Financial Interdictions to Curb Proliferation

Over the past four decades, the world has gotten several glimpses of the illicit procurement methods used to support nuclear programs: Iraq’s diversion in the 1980s of agricultural loan funds into its nuclear procurement program, the payment schemes of the Abdul Qadeer Khan network as part of its sale of uranium hexafluoride to Libya, [1] and the fraudulent transactions through New York banks of shell companies linked to IRISL, Iran’s state-owned shipping company.

These transactions are a powerful reminder that proliferators rely on access to the global financial system for their illicit activities. The globalized nature of this trade is an important asset to proliferators and their support networks, but it also is a vulnerability that countries seeking to stop the spread of weapons of mass destruction (WMD) are increasingly exploiting.

The use of a country’s economic leverage to advance foreign policy objectives is certainly not new, nor is the imposition of trade, travel, diplomatic, and financial restrictions by the international community on states in violation of their nonproliferation obligations and other rules of international law. Nevertheless, sanctions have evolved from devices of economic statecraft into practical tools that aid intelligence services and law enforcement in the complex tasks of tracking, mapping, and dismantling the financial support nodes of proliferation networks; prosecuting the criminals involved in these operations; and, ultimately, denying proliferant states the ability to conduct clandestine purchases of weapons-usable matériel.

Financial transactions leave a trail of information that intelligence and law enforcement officials can follow to identify key actors and their support networks. U.S. Secretary of the Treasury Henry Paulson noted that “opening an account or initiating a funds transfer requires a name, an address, a phone number; identification information that does not lie. Unlike a phone call or conversation that essentially disappears if it’s not captured at the moment it occurs, the financial system produces records that tend to survive.” [2] This makes financial data a timely and reliable source of intelligence for nonproliferation investigations.

The United States employs a broad palette of financial and economic tools to prevent WMD proliferation. For decades, Washington has applied trade restrictions against foreign individuals found to be part of proliferation activities and has threatened various penalties for violations of its nuclear cooperation agreements with other countries. More recently, Congress has enacted into law severe penalties against foreign banks that maintain business relationships with certain Iranian institutions, and the U.S. Department of the Treasury has used authorities under the PATRIOT Act to designate the entire Iranian banking system as posing a money-laundering and proliferation-financing risk, with the aim of cutting off Iran from the global financial system.

Tools of Disruption

U.S. officials have emphasized the singular benefits of anti-proliferation financial controls, and some of these actions have been widely adopted by the international community. The UN Security Council, for instance, has mandated global asset freezes against individuals and firms involved in the nuclear and ballistic missile program activities of Iran and North Korea. At a U.S. congressional hearing in 2006, Robert Werner, director of the Treasury Department’s Office of Foreign Assets Control, explained that entities “designated” to be added to sanctions lists “represent a starting point as we seek to unravel the support networks that enable these entities to function…. The subsequent designation of any entity or individual serves as an additional basis for aggressive investigation…with the aim of designating additional parties.” [3] He concluded that the targeting of the broader support networks of proliferators has been the critical factor behind successful nonproliferation programs.

The investigation that led to the indictment last year of 11 shell companies and five individuals allegedly conducting transactions on behalf of IRISL, which was under U.S. sanctions, illustrates this point. The information uncovered by law enforcement and intelligence officials convinced a grand jury in Manhattan that the suspects had probably helped the shipping firm evade U.S. sanctions and that the district attorney should proceed with criminal charges against them. Additionally, the U.S. government added the companies and individuals to its sanctions list, forcing IRISL to move some of its operations to Panama and register shell companies there, which were in turn traced and placed under sanctions by the Treasury Department.

Another recent novelty in the arsenal for anti-proliferation financial “warfare” is the inclusion of individual IRISL-owned vessels, stemming from the sanctions that the United States and the European Union levied against the shipping firm. (The UN Security Council imposed financial restrictions on three IRISL affiliates in 2010.) IRISL had been added to U.S. sanctions lists for providing logistical support to Iran’s Ministry of Defense and Armed Forces Logistics. [4] According to U.S. officials at the time, IRISL vessels had transported a shipment of a precursor chemical, allegedly for use in Iran’s ballistic missile program, to Parchin Chemical Industries, which was under the sanctions imposed by UN Security Council Resolution 1747. Although in the past, persons, governments, and entities had been targeted by financial restrictions, the public identification of individual vessels expands the reach of sanctions to more effectively target another layer of proliferation activity: the logistics support networks of proliferators.

