The main provision of the Executive Orders (EO 13959 by President Trump issued in November 2020, as replaced by EO 14032 by President Biden issued in June 2021) prohibits US persons from engaging in:
“the purchase or sale of any publicly traded securities, or any publicly traded securities that are derivative of such securities or are designed to provide investment exposure to such securities of [certain listed Chinese companies]”.1
Biden’s Order did not include much substantive change in terms of the prohibition.2 For our purposes, Trump’s Order included 42 (originally 44) “Communist Chinese Military Companies” (“CCMC”), while Biden increased the list to a total of 59 Chinese “military-industrial complex” companies (“CMIC”)3 (no longer using the “CCMC” basis due to legal issues raised in two cases,4 and removing some unqualified companies from Trump’s list5 ).
The business impact
There is a notable recent incident. Starting on 19 September 2022, fund manager State Street Global Advisors Asia Limited (“SSGA”)—a unit of the Boston-based State Street Corporation6 —will be replaced by a Hong Kong (“HK”) fund manager to run the highly-reputable HK exchange-traded fund (ETF) Tracker Fund of Hong Kong (“Tracker Fund”).7 Last year, State Street stopped investing in the Chinese stocks that were sanctioned by the US presidential Executive Order.8 Although State Street later retracted the decision,9 it reportedly “sparked anger from some investors, who called for SSGA to be replaced by a manager that could buy the [sanctioned] stocks.”10 As Tracker Fund continues to invest in the sanctioned Chinese stocks and therefore falls within the scope of the Executive Order, it has announced that it is not suitable for US entities to invest. 11
Following this incident, there are two important questions about the scope of the Executive Order. First, will the Order prohibit US investors from investing in ETFs which has only bought negligible or minimal amount of sanctioned Chinese stocks? Second, will the Order prohibit US fund managers from working for foreign funds that invest in sanctioned Chinese stocks?
Even though these two questions have not been directly answered by the broadly-framed Executive Order, the Office of Foreign Assets Control (“OFAC”) of the Department of Treasury has answered both questions in its recent guidance.12 However, even though it makes sense for a risk-averse fund manager to follow the guidance, it is not binding.13
This article will explore the conflicting considerations. The courts will only defer to the agency guidance if it is “reasonable”,14 in the sense that it is not “plainly erroneous or inconsistent with the [order]”.15 In practice, government’s interpretations of executive orders have often been subject to litigations.16
The confusion over Question 1
Looking at the Executive Order itself, Tracker Fund is not “designed to provide investment exposure to such securities.”17 Tracker Fund’s investment policy is to invest in the constituent companies of the Hang Seng Index (comparable to the Dow Jones in the US) in substantially the same weightings as they appear in the Index.18 The portfolio included only three sanctioned Chinese stocks that also happened to be Index constituents, namely China Mobile, China Unicom, and CNOOC.19 They together accounted for about 4% of the portfolio.20 Theoretically, any Index stocks can be ousted from the Index if they no longer fit the financial criteria. In other words, Tracker Fund is only designed to expose investors to Index stocks.
Furthermore, it can be argued that only a negligible amount of sanctioned Chinese stocks was held. The Executive Order has not specified a threshold of ownership. What if a small-sized ETF only allocates 0.5% of its assets to the sanctioned stocks? The OFAC said in their FAQ 861 that the prohibition in the Executive Order applies “regardless of such securities’ share of the underlying index fund, ETF, or derivative thereof.”21 Still, there are a number of arguments that go against the OFAC’s interpretation.
