Author: Morrison Foerster
Published: January 19th, 2021
Original Article Link
The following client alert is courtesy of CGCC
member Morrison Foerster.
I. Overview
With just one week remaining in
his term, President Trump amended Executive Order (“EO”) 13959, which prohibits U.S. persons
from investing in the securities of Chinese Military Companies (“CMCs”),
to continue his aggressive stance toward such CMCs. The amended EO now
generally prohibits all transactions (rather than just investments) in CMC
securities and requires U.S. persons to divest themselves of all such
securities by November 11, 2021, and within 365 days for future listed CMCs. We
discussed the earlier version of EO 13959 at length in a previous client alert, and OFAC’s interpretations of key terms (which generally
remain valid) in another client alert.
The amended EO
comes after weeks of uncertainty across global legal and financial markets
following the issuance of EO 13959 on November 12, 2020, and the multiple
weekly changes to the U.S. Treasury Department Office of Foreign Assets Control
(“OFAC”) guidance on its interpretation. Prior to the recent amendments,
outstanding questions regarding deadlines, divestment, and the scope of
prohibited activities contained in EO 13959 continued to puzzle interested
parties. Now that the amended EO has answered some of those questions, the
question remains whether the incoming Biden Administration will revise the EO
or issue additional guidance to limit the impact on the U.S. and overseas investing
community.
II. Key Takeaways from the Amended EO
- Section
1(b) of EO 13959 previously permitted purchases for value or sales of
otherwise prohibited securities of CMCs before November 11, 2021, in order
for U.S. persons to divest such prohibited securities. However, EO 13959
did not expressly prohibit U.S. persons from holding CMC securities after
the deadline. The amended EO clarifies that U.S. persons are not permitted
to possess prohibited securities after the November 11, 2021 divestment
deadline. Section 1(c), which permits purchases for value or sales of
prohibited securities by CMCs in order to divest, also forbids possession
of prohibited securities after the applicable divestment deadline. In
other words, mere failure to act may expose holders of CMC securities to
liability. For this reason, it is critical to stay informed of the current
list of CMCs, entities with names that closely match those of CMCs (see
FAQ 864),
and funds or other financial instruments that contain at least one
prohibited security in their portfolios (see FAQ 861). - Section
4(e) of EO 13959 previously defined “transaction” as the purchase for
value of any publicly traded security. The amended EO revises the
definition of “transaction” to the purchase for value, or sale, of any
publicly traded security. In so doing, this change emphasizes that U.S.
persons cannot even sell prohibited securities after the applicable
deadlines. - Revised
subsection (a)(ii) still relies on the definition of CMCs in the National
Defense Authorization Act for Fiscal Year 1999 (“NDAA FY1999”)
Section 1237(b)(4), rather than the expanded definition of CMCs in the
National Defense Authorization Act for Fiscal Year 2021 (“NDAA FY2021”)
Section 1260H (which now includes “military-civil fusion contributors”).
Consequently, the scope of CMCs under EO 13959 and that of CMCs the
Department of Defense (“DoD”) must report to Congress pursuant to
NDAA FY2021 are not identical. Despite this discrepancy, as a practical
matter, the amended EO is likely to prohibit transactions with any new
CMCs DoD identifies pursuant to NDAA FY2021.
III. The FAQs
Six weeks after the Trump
Administration issued EO 13959 on November 12, 2020, OFAC started to answer the
private sector’s questions through several FAQs addressing some of the concerns
related to the prohibition in EO 13959 (see our client alert on the first five
FAQs here). Since our latest client alert,
OFAC has issued an additional eight FAQs, as well as General License No. 1, which authorizes otherwise prohibited transactions with
entities whose names closely match those of a previously listed CMC, but that
have not been added to OFAC’s Non‑SDN Communist Chinese Military Companies List
(“CMC List”) until January 28, 2021, and General License No. 2, which authorizes otherwise prohibited transactions involving
securities exchanges for one year following the date an entity is added to the
CMC List. The new FAQs address topics such as divestment, the definition of
“transaction,” permissible activities by U.S. persons, market intermediaries,
and security exchanges.
FAQ 862
FAQ 862 clarifies that U.S. persons,
including U.S. funds and related market intermediaries and participants, are
not required to divest their holdings of prohibited securities by January 11,
2021. Indeed, as explained in the amended EO and discussed further below in FAQ
872, U.S. persons are required to divest their holdings in CMC securities by
November 11, 2021, and within 365 days for future CMCs. Possession of such
prohibited securities after November 11, 2021, or the applicable 365-day
deadline is prohibited.
