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Financial institutions as enablers of global conflicts: the implications of the FinCEN leaks

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By Sandra Huang

Protesters in Kuala Lumpur, Malaysia calling for then Prime Minister’s resignation over 1MDB embezzlement scandal in August 2015

The fundamental role of the global financial system is often overlooked when it comes to the discussion of international conflict, where attention is primarily concentrated on the state actors involved. However, what is alarming is the actor that is beyond the state control. Given that the financial system is an essential instrument for conflict actors to access their resources and carry out their activities, global financial institutions play a critical role in blocking the flow of money and intervening such activities. Nonetheless, the fact that the financial system is globalised and run by the profit-seeking private sector has made an effective state control challenging and resulted in numerous scandals of its misuse across multiple jurisdictions by the ill-intentioned actors. Consequently, the potential of financial institutions to enable global conflict warrants further scrutiny.

As a standardised control measure, financial institutions in most countries are required by law to submit suspicious activity reports (SARs) to the authorities if a customer activity is suspected of being involved in financial crimes. In the US, SARs are filed to the Financial Crimes Enforcement Network (FinCEN), a bureau of the US Treasury dedicated to combating financial crimes. In 2019, news agencies and investigative journalists worldwide received over 2,000 leaked SARs submitted to the FinCEN between 2000 and 2017 as well as other government reports. Their investigations of the leaked files, publicised in September 2020 and known as the FinCEN leaks, attributed the suspicious financial activities to organised criminals, prominent officials, terrorists and sanctioned individuals who were linked to a number of high-profile security incidents over the last two decades.

Those ill-intentioned individuals exploited the complexity of the global financial system to launder their money so that the illegal aspects of their activities could go undetected. Although the leaked files only reflected pure suspicions of compliance officers in financial institutions, they nonetheless provided valuable trails of scandals in the past and underlined the inadequacy of control measures in curbing financial crime, which has led to a variety of security issues beyond the financial arena. 

Among those security issues are socio-economic grievances and associated social unrest. They are usually triggered by the poor governance that failed to utilise public funding to provide better living conditions. For instance, the investigations into the FinCEN files revealed that the Venezuelan construction magnate, Alejandro Ceballos Jiménez, received over $146 million between 2013 and 2014 from government contracts to build public housing, while an excessive amount of the money was suspected of having been diverted to his family members through a money laundering scheme set up by Swiss lawyers. In 2015, an investigation into the housing project suggested that it was overcharged and that it was not properly furnished. The close relationship between the Ceballos family and the ruling elites has granted the family business numerous government contracts and sustained a luxurious lifestyle that can be witnessed through their high-end properties in the US; contrastingly, the ordinary Venezuelans are still suffering from the collapsed economy, poverty and insecurity. Notably, this is only a minor part of more than $4.8 billion involved in SARs related to Venezuela from 2009 to 2017, nearly 70% of which involved public money.

On the other side of the world, Malaysia was struck by large-scale protests between 2015 and 2016 over then-Prime Minister Najib Razak’s alleged embezzlement of billions of US dollars from an economic development fund, 1 Malaysia Development Berhad (1MDB). The scandal, which was brought to light in 2015 following a leak from a former Swiss banker, revealed a complex money laundering scheme, which spanned across multiple jurisdictions and involved Razak and his close associate Jho Low. While the trial over the case has been ongoing, the FinCEN files further revealed suspicious transactions involving over $2.5 billion between 2009 and 2016 linked to Jho Low and the 1MDB fund. Despite strong suspicions, those transactions were still carried out by multiple multinational banks throughout the whole period. Among the banks involved, Goldman Sachs was charged with the largest penalties of $5 billion by multiple jurisdictions for its role in facilitating and profiting from the money laundering scheme of the 1MDB fund. Troublingly, suspicions of corruption and money laundering revealed by the FinCEN leaks are not limited to these countries but are observed on a global scale, largely connected to powerful and well-connected individuals who pursue their self-interest at the expense of public good. 

