The U.S. Department of the Treasury (“Treasury”) recently issued a long-awaited Notice of Proposed Rulemaking (the “Proposed Rule”) that would create an outbound investment regime whereby U.S. persons would be prohibited from making, or required to notify the U.S. government regarding, certain investments in entities engaged in certain activities relating to semiconductors and microelectronics, quantum information technologies, and artificial intelligence in “countries of concern” (presently limited to China, Hong Kong, and Macau).[1]    

The Proposed Rule is largely consistent with the Advance Notice of Proposed Rulemaking (“ANPRM”) issued by Treasury on August 11, 2023 (which we summarized here).  However, the Proposed Rule clarifies certain aspects of the ANPRM in several important ways discussed below.

  • Scope of transactions involving AI systems: the Proposed Rule provides a refined definition of “AI systems” that is consistent with other recent executive orders and regulations.[2]  Transactions involving AI systems are prohibited under the Proposed Rule if the AI systems are designed exclusively for certain military, mass-surveillance, or government intelligence end uses.  The Proposed Rule also prohibits investments into entities involved in the development of AI systems using certain levels of computing power or primarily biological sequence data.  Investments into entities involved in AI systems are notifiable under the Proposed Rule if the AI systems are designed to be used for certain end uses or are trained using specific levels of computing power.    
  • Exception for publicly-traded securities: the Proposed Rule broadens the exception for investments in publicly traded securities (initially limited in the ANPRM to securities trade on U.S. exchanges) to include securities traded on non-U.S. exchanges and securities traded “over-the-counter.”
  • Knowledge standard: the Proposed Rule clarifies that a transaction is covered where a U.S. person engaging in the transaction has knowledge (“knows”) that the transaction is covered by the Proposed Rule, where “knowledge” is defined as actual knowledge, awareness of a high probability, or reason to know that the transaction is a “covered transaction.”  This revised knowledge standard effectively creates a requirement for U.S. persons to conduct “a reasonable and diligent inquiry” when facts regarding a transaction give notice that the transaction might be covered. 
  • Scope of the prohibition on U.S. persons “knowingly directing” certain transactions: Treasury clarified what it means for a U.S. person to “knowingly direct” a transaction that would be a “prohibited transaction.”  Under the Proposed Rule, a U.S. person “knowingly directs” a transaction if the U.S. person, as an officer, director, senior advisor, or in another role possessing the authority to “make or substantially participate” in decisions on behalf of a non-U.S. person, exercises that authority to direct a transaction that would be a prohibited transaction if engaged in by a U.S. person.    
  • Exception for transactions involving investments in countries that have similar outbound investment regimes: under the Proposed Rule, transactions would be excluded from the mandatory notification requirement or prohibition if they involve investments into countries designated by the Secretary of the Treasury based on to-be-determined criteria.  Those criteria likely will focus on whether a country has a similar outbound investment regime.  No countries have been designated by Treasury yet.
  • Excluded LP investments: the Proposed Rule includes two alternative ways that LP investments by U.S. persons would be excluded.
    • Under alternative 1, certain LP investments by U.S. persons in non-U.S. venture capital funds, private equity funds, funds of funds, or other pooled investment funds would be excepted if (i) the U.S. LP’s rights are consistent with passive investment and (ii) the LP’s committed capital is not more than 50 percent of the total assets under management of the pooled fund.  LP investments committing more than 50 percent of the total assets under management could still be excepted if the U.S. person making the LP investment secures a binding agreement that the fund will not engage in a transaction prohibited under the Proposed Rule.
    • Under alternative 2, LP investments would be excepted if the LP’s committed capital is not more than $1 million.

The period during which parties could comment on the Proposed Rule closed on August 4.  Treasury received 48 comments on the Proposed Rule, which it will evaluate before issuing what we expect to be a final rule.[3]  Such a final rule could include changes in response to comments on the Proposed Rule.  Once issued, the final rule could take immediate effect, or may be given delayed effectiveness by, for example, 30 or more days.

[1] The Proposed Rule implements Executive Order 14105, issued by President Biden on August 9, 2023.

[2] The Proposed Rule defines “AI system” as “(a) A machine-based system that can, for a given set of human-defined objectives, make predictions, recommendations, or decisions influencing real or virtual environments—i.e., a system that uses data inputs to: (1) Perceive real and virtual environments; (2) Abstract such perceptions into models through automated or algorithmic statistical analysis; and (3) Use model inference to make a classification, prediction, recommendation, or decision. (b) Any data system, software, hardware, application, tool, or utility that operates in whole or in part using a system described in (a).”

[3] Treasury has not made the received comments publicly available to-date.  See https://www.federalregister.gov/documents/2024/07/05/2024-13923/provisions-pertaining-to-us-investments-in-certain-national-security-technologies-and-products-in.