In 2022, the U.S. restricted technology exports to China that might have military uses, and an executive order is expected soon limiting investments in certain Chinese tech companies. Skadden M&A partner Ann Beth Stebbins leads a discussion about the reasons for the rules and their impact on companies doing business in China. Joining her are Jessie Liu, a partner in Skadden’s White Collar Defense and Investigations Group, and partner Brian Egan of the firm’s National Security, CFIUS and International Trade Groups.

Read the full summary of the conversation HERE.

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Name:  Brian Egan

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From Skadden, you are listening to The Informed Board, a podcast for directors facing the rapidly evolving challenges of a global market. A compliment to our newsletter for directors, our aim with this podcast is to help flag potential problems that may not be fully appreciated, explain trends, share our observations, and give directors practical guidance without a lot of legal jargon. Join Skadden partners who draw on years of frontline experience inside boardrooms to explore the complex issues facing directors today.

U.S. companies seeking to invest abroad have typically not faced scrutiny from U.S. regulators. With a bipartisan focus on economic security as national security, is that about to change? I’m Ann Beth Stebbins, a partner in Skadden’s M&A practice. Joining me today to talk about this topic are Brian Egan and Jessie Liu. Brian is a partner in Skadden’s national security practice, and prior to joining Skadden, Brian spent many years in the U.S. government, holding senior roles at the National Security Council, the Department of State and the Department of Treasury.

And Jessie, a partner in Skadden’s white collar defense and investigation practice, served as U.S. attorney for the District of Columbia. Prior to that, she was deputy general counsel at the Department of Treasury, with a focus on national security and economic and trade sanctions. Welcome Jessie. Welcome Brian. Thanks for being with us today on The Informed Board.

Thank you so much, Ann Beth, it’s really a pleasure to be here.

Likewise. Thanks, Ann Beth.

The U.S. government is increasingly concerned with the transfer of critical technologies to China. Is this being driven by concerns about our reliance on the Chinese economy or is this about preventing U.S. funding of technology that can be used by the Chinese military?

I think that the economic and military rivalry between the United States and China has been around for some time. And I harken back to 2018, when the Trump administration announced something it called the China Initiative, which was primarily framed as an effort to counteract trade secret theft and economic espionage. That particular initiative, which was a DOJ initiative, came in for a fair amount of scrutiny and criticism and the Biden administration eventually stepped back from it. But I think in this administration, if anything, the scrutiny of China and various business practices related to China, if anything has only intensified.

And this goes back to the Trump White House. This is nothing new. So how did we get to where we are today?

I think this concern has been around for some period of time, and it’s driven by government concerns that we will be helping China advance its military capabilities using our technology and using our dollars. It’s really picked up steam over the last three years as Congress and others have thought about what else we can do to prevent this from happening.

I think that, while military competition with China and national security issues with China are certainly at the very top of the list of concerns, there’s also a concern about economic security, so much so that you’ll sometimes hear economic security is national security. And I think that mantra is what’s driving some of the concern about semiconductors and other goods that may not have direct military applications, but certainly are very, very important economically.

Do you think this was exacerbated by the pandemic and by supply chain concerns that followed the pandemic?

I do, Ann Beth. One thing that struck me during the pandemic was that suddenly people were talking about the “supply chain” in ordinary conversation, which is not something that we were hearing before the pandemic and we all became much more aware of supply chain issues, shortages of goods.

But we’re not looking at a decoupling of our economy from the Chinese economy. We are too interrelated and just necessarily reliant is, isn’t that right?

I agree with you on that. There is sometimes rhetoric that you’ll hear about decoupling or a China-free supply chain. I don’t think that’s possible. The U.S. economy and the Chinese economy are so closely linked, that simply doesn’t seem like a feasible solution to me, nor would it be to our economic benefit, I don’t think. So the challenge here is how to handle economic competition and national security issues involving China while dealing with the reality that these two countries are very, very closely linked in many, many ways.

So Brian, the White House has been working on new rules, a new executive order that addresses investment by U.S. companies into China. What do we know about these new rules that are being considered?

Well, we know that there are a limited number of industries that are likely to be covered by these new rules — advanced artificial intelligence, advanced semiconductor manufacturing and development, quantum computing. Things like battery technologies, autonomy and maybe biotechnology have also been mentioned, but this is going to cover a limited number of industries.

And it’s investment by U.S. persons into those industries in China.

That’s correct, yeah. And we think investment is going to mean both capital investment dollars and also know-how, so you’re sharing your knowledge of the industry with a company in China.

In terms of the timing for implementation, we think that the rules are imminent. We think that there’s been an executive order that President Biden would issue that is basically ready to be issued. We understand that there’s some consultation that’s likely going on with allies about the executive order, maybe with Congress as well, but it could come out as soon as on the margins of the G7 summit in May.

We think the rules will be a combination of prohibitions plus reporting. So in other words, the rules are likely to prohibit investments in a small subset of industries, and probably require notification of investments in a broader subset of industries, so a combination of an outright prohibition and notification. And this is going to really result in limitations on investments in startup technology companies in China. I think that’s kind of one of the goals of the new rules.