Another security issue stems from terrorist financing, which refers to the way terrorist groups gain access to financial resources to support their operations. To combat terrorist financing, financial institutions are on the front line to detect and block the flow of money that fund terrorist activities. However, there is much to be improved in this area. Among the most notable examples revealed in the FinCEN leaks were transactions involving over $4 billion to and from Iraqi banks in SARs filed by Deutsche Bank’s US branches and Bank of America in 2014 and 2015.  During this period, the extremist Islamic State (IS) group controlled a large swath of territories in Syria and Iraq and seized over 120 Iraqi banks. Although the SARs submitted did not clearly state the senders or recipients, which made direct attribution unfeasible, considering IS’s funding sources and financial activities, there is a high possibility that related transactions were made by the IS to channel its funds into the legitimate banking system in order to purchase weapons or receive funding from overseas charities. After all, SARs were filed by the banks with delays, by which point the transactions of suspected terrorist money had already been processed through the global financial system, representing a loophole in the global counter-terrorism efforts. 

The FinCEN leaks also revealed other SARs involving large international banking institutions related to the financing of the sanctioned extremist groups Taliban and Al-Qaeda. This brings about another issue that is closely related to international security: sanctions evasion. Sanctions are a series of measures implemented by a country, a regional body, or an international body against targeted countries, groups or individuals for military, social or political reasons in a variety of forms, including financial restrictions, in order to effect changes to the sanctioned targets. On the first line of defence of the financial sanctions are financial institutions, whose compliance is key for a sanctions programme. Regrettably, several global banking institutions have undermined the US sanctions regime over time. For instance, in 2013, the Standard Chartered Bank (SCB) submitted the SARs against its Iranian clients following the whistleblowing of its former employees to the US authorities regarding its breaches of sanctions against Iran. The whistleblowing and the follow-up investigations by the authorities did not give the SCB penalties that were harsh enough to cut ties with Iran. Furthermore, in 2016, an Iranian-Turkish gold trader, Reza Zarrab, was arrested by the US authorities for carrying out transactions on behalf of sanctioned Iranian entities. The SCB only filed SARs against Zarrab and these entities months after the former’s arrest. Despite a number of penalties the bank received for its sanctions violations, the FinCEN files suggest that it had continued to report suspicions on Iran-related transactions until at least 2017, most of which were processed even though an SAR was filed.

Certainly, for financial institutions, gaining lucrative business deals that are likely to come from ill-intentioned actors and protecting the integrity of the financial system are two conflicting goals that are inherently difficult to maintain at the same time. By examining previous FinCEN files, it appears that the penalties imposed by the authorities have not had deterrent effects in the long term. Moreover, under the pressure of legal requirements, filing SARs has become more of a box-ticking exercise to ensure compliance, rather than a serious effort to combat money laundering, terrorist financing and other financial crimes. This is reflected in the FinCEN files where the leaked SARs were either submitted with severe delays, without sufficient information, or in a significant volume. This leads to an inefficient allocation of resources by the FinCEN as it may invest unproportionate amount of time in delving into irrelevant transactions and have limited capacity left to investigate into plausible money laundering cases, hampering its efforts to timely, effectively detect and suspend related illegitimate activities. 

To respond to this challenge, the close cooperation between the public and private sector is essential to assist financial institutions in building effective compliance programmes that meet the needs of the authorities. The prevalence of transnational transaction activities also underlines the need for global coordinated efforts to curb financial crimes. These include standardised criteria in compliance requirements across different jurisdictions so that no gaps can potentially be exploited, and a mechanism to effectively share financial intelligence among different countries to facilitate cross-border investigations.

The leak of the FinCEN files has faced criticism because it disclosed confidential information and may impede the investigations by the authorities. Financial institutions may also be reluctant to trust the authorities and file SARs in the future. However, the insights revealed by investigative journalists – who have connected the dots of security events across the world – highlighted the scale of the problem and emphasized the pressing need to improve the current system in order to safeguard not only the integrity of the financial system, but also security at the global stage.

 

Sandra recently attained her MA with distinction in Intelligence and International Security at the Department of War Studies, King’s College London. Previously, she worked as a security consultant in a private company in Beijing and London, collecting and analysing open-source intelligence regarding travel security in Asia-Pacific, Europe and parts of Africa. Her research focuses on financial intelligence and its use to combat transnational corruption and the security implications of global financial crime. You can connect with her on LinkedIn. (Disclaimer: opinions expressed in the article are those of the author and do not represent any organisation.)

The Funding of Terrorism (Part III) – America Needs a New Economic Patriot Act

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by Michael Greenwald

8 August 2019

Section 311 of the Patriot Act, an effective tool against money laundering (Image credit: Financial Tribune)

 

Since 9/11, Washington has deployed a powerful weapon to halt the financing of terrorism: Section 311 of the Patriot Act. By shutting down the ability of banks to facilitate cross-border payments, Section 311 has revolutionised the field of anti-money laundering while helping the U.S. implement aggressive and effective sanctions against Iran and North Korea.

