[co-author: Matthew Tikhonovsky]
- Last week, the Secretary of the Treasury released proposed final regulations to implement the Biden Administration’s August 2023 Executive Order on Foreign Investment.
- The proposed rules are intended to “prevent countries of concern from exploiting” U.S. investments in certain technologies, such as AI and semiconductors for AI systems, that could pose risks to U.S. national security.
- The proposed rules would build on existing requirements for certain foreign transactions to require and prohibit notification of certain investments involving U.S. persons in countries of concern developing sensitive technologies, such as AI and semiconductors.
- Comments on the rule can be submitted until Aug. 4, 2024, but the Treasury Department is expected to finalize the rule by the end of the year.
On June 21, 2024, the U.S. Department of the Treasury (Treasury) issued a Notice of Proposed Rulemaking (NPRM) to implement the Biden Administration’s 2023 Executive Order “Addressing U.S. Investments in Certain National Security Technologies and Products in Countries of Concern” (the “Outbound Order”).
According to a Treasury fact sheet, the proposed rule would address U.S. foreign investments in “countries of concern seeking to develop sensitive technologies,” including AI systems and semiconductors for such systems, for “military, intelligence, surveillance, or cyber-enabled capabilities” that could threaten the national security of the U.S. To this end, the rule would establish notification requirements for certain transactions and prohibit certain other transactions between certain foreign countries and U.S. persons involving sensitive technologies, including AI.
The proposed rules build on the existing framework for foreign transaction review established by the Committee on Foreign Investment in the United States (CFIUS). The rules are open for comment until August 4, 2024, and may be subject to change before being finalized. The final rules are expected to closely follow the proposed rules. Below we discuss the requirements for foreign investments involving semiconductors and AI.
Presidential Decree on Foreign Investment
As AI has evolved in recent years and its potential risks have become more apparent, lawmakers have become increasingly concerned that foreign nations of concern, including China, are exploiting and profiting from U.S. AI investments. As we reported, the Biden Administration issued restrictions on exports to China of chips critical to AI systems in October 2023. At the time, Commerce Secretary Gina Raimondo suggested the purpose of the restrictions was to limit China’s “access to advanced semiconductors that could fuel breakthroughs in artificial intelligence.”
With a similar goal in mind, President Biden previously signed an Executive Order on August 9, 2023 to address U.S. investments in certain national security technologies and products in countries of concern. The Foreign Order aims to restrict countries of concern from exploiting U.S. investments in certain technologies that may be used in ways that pose risks to U.S. national security or competing with the United States in AI development and innovation. The Foreign Order specifically identifies artificial intelligence and semiconductors as two of the three technology areas involved in U.S. foreign investments that could threaten U.S. national security.
An annex to the overseas departure order identifies the People’s Republic of China (PRC), the Hong Kong Special Administrative Region, and the Macau Special Administrative Region as countries of concern.
The Outbound Order directs the Secretary of the Treasury to develop specific notice and prohibition requirements for U.S. outbound investments, including requiring U.S. persons to “provide notification information related to certain transactions involving covered foreign persons” and prohibiting U.S. persons from “engaging in certain other transactions involving covered foreign persons.” Currently, CFIUS requires certain transactions involving foreign countries to be reported to the U.S. Government and reviewed and approved on a case-by-case basis, but the requirements of the Outbound Order, if finalized, would automatically apply to certain outbound investments that may threaten U.S. national security.
Advance Notice of Proposed Rulemaking
Pursuant to the Foreign Investment Mandate, the Treasury Department also issued an Advance Notice of Proposed Rulemaking (ANPRM) on Foreign Investment on August 9, 2023. Recognizing that “AI is a rapidly changing technology area with new dimensions,” the ANPRM sought comments on semiconductors and AI and posed several questions, including the definition of an AI system.
Scope of the Proposed Rule
The Treasury Department’s NPRM incorporates comments submitted in response to the ANPRM and expands the notification requirements and prohibitions that were foreseen in the ANPRM that apply to U.S. foreign investments in three types of technologies: semiconductors and microelectronics, quantum information technology, and artificial intelligence.
The proposed rules would apply broadly to transactions by U.S. persons involving covered foreign persons (defined as “persons from countries of concern,” which include:
- Individuals who are nationals or permanent residents of a country of concern and who are not U.S. citizens.
- Entities that are headquartered in, incorporated in, organized in, or have their principal place of business in a Country of Interest.
