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You want maximum pressure? Oh, I’ll show you maximum pressure.

SINCE LAST WEEK, WHEN THE TREASURY DEPARTMENT announced 56 designations of ships, shipping companies, and trading companies, reporters have been emailing me to ask whether this is finally the “maximum pressure” the Trump administration has been talking about. The short answer is “no.” In terms of length alone, yes, this was the largest set of North Korea designations ever, although we should discount for the fact that most of the 28 ships were effectively designated twice (once per ship, and once per front company). These designations follow another large set of designations in late January. Together, both sets represent a quantitative increase in the pace of designations. Whether that increase is also a qualitative one depends on whether they are part of a longer-term strategy. In this post, I’ll analyze the designations for patterns and potential legal strategies that might help us answer that question.

In 2014, when President Obama called North Korea the “most sanctioned, most cut off” nation ever – and no journalist questioned this, or seemingly knew enough to question it – it was left to Anthony Ruggiero and me to prove otherwise. Since then, President Trump has strengthened sanctions substantially, but his claim that our sanctions against North Korea are the “heaviest sanctions ever” still isn’t accurate. Both qualitatively and quantitatively, Obama’s circa-2014 sanctions against Iran were far stronger. We’re starting to see some evidence of the pressure sanctions are exerting on Pyongyang — more on that another day — but the pressure is still far from maximum, and far from the existential pressure that will be necessary to disarm Kim Jong-un, with or without his voluntary consent.

So how will we know we’ve reached maximum pressure? When the Port of Dandong begins diligent inspections of cargo from Nampo, for fear that its exporters’ wares will be held up in customs warehouses in Seattle. When Sierra Leone quits reflagging North Korean ships, for fear that other ships flying its flag of convenience will be banned from U.S. waters.

When Commando Solo interrupts Korean Central Television with an address from Thae Yong-ho, imploring Kim Jong-un’s generals not to kill South Korean civilians or inflict crimes against humanity on their own people, and warning them that they’ll be held accountable if they do. When cheap, encrypted satellite phones with the capability to receive calls, payments, and video from South Korea become inexplicably ubiquitous in North Korean markets. When people in Hamhung and Chongjin can watch well-produced, politically conscious content that’s made for them.

But in terms of financial sanctions, I’ll believe we’ve reached maximum pressure when Treasury begins to impose nine-digit penalties on major Chinese banks that continue to launder Kim Jong-un’s money – like the ones the Obama administration assessed against major European banks in 2014 and 2015 for laundering Iran’s money. In the coming days, the U.N. Panel of Experts will issue a long-delayed report reaffirming that banks around the world continue to fall short of their due diligence obligations (the U.N. calls it “enhanced monitoring“) to stop Pyongyang’s money laundering. In 2016 and 2017, Justice Department filings alleged that major Chinese banks continued to host accounts used to launder Pyongyang’s money. Before that, the Bank of China got away with flagrant violations of our money laundering laws and facilitated a major illegal shipment of North Korean weapons from Cuba to North Korea. I’ll believe it’s maximum pressure when major Chinese banks are serious enough about blocking and closing North Korean accounts that U.N. reports and Justice Department documents cease to confirm that the banks aren’t complying.

Kim Jong-un will not cease to endanger us because of any piece of paper he signs under duress, but because either (a) his generals have overthrown him, or (b) he needs the U.N. 1718 Committee to countersign every check he writes because the freezing of his accounts has put his economy under the equivalent of receivership. For sanctions to be effective, they must prevent him from accessing its cash reserves. I’m not convinced we’ve done that yet.

