Private Fund Insights Blog

The U.S. government’s Outbound Investment Security Program, stemming from Executive Order 14105 issued in August 2023 and finalized in the Treasury’s rules effective Jan. 2, 2025, reflects ever-increasing U.S. governmental concerns at the intersection of global capital flows and national security. The OISP targets U.S. investments in sensitive technologies in “countries of concern,” primarily the People’s Republic of China (including Hong Kong and Macau), but it doesn’t just add another layer of compliance. Instead, it fundamentally alters how general partners manage funds and how limited partners deploy capital, particularly in sectors like semiconductors and microelectronics, quantum information technologies and artificial intelligence, which are the technologies currently covered by the OISP.

OISP Overview: Key Requirements

The OISP introduces prohibitions on certain transactions, mandatory notifications for others and a stringent “knowledge” standard that demands rigorous due diligence. While the OISP’s goal of enhancing safeguards for U.S. technological leadership toward protecting national security interests is laudable, the rules have posed operational challenges and, while enforcement actions remain nascent at this time, potential deal disruptions for funds with exposure to China or other countries of concern are excepted to develop. This post considers certain of the program’s mechanics and its effects on general partners and limited partners, offering commentary and points for consideration regarding OISP compliance. The program’s requirements, however, are complex; and the currently effective rules are ambiguous in some respects, so any specific OISP-related determinations and program or policy developments for fund sponsors and investors necessarily require a robust analysis of applicable regulatory requirements based on specific circumstances.

The OISP applies broadly to U.S. persons, imposing prohibitions and notice requirements on outbound transactions into entities in or tied to “countries of concern” when the specific technology sectors noted above are involved, which could benefit foreign military or intelligence actors, potentially to the detriment of U.S. interests.

Knowledge and related due diligence standards imposed by the OISP can result in liability for U.S. persons who knowingly (including due to constructive knowledge) engage in a transaction covered by the program. Importantly, both direct and indirect investments may be covered, which includes some transactions engaged in by private funds and which may impose obligations on both the funds’ sponsors and their investors.

Transactions completed on or after Jan. 2, 2025, may fall within the scope of the OISP, even if agreements were executed earlier. The OISP also requires U.S. persons to take certain steps to prevent their controlled foreign entities from engaging in prohibited transactions, but assessing that portion of the program is beyond the scope of this post.

Implications for Fund Sponsors and General Partners

Program-related implications for fund sponsors and general partners are numerous. For example, deal sourcing and screening are increasingly important under the OISP regime, and sponsors should treat outbound screening as a first-line compliance check. As opposed to regimes like the Committee on Foreign Investment in the United States, which provides for pre-closing governmental review and approval of prospective investments, under the OISP, transaction parties are themselves required to determine whether their activities give rise to prohibited or notifiable transactions. Such screening should incorporate enhanced country and technology analysis along with ownership mapping into standard diligence workflows to identify covered foreign persons and covered technologies early in the sourcing process and to appropriately vet them if identified. The OISP’s knowledge standard emphasizes robust diligence. Knowledge includes actual awareness, a high probability that facts exist or a “reason to know.” If a reasonable inquiry could have uncovered OISP-related facts, that knowledge is imputed to the fund sponsor or general partner.

When a sponsor’s enhanced OISP-focused diligence identifies a notification requirement, review by the Treasury could delay or potentially bar the transaction, which can impact deal timelines and may deter counterparties or co-investors. There is also potential post-closing risk, as the sponsor is required to confirm transactions were correctly classified for OISP purposes, and the Treasury may take enforcement action on closed deals if they are later found to have been prohibited, which can include nullification of a transaction or mandating divestment. Finally, there is some degree of ongoing monitoring required, and if a fund sponsor gains new knowledge about a transaction after it closes that would have made it prohibited or notifiable, a new filing must be made within 30 days of gaining that knowledge, including an explanation as to why the new information was not known earlier. Given the potential impacts of such occurrences, sponsors should consider their approach to ongoing monitoring and Treasury engagement along with having contingency plans in place in the event investments are ultimately determined by the Treasury to be prohibited.

