Outbound Investment Screening: Managing U.S. National Security Controls on Overseas Investments

The Department of the Treasury is the lead agency responsible for implementing these outbound controls. The program is built upon the executive authority to manage transactions that involve a significant threat to national security. Unlike the voluntary nature of some inbound filings, the notification requirements for outbound investments are often mandatory for covered transactions. This shift from a permissive to a restrictive investment environment means that U.S. persons must now treat international capital deployment with the same level of compliance rigor reserved for export controls or economic sanctions.

The jurisdiction of Outbound Investment Screening is tied to the concept of the U.S. person, which includes citizens, permanent residents, entities organized under U.S. law and their foreign branches. This creates a global net that follows American capital regardless of where the transaction occurs or which offshore entity is utilized to facilitate the deal. Furthermore, U.S. persons can be held liable for "knowingly directing" a transaction by a non-U.S. entity that would be prohibited if performed by a U.S. person. This prevents the use of foreign subsidiaries or joint venture partners as a workaround to the screening requirements.

Investments in the semiconductor sector are categorized by their application in advanced computing and weapon systems. This includes entities involved in the design of integrated circuits, the manufacturing of advanced semiconductor production equipment and the packaging of high-end chips. The goal is to prevent U.S. capital from funding the manufacturing capacity of foreign entities that could provide a strategic military advantage. Even investments in ancillary services, such as specialized software for chip design, may fall under the screening mandate if the resulting technology meets specific performance benchmarks.

Quantum computing represents a fundamental threat to current encryption and cybersecurity standards. Consequently, Outbound Investment Screening focuses on foreign entities developing quantum computers, quantum sensors and quantum communication systems. Because the field is still in its nascent stages, the government takes a broad view of what constitutes a quantum-related activity. This means that venture capital firms investing in early-stage quantum startups must be exceptionally cautious about the geographic location and ownership structure of the target company.

In the AI sector, the screening program targets systems that are specifically designed for military use, mass surveillance or advanced cyberattacks. However, even dual-use AI technologies may be covered if they are trained using specific levels of computing power or are intended for applications that threaten national security. The challenge for investors is that the definition of a "covered AI system" is evolving alongside the technology itself, requiring an ongoing compliance audit of any portfolio company involved in large-scale model training or specialized algorithm development.

Investors must look past the immediate target and analyze the entire corporate tree to identify covered foreign entities. This includes identifying shadow directors, significant shareholders and entities with contractual control over the target's technology. In many tech sectors, complex holding company structures are used to obscure the true beneficiaries of the investment. We perform deep-dive entity audits to ensure that our clients are not inadvertently funding a prohibited foreign interest through a third-party intermediary.

A critical component of the screening process is the transfer of intangible assets. The U.S. government is concerned not just about money, but about the "smart capital" that Americans bring to the table. This includes technical know-how, managerial oversight and access to global markets. If a U.S. person provides consulting services or sits on the board of a foreign tech company in a sensitive sector, that activity may be scrutinized as part of the overall investment transaction. The program aims to sever the link between American expertise and adversarial technological growth.

The Treasury utilizes a wide range of investigative tools to identify non-compliant transactions. This includes monitoring public announcements, tracking cross-border bank transfers and utilizing intelligence data. If a transaction is identified as a potential violation, the government can issue a subpoena for all internal communications, due diligence reports and financial records. The burden of proof is on the investor to show that they performed a reasonable inquiry into the status of the target entity before the capital was deployed.

For investors who discover a potential violation after the fact, the program may allow for voluntary self-disclosure. While this does not guarantee immunity, it can significantly reduce the severity of the penalties. However, a self-disclosure must be exhaustive and proactive. We guide our clients through the process of internal investigations and the development of mitigation plans that satisfy the government's security concerns while preserving as much of the investment's value as possible.

Standard investment agreements must be updated to include specific representations and warranties regarding Outbound Investment Screening. This includes clauses that allow the fund to withdraw from a deal if the target is found to be a covered foreign entity. Additionally, funds should include indemnification provisions that protect the U.S. persons from losses resulting from the target's misrepresentation of its technological activities or ownership structure. These contractual safeguards are the first line of defense in a high-stakes investment environment.

Indirect investments, such as those made through a fund-of-funds or a secondary market transaction, present unique compliance challenges. A U.S. person may have no direct control over the ultimate target but could still be liable for their indirect participation in a covered transaction. Managing this risk requires a tiered due diligence process where the investor evaluates the compliance protocols of the primary fund to ensure they align with Treasury mandates. We help our clients build these multi-layered compliance frameworks to maintain the integrity of their global portfolios.