President Trump’s Executive Order Addressing the Threat from Securities Investments that Finance Communist Chinese Military Companies (EO 13959) prohibits transactions by or on behalf of US persons in publicly traded securities of Chinese companies identified by the US government as “Communist Chinese military companies.” This update discusses significant developments related to EO 13959 since our November 17 LawFlash, including OFAC actions and interpretations, and implications arising from those developments.
Executive Order 13959
On November 12, 2020, then President Trump signed EO 13959 to address national security concerns arising from China’s “Military-Civil Fusion” strategy. Using the authority of the International Emergency Economic Powers Act, 50 U.S.C. § 1701 et seq. (IEEPA), EO 13959 restricts the ability of “Chinese Communist military companies” (CCMCs) to tap into US capital markets or otherwise receive US funding for CCMCs, which the EO describes as contributing to China’s “development and modernization of its military.”
EO 13959 prohibits the purchase of publicly traded CCMC securities, including those that are derivative of, or otherwise designed to provide “investment exposure” to, CCMC securities, starting 60 days after an entity is identified as a CCMC. For those entities that had already been identified as CCMCs on November 12, 2020, the EO’s prohibitions went into effect at 9:30 am Eastern Standard Time (EST) on January 11, 2021. Although new acquisitions by US persons may not occur starting 60 days after an entity is designated a CCMC, EO 13959 allows an additional 10 months to divest those securities. Therefore, divestment of the originally identified CCMC securities must occur no later than November 11, 2021. Similarly, acquisition and divestiture of CCMC securities identified after November 12, 2020, must occur 60 days and 365 days, respectively, from the date those entities were designated (or listed) as CCMCs. Thus, for the additional CCMCs that were identified by the Department of Defense (DoD) on December 3, 2020, acquisitions of these companies’ securities by or on behalf of US persons must cease as of February 1, 2021, and divestiture must occur by December 3, 2021.
CCMC designations occur in one of the following ways:
- By DoD pursuant to Section 1237 of the Strom Thurmond National Defense Authorization Act of 1999, Pub. L. No. 105-261 § 1237 (1999)
- By DoD in consultation with the US Department of the Treasury
- By the Treasury Department’s Office of Foreign Assets Control (OFAC)
The “Chinese Communist Military Company” Designation
At the time EO 13959 issued, the initial list of CCMCs designated by DoD included 31 entities. DoD added four entities on December 3, 2020, and nine entities on January 14, 2021, expanding the DoD designations to 44 entities. The DoD designations included a number of entities with publicly traded securities, and some whose securities were used in exchange-traded funds (ETFs), mutual funds, and index funds. On December 28, 2020, OFAC published its initial list of entities subject to EO 13959, designating these entities “Non-SDN Communist Chinese Military Companies” (the NS-CCMC List). The NS-CCMC list, which was updated on January 8, 2021, includes the 44 DoD designations and also identifies a number of entities whose names exactly or closely match the names of companies identified under EO 13959. The entities added by OFAC came in conjunction with its announcement that NS-CCMC List would not automatically capture all subsidiaries 50% or more owned by the named CCMCs.
Amending Executive Order 13959
On January 14, 2021, President Trump issued Executive Order 13974, amending EO 13959 (the Revised EO), clarifying and revising certain parts of the original EO. As originally drafted, sections 1(b) and (c) of EO 13959 provided US persons with 365 days from the entity’s designation to divest affected securities. The Revised EO clarifies that the divestment obligations under the EO depend upon the date that the entity was designated. Thus, the Revised EO provides that while EO 13959 established 11:59 pm EST on November 11, 2021, as the divestment date for the originally named NS-CCMCs, for NS-CCMCs designated subsequent to the issuance of EO 13959 (e.g., the CCMCs designated on December 3, 2020, December 28, 2020, and January 14, 2021), the divestment period extends for 365 days, or one year, from the date of the CCMC designation (i.e., December 3, 2021, December 28, 2020, and January 14, 2022, respectively).
The Revised EO also clarifies that the original EO’s intent was to prohibit continued “possession” of any CCMC securities by a US person following the divestment period. Prior to the amendment, EO 13959 did not appear to prohibit the continued possession of CCMC securities by US persons after the divestment period ended.
In addition, the Revised EO adds to the definition of the term “transaction” the words “or sale” to make clear that divestment sales of CCMCs would violate the EO after the end of the divestment period. The definition now covers “the purchase for value, or sale, of any publicly traded security.” These changes highlight that the “possession” of any CCMC securities by or on behalf of a US person after the divestment period will violate the EO and therefore the sanctions.
