Sanctions and prosecutions against international banks creates dark market, increase risk

September 4, 2012

By Kim R. Manchester, Thomson Reuters Accelus contributing author

TORONTO, Sept. 4 (Thomson Reuters Accelus) – The black market for Iranian oil will carry increasingly sophisticated money laundering risks for international banks engaged in correspondent banking, international trade finance and global payments. Sanctions evasion will remain the top priority for the Iranian government, state-owned enterprises and the bankers that enable firms around the globe who aim to profit from this black market.

The increase in risk is a result of tightening sanctions against Iran and the crackdown by American authorities on international banks accused of providing Iranian entities access to the U.S. financial system, often leading to enormous multi-million dollar settlements.

Despite the recent consequences, however, banks and trading companies around the globe will be tempted to evade the sanctions based on the global thirst for the underlying commodity. Dependence on oil, much like addiction to illicit narcotics, will cause people to commit extraordinary acts of willful blindness in the pursuit of profit.

Earlier this year, U.S. Treasury designated The Lebanese Canadian Bank SAL (LCB) as a financial institution of primary money-laundering concern under Section 311 of the USA PATRIOT Act, one of the most powerful pieces of legislation to confront an international financial institution.

By denying LCB access to the U.S. financial system, the bank’s ability to transact in U.S. dollars vaporized with the stroke of a pen, paralyzing its international payments transactions in the currency and causing other international banks to shut their correspondent banking doors. LCB was on the ropes within hours of the U.S. Treasury announcement.

According to the Treasury, LCB was facilitating an “international narcotics trafficking and money-laundering network “with specific activity in trade-based money laundering involving consumer goods “throughout the world.” LCB was cited for laundering as much as $200 million per month for drug traffickers and terrorist organizations, including Hezbollah, a Shi’a Islamic militant group and political party that is based in Lebanon included on the U.S. State Department’s list of terrorist organizations.

In September 2011, Société Générale de Banque au Liban (SGBL) acquired most of the assets from the then-skeletal LCB for $580 million. As of August 2012, $150 million from the sale of the LCB assets were being held in escrow by Banque Libano Française SAL (BLF), a bank in Lebanon.

On August 20, 2012, the District Attorney for the Southern District of New York, Preet Bhahara, and the U.S. Drug Enforcement Administration (DEA) announced that $150 million had been seized from five banks in the United States who operated U.S.-dollar correspondent accounts on behalf of BLF in connection with a civil lawsuit filed by American prosecutors against LCB.

A civil lawsuit for at least $329-million launched by Bhahara in December 2011 was a forfeiture action by the District Attorney’s office to penalize LCB and various corporations and individuals for money laundering related to narcotics trafficking, used car sales and terrorist financing.

As the U.S. government could not directly access the funds being held in escrow by BLF, they simply raided the U.S. dollar correspondent bank accounts of BLF at clearing banks in New York and took the $150 million from them instead. This left BLF with the problem of extracting the debt from the escrow account and leaving the sellers of LCB assets somewhat short in sale proceeds.

As stated by Bhahara in the August 2012 news release:

Money is the lifeblood of terrorist and narcotics organizations, and while banks which launder money for terrorists and narco-traffickers may be located abroad, today’s announcement demonstrates that those banks and their assets are not beyond our reach. We will use every resource at our disposal to separate terrorists and narco-traffickers, and the banks that work with them, from their illicit funds, even those hidden in foreign accounts.

In summary, Bhahara and his colleagues are now more willing than ever to enforce the extra-territoriality of their domestic laws and political goals by releasing civil forfeiture actions against the dollar correspondent banking accounts of financial institutions commercially tied to a sanctioned entity or defendant in one of their civil forfeiture lawsuits.

In addition, recent actions by various American regulators against HSBC, Standard Chartered, Lloyds TSB, ING Bank and other major international banks have produced multimillion-dollar settlements that have captured headlines around the globe. Failures in an international financial institution’s anti-money laundering, counter-terrorist financing and country sanctions compliance regime is no longer met with mere admonishments and small sums charged by a regulator, but rather substantial sums yanked from the shareholder profits of an offending firm.

One example of such money-laundering and country-sanctions violations is “payment stripping” — the practice of removing material information about sanctions entities and individuals (including those in Iran) from a Society for Worldwide Interbank Financial Telecommunication (SWIFT) payment to camouflage the true applicant or beneficiary sending bank or receiving bank, or any combination thereof.

In the past, if an international bank encountered a major compliance violation such as payment stripping, it could investigate and then resolve the problem, making a voluntary disclosure to various regulatory bodies that it had uncovered such activity and was in the process of changing business practices, compliance functions and possibly staffing.

Recent regulatory sanctions against international banks, whether coordinated among agencies or unilaterally, may now cause international banks to reconsider their options and increase the probability that future violations are buried. As a result, financial intelligence professionals would lose valuable insight into the commercial dealings of their targets.

As the United States and its allies tighten the financial screws on Iran’s ability to engage in commerce with the world, pressure mounts on Iran over its suspected national nuclear weapons development program.

The latest Organization of Petroleum Exporting Countries (OPEC) annual report for 201110 describes Iran as accounting for 12 percent of OPEC’s annual production. According to OPEC, Iran produced 3.6 million barrels per day (bpd) in 2011. If Iranian oil is sold for $100 per barrel, daily revenues from foreign buyers of $362-million (or USD 130-billion per annum) are possible.

In 2011, Iranian GDP at purchasing-power parity was estimated at $1 trillion, with a labor force of 26 million people, ranking its economy 18th in the world. This gives Iran considerable resources to bring to the problem of engaging in international trade for oil, its primary export, while under international sanctions.

To circumvent sanctions, the Iranian government, Iranian companies and legions of opportunists in the region will undoubtedly expand and complicate the international black market for Iranian oil.

The smuggling and financial techniques favored by drug trafficking cartels will find secondary uses throughout the Middle East and within financial centers around the globe.

For international banks, both correspondent banking relationships and international trade finance and global payments will become prone to more sophisticated money-laundering risks related to this rapidly-expanding dark market. Evading the regulatory sanctions currently collecting the well-coiffed scalps of international bankers will remain a top priority. As the market for oil is global, these risks will not be limited to the Gulf only.

Large-scale Iranian money-laundering is already taking place, in venues ranging from the currency exchange alleys of Kabul to Iraqi banks. Trade-based money laundering for those engaged in international trade is a natural outlet for washing the proceeds generated from sanctions evasion.

Business left “on the table” by major banks after cutting settlement checks to Washington will most likely be picked up by competitors and smaller regional banks better able to manage the associated risks of getting caught. Given the amounts at stake, it is unlikely these will be small or unsophisticated operations.

The alertness and diligence of senior managers and employees is the most formidable defense available to an international bank in fending off the now stratospheric consequences of regulatory infractions.

The opinions expressed in this article are the author’s own.

Kim R. Manchester is the founder and Managing Director of ManchesterCF, a Toronto-based firm that provides financial crime risk management training programs and advisory services to financial institutions and public-sector agencies around the globe.

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. <a href=” ions/regulatory-intelligence/compliance- complete/” target=_new”>Compliance Complete</a> provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges.)

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