Monday, March 26, 2007

Financial Waterboarding: A Section 311 Primer

Do you know whom the North Koreans can blame for the whole BDA mess?

John Kerry!

According to a superb March 18 backgrounder by McClatchy’s Kevin Hall, Treasury's Patriot Act power goes too far, critics say, we learn:

Section 311... was drafted as stand-alone legislation by Sen. John Kerry, D-Mass., but incorporated into the Patriot Act...

Section 311 of the Patriot Act, which was the basis for Treasury’s action against BDA, essentially allows the Treasury Department to effectively shut down any bank in the world if it has “reasonable grounds” to assume that bank is “of primary money laundering concern”, by making it illegal for US financial institutions to maintain correspondent relations with that bank.

Big John has, surprisingly, been silent on this latest application of his extra-Constitutional handiwork.

It’s a power that foreign banks and nations fear...and the Treasury Department is loathe to surrender.

Due process consists of consultations between Treasury, State, and Justice to announce an investigation, then a final decision which, if negative, requires U.S. financial institutions to break off correspondent relations.

When the BDA investigation was announced in 2005, nervous depositors in BDA ran on the bank and withdrew HK$300 million—amounting to about 10% of the bank’s capital and more than enough to topple it into insolvency.

The bank went into receivership. The Macanese authorities froze accounts identified by the U.S. Treasury Department as suspect, and waited for the outcome of the investigation.

And waited...and waited...

Finally, the axe fell on March 14, 2007, on the last day of the deadline that Christopher Hill had promised the North Koreans for the resolution of the matter.

Treasury stated categorically that the bank was dirty and instituted the formal ban on correspondent relationships.

Now the Macau authorities are free to return the money to the various depositors and possibly even return the bank to its original owners. Stanley Au, the chief shareholder, wants it back and is agitating to get the Treasury ban lifted.

To fully understand the nature of the Treasury Department action, it is necessary to understand that now in this world there are three types of sanctions:

U.N. sanctions, relying on U.N. Security Council unanimity, therefore usually diluted, consensual, and weak;

Sanctions under national law, involving advise and consent, due process, and appeal and judicial interpretation, and various constitutional rigamarole, at least in the United States;

A new category, national security sanctions, which is what the Treasury money-laundering sanctions fall under.

By design, national security sanctions have a bias for action. The philosophy is, in this ticking time bomb mushroom-cloud world, there is no time for evidentiary niceties and no leeway for bad guys to hide behind U.S. legal mumbo jumbo.

And, since watching the actual process of national security sausage being made would be deleterious to the morale of observers with a bias toward due process transparency, and accountability—not to mention possibly providing the basis for challenges to Treasury’s diktat in the courts or in the press--Treasury investigations under Section 311 are conducted unilaterally and in secret.

Again, from Kevin Hall:

Supporters view Section 311 as a diplomatic sledgehammer that gets results. Critics -- many of whom refused to speak on the record, saying they fear retribution -- complain that the provision denies suspects due process and presumes that the accused are guilty rather than innocent.

Through Section 311, the Treasury doesn't have to tell accused banks or countries what threat they allegedly pose to the U.S. financial system, and the Treasury has the power to act as both prosecutor and judge.

``There is certainly an element of unfairness when you are accused,'' said Peter G. Djinis, a money-laundering expert and former high-level Treasury official who was involved in the earliest Section 311 proceedings. ``First, you don't know who the accusers are and the strength of their convictions, and you have to work yourself out of the hole. And in many cases you won't succeed.''

As a footnote in the final BDA rule indicates, classified information can be used in internal Treasury deliberations:

These conclusions were derived in part from classified sources...

In its final decision, Treasury announced it had received comments on its investigation from two sources—one from a college professor offering his apparently unnecessary observations on how the net around money laundering banks could be drawn even tighter—and a clutch from BDA.

The BDA comments were dismissed in relatively short order. My favorite:

Finally, the bank suggested in its comments that imposing the fifth special measue would be inconsistent with U.S. foreign policy considerations. We disagree.

Full stop.

Handwringers anxious about Star Chamber proceedings based on secret information can rest easy, according to the Treasury Department as reported by Hall:

The accused do have rights, said Molly Millerwise, a Treasury spokeswoman.

``We have previously lifted proposed rules when the institution took appropriate steps to strengthen their controls,'' she said. ``Moreover, as with all regulatory actions, 311 rules can be challenged in federal court.

Actually, Molly—and Stanley Au, who is talking in some vague way about a court challenge--I think that since U.S. financial institutions—not BDA—are the subject of the Treasury rule, under the Administrative Procedures Act, BDA’s grounds for challenging this ruling in U.S. court amounts to about zip.

Of course, if some U.S. bank wants to paint a bullseye on its back and go to bat on behalf of BDA, well go ahead.

But don’t expect things to go too well (another footnote from the BDA ruling):

Classified information used in support of a section 311 finding...may be submitted by Treasury to a reviewing court ex parte and in camera.