The designations of IRISL resulted in its loss of maritime insurance from its underwriter, Lloyd’s of London. The Iranian firm sought insurance coverage from a Bermuda-based company, which later also adopted the restrictions. IRISL was then forced to turn to Moallem Insurance, a company created by the Iranian government, to ensure it could remain in operation. Still, the EU has refused to validate this coverage and has shut IRISL vessels out of its ports. At the same time, because of the financial sanctions, the shipping firm has had trouble transmitting payments for mortgages on its vessels, its creditors have ordered the vessels arrested at ports in Europe and Asia, and the company has had to tap valuable foreign currency reserves to have the vessels released. This is a prime example of how financial controls can target proliferators and their broader support networks.

Private institutions that purposely or unwittingly violate sanctions face the real prospect of hefty fines. This is an additional dimension that adds potency to anti-proliferation financial tools and amplifies their effectiveness. For example, in 2010, ABN AMRO, now Royal Bank of Scotland, was fined an unprecedented $500 million as a result of sustained violations of U.S. sanctions by some of its foreign branches. From 1998 to 2005, some of ABN AMRO’s foreign branches altered the names of Iranian and Libyan entities in payment messages or removed references to the target countries altogether before forwarding letters of credit, wire transfers, and U.S. dollar-denominated checks to branches in the United States. This practice, known as “stripping,” had already cost the bank a $40 million administrative penalty from the U.S. government, but the Department of Justice pursued a criminal investigation that resulted in a deferred prosecution agreement for two charges and forfeiture of the value of the illegal transactions—$500 million. [5] ABN AMRO is not the only bank found to be involved in stripping. Credit Suisse was assessed a record-breaking $536 million fine in 2009, and Lloyd’s TSB agreed to pay $350 million as part of a settlement.

Although in recent times the United States has been enforcing its financial restrictions more aggressively, the Treasury Department has increasingly provided incentives, in the form of less-severe penalties, for financial institutions to self-disclose any violations and fully cooperate with investigators. This approach is particularly effective because it signals to private firms that violations will result in a financial loss while authorities gain access to a wealth of data that can lead them to identify more proliferators, understand how their networks operate, and disrupt their activities.

Global Enforcement

The Security Council resolutions against Iran and North Korea identify individuals and entities engaged in the proliferation activities of those two countries. All states must ensure that their financial institutions prevent access to their funds and block transactions with these individuals and entities. The same resolutions direct countries to prevent financial transactions related to the acquisition of components for the Iranian and North Korean nuclear and missile programs.

These two types of obligations are country specific, and as such, their impact might be limited. The breach of nonproliferation norms, however, is not limited to cases that have gained the attention of the Security Council, and rogue regimes are not the only ones interested in acquiring weapons of mass destruction. Last March at the nuclear security summit in Seoul, UN Secretary-General Ban Ki-moon spoke of the need to curb the financing of terrorism and proliferation as a means to prevent nuclear terrorism.

The international community had sought to confront this latter threat through UN Security Council Resolution 1540, which obliges all states to establish domestic controls on the financing of WMD matériel and means of delivery and transit. It also requires them to adopt and enforce legislation to prevent and penalize the financing of these and related activities. Much effort has gone into implementing the tighter controls on exports of sensitive goods, while other important areas, such as the financial restrictions, have received far less attention from the nonproliferation community. Consequently, nonproliferation specialists understand the flow of goods better than the financial flows.

At the 2005 Gleneagles summit in Scotland, the Group of Eight (G-8) industrialized countries—Canada, France, Germany, Italy, Japan, Russia, the United Kingdom, and the United States—committed themselves to developing cooperative procedures to identify, track, and freeze proliferation-related financial transactions and assets. Shortly afterward, participants in the Proliferation Security Initiative formed a working group on proliferation financing. Another ad hoc group, the Global Initiative to Combat Nuclear Terrorism, turned its attention to nonproliferation financial tools and in 2010 conducted an exercise on nuclear terrorism counterfinancing. Ultimately, the members of the G-8 other than Russia decided that technical work on measures to implement anti-proliferation financing obligations under Resolution 1540 and other UN Security Council resolutions should be entrusted to the group of financial experts at the Paris-based Financial Action Task Force (FATF). [6]

