On June 3, 2021, the White House issued an Executive Order (EO) amending EO 13959 of November 12, 2020, which imposed restrictions on US persons transacting in publicly traded securities of companies identified by the US Department of Defense (DoD) as “Communist Chinese military companies” (CCMCs). The new EO, “Addressing the Threat from Securities Investments that Finance Certain Companies of the People’s Republic of China,” reformulates and recasts the prior EO, by providing important clarifications on the scope of the restrictions, revising the criteria for designating Chinese companies under the EO, and shifting responsibility for designations from the DoD to the US Treasury Department. As a result of these changes, the EO creates a securities-related sanctions regime for so-called “Chinese Military-Industrial Complex Companies” that is effectively separated from the CCMC list maintained by DoD pursuant to Section 1237 of the Fiscal Year 1999 National Defense Authorization Act (NDAA) as amended. The new EO takes effect on August 2, 2021, at 12:01 a.m. eastern daylight time.
In conjunction with the new EO, the US Treasury Department’s Office of Foreign Assets Control (OFAC) published several new and revised Frequently Asked Questions (FAQs) explaining the new EO and addressing questions raised by the securities industry since the issuance of EO 13959 in November 2020. Finally, as evidence that the Biden Administration is pursuing a comprehensive effort across the relevant agencies, the DoD released for the first time a “Chinese Military Companies” (CMC) list under Section 1260H of the Fiscal Year 2021 NDAA.
59 Companies Targeted
The new EO includes an annex identifying a total of 59 companies whose publicly traded securities will be covered by the restrictions starting in August 2021. (The list is available here.) These companies are now referred to as “Chinese Military-Industrial Complex Companies” (CMICs) (the term “Communist” no longer appears in the title of the EO). The new EO expands the criteria for designation beyond Chinese military companies to also include companies in the surveillance technology sector of China’s economy.
Eighteen companies that were previously identified as CCMCs do not appear on the new CMIC list. Thirty-one names were added including several subsidiaries of previously identified CCMCs. Importantly, the new EO only applies to securities issued by companies whose names exactly match an identified CMIC; under the November 2020 EO and related guidance that has now been rescinded, the prohibitions applied to securities issued by the identified CCMCs and also to securities of entities whose names “closely match” those CCMCs.
None of the entities identified by the DoD as CCMCs on January 14, 2021, including three companies that challenged their designations in the US District Court for the District of Columbia, are identified as CMICs in the annex to the EO.
In addition, the DoD has now issued its own list of “Chinese military companies” (CMCs) in accordance with Section 1260H of the NDAA for Fiscal Year 2021. The DoD’s list includes 47 names, 39 of which also appear in the annex to the new EO. The remaining eight names on the DoD list are subsidiaries of Semiconductor Manufacturing International Corporation (SMIC), which itself appears in the annex to the EO. While the DoD’s new list complies with the requirements of Section 1260H, it does not appear to impose any new restrictions, as responsibility for designating companies under the new EO falls solely to the Treasury Department. The statutory requirement on DoD to maintain a list of CCMCs under Section 1237 (as amended) of the NDAA for Fiscal Year 1999 also remains in place. As a result of the changes in the new EO, however, the CCMC list no longer automatically triggers any sanctions restrictions.
As a result of the new EO issued yesterday, EO 13974 of January 13, 2021, which amended EO 13959, has been revoked, and the prior prohibitions under EO 13959 are no longer effective. In essence, there are presently no restrictions on US persons transacting in publicly traded securities of previously identified CCMCs or newly identified CMICs until August 2, 2021. OFAC’s Non-SDN CCMC List has also been revoked and replaced with the new Non-SDN CMIC List (NS-CMIC List).
Amended EO 13959
The overall structure of the EO remains unchanged, providing a 60-day lead in period for newly identified companies and a one-year divestment countdown.
In addition to the designation of CMICs in the annex, Section 1(a) of the new EO gives the Treasury Department (in consultation with the State Department and the DoD) authority to designate additional companies that are determined:
(i) to operate or have operated in the defense and related materiel sector or the surveillance technology sector of the economy of the PRC; or
(ii) to own or control, or to be owned or controlled by, directly or indirectly, a person who operates or has operated in any sector described in subsection 1(a)(i) of the EO, or a person who is listed in the annex to the EO or who has otherwise been determined to be subject to the prohibitions in subsection 1(a) of the EO.