And what do we mean by startup technologies in China?

We mean that companies that are not big enough that they could be impacted by some of the other restrictions that the U.S. government has on the books where companies are really trying to develop the technologies that, in the U.S. government view, will help the Chinese military advance.

Will the administration of these new rules be CFIUS-like? Will we have a multi-agency oversight process? Is that something we know?

We don’t know, but my sense is that is relatively unlikely. I think there are a couple of agencies that have been involved in developing the rules and have been flagged by Congress as the key agencies. It’s Treasury, which is in charge of CFIUS, which also is in charge of sanctions at OFAC [Office of Foreign Assets Control], and then the Commerce Department, which is in charge of the commercial export controls. So Commerce and Treasury were asked by Congress to develop a budget for implementing a new strategy. They came forward with something a few months ago, and I suspect that any new rules will be implemented by Treasury and/or Commerce. Talking to other agencies is appropriate, but not in the same way that CFIUS is nine-plus agencies reviewing every single transaction that comes to the government.

It looks like there will be coordination among those agencies, even if Commerce and Treasury are in the driver’s seat.

I think of Treasury and Commerce as the agencies that have to balance national security and economic prosperity. And they also have to think about national security and what they already do in implementing sanctions, CFIUS, and export controls. So they’re in the middle already on a lot of these topics. And on the security-oriented side, you have the Defense Department, you have the Justice Department, who will undoubtedly be behind the scenes. And then, on the economic side, you have the U.S. Trade Representative, but Treasury and Commerce have learned how to play in the middle of these debates, and I think that’s one of the reasons that they’re the most likely home for any new rules.

I agree with that. I think in the last few years there’s been an increasing repetition of the mantra, economic security is national security and Treasury and Commerce are particularly good at balancing those two. We’ve seen a lot of increase in Commerce’s involvement in national security issues over the last few years.

Have we been discussing these measures with other countries, with our allies, with the EU?

I think the short answer is yes. That has to be part of the U.S. government’s approach. We saw the EU leadership come out with a statement in March, for example, saying that they are considering and will likely pose some sort of outbound restrictions of their own. Korea and Taiwan have some existing outbound investment restrictions that could compliment what we’re thinking about doing. I suspect, though, that the United States is going to be the leader in this area, for better or worse, and others will look at what we do and react to that. Maybe not by doing exactly the same thing, but complimenting what we do in some ways.

Do we really need a new set of rules? How are these rules going to differ from existing Treasury sanctions and the export control tools that we currently have in place?

My view is that that’s one of the biggest challenges for the administration, designing new rules in this space that don’t duplicate existing authorities or create unnecessary new bureaucracies, because for, as much as there’s agreement that we need to be tough on China, I think there are many who say we don’t necessarily need a new agency or new process to deal with this issue. We have on both the Treasury and the Commerce side, existing authorities. OFAC, the Office of Foreign Assets Control right now restricts new investments by U.S. companies in Russia.

They also restrict new investments in publicly traded securities in certain companies in China. So there are tools to address investments.

On the Commerce side, export controls restrict access to technology already. Commerce can impose controls on U.S. companies sharing their technology with Chinese companies already. And so one of the big questions is, where are the gaps that this new program would be trying to fill that can’t be filled with existing Treasury department or Commerce department authorities?

Deputy Attorney General Lisa Monaco made the statement initially last fall that sanctions are the new FCPA. And as I’m sure our listeners know, the Foreign Corrupt Practices Act has been an area of very, very active criminal enforcement against companies over the last 15 or so years. The law is much older than that, but the enforcement has been particularly active in the last few years. And so the statement that sanctions are the new FCPA, and therefore an area for companies to really have very strong compliance programs in and to look out for potential violations, caused quite a buzz in the white-collar criminal defense community.

Can you discuss some of the enforcement priorities and the techniques that are being used to enforce sanctions and our new FCPA?

This administration has been very active in promoting interagency collaboration to enforce sanctions, export controls, especially with respect to China. One example of that is a new interagency collaboration called the Disruptive Technology Strike Force. The government loves its strike forces. This one is a joint strike force between the Department of Commerce and the Department of Justice. And the goal is to investigate and prosecute export control violations. And when it was announced to great fanfare, there were statements by the deputy attorney general, who’s the number two official at DOJ, as well as key officials at the FBI and at the Department of Commerce. That’s just one example of how this administration is making very public statements about the risk to national security that’s posed by technology transfer as well as trying to take very active steps to counter it.

What should companies that currently do business in China be thinking about? Should they be changing any of their existing practices based on this ramped up focus on China?

I think it’s really an occasion to take a fresh look at your compliance programs that have to do with China. Are you making assumptions as a company that should be pressure tested even if you’ve been doing business in China for a number of years? I think particularly with the new rules that are coming out of Commerce on export controls, they’re novel, they’re extraterritorial. How are you as a company implementing those rules and is there something else you should be doing to make sure you’re on the right side of those rules?