Bringing in the Financial Experts

The FATF was first convened by the G-7 (as the G-8 was known before Russia joined) in 1989 in response to growing concern about the pervasiveness of money laundering and counterfeiting. The task force developed 40 countermeasures to address these threats to the international financial system. Initially, a handful of countries that are members of the Organization for Economic Cooperation and Development actively participated in this effort. An ever-larger group of countries accepted the recommendations, and the intergovernmental body itself expanded into its current composition of 34 member countries and two supranational institutions (the European Commission and the Gulf Cooperation Council). The task force encouraged the creation of regional bodies, such as the Council of Europe’s Moneyval and the Middle East and North Africa FATF, which adopted the policy standards. The FATF also established partnerships with more than 20 international and regional organizations that have a role to play in its anti-money laundering remit, including Interpol, the International Monetary Fund (IMF), the UN Office on Drugs and Crime, and various regional development banks.

In 2001, just weeks after the September 11 attacks, the FATF adopted eight countermeasures against the financing of terrorism (the so-called Special Recommendations), adding a ninth in 2005. Collectively, the “40+9 Recommendations,” embraced by 180 jurisdictions, are the global standard for the prevention of money laundering and terrorism financing. The speed with which the FATF adopted the new policies highlighted not only the urgency of the terrorism threat but also the virtues of the informal task force model.

In 2007 the FATF issued two sets of guidance on how countries could implement proliferation-related sanctions. One set dealt with sanctions based on designations [7] while the other covered so-called activity-based sanctions, beyond the list of individuals or entities but still targeting the procurement programs of specific countries. [8]

Nevertheless, FATF members recognized that the global community at large did not have a very good understanding of the dynamics of proliferation financing, and in 2008 the FATF conducted a comprehensive study of the techniques employed by proliferation networks to finance illicit trade in WMD matériel as well as possible measures to implement the broad anti-proliferation financing requirements under Resolution 1540. [9] In 2010 the task force produced a document with 23 policy proposals to improve the regulatory, investigative, and judicial components that are necessary for an effective, multilateral strategy to combat the financing of WMD proliferation. [10]

The formulators of the FATF policy document envisioned a comprehensive architecture that includes elements to harness the vigilance of financial institutions, aid law enforcement and intelligence agencies in their effort to track and disrupt proliferation networks and their operations, and facilitate the punishment of proliferators and their abettors. For instance, some policy options encourage countries to criminalize proliferation financing, ensure procedures to support extraterritorial investigations, and create channels for information sharing with financial institutions.

A New Tool of Enforcement

Last February, the FATF formally incorporated proliferation financing into its standards by adopting a consolidated set of recommendations, “International Standards on Combating Money Laundering and the Financing of Terrorism and Proliferation.” The recent additions include two standards that could aid in the targeting of proliferation financiers. One of them seeks to foster greater intelligence coordination among domestic export control, security, and law enforcement agencies to investigate proliferation financing. The other requires that financial institutions include identifying information for the ultimate beneficiary of wire transfers—a further data point that could aid in designations.

A third recommendation calls for the implementation of proliferation-related UN Security Council sanctions. All countries are already required to implement Security Council financial sanctions against designated targets and to prohibit proliferation-related transactions with target countries, but the FATF’s contribution in this area could significantly bolster the effectiveness of existing and future financial controls by producing public evaluations of individual countries’ implementation of sanctions.

The FATF is not a formal organization. Its mandate, which specifies its remit, must be renewed by its members. Its recommendations are nonbinding. Its resources are very limited; it has a budget of just more than three million euros and a very small technical secretariat. At first glance, this might not seem like the most appropriate instrument to enforce international norms against proliferation, but the FATF boasts some unique tools that could increase pressure on countries to comply with these obligations.

To ensure that its members implement the standards on money laundering and counterterrorism financing, the FATF established two compulsory processes. One is a self-assessment similar to the national reports countries submit to the UN committee of Security Council members overseeing the implementation of Resolution 1540 (the 1540 Committee). The other, which has no parallel in the nonproliferation regime, is a peer review of each member’s performance with regard to each of the recommendations. For FATF members, this review is conducted by a group of evaluators selected from the national financial experts. For members of the FATF associate bodies, the IMF or the World Bank typically works with the FATF Secretariat to conduct the assessments. [11]

A member may opt not to publish the full report of the FATF’s findings, but may not refuse the public release of a summary report on its performance, which the FATF publishes on its website. The summary includes a “grading rubric”—“compliant,” “largely compliant,” “partially compliant,” and “non-compliant”—along with comments and a brief description of any deficiencies. Countries and territories that are found to underperform significantly can be publicly identified if the FATF plenary decides to do so. FATF members are warned of the potential risks of doing business with those countries and, on occasion, are urged to apply countermeasures that include increased vigilance and scrutiny of transactions from listed countries.