As with the old EO 13959, OFAC’s “50 Percent Rule” does not apply to CMICs.
Like the old EO 13959, the new EO prohibits “US persons” from the purchase or sale of any publicly traded securities of CMICs, or any “securities that are derivative of such securities or are designed to provide investment exposure to such securities.” The revised language makes clear that derivatives must be publicly traded (on an exchange or over the counter) to be covered by the new EO. Unlike the old EO 13959, the new EO does not prohibit US persons from “possessing” covered securities at the end of the authorized divestment period. With regard to securities purchases, the old EO 13959 prohibited “purchase[s] for value” while the new EO simply prohibits “purchases,” a change that could have implications for securities lending.
Section 3(d) of the new EO defines a “US person” as any US citizen or permanent resident, any person in the United States, and any entity organized under US law and its foreign branches. This definition excludes non-US subsidiaries of US companies.
The new EO provides a revised definition of “publicly traded security,” at Section 3(c), which includes any security as defined in Section 3(a)(10) of the Securities Exchange Act of 1934 denominated in any currency that is traded on an exchange or over-the-counter in any jurisdiction. The new definition has broadly the same effect as the old EO 13959. Indices, exchange-traded funds, and other instruments that provide exposure to covered securities remain in scope regardless of the amount of exposure to a covered security.
Section 1(c) of the new EO also provides for a divestment period of one year after the identification of a company (i.e., by June 3, 2022, for companies in the annex) and clarifies that purchases and sales “made solely to effect the divestment, in whole or in part” of covered securities are permitted through the divestment period.
Section 2 of the new EO prohibits any transaction that “evades or avoids, has the purpose of evading or avoiding, causes a violation of, or attempts to violate any of the prohibitions” in the EO, as well as any conspiracy formed to violate the EO. These are standard prohibitions found in most sanctions-related EOs. While this provision in the old EO 13959 applied only to US persons and activities in the United States, the revised Section 2 is not limited on its face to US persons.
New OFAC FAQs
Meanwhile, OFAC issued a bevy of new and amended FAQs along with the new NS-CMIC List. The eight new FAQs include:
- FAQ 898 – describing the new EO.
- FAQ 899 – explaining the relationship between the retired NS-CCMC List and the new NS-CMIC List. Importantly, OFAC states that “[o]nly entities whose names exactly match the names of the entities on the NS-CMIC List are subject to the prohibitions in E.O. 13959, as amended.”
- FAQ 900 – explaining how OFAC intends to identify companies to designate under Section 1(a)(i) and (ii) of the new EO.
- FAQ 901 – stating that US persons can rely on “information available to them in the ordinary course of business” in identifying covered securities (i.e., a reasonable level of due diligence).
- FAQ 902 – stating that in general US persons are not prohibited from “providing investment advisory, investment management, or similar services to a non-US person, including a foreign entity or foreign fund, in connection with the non-US person’s purchase or sale of covered securities.”
- FAQ 903 – clarifying that there is no facilitation prohibition for US persons employed by non-US companies. Specifically: “US persons employed by non-US entities are not prohibited from being involved in, or otherwise facilitating, [permissible] purchases or sales related to a covered security on behalf of their non-US employer . . . in the ordinary course of their employment.”
- FAQ 904 – stating that US market makers may facilitate divestment transactions.
- FAQ 905 – stating that the new EO “does not prohibit activity with entities listed on the NS-CMIC List that is unrelated to such securities.” In other words, unless there is a separate prohibition outside of this EO applicable to a CMIC, US persons can continue to transact with them, sell and buy goods and services, and engage in other transactions with them.
The new EO maintains the thrust of the old EO 13959, while expanding the criteria for designation and placing the EO and its designations on firmer legal ground. Companies that wish to contest their designation as a CMIC in US federal court will likely face a more difficult challenge.
The revised EO is clearer and addresses many of the problem areas in the old EO. OFAC’s new FAQs appear to incorporate feedback from industry participants and reflect a common-sense understanding that US persons can continue to act on behalf of non-US persons—such as non-US funds—that deal in covered securities under the EO. The elimination of “close name matches” from the scope of the EO will undoubtedly come as a relief to companies that expended significant resources on trying to identify covered securities in the absence of clear OFAC guidance under the old EO 13959.