FAQ 863
FAQ 863 clarifies that U.S.
persons can engage in activities involving CMCs that relate to clearing,
execution, settlement, custody, transfer agency, and back-end services, as well
as other such support services, provided that these activities are not provided
to U.S. persons in connection with otherwise prohibited transactions.
FAQ 864
FAQ 864 clarifies that EO 13959
applies to the securities of entities with names that exactly or closely match
the name of a CMC. This includes transactions with entities, including
subsidiaries of CMCs, whose names are similar to the names of previously
designated CMCs, but are not on the CMC List. When OFAC issued FAQ 864, it
reiterated its ongoing efforts to update its CMC List, which includes details
such as the name of the company, A.K.A., issuer name, and equity ticker.
However, OFAC issued General License No. 1 two days after FAQ 864 was published, which permits
otherwise prohibited transactions with entities whose names closely match the
name of a previously listed CMC but that have not been added to the CMC List
through 9:30 am ET, January 28, 2021. After that time, transactions with
entities whose names closely match the name of a CMC but that are not listed on
the CMC List are prohibited.
FAQ 865
FAQ 865 clarifies that market
intermediaries and other participants may engage in ancillary or intermediary
activities that are necessary to effect divestiture during the relevant
wind-down periods or that are otherwise not prohibited under the EO.
Transactions between U.S. persons and investment funds for the purposes of
divestment are also permitted.
FAQ 871
FAQ 871 addresses securities
exchanges operated by U.S. persons and refers to General License No. 2, which authorizes otherwise prohibited transactions involving
securities exchanges for one year following the date an entity is added to the
CMC List. Together with General License No. 1, the new deadlines contained in
the two general licenses underline how important it is for U.S. persons and
other holders of securities to monitor not only which entities are added to the
list of CMCs, but also the nature of each transaction at issue in order to
ensure full compliance.
FAQ 872
FAQ 872 clarifies that U.S.
persons must divest their holdings of prohibited securities by November 11,
2021, or 365 days after a CMC is added to the list. As previously discussed,
even possession by U.S. persons of prohibited securities after these deadlines
is prohibited.
FAQ 873
FAQ 873 restates the revised
definition of “transaction” as the purchase for value, or sale, of any publicly
traded security.
FAQ 874
In response to further questions
regarding the scope of permissible activities for U.S. persons seeking to
divest, FAQ 874 reiterates that any transaction by a U.S. person involving
CMCs before November 11, 2021, for the purposes of divestment is permitted. U.S.
persons are also permitted to engage in otherwise prohibited transactions in
order to divest for one year following the date of a new CMC listing.
IV. Conclusions
Although the amended EO has added
much-needed clarity to the scope of EO 13959, it still might take some time for
industry players to fully grasp the precise scope of permissible and prohibited
transactions, particularly as the Biden Administration takes office. Indeed,
while President Trump may be on his way out of the White House, the sanctions
against CMCs will likely remain, and with them, intensifying pressure on China
and its “Military-Civilian Fusion” policy.
The incoming Biden Administration
has signaled a willingness to remain tough on China. President-Elect Biden has
recently picked a longtime critic of China for the cabinet post of U.S. Trade
Representative and has said that he would not immediately remove tariffs
imposed by President Trump, who is leaving behind a network of executive orders
directly or indirectly targeting China. As recently as January 15, OFAC added
several individuals from Hong Kong to its List of Specially Designated
Nationals and Blocked Persons (“SDN List”) and issued skeletal
regulations to implement EO 13936, which authorizes blocking sanctions against parties that
engage in a variety of practices that undermine democratic processes or
institutions of Hong Kong. See our previous client alert on the Hong Kong
Autonomy Act here.
In the meantime, global financial
institutions should take steps to carefully evaluate transactions involving the
purchases of CMC securities and the securities of entities with similar names
where there may be a U.S. nexus, especially since foreign financial
institutions could be impacted if they manage or hold any index or mutual funds
containing CMC securities on behalf of U.S. investors. MoFo’s National Security
practice will continue to monitor this situation and keep you apprised of any
significant developments or clarity received from OFAC.
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alert
For any questions regarding this resource,
kindly contact Jiang Liu,jiangliu@mofo.com