OFAC’s Frequently Asked Questions for EO 13959
Although EO 13959 directs the Secretary of the Treasury to promulgate regulations, it usually takes six months or more for OFAC to draft and issue those regulations. With a presidential transition occurring during this same period, regulations will likely take even longer. To shed some light on select provisions of the EO, OFAC has followed recent practice and issued Frequently Asked Questions (FAQs), and answers, interpreting the EO and clarifying its view of certain EO provisions.
Perhaps the most significant clarification came in OFAC’s first FAQ, number 857, where OFAC informed the public that it would apply the 50% rule selectively under this EO. Unlike other sanctions regulations, where OFAC guidance instructs that entities 50% or more owned by one or more sanctioned entities is itself a sanctioned entity, for EO 13959, OFAC decided that the 50% rule will apply only to subsidiaries of a CCMC that are both
- 50% or more owned by one or more CCMC(s) and
- have been identified by OFAC on the public list of CCMC entities.
OFAC subsequently stated that it would introduce a new criterion for determining which 50% or more entities would be subject to the CCMC prohibitions—when an entity has a name that “exactly or closely matches the name of an entity identified” on the EO CCMC lists. FAQs 857, 858. OFAC did not directly address when subsidiaries that are “controlled” by one or more CCMCs might also be subject to these sanctions, thus leaving in place the usual OFAC rule that subsidiaries will be included based on ownership and not control.
Other FAQs clarify particular issues of relevance to US industry, including:
- OFAC confirmed that the term “publicly traded securities” includes securities denominated in “any currency that trade on a securities exchange or through the method of trading that is commonly referred to as ‘over-the-counter,’ in any jurisdiction.” FAQ 859. This clarifies for those who were unsure that the intent of EO 13959 is to apply the prohibitions against US person ownership of covered securities anywhere in the world.
- In response to a certain measure of “disbelief” that the EO means what it says when it defined securities, OFAC confirms in FAQ 860 that the term “financial instruments” should be interpreted broadly to include a nonexhaustive list of example financial instruments, such as “derivatives (e.g., futures, options, swaps), warrants, American depositary receipts (ADRs), global depositary receipts (GDRs), exchange-traded funds (ETFs), index funds, and mutual funds.” FAQ 860. By defining “securities” coordinate with the definition in the Securities Act of 1934, the EO excludes from its coverage securities regulated by agencies other than the Securities and Exchange Commission, including certain indexes regulated exclusively by other agencies, such as the Commodities Futures Trading Commission.
- Activities by US persons related to clearing, execution, settlement, custody, transfer agency, and back-end services, as well as other such support services, are permissible, to the extent that such support services are not provided to US persons in connection with prohibited transactions. FAQ 863. This specific guidance resolves certain questions, but raises others. Typically, OFAC considers any US person involvement with sanctioned securities to be independent facilitation violations of the regulations. But this FAQ suggests that US intermediaries, such as brokers and clearinghouses, may be able to support CCMC transactions so long as they do not involve US persons. Because this would be an unusual result in an OFAC regulatory scheme, parties should be cautious before adopting this position. FAQ 863.
- A number of other FAQs address a series of questions, some obvious, and some less so, reflecting the impact of the EO on a broader range of entities not used to complying with such targeted, transaction-based sanctions. See the full list of FAQs >>
OFAC’s FAQ guidance, while helpful, is instructive for what it does not address as well. The FAQs do not address a number of important definitions for terms not previously found in sanctions regulations, such as “investment exposure”, “purchase for value” or even “held by US persons.” Each of these terms’ definitions can have a significant impact on the scope and applicability of the sanctions imposed under EO 13959.
The difficult questions raised by this sanctions program is reflected in the uncertainty created by OFAC’s decision to substitute for the 50% rule a new standard—whether a subsidiary has a name that “exactly or closely matches” the name of a designated CCMC. Perhaps reflecting that uncertainty, on January 8, 2021, OFAC issued General License 1 (GL1), which delayed, until January 28, 2021, the effective date of the prohibition on transactions in public securities of entities whose name “closely matches” that of a named CCMC. On January 26, OFAC withdrew GL1 and issued General License 1A (GL1A) in its place, this time authorizing “all transactions” involving closely named entity securities until May 27, 2021. GL1A, like GL1, excludes from its coverage any entities, including closely named entities, specifically identified on the OFAC list of sanctioned CCMCs. The revised license also makes clear that the extension applies to all of the prohibitions in section 1(a) of EO 13959. Finally, GL1A appears to indicate in a note that when a subsidiary entity is added to the OFAC list, OFAC will begin the 60-day effective date from the date of the subsidiary’s listing, and not from the date the parent was listed, thus allowing for extra time for US persons to adjust to those designations. GL1A does not indicate what happens if DoD designates the subsidiary first, however.