The January Designations

Qualitatively, the January designations were the more significant ones. They included the Gorgeous Bank of North Korea (seriously) and the Brilliance Banking Corporation, which are fronts for the Hana Banking Corporation. Also designated were six ships, three Chinese trading companies, North Korea’s oil ministry, a senior Workers’ Party official based in China, the Russian oil trader featured in this Justice Department forfeiture suit, ten representatives of designated North Korean arms vendors operating in China or Russia, and five North Korean bank representatives operating in China or Russia. Both Russia and China have long acted as havens for North Korean money laundering. Last week, China was vocal in complaining that the U.S. sanctions are “unilateral,” but U.N. member states have been obligated to expel all representatives of North Korean financial institutions since the end of 2016, under UNSCR 2321, paragraph 33. China, as a veto-wielding member of the Security Council, voted to undertake that obligation, but consistent with its long-standing practice, refuses to enforce it. If anyone is acting unilaterally here, it’s Beijing.

The February Designations

By contrast, last week’s designations focused on North Korean ships and shipping companies. Pyongyang has long used its merchant fleet to smuggle weapons and other contraband. It typically registers each individual ship through one shipping company, and frequently renames and reflags its ships to confuse port directors and shipping registries. By designating the individual ships, Treasury will make it harder for them to obtain financing, insurance, bunkering services, landing rights, and registration under flags of convenience — provided our diplomats tip off local authorities when North Korean ships are coming, make strong cases to the governments concerned, and make it clear that those who don’t comply will face serious consequences. By issuing this lengthy advisory on North Korea’s evasive methods, Treasury put those ports, insurers, and registries – and their bankers – on notice of their legal duties not to facilitate North Korean shipping. That notice could make it easier for prosecutors to prove that a future defendant failed to carry out those legal duties. The U.S. is also trying to have these ships designated by the U.N. Security Council.

The administration is also talking about boarding and searching North Korean ships at sea. The U.N. Security Council has provided limited legal authority to support such a strategy, though it usually requires the consent of the flag state. Although I’m cautious about the use of force against North Korea generally, I don’t view this particular risk as unacceptable given the countervailing proliferation and war risks. On one hand, past interceptions of North Korean ships such as the So San and the Pong Su did not trigger wider conflicts. On the other hand, allowing Pyongyang to ship WMD materiel to clients around the world is probably facilitating their use against innocent people in at least one major conflict now.

The move to choke off North Korea’s shipping industry is long overdue. The Obama administration should have done it years ago, and the Trump administration deserves credit for doing it now. The strategy seems to be to sanction North Korea’s merchant fleet to extinction and force it to rely on third-country shippers, although Treasury may still have a way to go to find all the ships.

Despite these enforcement challenges, these designations could still have some significant short-term effects. Some potential partners, such as the shipping conglomerate Comtrans, will now be less willing to take legal risks to smuggle on North Korea’s behalf. Others, such as Dandong Zhicheng Metallic Materials, have already been hit hard by the Justice Department. Those that are willing to take those risks on will charge Pyongyang higher risk premiums, thus raising the burn rate on its cash reserves. If the U.S. government puts enough staff on the task of watching these ships, and designates them as fast as Pyongyang renames and reflags them, it will do serious damage to Kim Jong-un’s earning capacity. Sanctions against Iran’s shipping line were an important part of the pressure that collapsed its economy and forced it to come back to the bargaining table.

Having said this, I also doubt that shipping will be the critical vulnerability for North Korea that oil was for Nazi Germany. I could be convinced otherwise, but I still say money is. Specifically, Pyongyang’s critical vulnerabilities are the political support of its people and its access to hard currency. The shipping effort should be seen as a defensive measure against proliferation first, and secondarily, as the closing of a potential loophole in the main effort – to choke off the regime’s access to international finance.

Follow the Money

Although the sanctions in effect against Iran in 2015 were easily more powerful than those in effect against North Korea now, the pressure on the financial industry over North Korea is rising. Title 31 of the Code of Federal Regulations contains the regulations that require “financial institutions,” including banks, money transmitters, and insurance companies, to conduct due diligence to combat money laundering and the financing of proliferation.

