Background

U.S. law has long subjected foreign investments into the U.S. to review and restriction by the Committee on Foreign Investment in the United States (“CFIUS”), but outside of economic sanctions programs, has typically not restricted the ability of U.S. persons to invest into foreign countries. That changed on January 2, 2025, when a Treasury Department final rule (the “Final Rule”) took effect that broadly limits investments into Chinese¹-located or -controlled companies engaged in the semiconductor and microelectronic, quantum information technology, and artificial intelligence sectors.

As explained below, the Final Rule (31 CFR Part 850) presents challenges and ambiguities to advisers, funds, and investors and may necessitate changes in the investment strategies and governance of (i) U.S. and non-U.S. private funds advised by U.S. investment advisers and (ii) non-U.S. funds advised by non-U.S. advisers with U.S. person investors.

The Final Rule implements the directives of Executive Order 14105, issued by then-President Biden on August 9, 2023, and is intended to prevent U.S. investments from accelerating or enhancing the military, intelligence, surveillance, or cyber-enabled capabilities of China. As detailed in our client memo of January 24, 2025, President Trump has ordered a review of E.O. 14105 and the Final Rule, but the rule is currently in effect.

A violation of the Final Rule is punishable by a civil money penalty of up to double the value of the violating transaction, or $368,136 under the International Emergency Economic Powers Act. The Treasury Department may also seek a criminal fine of $1 million  and up to 20 years’ imprisonment.

Summary of the Final Rule

1. Scope

The Final Rule imposes investment restrictions on U.S. citizens (wherever residing), U.S. lawful permanent residents, persons located in the U.S., U.S.-organized or -domiciled entities, and “controlled foreign entities” of which any of the foregoing is a “parent.”

An investment by a person subject to the Final Rule may be prohibited or subject to notification requirements if the investment is knowingly made into:

• An entity with a principal place of business in or incorporated in China; or
• An entity (wherever located) that is 50% or more owned or controlled, directly or indirectly, by:
  • The Chinese government;
  • An entity with a principal place of business in or incorporated in China; or
  • A Chinese citizen or permanent resident of China (excluding U.S. citizens in China).

A non-Chinese person or entity is captured if it (i) has a board seat on, holds any interest in, or exerts control over, a Chinese entity and (ii) 50% or more of its revenue, net income, capital expenditure, or operating expenses are attributable to a Chinese entity.

The Final Rule only restricts investments when the U.S. person (or foreign entity controlled by a U.S. person) has “knowledge” that the investment target is a Chinese or Chinese-controlled entity active in one of the specified industries. Knowledge is broadly defined as (i) actual knowledge that a fact or circumstance exists or is substantially certain to occur; (ii) an awareness of a high probability of a fact or circumstance’s existence or future occurrence; or (iii) reason to know of a fact or circumstance’s existence.

2. Covered Industries

Currently, there are only three industries into which investment is restricted under the Final Rule:

• Semiconductors and microelectronics, including supercomputers, certain software and equipment, and the design or fabrication of certain integrated circuits;
• Quantum information technologies, such as quantum computer technology; and
• AI systems designed for or intended to be used for military, government intelligence, or mass-surveillance end uses or that is trained using a specified quantity of computing power.

Investments into Chinese entities engaged in certain activities in the specified industries are prohibited, while others merely require advance notification to the Treasury Department. The activities of a Chinese entity’s subsidiaries are likely relevant in assessing the propriety of an investment (the regulation is unclear), but the activities of a Chinese entity’s parent or affiliates are irrelevant.

3. Covered Transactions

The Final Rule applies to “Covered Transactions,” which includes:

• Acquiring equity interests, options, warrants, convertible debt or debt providing equity-like rights;
• Entering a joint venture;
• Acquiring a “limited partner or equivalent” interest in a non-U.S. investment vehicle if the investor knows at the time of the investment that the vehicle “likely will invest in” a Chinese entity in a restricted industry.

Equity that is publicly traded (in any market) and any equity issued by an SEC-registered investment company is excluded if the U.S. person investor does not acquire affirmative or blocking rights of any kind other than standard minority protections. These prohibited rights expressly include the right to make a shareholder proposal, which can arise under Chinese law with as little as a 3% interest and thus effectively imposes an equity cap. Carried interest is excluded.

Covered Transactions are either prohibited or “notifiable.” Prohibited transactions include investments in the forementioned technologies that significantly enhance the military, intelligence, surveillance, or cyber-enabled capabilities of China or pose an acute national security risk to the U.S. For investments in semiconductors and microelectronics and AI systems, the Final Rule describes the technological specifications of the investment target that implicate such investment as being prohibited. All investments in Quantum information technologies are prohibited unless the investment fits into a relevant safe harbor.

Investments into semiconductors and microelectronics and AI systems that do not meet the technological specifications referred to above are notifiable transactions. A person subject to the notification requirement is required to file a notification form with Treasury that includes information related to the transaction no later than 30 days after the relevant transaction is completed or 30 days after the person knows of such transaction.

Important Considerations for Investment Advisers and Private Funds

An investment into a Chinese or Chinese-controlled entity in a restricted industry by any of the following is prohibited or subject to advance notification of the Treasury Department:

• Investors and advisers organized, domiciled, or located in the U.S., including U.S. subsidiaries of non-U.S. entities;
• Registered and unregistered investment advisers and investment vehicles organized or domiciled in the U.S.;
• Investors and advisers located outside of the U.S. that are:
  • U.S. citizens;
  • U.S. organized entities; or
  • Subsidiaries of U.S. entities (when controlled by the U.S. parent);
• Non-U.S. investment vehicles in which a singleS. person or entity (including one or more affiliated feeder funds) directly or indirectly has a majority of the voting interests;
  • Note: this does not automatically mean a non-U.S. investment vehicle in which the majority of voting interests is controlled by multiple U.S. persons none of whom individually exceeds 50%.
• Non-U.S. investment vehicles advised by a U.S. adviser or a non-U.S. adviser controlled by a U.S. person or entity; and
• Non-U.S. investment vehicles with a general partner or managing member that is a U.S. person or controlled by a U.S. person.

Important Considerations for Investors in Private Funds

The Final Rule also restricts the investment of a U.S. person limited partner (or equivalent) into a U.S. or non-U.S. private fund that invests in a Chinese or Chinese-controlled entity active in one of the specified industries if the limited partner knows at the time of the investment that the fund will “likely” make such an investment.

The Treasury Department will assess such limited partner’s knowledge by evaluating whether the limited partner undertook a reasonable and diligent inquiry before making any investment. Certain factors that indicate whether a reasonable and diligent inquiry took place include, but are not limited to, (i) the substance of the questions asked by the limited partner at the time of a relevant transaction, (ii) the efforts made by the limited partner to obtain public information relevant to the transaction, and (iii) the presence of or absence of warning signs apparent to the limited partner at the time of the transaction.

The Final Rule provides two safe harbors for limited partners. First, the limited partner can limit its total investment in a fund to $2 million. Second, the limited partner can enter into a binding contractual commitment with the fund that the limited partner’s capital will not be used in the problematic investments. In addition to the two safe harbors, investments made prior to the Final Rule’s effective date or satisfying a binding capital commitment entered into prior to the effective date are exempt.

If you have any questions regarding the foregoing, please contact one of the partners listed below or your primary Seward & Kissel attorney.