GL1, and GL1A after it, do not impact other prohibited transactions that became effective January 11, 2021. As a result, to address another issue that had been causing market turmoil—the apparent need for US exchanges to delist certain publicly traded stocks and ADRs listed on US exchanges—in conjunction with the amendments to the EO issued on January 14, 2021, OFAC issued General License 2 (GL2). GL2 authorizes all transactions “by securities exchanges operated by U.S. persons” in NS-CCMC securities, for 365 days after the entity is listed as an NS-CCMC. This license thereby authorizes the exchanges to undertake those transactions necessary to divest CCMC securities traded on them. In conjunction with GL1A, US persons may now transact in CCMC securities listed on US exchanges through May 27, 2021, and those US exchanges are authorized to allow transactions to purchase and divest such securities in the times allotted, so long as the divestments are to non-US persons. Whether these actions will be sufficient to allow CCMC securities to continue to be listed on those US exchanges remains to be seen, as the exchanges will need to have in place a mechanism for ensuring that trades after May 27, 2021, do not result in sales to a US person, unless further extensions are provided.
Issues for Further Consideration
While OFAC’s FAQs and the Revised EO provide certain clarifications, the broad impact of EO 13959 and certain unique aspects of its reach have left uncertainties. Moreover, since FAQs are nonbinding guidance, reliance on them does not relieve all risk. In addition to the potential concerns described above, there are areas where additional OFAC guidance would be useful that present potential pitfalls:
- OFAC interprets the term “publicly traded securities” to cover over-the-counter markets, leaving open the possibility that the EO could cover numerous informal or similar trades. FAQ 859. Presumably, “publicly traded” impacts and thereby limits the definition, but by issuing the broad guidance it has so far, OFAC may have obfuscated the original intent of the EO.
- OFAC has clarified that providing other “support services” in connection with a permissible transaction is allowed, but leaves open the question when a party to a transaction may rely on that third party’s compliance efforts. FAQ 863. Given the nature of many securities trades and markets, this will likely lead to “overcompliance” because parties will be unwilling to engage in otherwise legitimate trades where clarity of these issues is missing.
- The lack of definition for the term “investment exposure” requires that parties read and apply the EO broadly. Equally, however, it allows for a dramatic alteration of the reach of the EO should the new administration want to narrow the EO’s impact while leaving the basic premise of the EO intact.
- Although EO 13959 defines US person in the usual manner—as “any United States citizen, permanent resident alien, entity organized under the laws of the United States or any jurisdiction within the United States (including foreign branches), or any person in the United States”—it is unclear the extent to which the EO applies extraterritorially.
- The EO and guidance leave unclear the question of inflows of US funds to US and non-US funds that own CCMC securities. Although reports of informal guidance have circulated, the FAQs are inconsistent and lack the necessary clarity to provide the level of comfort many funds would prefer.
Notwithstanding the ambiguities and uncertainties, a broad array of parties, many previously unaffected by sanctions, must now ensure that they consider the impact of EO 13959. Not only must those who trade or hold securities be familiar with additions to the CCMC lists, but they must endeavor to keep apprised of those subsidiaries with names equal or close to named entities that also have publicly traded securities. As more entities are identified as CCMCs, the impact on indexes and funds also can become magnified.
As OFAC irons out its position on the 50% rule and subsidiaries of CCMCs, the impact could grow exponentially. If expanded to its fullest (i.e., if the 50% rule were applied in the normal manner), for example, the current list of CCMCs alone would include a larger number of publicly traded securities.
Since CCMC designations can come from more than just OFAC, greater diligence may be required. DoD can and has designated CCMCs, and the Department of Commerce has identified military end user companies under its own authorities. This whole-of-government approach means that Commerce, State, and Treasury may make determinations that result in these sanctions applying to an increasing number of entities. The interconnection between and among the various agencies and authorities must therefore be considered when making assessments about the impact of a CCMC designation. For example, whether a company will be added to the list of CCMCs may sometimes be discerned from other agency activities. Numerous statutes and executive orders remain in place that require agencies to determine or designate Chinese company ties to the Chinese government. Actions under these authorities could signal that an entity will become a CCMC.
The new administration has issued about 40 executive orders in less than a week, setting a record for executive orders, and has signaled that this course will continue. In addition, as is typical during a transition period, the administration issued a “Regulatory Freeze Pending Review” memorandum, requiring all agencies to hold up any rule under consideration until the new political appointees review and approve the rule. Thus far, none of the new administration’s actions have implicated EO 13959. Eventually, however, the administration will need to determine where it stands on the order and whether it will expand, contract, or simply leave the order, and the accompanying sanctions lists, as is.