First, the common law-based de minimis rule is applicable and would support the view that negligible ownership is a relevant consideration when analyzing the scope of the Executive Order. Prof. Oren Bracha has succinctly explained the rule:
“De minimis is a principle with deep roots in equity and common law that applies across doctrinal fields. While there are debates over the scope and the exact details of this doctrine, its core is clear. It is captured by the maxim de minimis non curat lex, which is commonly translated as ‘the law does not concern itself with trifles.’ Under this principle, courts refuse to find that a legal norm is violated when such violation is trivial or of negligible harm—even if technically the relevant conduct does violate the norm.”22
Moreover, the wide applicability of the de minimis principle has long been judicially acknowledged, and so it should be relevant to the present context. For instance, the District Court for the Northern District of Ohio has opined that “[c]riminal law, as well as civil, honors the maxim, ‘De minimis non curat lex,’ which has controlling application to the enforcement of a statute which aims at the repression of real and substantial abuses….”23
Second, it is important to pay attention to the rules of interpretation applicable to executive orders. The Supreme Court has noted that the starting point is that courts will “approach the construction of [executive order] as we would approach the construction of legislation.”24 Newland has also noted that the “guiding principle” is to “give effect to presidential intent” because executive orders “are written by Presidents, and so when interpreting these orders, courts should see themselves as faithful agents of the President.”25 What’s more, Prof. Tara Grove argued in favor of giving effect to the ordinary meaning of an executive order because the text itself “best give[s] effect” to the President’s final decision after the inter-agency consultations.26
However, one could counter-argue that, in light of the broader presidential intention to safeguard national security, there should be zero tolerance for any holding of the sanctioned stocks. Trump’s Executive Order noted that the sanctioned companies “directly support the PRC’s military, intelligence, and security apparatuses and aid in their development and modernization,” which “allow the PRC to directly threaten the United States homeland and United States forces overseas”.27 Biden’s Order noted that “additional steps are necessary to address the national emergency declared in Executive Order 13959”.28
Yet, this counter-argument may not necessarily receive judicial support, in light of two injunctions issued by the court to remove sanctioned companies from Trump’s Executive Order. In both Xiaomi Corp. v. Dep’t of Def. and Luokung Technology Corp. v Dep’t of Def., the court remarked that the CCMC designation under section 1237 of the National Defense Authorization Act was unused for almost twenty years.29 This led to judicial doubt as to whether “weighty security interests are actually implicated.” (For background reference, likely for this reason, Biden’s Order no longer uses the CCMC sanctioning basis, which was in charge by the Department of Defense.30 It is now based on the CMIC basis in charge by the Treasury’s OFAC,31 supposedly with a “stronger legal grounding.”32 ). The point here is, despite the high judicial deference to national security issues, the court is prepared to question the scope of the Executive Order.
Furthermore, by allowing US fund managers to work for non-US funds that invest in sanctioned stocks, it indicates that the intended tolerance is hardly absolute even in the eyes of the OFAC. This brings us to Question 2.
The oddity in Question 2
FAQ 902 of the OFAC’s guidance says US fund manager is “not prohibited from advising on, authorizing, directing, or approving purchases or sales of covered securities by the non-U.S. investment fund,” provided it is not a way to help US investors to circumvent the prohibition.33 That said, Tracker Fund decided to change State Street, who has acted as the fund manager already for 22 years, and the Financial Times reported that:
“It is more than a commercial decision, and the decision over which company should manage the Tracker Fund has now become very political, considering the scale of the fund, the operational challenges and duties the manager has to Hong Kong’s largest ETF.” (Emphasis added)34
(For clarity, as Tracker Fund announced its ineligibility for US investors, it should have become a non-US investment fund that contains no US capital. In this sense, State Street has fallen within the safety net provided by FAQ 902.)
The exact commercial and political considerations and their respective weighting cannot be ascertained by the public, though the new HK fund manager’s fees are lower. Is the OFAC’s guidance again questionable, prompting the cautious route to be taken to prevent agency enforcement?
On the one hand, the OFAC guidance makes sense because no US capital will flow into the Chinese companies from such fund management. This conforms with the rationale of Executive Order 13959, which seeks to prevent Chinese companies from raising US capital to finance the development and modernization of China’s military.
On the other hand, the guidance is quite illogical. Despite significant US national security interests being allegedly at stake and a national emergency that warrants “additional steps” as Biden’s Order claims, a US fund manager can nevertheless freely advise non-US entities to invest and supply new capital to the Chinese companies.
The problem is that state agencies themselves are not bound by their own guidance.35 Looking at the Order itself, the term “United States person” includes “foreign branches.” Even more importantly, the OFAC has long adopted the notion of “facilitation” in their previous sanctions against other countries.36 It means “U.S. persons are prohibited from facilitating transactions by foreign persons that would be prohibited if performed by a U.S. person” (see, e.g., FAQ 1021 on Russian sanction; FAQ 36 on Iranian sanction; FAQ 497 on exempted professional services).37 In those contexts, the professional sector believes that this “facilitation” notion applies to “banks, accounting firms, law firms and other service providers.”38 However, going back to the present Chinese context, this has been dubiously exempted, with no apparent justification, in FAQ 903 (“U.S. persons employed by non-U.S. entities are not prohibited from…facilitating, purchases or sales related to a covered security on behalf of their non-U.S. employer”). Shouldn’t the same standard apply, especially when the US national security is at risk?
