Outbound Investment Rule Embraces New National Security Paradigm

Three times in the past four months, two US agencies with national security mandates have drawn on a largely unheralded legal standard from the Foreign Corrupt Practices Act in setting expectations for US legal and natural persons’ compliance due diligence.

Instead of holding companies accountable only when they actually know of violations of US export control laws, these agencies expect companies to react when aware of a “high probability” of such violations.

Both agencies—the Department of Commerce and Department of the Treasury—are using the same high probability standard that has driven the past two decades of FCPA enforcement by the Department of Justice and Securities and Exchange Commission.

These developments sound a warning to companies to apply the same risk-based due diligence methodologies required to mitigate FCPA enforcement risks to export controls compliance and, most recently, outbound investment screening.

Commerce

Commerce’s Bureau of Industry and Security emphasized the high probability standard in both July 10, 2024, guidance and an Aug. 15, 2024, corporate settlement. Whether it was that guidance’s expectations related to responding to warnings from BIS, or that settlement’s application of the catch-all provisions under the Export Administration Regulations, known as EAR, acting with knowledge was defined to include an awareness of a high probability of relevant facts and circumstances.

On Oct. 9, BIS highlighted the high probability standard in guidance for financial institutions. This guidance focused on the EAR’s General Prohibition 10, which prohibits any US person—including those institutions—from financing or otherwise servicing an item subject to the EAR with “knowledge” that a violation of the EAR “has occurred, is about to occur, or is intended to occur in connection with the item.”

BIS warned that such knowledge includes an awareness of a high probability of those circumstances and outlined its expectations for financial institutions’ due diligence.

Treasury

These developments provide an interagency context for the Treasury’s Oct. 28 final rule on US investments in national security technologies and products in countries of concern issued by its Office of Investment Security.

The final rule regulates outbound investment by US legal or natural persons, directly or indirectly, through transactions with persons of the People’s Republic of China (along with Hong Kong and Macau), which the underlying executive order defined as the jurisdictions for “covered foreign persons.” Those transactions must involve certain technologies and products related to semiconductors and microelectronics, quantum information technologies, and artificial intelligence.

The linchpin is what the US person knows about the relationship of any covered foreign persons to the transaction. Knowledge includes not only actual knowledge and a reason to know, but also an “awareness of a high probability of a fact or circumstance’s existence or future occurrence.” Whether the investment is prohibited, or instead only triggers a notification requirement, depends on the technologies and products involved.

In practice, the high probability standard requires risk-based methodologies to make and defend subjective judgments. The Treasury expects companies to conduct a “reasonable and diligent inquiry” to determine whether covered foreign persons are involved. The Treasury can assign constructive knowledge to US persons “based on information a US person had or could have had through reasonable and diligent inquiry.”

For a US person who fails to do so, such person may be “assessed to have had reason to know of a given fact or circumstance, including facts or circumstances that would cause the transaction to be a covered transaction.”

Compliance Considerations

What is a reasonable and diligent inquiry? The Treasury puts the burden on US persons to design—and defend—a methodology for this purpose. Contractual representations and warranties alone aren’t sufficient.

The Treasury will also consider “the totality of relevant facts and circumstances,” including what due diligence was done, what efforts were made “to obtain and consider available non-public information,” whether “available public and commercial databases” were used “to identify and verify relevant information,” and whether “warning signs” existed.

Beyond a US person’s assessment of the facts and circumstances up to the time of a transaction, if the US person subsequently acquires knowledge that would have made the transaction a covered transaction, the US person must notify the Treasury within 30 days. This notification must include a root-cause analysis of what due diligence was undertaken and why it failed.

What about foreign parents of US persons? The final rule includes the usual offenses that accompany US sanctions programs, whereby any action that “evades or avoids, has the purpose of evading or avoiding, causes a violation of, or attempts to violate” any aspect of the final rule, or any conspiracy to violate the final rule, is prohibited—without specifying by whom the action is taken.

Foreign parents should accordingly take steps to ensure they don’t inadvertently cause a US person to violate the final rule.

Enforcement Signals

The continued re-emergence of the high probability standard in regulations of economic activity to achieve national security objectives is not a coincidence. It signals that the Commerce and Treasury Departments are serious about requiring substantive, risk-based due diligence and believe that the standard will both encourage desired behavior and facilitate enforcement.

As with FCPA enforcement, the standard invites companies to design a methodology for making and defending the necessarily subjective decisions they need to make to analyze risk with imperfect—often, far from perfect—information.

Accordingly, US persons who engage in covered transactions need to ensure that, by the final rule’s effective date of Jan. 2, 2025, their processes include risk-based assessments of whether covered foreign persons are involved. Failing to do so can carry dire consequences for both the contemplated investment and the US persons involved.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Michael H. Huneke is co-chair of the sanctions, export controls, and anti-money laundering practice group and partner in the global investigations, enforcement and compliance practice group at Hughes Hubbard & Reed.

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