- Governments of countries of concern.
- An entity in which any of the above individuals, organizations, or governments, individually or in the aggregate, directly or indirectly, “holds at least 50 percent of the entity’s outstanding voting power, board of directors voting power, or stock interest.”
This requirement also applies to certain foreign corporations of U.S. parent companies.
The types of transactions covered by this rule are numerous and include certain acquisitions of equity securities, provisions of certain loans or similar debt financing arrangements, certain conversions of equity securities or debt securities, certain joint ventures, and acquisitions and leases of certain businesses, land, or other assets. From the types of transactions identified in the NPRM, this rule is intended to gather more information about and limit foreign-involved private equity and venture capital investments in the United States.
Prohibited Transactions Related to AI and Semiconductors
The proposed rule would prohibit transactions by U.S. persons involving covered foreign persons developing the following AI systems, semiconductors, and microelectronics:
- AI systems that are “purposefully designed” or intended to be used for military, government intelligence, or mass surveillance purposes.
- AI systems that are trained using computational power above levels to be determined, and computational power using primarily biological sequence data above levels to be determined. The NPRM includes several alternatives for the computational power thresholds for prohibited AI systems, on which it solicits comments.
- Electronic design automation software “for the design of integrated circuits.”
- “Front-end semiconductor manufacturing equipment designed for the mass production of integrated circuits.”
- An integrated circuit that meets or exceeds certain performance parameters, meets certain standards, or is packaged in accordance with advanced packaging techniques.
- Certain quantum information technologies.
Under the proposed rule, U.S. persons would be responsible for determining whether their transactions are prohibited. U.S. persons who violate the prohibitions may be subject to criminal and civil penalties, and completed prohibited transactions may be subject to divestment and invalidation.
Notifiable Transactions Regarding AI and Semiconductors
A U.S. person who intends to complete a transaction with a covered foreign person must notify the Treasury Department about the transaction if it involves any of the following technology:
- AI systems designed to be used for, but not limited to, military purposes, government intelligence, or mass surveillance.
- AI systems that are “intended for use by covered foreign persons to control cybersecurity applications, digital forensic tools, penetration testing tools, or robotic systems.”
- An AI system is trained using an amount of computing power that exceeds a level to be determined. The NPRM includes several alternatives for computing power thresholds for notifiable AI systems and solicits comments on them.
- The design, manufacture, and packaging of integrated circuits not otherwise prohibited.
- Certain quantum information technologies.
The Treasury Department is proposing that notices of transactions involving the above technologies must be filed within “30 days after the transaction is consummated.” In addition, any U.S. person with knowledge of such a notifiable transaction must also notify the Treasury Department “within 30 days after the U.S. person gains such knowledge.” Transaction notices must include information about the U.S. persons and covered foreign persons involved in the transaction, the status of the transaction, the amount of the transaction, and the commercial basis, among other information.
Definition of AI
The proposed rule, which adopts the definition of an AI system set forth in the Biden Administration’s October 2023 Executive Order on AI, broadly defines an AI system to include “a machine-based system that can make predictions, recommendations, or decisions that affect real or virtual environments for a set of human-defined purposes” and “any data system, software, hardware, application, tool, or utility that operates in whole or in part with such a system.” The Treasury Department specifically seeks additional comment on the definition of an AI system.
Conclusion
The Treasury Department’s proposed rules on AI-related foreign investments are part of a recent Executive Order aimed at protecting U.S. national security and ensuring the United States has a competitive advantage over foreign adversaries in the field of AI, which we have covered. The Treasury Department is inviting comments on the proposed requirements related to AI systems, and interested parties can submit comments by August 4, 2024 at https://www.regulations.gov. Early reports indicate that the Treasury Department plans to finalize the rules by the end of the year, and interested parties should now take the first steps to prepare for compliance with the final rules.
Although the rule, if finalized, could be amended or repealed by a future administration, Congress is also considering several bills aimed at regulating and restricting U.S. foreign investment related to AI. The proposed Foreign Investment Transparency Act of 2023 and the Preventing Our Adversaries from Developing Significant Capabilities Act both contain provisions regarding foreign investment in AI, but both bills are stalled in Congress. However, they lay the groundwork for future legislative activity regarding foreign investment in AI in 2025.
We will continue to monitor, analyze, and issue reports on the proposed rule and other AI developments in Washington State.
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