Sponsors also need to consider updating transaction and governing documents for their funds across the board, with particular focus on representations regarding knowledge of certain information germane to analyzing transactions under the OISP, covenants limiting the use of fund capital for prohibited or notifiable transactions, and indemnities and potentially insurance to allocate OISP-related risks and compliance costs (which are generally material). Further, in light of fiduciary duties owed to funds by general partners, sponsors should carefully document the investment decision-making process along with the diligence documentation discussed above to clearly illustrate how their approach was both OISP-compliant and also, to the extent practicable in light of the program, maximized investor returns.

Implications for Investors

Limited partners of private funds are not necessarily insulated from the OISP’s requirements by virtue of being passive investors, which is a shift from past practice pursuant to which limited partners generally could rely on a fund’s sponsor for investment-related compliance considerations. The OISP does exempt investors in venture capital, private equity or other pooled funds where the investor’s total committed capital does not exceed $2,000,000 across all fund vehicles (a very low threshold in the context of private fund investing), or the investor has secured a binding contractual assurance that its capital in the fund will not be used to engage in a transaction that would be a prohibited transaction or notifiable transaction if engaged in by a U.S. person. Limited partners should be aware, however, that such exemptions may be lost if investments afford non-passive rights beyond standard minority shareholder protections with respect to a foreign person. Importantly, investors with large commitments, sovereign-wealth or U.S. pension plans, and many U.S. institutional investors remain directly subject to the OISP if their capital is deployed into transactions covered by the program, and such investors are generally seeking side letter or other contractual concessions to mitigate their potential liability under the OISP, including restrictions on use of capital, notice obligations if a target may be covered, OISP-related excuse rights, termination or clawback rights if the Treasury blocks an investment, and additional OISP-related reporting, including, for example, clear and frequent disclosure of geographic exposures and portfolio company activities related to covered technologies and even details as to general partners’ compliance programs and policies.

Navigating OISP Ambiguities

Both investors and sponsors of private funds have expressed concerns at ambiguities in certain key terms and requirements under the OISP. For example, in some circumstances, it is unclear whether activities undertaken by an entity or other person of a country of concern with respect to technology covered by the OISP make a related investment notifiable or prohibited. By way of illustration, artificial intelligence systems designed to be exclusively used for (or intended to be used for) mass surveillance are classified as prohibited, while the development of artificial intelligence systems that are not categorized as prohibited but are designed to be used for mass surveillance are categorized as notifiable. To further complicate matters, the Treasury has indicated that such mass surveillance need not be on behalf of a government, which dramatically expands the scope of potentially captured technologies, including those that capture user information for social media, marketing or other customer segmentation purposes. Further, the knowledge standard under the OISP has been viewed as unclear with regard to constructive knowledge. In the context of private investment funds with large portfolios and investors in such funds, the degree of diligence required to avoid liability, including how far back in a target’s history and how deep of a dive is required into information regarding its principals and technologies, is sufficient for asserting that constructive (should have known) knowledge is not in play. The OISP regulatory landscape is likely to become even more complex due to potential expansion into new sectors like hypersonics, biotechnology, aerospace, advanced manufacturing and directed energy, and potentially to the development of expanded and possibly more complex restrictions and requirements as the regime is extended and refined.

Enforcement and Penalties

The Treasury has broad authority to investigate potential OISP violations, including requesting records, conducting audits and compelling information from U.S. persons involved in covered transactions. Enforcement actions can include civil penalties for violations, such as failure to file required notifications or engaging in prohibited transactions, with fines up to twice the value of the transaction or $368,136 (as of 2024 and reflecting inflation adjustments), whichever is greater. Criminal penalties may apply for willful violations, with fines up to $1 million or imprisonment for up to 20 years. The Treasury may also issue divestment orders to unwind prohibited investments.

Key Takeaways

The OISP reshapes private fund operations, demanding proactive compliance from sponsors and investors. To navigate this regime, sponsors should enhance diligence, update fund documents and plan for post-closing risks. LPs, particularly large institutional investors, must secure contractual protections to mitigate exposure. As the OISP evolves, staying ahead requires robust compliance programs and expert guidance. Contact our Private Funds & Investments team for tailored advice.

Abbey Bloom, a rising third-year law student at Duke University and summer associate at Robinson Bradshaw, contributed to this post.