Parallels with Guantanamo are not accidental. The Treasury money laundering provisions under Patriot Act Section 311 were designed to give the Treasury Department the ability to act as judge, jury, and executioner, in order to protect the U.S. homeland.

The best description of the Patriot Act 311 provisions I read somewhere called them “financial waterboarding”.

In some respects, the result of the BDA sanctions were undoubtedly encouraging. There was a run on the bank, a good demonstration of the intimidating power of U.S. disapproval.

But once the bank went into receivership, it continued to make money!

Herculano de Sousa, who was selected in 2005 by Chief Executive Edmund Ho as chairman of the administrative commission that manages Delta Asia Bank, declined to disclose details of the operation but said the bank had made profits "despite the adverse circumstances under which it is operating".

Concerning these adverse circumstances, de Sousa explained they were the result of "all commercial relations with the parallel banks having been severed", and said that the setback did not hamper the bank from achieving a positive balance logged at the end of the year.
At the end of the first trimester of 2006, and according to data published in the Official Gazette, the bank's operation showed earnings of 43.9 million patacas and expenses of 28.8 million patacas, with a positive balance of 15 million patacas.

The other interesting point here is the phrase “all commercial relations with the parallel banks having been severed” which indicates that, despite the whole veneer of due process covering the Treasury Department’s lengthy and disputed investigation, foreign banks—undoubtedly under U.S. pressure—had severed correspondent relations with BDA even before the final ruling came down.

Though isolating BDA prior to the final ruling probably pleased Treasury, I doubt many international banks appreciated participating in this campaign of coercion meant to advance U.S. diplomatic priorities (as opposed to assisting hot financial pursuit of terrorists planning an attack).

I suspect the U.S. action was more in lines of a naked threat, rather than a collegial request. Perhaps any bank contemplating corresponding was confronted with the Treasury threat that they too might become a target of “primary money laundering concern” if they helped move money from the bank.

Indeed, it is reportedly because of fears of being “contaminated” that the Bank of China is reportedly balking at accepting the North Korean funds released from BDA, even if it threatens to fatally delay the execution of the Six Party Agreement.

Beyond BDA being able to continue functioning while under Treasury’s investigatory stigma, the U.S. juggernaut hit a few other bumps.

Despite the fact that the decision was Treasury’s to make and the investigation Treasury’s to conduct as it saw fit, the Macanese conducted their own audit which, embarrassingly, indicated that there was little justification for shutting down the bank:

An audit of the Banco Delta Asia's finances by accounting firm Ernst & Young found no evidence that the bank had facilitated North Korean money-laundering, either by circulating counterfeit U.S. bank notes or by knowingly sheltering illicit earnings of the North Korean government.

In a filing submitted to the Treasury Department last October, Heller Ehrman LLP, the bank's New York law firm, reported that an audit by the government of Macau also had found no evidence of money-laundering.

As for my favorite dubious allegation of North Korean malfeasance, the Supernote counterfeit $100 bill boondoggle:

...according to the filing by the bank's attorneys, which the Treasury Department hasn't challenged, there was almost no way that North Korea could have laundered counterfeit U.S. currency through the bank.

Large deposits of North Korean cash were sent to the New York branch of the giant HSBC bank to be run through sophisticated counterfeit-detecting machines, the law firm's filing said. The only evidence of counterfeit currency that Banco Delta Asia found was much earlier, in 1994, and the bank notified local authorities immediately, the filing said.

Then the State Department landed a body blow, pressuring Treasury Secretary Paulson to override the Treasury Departments attempt to block repatriation of about $15 million in funds:

Until the intervention by Mr Paulson, Treasury had been prepared to tell the Macao government that it would not object to returning about a third of the $25m for which there was less-than-conclusive evidence of illicit activity. Treasury on Wednesday dismissed suggestions that it had succumbed to political pressure.

Perhaps the most conspicuous virtue of the Patriot 311 sanctions is that they are, in theory, completely shielded from outside pressure.

Invoking the sacred cause of American national security against terrorism, they are not supposed to be bartered away in the cause of diplomatic compromise.

In fact, even at the time that the United States was conducting a concerted campaign of diplomatic and economic coercion against North Korea through the United Nations, the Treasury Department went to great pains to insist that the money laundering investigation had “nothing to do” with sanctions.

That’s why the deal with North Korea under the Six Party Agreement was such an unwelcome shock to the Treasury Department.

Its supreme coercive instrument, money laundering investigations under Patriot Act Section 311 had, at a stroke, been devalued and shown to be just another component of the diplomatic package to be employed or discarded as needed to advance U.S. foreign policy goals.

Given these challenges to the morality, efficacy, veracity, and legitimacy of the Treasury actions, it is not surprising after all that Treasury, for the sake of its own reputation if not the needs of U.S. national security, came out with a thoroughgoing blood-and-thunder condemnation of BDA in its final decision.

But the damage has been done. Post-BDA, the United States will find it difficult to assert credibly that Section 311 sanctions are anything more than fundamentally flawed, coercive, and reversible expressions of American diplomacy and politics.

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