Overall, there are uncertainty and confusion over the scope and objective of the Executive Order. The ambiguity over Question 1 heightens the regulatory risk of investment, and there are other related questions over where the red line is. For instance, if a non-US company happens to own some minor shares in the sanctioned companies, would it be acceptable to invest in that non-US company?
Question 2 shows the confusing inconsistency between the objective (supposedly-paramount national security) and scope (yet room for exemptions for fund managers). This self-contradiction is observable here and there. For example, the definition of publicly traded “securities” adopted by the Executive Order refers to the one adopted by section 3(a)(10) of the Securities Exchange Act of 1934.39 It includes stocks and bonds amongst others. US capital will not be channeled to the sanctioned Chinese companies if US persons cannot participate in their equity or debt/bond financing. However, logically, trading already-issued stocks and bonds with other investors in the secondary market will not directly provide funding to the sanctioned Chinese companies.40 But the Executive Order has not made this distinction and instead applies a blanket prohibition that may or may not achieve the goal of upholding national security. As a result, US-based fund managers and investors, and also non-US funds now closed to US investors, may all be unnecessarily losing opportunities because of these issues.
- 1Exec. Order No. 13959 of Nov.12, 2020, s. 1(a); Exec. Order No. 14032 of Jun. 3, 2021, s. 1.
- 2Jamie L. Boucher, Eytan J. Fisch & Ondrej Chvosta, US Amends Sanctions Targeting Investments in Securities of Chinese Companies (Skadden, 11 Jun. 2021), https://www.skadden.com/insights/publications/2021/06/us-amends-sanctions.
- 3Hong Kong Trade Development Council, U.S. Expands List of Mainland Chinese Firms Subject to Securities Transaction Ban (HKTDC Research, 11 Jun. 2021), https://research.hktdc.com/en/article/NzcwNzU5Mjkw.
- 4Gary Stein et. al., White House Revamps Chinese Securities Trading Ban (Schulte Roth & Zabel: Alert, 8 Jun. 2021), https://www.srz.com/resources/white-house-revamps-chinese-securities-trading-ban.html.
- 5US-China Economics and Security Review Commission, Economics and Trade Bulletin (Jun. 21, 2021), https://www.uscc.gov/sites/default/files/2021-06/June_2021_Trade_Bulletin.pdf, 4.
- 6Kiuyan Wong, State Street Dropped as Manager of Hong Kong’s Biggest ETF, Bloomberg (Mar. 29, 2022) https://www.bloomberg.com/news/articles/2022-03-29/hong-kong-s-biggest-etf-gets-new-manager-as-state-street-removed.
- 7Tracker Fund of Hong Kong, Notice to Unitholders (Aug. 19, 2021), https://www.trahk.com.hk/eng/download/20220819_Press-Release_Eng.pdf.
- 8Tracker Fund of Hong Kong, Notice to Unitholders (Jan. 11, 2021), https://www.trahk.com.hk/eng/download/20210111_Press-Release_Eng.pdf.
- 9Tracker Fund of Hong Kong, Notice to Unitholders (Jan. 13, 2021), https://www.trahk.com.hk/eng/download/20210113_Press-Release_Eng.pdf.
- 10Selena Li, State Street’s SSGA set to lose $14 bln Hong Kong ETF mandate –sources, Reuters (Mar. 21, 2022) https://www.reuters.com/business/state-streets-ssga-set-lose-14-bln-hong-kong-etf-mandate-sources-2022-03-21/.
- 11See supra note 9.
- 12Office of Foreign Assets Control, Frequently Asked Questions (U.S. Department of the Treasury: Sanctions Programs and Information), https://home.treasury.gov/policy-issues/financial-sanctions/faqs/topic/5671
- 13Exec. Order No.13891 of Oct 9, 2019 (“Agencies may clarify existing obligations through non-binding guidance documents”).
- 14Udal v. Tallman, 380 U.S. 1, 4 (1965).
- 15Kester v. Campbell, 652 F.2d 13, 16 (9th Cir. 1981).
- 16Matthew Chou, Agency Interpretations of Executive Orders 71(3) Admin. L. Rev. 555, 564 (“Courts have reviewed executive orders for over 100 years, and agency interpretations of executive orders have been contested in many cases.”).
- 17Exec. Order No. 13959 of Nov.12, 2020, s. 1(a); Exec. Order No. 14032 of Jun. 3, 2021, s. 1.
- 18Tracker Fund of Hong Kong, Fact Sheet (Jul. 31, 2022), https://www.trahk.com.hk/eng/download/TraHK_Factsheet-English.pdf.
