of § 850.210. However, in response to relevant comments, Note 2 further clarifies that foreclosure on collateral where the

U.S. person

does not

know

at the time of issuing or acquiring the secured debt that the pledged equity was in a

covered foreign person

does not constitute a

covered transaction.

This addresses the concerns raised by commenters that a debtholder may be prevented from foreclosing on equity that was pledged as collateral if the entity whose equity was pledged was not engaged in a

covered activity

at the time the debt financing was provided but pivots into a

covered activity

while the debt is outstanding. With this change, foreclosure on equity pledged as collateral will constitute a

covered transaction

when a

U.S. person

has

knowledge

at both the time of the issuance or acquisition of the secured debt, and at the time of foreclosure, that the equity is that of a

covered foreign person.

Further, as highlighted by the comments, the Treasury Department does not intend to define as a

covered transaction

foreclosure on equity that was taken as collateral prior to the effective date of the Final Rule. As such, Note 2 to § 850.210 of the Final Rule clarifies that foreclosure on equity pledged prior to the effective date of the Final Rule as collateral for secured debt is not a

covered transaction.

Therefore, “existing” debt as highlighted by one commenter,

i.e.,

a convertible interest acquired in connection with debt financing provided prior to the effective date of the Final Rule, could be restructured in ways that involve the conversion of such an interest without triggering the definition of a

covered transaction.

The Treasury Department agrees with commenters' request for clarification of the Proposed Rule's reference to “mak[ing] management decisions” in § 850.210(a)(2)(ii). The Final Rule revises § 850.210(a)(2) to specify that the provision of debt financing to a

person

that the

U.S. person knows

at the time of the provision is a

covered foreign person

is a

covered transaction

where the debt financing affords or 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 (or equivalent) of the

covered foreign person,

or other comparable financial or governance rights characteristic of an equity investment but not typical of a loan. In the Final Rule, the Treasury Department does not intend to cover debt financing unless it has these equity-like characteristics or is convertible into an equity interest. As noted above, to avoid duplication in light of the revision in the Final Rule to the definition of

contingent equity interest

in § 850.205, the Final Rule removes from § 850.210(a)(2) the reference to the provision of debt financing that is convertible to an equity interest, as was included in the Proposed Rule, since such a transaction is covered in the Final Rule by § 850.210(a)(1) as an acquisition of a

contingent equity interest.

Greenfield or Brownfield Investment

Under § 850.210(a)(4) of the Proposed Rule, the definition of

covered transaction

included a

U.S. person'

s acquisition, leasing, or development of operations, land, property, or other assets in a

country of concern

when the

U.S. person knew

that such acquisition, leasing, or development would, or the

U.S. person

intended it to, either (1) establish a

covered foreign person,

such as the acquisition of land in a

country of concern

with the intent to build a facility that designs an integrated circuit, or (2) pivot an existing entity's operations into a new

covered activity,

such as the acquisition of a factory with the intent to retrofit it to produce equipment for performing volume advanced packaging. A

U.S. person'

s intent (as distinct from

knowledge

) would have been sufficient in these cases for the transaction to be a

covered transaction.

This was because in the greenfield and brownfield context, a

U.S. person

may not have

known

at the time of the transaction that the investment would result in a

covered activity,

yet the Treasury Department nevertheless sought to cover activities intended to bring about the establishment of a

covered foreign person

or a

person of a country of concern'

s engagement in a new

covered activity,

since such a situation was likely to convey intangible benefits from the

U.S. person

to a

covered foreign person.

That a

covered foreign person

ultimately would have resulted from a greenfield or brownfield investment would not have been necessary for coverage under the Proposed Rule, as long as the intent to establish a

covered foreign person

was present at the time of the transaction. The Treasury Department assessed that requiring a greenfield or brownfield investment to result in the establishment of a

covered foreign person

or a

person of a country of concern'

s engagement in a new

covered activity

before triggering obligations associated with

covered transaction

status would have risked undermining the national security goals of the program. For the avoidance of doubt, the Treasury Department did not intend to scope in a real estate transa

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