One of the ways that financial institutions comply with these obligations is by reporting “suspicious” activity to the Treasury Department; another is by satisfying “Know Your Customer” obligations to spot shady characters and practices; another is by subscribing to compliance software offered by companies that watch every Treasury Department designation and load the names, addresses, and other publicly available information about each such entity into their software. When banks receive wire transfer orders from their customers, they are obligated to ask enough questions to spot red flags and risky behavior, and to cross-check the parties and counterparties to a transaction against that compliance software. Banks that flunk those obligations face a range of potential legal consequences, including civil penalties, criminal prosecution, and Patriot Act special measures that limit their access to the financial system. Even being a target of an investigation can be costly to a bank’s reputation, stock price, and credit rating, to say nothing to the legal fees.

In November 2016, the Obama administration designated North Korea as a primary money laundering concern after Congress effectively forced it to do so. It implemented that designation with this regulation, putting banks on notice of their “enhanced due diligence” obligations to guard against North Korean money laundering. The Trump administration is saying the right things to the financial industry about its obligations to perform that due diligence. In one year, it has done more to enforce financial sanctions and anti-money laundering regulations against North Korea than the Obama administration did in eight. The 311 actions against the Bank of Dandong and the more recent one against ABLV Bank in Latvia will be significant deterrents.

Actions like these drive home the point that laundering Pyongyang’s money, whether by design or neglect, can have extinction-level consequences. Banks will now have greater incentives to invest in anti-money laundering compliance software, take stronger steps to know their customers, and report suspicious activity to the Treasury Department. But the Bank of Dandong and ABLV Bank are small banks. So far, not one major bank has incurred a civil penalty for violating the new due diligence rules that apply to North Korea, in contrast to at least a dozen that have been penalized for violating Iran sanctions. As we’ve seen, it’s not because the banks’ conduct has been pristine.

One possible reason for this is that it takes time to build a penalty case. Read the links to “2014” and “2015” above, and some of those Iran-related penalties were based on actions occurring several years previously. Another possible reason is that the regulations raising the due diligence obligations applicable to North Korea-related transactions have only been in effect for just over a year. Since November 20, 2017, entities dealing with North Korea have also had to worry about violating 18 U.S.C. 2332d, a criminal statute prohibiting unlicensed financial transactions with governments that are listed as state sponsors of terrorism. That statute carries a penalty of ten years in prison.

There is no such thing as “too big to sanction”

A more concerning possibility is that Treasury believes that China’s bigger banks are “too big to sanction.” If so, Kim Jong-un will continue to access his offshore slush funds, and the pressure on his regime will be less than existential, and thus insufficient to disarm him. Some well-informed friends of mine speculate that the administration is only hitting small targets to run up the designations score, but is staying its hand against bigger targets, either because it has been snookered by Beijing, or because it has been lobbied by business interests that are more interested in trading with China than disarming North Korea. I don’t claim to know if this is true. Frankly, I understand and share Treasury’s reluctance to block a larger bank out of the financial system completely, for fear that doing so could affect our own economy. But this doesn’t mean we’re powerless to enforce our laws when those banks misuse our financial system.

In The Hill, Brian O’Toole makes a well-informed, but ultimately unpersuasive, case against sanctioning major banks at all. First, contra O’Toole, the number of North Korea designations is still not higher than the number for Iran (nearly 900 in 2015). But more fundamentally, sanctioning big banks that flunk due diligence isn’t a binary, all-or-nothing proposition. We have different sanctions and penalties that are appropriate for different sizes of institution, and other deterrents that, strictly speaking, aren’t penalties at all.

Summons & Subpoena Authority. For example, the Treasury and Justice departments can subpoena records about certain transactions, or classes of transactions, from the foreign banks’ correspondent banks in New York, if they have probable cause to believe either the U.S. or foreign correspondent isn’t complying with its due diligence obligations. One effect of this would be to send compliance officers scurrying to their lawyers, or even to their corporate officers. This would incentivize banks to reinforce their internal safeguards to isolate North Korea and de-risk any indirect transactions with it. Just making the banks review and produce documents might yield better compliance procedures, more suspicious activity reporting, and better financial intelligence.

