Biden Administration Retools Investment Rules for Chinese Military-Industrial Companies
On June 3, 2021, President Biden signed Executive Order No. 14032, entitled "Addressing the Threat from Securities Investments that Finance Certain Companies of the People’s Republic of China" (Executive Order), which replaces a similar executive order issued by former President Trump in November 2020. Under the Executive Order, US persons (including US citizens, US companies, permanent residents, and individuals and entities located within the US) will be prohibited from transactions involving publicly traded shares of any of the 59 Chinese companies identified by the Executive Order as companies operating in China's defense and surveillance technology sectors. Many of the identified companies are currently trading on stock exchanges around the world.
Also on June 3, 2021, the US Department of the Treasury's Office of Foreign Assets Control (OFAC) published updated and new Frequently Asked Questions (FAQs) addressing the Executive Order.
In November 2020, former President Trump signed Executive Order No. 13959, “Addressing the Threat from Securities Investments that Finance Communist Chinese Military Companies” (EO 13959). As discussed in our prior November 2020 and January 2021 advisories, EO 13959 introduced a novel prohibition on certain transactions by a US person involving securities or derivatives of securities of Communist Chinese Military Companies (CCMCs). In January 2021, President Trump issued Executive Order No. 13974 (EO 13974), which made minor adjustments to EO 13959, including clarifying that US persons holding CCMC securities beyond a permitted period would violate EO 13959.
The Executive Order
The Executive Order rescinds and supersedes much of EO 13959, and revokes EO 13974 entirely. Specifically, although it maintains similar prohibitions on transactions involving securities of many well-known Chinese companies, the Executive Order expands the overall focus of the prohibitions to cover Chinese Military-Industrial Complex Companies (CMICs), including certain companies associated with the Chinese surveillance technology sector to counter the use of such technology within or outside China "to facilitate repression or serious human rights abuse." 1 Presumably this expanded focus is meant to address the US Government's ongoing concerns with China's recent alleged human rights abuses, including those related to the country's widely reported surveillance activities in Hong Kong and Xinjiang.
The Executive Order prohibits US persons from engaging in "the purchase or sale of any publicly traded securities [of any listed CMIC entity], or any publicly traded securities that are derivative of such securities or are designed to provide investment exposure to such securities" (Covered Transactions). 2 The term "publicly traded securities" is defined by the Executive Order to include any “security,” as defined in Section 3(a)(10) of the Securities Exchange Act of 1934, Public Law 73–291 (as codified as amended at 15 USC § 78c(a)(10)), denominated in any currency that trades on a securities exchange or through “over-the-counter” transactions.
The Executive Order directs that US persons are prohibited from engaging in Covered Transactions beginning August 2, 2021, and must divest any securities of CMIC companies identified in the Executive Order obtained prior to June 3, 2021, by June 3, 2022. For companies added to the NS-CMIC List after June 3, 2021, US persons must divest CMIC securities within one year. As noted above, the Executive Order revokes EO 13974 entirely, including that order's requirement to divest relevant securities after a permitted period. Although the Executive Order prohibits Covered Transactions, it does not prohibit the mere ownership of CMIC securities. Practically speaking, however, we expect the Executive Order to effectively eliminate ownership of such securities by US persons as such persons, would be required to hold such securities beyond the sale or divestiture period permitted by the Executive Order indefinitely.
The Executive Order also revokes and replaces the list of companies previously targeted under EO 13959. Unlike the previous CCMC regime—which placed primary responsibility for identifying CMCCs on the US Department of Defense—the Executive Order directs the US Department of the Treasury to drive the process for identifying entities subject to the Executive Order. Specifically, the Executive Order authorizes the Secretary of the Treasury (in consultation with the Secretary of State, and, as the Secretary of the Treasury deems appropriate, the Secretary of Defense) to designate additional entities pursuant to the Executive Order, if the Secretary of the Treasury determines that such entities:
i. Operate or have operated in the defense and related materiel sector or the surveillance technology sector (covered sector) of the economy of the PRC; or
ii. Own or control, or are owned or controlled by, directly or indirectly, an entity who operates or has operated in a covered sector, or a previously identified CMIC entity.
To implement the Executive Order, OFAC published a list on its website containing the names of entities identified in the Executive Order, titled the “Non-SDN Chinese Military-Industrial Complex Companies List” (NS-CMIC List). The NS-CMIC List includes 31 companies that were previously targeted under EO 13959, as well as 28 additional companies. Notably absent from the NS-CMIC List are Gowin Semiconductor, Luokung Technology Corporation and Xiaomi Corporation—three entities that previous challenged their CCMC designations under EO 13959 in US Federal District Court.
As noted above, OFAC issued a number of new and updated FAQs addressing the Executive Order's new investment-related rules. We address key aspects of these FAQs below.
- Scope of Covered Transactions. The FAQs clarify that the Executive Order does not prohibit US persons from engaging in all activities with CMICs. Specifically, the Executive Order prohibits purchasing or selling publicly traded CMIC securities or trading derivatives of such securities. However, US persons may continue to engage in transactions with NS-CMIC listed entities unrelated to the entity's securities. Thus, the Executive Order will have a significant impact on securities-related dealings with respect to CMICs, but US persons may expect to continue to conduct noninvestment-related business activities with such companies. US and non-US market makers, as well as market intermediaries and other participants may also facilitate divesting CMIC securities during the relevant divestiture period (i.e., one year after CMIC designation).
- US persons are also not prohibited from providing investment advisory, investment management or similar services to a non-US person in connection with the non-US person’s purchase or sale of a covered security, provided that the underlying purchase or sale of CMIC securities would not otherwise violate the prohibitions of the Executive Order (e.g., where the US person is not the ultimate beneficiary of the sale and the transaction is not a willful attempt to evade the Executive Order). In addition, the FAQs clarify that the Executive Order does not apply to US persons who are employed by non-US entities and who, in the ordinary course of their employment, are involved in purchases or sales of CMIC securities.
- Scope of CMICs. The updated FAQs specifically note that OFAC's "50 percent rule" does not apply to the Executive Order. Accordingly, the Executive Order does not prohibit securities-related transactions with subsidiaries, joint ventures or other related parties of entities identified on the NS-CMIC List unless such entities are separately included on the list. Under the prior CCMC regime, the FAQs stated that OFAC intended to list entities owned or controlled by CCMCs as subject to EO 13959. Moreover, only entities whose names exactly match those included in the NS-CMIC List are subject to the Executive Order.
Although the Executive Order adjusts and refines several substantive aspects of the Trump Administration's efforts to isolate and limit Chinese technology companies, the Executive Order largely stays the course with respect to these investment-related prohibitions. This aligns with the Biden Administration’s stated intent to increase pressure on China to cease its alleged human rights abuses. We expect US-China tensions to continue to rise in the coming months, and the Executive Order signals to US and non-US investors that additional investment and trade restrictions are on the horizon.
© Arnold & Porter Kaye Scholer LLP 2021 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.
Notably, the U.S. Government plans to target "persons whose operations include or support, or have included or supported, (1) surveillance of persons by Chinese technology companies that occurs outside of the PRC; or (2) the development, marketing, sale, or export of Chinese surveillance technology that is, was, or can be used for surveillance of religious or ethnic minorities or to otherwise facilitate repression or serious human rights abuse."