Author: Morrison Foerster
Published: January 19th, 2021
Original Article Link
The following client alert is courtesy of CGCC member Morrison Foerster.
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 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 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 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 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 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 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 restates the revised definition of “transaction” as the purchase for value, or sale, of any publicly traded security.
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.
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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