Perhaps not surprisingly, given the potential loss of access to the global financial system that could come with these penalties, countries with deficiencies are keen to work with the FATF to address them. Even Iran, which is not a member of the task force, quickly enacted anti-money laundering legislation after a 2007 public warning by the FATF. The changes, however, did not assuage the FATF’s concerns. Tehran, facing the prospect of a second public rebuke, dispatched a high-level delegation of government and central bank officials to Paris to lobby the FATF. Although ultimately unsuccessful, Iran’s reaction to the decisions of an informal and seemingly powerless group of experts is remarkable given its defiance of the international community in more prominent forums.

Next year, when the FATF begins to evaluate compliance with the newly adopted standards, each country’s enforcement of Security Council proliferation sanctions will be evaluated. For the first time, the international community will be able to gauge the lacunae in the system; provide technical assistance where needed, just as the 1540 Committee does in support of the export control provisions of the resolution; and identify the willful abettors of noncompliance.

Last year, in Deauville, France, the G-8 resolved to promote “a more concrete approach” to curbing WMD proliferation through “effective implementation of multilateral instruments and strong national measures.” Notably, these concrete steps include the following:

To fight proliferation financing, we support the process launched at the Financial Action Task Force (FATF) that will strengthen the financial vigilance of G8 countries in a coordinated manner. To support UN proliferation sanctions, we will bolster the existing criminal provisions in national legislation and encourage States to identify as a specific offence the proliferation of WMDs, their means of delivery and related materials. Such provisions will also target financing and financial services…. Such actions will be taken to further implement Resolutions 1540 and 1887, as well as other UNSC resolutions. [12]

The new FATF guidelines clearly are a modest achievement in comparison with the comprehensive global system that was envisioned by the authors of the policy proposals and by the G-8. Nevertheless, the recognition by global leaders of the singular importance of financial vigilance in curbing the spread of weapons of mass destruction augurs well for the development of a much-needed coordinated strategy. This sustained effort will be critical to maximize the potential of financial tools in support of the global nonproliferation regime.

Javier Serrat is a research assistant and was a Scoville Peace Fellow at the James Martin Center for Nonproliferation Studies in Washington.

ENDNOTES

1. International Institute for Strategic Studies, “Nuclear Black Markets: Pakistan, A.Q. Khan and the Rise of Proliferation Networks,” 2007, p. 78.

2. Henry Paulson, “Targeted Financial Measures to Protect Our National Security,” Remarks to the Council on Foreign Relations, New York, June 14, 2007.

3. Robert W. Werner, Testimony before the House Financial Services Subcommittee on Oversight and Investigations, February 16, 2006.

4. The ministry was sanctioned by the United Nations under Security Council Resolution 1737. A November 2011 report by IAEA Director-General Yukiya Amano identified the ministry as the entity overseeing Iran’s clandestine nuclear program.

5. Under a deferred prosecution agreement, the Department of Justice files a “criminal information”—a criminal charge without a grand jury indictment—but agrees not to proceed with prosecution, provided that the defendant complies with the requirements outlined in the settlement.

6. The announcement was made by the finance ministers of the seven countries, following a meeting in February 2007. Russia, a member of the G-8 since 1997 and the Financial Action Task Force (FATF) since 2003, did not join the statement.

7. FATF, “Guidance Regarding the Implementation of Financial Provisions of United Nations Security Council Resolutions to Counter the Proliferation of Weapons of Mass Destruction,” June 21, 2007.

8. FATF, “Guidance Regarding the Implementation of Activity-Based Financial Provisions of UNSCR 1737,” October 12, 2007.

9. FATF, “Proliferation Financing Report,” June 18, 2008.

10. FATF, “Combating Proliferation Financing: A Status Report on Policy Development and Consultation,” April 23, 2010.

11. Some offshore financial centers are members of the FATF-associated Group of International Finance Centres Supervisors, and their compliance with FATF standards is independently assessed. For example, the performance of the Isle of Man, a British crown dependency whose foreign affairs and defense are the responsibility of the United Kingdom, does not factor into the United Kingdom’s ratings.

12. G-8, “Renewed Commitment for Freedom and Democracy,” Deauville, France, May 26-27, 2011.