Take the case of Banco Delta Asia (BDA), a bank that facilitated financial transactions with North Korea. When the 311 was used in 2005, BDA lost its access to correspondent banking in the United States. This loss provoked a run on the bank and caused Macanese authorities to freeze $22M in North Korean deposits. However, the effects of the 311 were not localised—they swept across the entire Asian banking system. Chinese banks, in particular, dumped their North Korean exposure for fear of being targeted with a 311 designation themselves. The 311 was so powerful that, when North Korean negotiators demanded the release of the $22M in frozen funds, no Asian banks were willing to facilitate the payments transfer.

In the sanctions campaign against Iran, Washington used the 311 designation to punish a nation-state for the first time. Treasury officials had one-on-one discussions with CEOs and officers to convince them that the compliance costs of doing business in Iran were too steep to justify investment. Later, the United States sanctioned several private banks before levying a 311 on the Central Bank of Iran. Doing so classified the entire Iranian jurisdiction as a primary money laundering concern. This translated into the Society for Worldwide Interbank Financial Telecommunications (SWIFT) disconnecting the Iranian financial system from access to international commerce.

While Section 311 has been extremely useful in weakening terrorist and other enemy nations, the current strategic environment is changing. Rogue states, terrorists, and money launderers have developed innovative tactics to evade sanctions. Additionally, secular shifts in the global economy have altered Washington’s sanctions calculus. In today’s era of great power competition, priority threats are no longer rogue states with little economic clout but instead nations with systemically important financial institutions and economic linkages. Russia and China top the list.

America’s sanctions strategy, however, has not evolved to meet the challenges of this new global landscape. Like Thor’s Hammer, Section 311 remains a powerful tool, but its collateral costs are too high to confront banks that are too big to fail. After levying this tool throughout the past two decades, it has become clear that the mere threat of its deployment can trigger severe reputational damage; its actual use can generate devastating shockwaves across a regional banking sector.

It is time for a new Economic Patriot Act that can provide the scalpel-like instruments Washington needs to thwart our adversaries, such as Russia and China, with speed and precision.

As the United States sanctioned Russia, a nation with significantly more financial links to the Western World (and Europe in particular), this weakness became apparent. The costs to of implementing financial and energy sanctions from Iran’s playbook against Moscow are too great for Brussels to seriously contemplate an escalation to this stage.

China presents an even trickier challenge. China’s four biggest banks rank among the largest in the world. If even one of them were targeted in the same manner, as the far less systemically important Iranian banks, the result could be a deep financial crisis not limited to China’s borders. Think of it as a Lehman Brothers-style collapse – only a deliberate one.

Section 311 may be a crude cudgel, but Washington still has options to develop a savvy sanctions strategy in the era of great power competition. In the fight against illicit finance, Russia benefits from lax financial transparency in jurisdictions ranging from Cyprus to Delaware. Money laundering from Russia represents not only a law enforcement issue but also a geopolitical dilemma: Russia’s ability to move money outside its boundaries and place it in the security of European banks upholds the patronage networks that form the beating heart of the Kremlin’s kleptocracy.

Other sections of the Patriot Act have also proved out-dated and ineffective in the current geopolitical landscape. The Patriot Act’s Section 313 fully banned correspondent banking with foreign shell banks, which have no physical presence in a jurisdiction and are thus virtually unregulated entities. The move was instrumental in fighting terrorist financiers, but these vulnerabilities are no longer loopholes that facilitate threats. These loopholes are threats themselves and form the core of the Kremlin’s business model.

Over the past two decades, the US Treasury has done quiet heroic work to financially weaken terrorists and rogue states. But complacency regarding the Patriot Act is handicapping our ability to respond to Russian and Chinese provocations. An executive order spelling out a new Economic Patriot Act would enable a smarter sanctions strategy backed by a suite of new, powerful instruments for the era of great power competition at hand.

Michael B. Greenwald is a fellow at Harvard Kennedy School’s Belfer Center for Science and International Affairs. He is also a Senior Adviser to the Atlantic Council President and Chief Executive Officer Frederick Kempe and an Adjunct Professor at Boston University. From 2015-2017, Greenwald served as the US Treasury attaché to Qatar and Kuwait.