- 19Avery Chen, Tracker Fund shows US investors the door, The Standard (Jul. 30, 2021), https://www.thestandard.com.hk/section-news/section/2/232676/Tracker-Fund-shows-US-investors-the-door.
- 20Tracker Fund of Hong Kong, Fund Information: Holdings, https://www.trahk.com.hk/eng/Fund/fundInformation#holdings.
- 21OFAC, supra note 12, FAQ 861.
- 22Oren Bracha, Not De Minimis: (Improper) Appropriation in Copyright (2018) 68(1) Am. U. L. Rev. 139, 158.
- 23United States v. Hocking Valley Ry. Co., 194 F. 234, 250 (1911). See also Wisconsin Dept. of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214, 231 (1992) (“the venerable maxim de minimis non curat lex (‘the law cares not for trifles’) is part of the established background of legal principles against which all enactments are adopted, and which all enactments (absent contrary indication) are deemed to accept.”); Max L. Veech and Charles R. Moon, De Minimis Non Curat Lex 45(5) Mich. L. Rev. 537, 542 (1947) (“it is a rule of reason, a substantive rule that may be applied in all courts and to all types of issues.”).
- 24Ex parte Mitsuye Endo, 323 U.S. 283, 298 (1944).
- 25Erica Newland, Executive Orders in Court 124 Yale L. J. 2026, 2069-70 (2015).
- 26Tara Leigh Grove, Presidential Laws and the Missing Interpretative Theory 168 U. Penn. L. Rev. 877, 882, 929 (2020).
- 27See supra note 1.
- 28See supra note 1.
- 29Xiaomi Corp. v. Dep't of Def., Civil Action No.: 21-280 (RC), at 25 (D.D.C. Mar. 12, 2021); Luokung Technology Corp. v Dep’t of Def., No. 1:2021cv00583 - Document 33, at 30-31 (D.D.C. 2021).
- 30See supra note 5, 4.
- 31See supra note 2.
- 32Jeanne Whalen & Ellen Nakashima, Biden expands Trump order by banning U.S. investment in Chinese companies linked to the military or surveillance technology, The Washington Post (Jun. 3, 2021), https://www.washingtonpost.com/technology/2021/06/03/investment-ban-chinese-surveillance-tech/.
- 33OFAC, supra note 12, FAQ 902. See also FAQ 903 (which says the same for US persons employed by non-US entities).
- 34John Sedgwick & Echo Huang, State Street’s role as manager of Hong Kong’s largest ETF under scrutiny, Financial Times (25 May., 2021), https://www.ft.com/content/7fbe86e0-1e73-4297-9241-5af2b1b649e0.
- 35Nicholas R. Parrillo, Federal Agency Guidance and the Power to Bind: An Empirical Study of Agencies and Industries 36 Yale J. on Reg. 165, 168 (2019) (“guidance, unlike a legislative rule, is not binding on the agency or the public. It is only a suggestion a mere tentative announcement of the agency's current thinking about what to do in individual adjudicatory or enforcement proceedings, not something the agency will follow in an automatic, ironclad manner as it would a legislative rule. Guidance is supposed to leave space for the agency's case-by-case discretion.”)
- 36Behnam Dayanim & Carolyn Morris, United States Sanctions: General Considerations for Minority Investment (Paul Hastings: Stay Current, 19 Jul. 2010), https://webstorage.paulhastings.com/Documents/PDFs/1676.pdf, 1, 3.
- 37See, e.g., OFAC, supra note 12, FAQ 1021 on Russian sanction; FAQ 36 on Iranian sanction; FAQ 497 on exempted professional services).
- 38Thomas B. McVey, Understanding the OFAC Sanctions Laws: Requirements for U.S. Companies (Williams Mullen, 18 Dec. 2020) https://www.williamsmullen.com/news/understanding-ofac-sanctions-laws-requirements-u.s.-companies#_edn15.
- 39Exec. Order 14032, supra note 1, s. 3(c).
- 40On the facts, Tracker Fund maintains a portfolio of Index companies through “its daily voluminous trading in the secondary market”. See Hong Kong Exchanges and Clearing Limited, The Functioning of Market Products During the 2020 Market Turmoil - Are ETFs Volatility Absorbers or Amplifiers. (HKEX Research Report, December 2020) at 19, https://www.hkex.com.hk/-/media/HKEX-Market/News/Research-Reports/HKEx-Research-Papers/2020/CCEO_USETF_202012_e.pdf?la=en.