Lesser “Special Measures.” We also forget that there are five special measures under section 311 of the Patriot Act, not just 31 U.S.C. 5318A(b)(5), the “nuclear option” that isolates a bank from the financial system entirely. The other four special measures impose heightened due diligence, record-keeping, and reporting requirements. If imposed on a larger bank, they might not be lethal, but they might still be powerful deterrents and valuable sources of financial intelligence. Even lower-level special measures would likely hit a bank’s stock price and Moody’s rating.

Civil Penalties. In the end, it’s also difficult for me to believe that the Trump administration can’t do to banks in China what the Obama administration did to banks in Europe – issue nine-digit civil penalties in appropriate cases. Obviously, the issuance of a fine can’t be arbitrary. There are guidelines on setting appropriate penalties published here, based on the number of transactions, their amounts, and the willfulness and egregiousness of the violations. The penalties must be based on “substantial evidence,” which isn’t a high evidentiary burden for Treasury to meet. If Treasury could hit multiple European banks with nine-digit penalties for violating Iran sanctions, why are we afraid to hit Chinese banks? And if EU nations and the State of New York are willing to issue nine-digit penalties against Chinese banks for having insufficient programs to prevent money laundering, why isn’t the Treasury Department?

Criminal Prosecution. Also, if we’re willing to prosecute the Chinese conglomerate ZTE for sanctions violations until it pleads guilty, pays a nine-digit penalty, and cooperates with the feds, then why shouldn’t we offer deferred prosecution to a bank that cooperates and implicates other Chinese, North Korean, or third-country targets? If we’re willing to charge the French bank BNP Paribas and prosecute it for Iran and Sudan sanctions violations until it pays an $8.9 billion settlement — yes, I know; that’s ten digits — why should banks in China banks be immune? Whatever the risks of this course, are they greater than the risk of a nuclear war?

A Foundation for a Long-Term Strategy?

But there is another possibility – that the current designations might actually be laying a foundation for actions against larger banks that will be easier for the Treasury and Justice departments to defend in court later. True, the January and February designations seem, at a glance, to harvest bushels of small potatoes. The North Korean targets designated have no direct access to our financial system anyway. Many of them will be replaced or renamed within weeks. So are these empty gestures against entities that will be renamed and back in operation shortly? Maybe not.

When a North Korean shipping company, or a Chinese or Panamanian middleman, is designated, the banks are not only supposed to close their accounts, but also to cross-check the names of the parties and counterparties to wire transfers to make sure none of their undesignated customers are helping the designated parties access the financial system indirectly. The case of Chinpo Shipping and the Bank of China is an example of a bank evading these legal obligations. The case of HSBC freezing the accounts of Sam Pa is an example of a bank complying with them. Right now, compliance software providers are probably combing through commercial databases, public records, and corporate filings to fill their software with information about the latest designees. That new information will raise red flags when Pyongyang’s fronts and pwags try to shape-shift.

[pwag. n. An official or agent of the government of North Korea who lives or travels abroad under a fictitious name.]

Banks will ignore those red flags at their grave peril. Next year’s penalty case could be built next month, on evidence that a major bank overlooked the red flags that are being raised in compliance software today, perhaps about a target that was designated last week. If so, today’s designations are merely a case of Treasury putting more bricks around the Cask of Amontillado.

I’ve begun to see some signs that sanctions are forcing Pyongyang to shift its priorities, to adapt by replacing some income sources with others, and to appeal to a weak-minded South Korean government to break the coalition that is forming against it (though this also advances its plans to finlandize the South). But U.N. member states and banks still aren’t enforcing sanctions well enough to deny Kim Jong-un access to the ill-gotten gains he has on deposit in China and Europe, under the names of front companies, agents, and aliases – at least not quickly enough. And it won’t happen quickly enough, as long as the big players in China’s financial industry enjoy de facto immunity from our money laundering and sanctions laws.

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Further reading:

3 Responses

  2. Apologies – I messed up the Question line. It should read

    Question: who has Brazilian passport number CE375365 ?

  3. Josh,

    Please see my email about the March 1st rallies in Seoul.

    Some of the information provided to you was inaccurate
    and/or misleading, particularly that by one “usual suspect”.