Okay. Wait, pause on that one for a second, Brian. So new rules coming out of Commerce on export controls — this is different than the executive order that we’re anticipating?

That’s correct. In October of 2022, Commerce came out with a broad new set of rules having to do with semiconductor export controls and advanced computing export controls that not only impact shipments of goods and technologies directly from the United States to China, but also impact shipments of goods and technologies that are made overseas in third countries that are shipped to China if those goods and technologies made overseas are made using U.S. technology.

So this rule, which is called the Foreign Direct Product Rule, used to be kind of a backwater part of the export regulations. It’s now increasing in prominence and it’s the subject of what was the largest export controls case in history that was announced a few weeks ago by Commerce, a 300 million penalty against the U.S. company, Seagate. So that’s an area where your old assumptions may no longer apply. It’s important to think about the new rules holistically and are you doing enough to implement them.

So Jessie, it’s not business as usual for companies that are doing technology work in China, the DOJ is ramping up, there’s more FCPA enforcement, what should companies be doing?

I would echo what Brian said about reviewing and refreshing a company’s compliance program. I’ve found that companies are now pretty sophisticated about FCPA, anti-bribery, anti-corruption compliance programs as a result of many years of very active enforcement. Most companies have recognized that they need to have a strong anti-corruption compliance program and they have a pretty good sense of what to look for.

The sanctions and export control space is newer to a lot of companies, and I found that some are just now realizing that they need to have strong compliance programs in those areas too. They need to understand, for example, if they’re selling goods overseas, do they know where those goods are going? Ultimately, do they know who the end user is? Do they have a good program for screening the counterparties that they’re dealing with? It’s not rocket science, but it’s just a matter of being aware of where the risks are.

And so my advice to companies, especially those that are doing technologically heavy transactions in China, is to do a risk assessment. Think about where your potential risk is on some of these sanctions and export control type issues and refresh your compliance program. You may need to do some more training. You might think about whether you have the policies and procedures that you need.

And I wouldn’t forget about the M&A context. Again, I think companies are pretty sophisticated now about doing due diligence in transactions and they’ll look at a company that they’re thinking of acquiring and look at whether that company has a strong anti-corruption compliance program. Companies now need to do the same for sanctions and export controls too, and that’s the expectation that’s coming from the government. DOJ, for example, has issued a lot of pronouncements recently about what it expects in a strong compliance program.

Kicked off this discussion about this pending executive order, which has everyone excited about potential oversight of investments into China. But equally as important is the increased enforcement efforts with the framework that’s currently on our books for export control.

I think it’s spot on, Ann Beth. You’ve got to be focused on the new rules that are already in play, and you’ve got to be thinking about something that is kind of allergic to a lot of companies, which is, should I be engaging with the U.S. government on some of these new rules? And that goes for the new executive order too. But, where there’s ambiguity and the potential for penalties, is there a space for engagement, for seeking clarity or relief as necessary? So that’s got to be a part of the strategy as well.

What if companies get it wrong? What if they don’t have a monitoring program that’s sufficiently robust? Is there any ability to self-report deficiencies, work with Commerce, work with other government agencies to put in place sufficient compliance programs, monitoring programs. Jessie, what advice are you giving your clients that are doing business with China or with companies that then in turn do business with China?

Well, the first piece of advice is, as I said before, to put in a strong compliance program or to look at your compliance program to make sure that it’s operating in the way that it should and it has the elements that you need. If there are deficiencies, it’s really important to try to address those deficiencies as promptly as possible.

The question of whether to self-report a violation that a company might have found through an internal investigation or an internal report of some sort is always a very difficult, and fact-specific determination.

The government has been encouraging voluntary self-disclosure. Generally, companies have a better outcome if they self-disclose and if they didn’t self-disclose and the government came knocking. But that doesn’t necessarily mean that they should self-disclose. That’s one of the hardest questions I have to confront when advising clients on this issue. It’s just a very difficult and very fact-specific decision.

One of the interesting parts to me about the Commerce statement recently, Jessie, was not just self-disclosing but disclosing about your competitors. If you believe that they are committing violations, Commerce is saying, please come to us, we’d love to hear from you. The U.S. government side, they’re anxious and eager to hear from industry about your own problems or about somebody else’s problems.

Well, Jessie, Brian, thanks so much for joining me today to talk about what’s coming down the road and what’s already here that companies need to be aware of, particularly if they’re doing business in China. So thanks again.

Thank you.

Thanks, Ann Beth, it was really a pleasure.

Thank you for joining us for today’s episode of the Informed Board. If you like what you’re hearing, be sure to subscribe in your favorite podcast app so you don’t miss any future conversations. Additional information about Skadden can be found at skadden.com. The Informed Board is a podcast by Skadden, Arps, Slate, Meagher & Flom LLP and Affiliates. This podcast is provided for educational and informational purposes only and is not intended and should not be construed as legal advice. This podcast is considered advertising under applicable state laws.