HFSC Sanctions Evasions Hearing
House Financial Services Subcommittee on National Security, International Development and Monetary Policy
Schemes and Subversion: How Bad Actors and Foreign Governments Undermine and Evade Sanctions Regimes
Wednesday, June 16, 2021
Witnesses
- Dr. Jeffrey W. Taliaferro, Professor, Department of Political Science, Tufts University
- Ivan A. Garces, Principal and Chair, Risk Advisory Services, Kaufman Rossin
- Lakshmi Kumar, Policy Director, Global Financial Integrity
- Jesse Spiro, Global Head of Policy & Regulatory Affairs, Chainalysis
- Eric B. Lorber, Senior Director, Center on Economic and Financial Power, Foundation for Defense of Democracies
Opening Statements
Chairman Jim Himes (D-Conn.)
In his opening statement, Himes noted the importance of sanctions as an instrument in foreign policy to persuade an entity to change illicit behaviors. He said there has been some success in the U.S. sanctions regime in terms of isolating human rights violators but emphasized that sanctions can only be as impactful as they are effective. Himes said when entities evade our sanctions, we lose an important diplomatic tool. Himes applauded the Committee’s work to address sanctions evasion through passage of the Corporate Transparency Act and the Anti-Money Laundering Act as part of the 2021 National Defense Authorization Act. Himes said the Office of Foreign Assets Control (OFAC) and Financial Crimes Enforcement Network (FinCEN) continue to do the extremely important work of educating market participants about sanctions evasion. He called the launch of Venezuelan cryptocurrency, Petro, a failure and stated his fears that the widespread use of alternative financial platforms could make sanctions evasions “trivially” simple. Himes concluded that it is very likely that we will see continued growth in ransomware attacks as a way to raise funds.
Ranking Member Andy Barr (R-Ky.)
In his opening statement, Barr said this hearing presents an opportunity for bipartisan cooperation to defend the national interest of this country. He added that the Subcommittee plays a crucial role in maintaining U.S. national security and ensuring robust international development and that as China continues to pose a threat, our sanctions policy becomes more important than ever. Barr said this Subcommittee also plays a crucial role as the intersection of the financial system and national security and explained that the U.S. employs a robust sanctions program to deny funding to bad actors and compel them to change their misguided behaviors. He said that although sanctions are usually an effective deterrent for bad actors, adversaries have continued to adapt and evade, requiring Congress to better understand how to mitigate continued evasion in the future. Barr listed typical evasion mechanisms such as trade-based money laundering, illicit shipping, corrupting other internationally mandated identification systems, or utilizing front companies to mask the true recipient of funds. He said that while these mechanisms have been used for years, entities have recently amped up their evasion techniques through the use of technology. Barr mentioned the early widespread use of cryptocurrency and the focus of exchanges on regulatory compliance, which unforeseeably pushed criminals into unlicensed exchanges, allowing them to identify and exploit vulnerabilities. He urged improved security between the private sector and government due to the increase in high-profile ransomware attacks – noting in the past three years, victims have paid nearly $350 million in cryptocurrency to satisfy the demands of hackers using ransomware. Barr concluded that Congress and the Administration must keep pace with technology as adversaries continue to find new ways to evade enforcement.
Testimony
Dr. Jeffrey W. Taliaferro, Professor, Department of Political Science, Tufts University
In his testimony, Taliaferro stated that he will provide a geopolitical overview of the United States’s use of sanctions against a variety of actors and the geopolitical implications of the evasion or subversion schemes completed by those targeted actors and their allies. He explained that the primary aim of sanctions is to influence a change in the target’s cost-benefit calculations and behavior. He discussed that the threat and imposition of sanctions is reliant on the target’s observable behavior, and the coercer must have the capability and the resolve to do so. He highlighted how the shifting politics of the 20th and 21st centuries have impacted sanctions, focusing on the effect of the U.S. emerging as a great power following the Cold War. He stated that the U.S. has wide latitudinal power in pursuit of a unipolar distribution of power, which has led to an imbalance of international power. Taliaferro focused on implications involved with the imbalance of international power, including his belief that the U.S. is the only state with the capability to impose economic and trade sanctions against recalcitrant states and that U.S. military dominance has caused state and non-state actors to pursue asymmetric strategies, such as hybrid interference. He then described how the unipolar distribution power incentivized targets and other disaffected actors to collaborate to evade or subvert U.S. sanctions. He highlighted that the unipolar distribution power is being altered by the rise of China, the fall of Russia, and the adversaries of Iran and North Korea, stating that all of these actors will seek creative means to evade the economic and trade sanctions that the United States seeks to enforce going forward.
Ivan A. Garces, Principal and Chair, Risk Advisory Services, Kaufman Rossin
In his testimony, Garces provided an overview of OFAC compliance programs, which begin with a risk assessment of financial institutions. He explained that financial institutions are expected to develop and implement policies and procedures for complying with OFAC based on the risk assessment and that sanctioned parties use complex structures and transactions to obscure their interest in the assets or omit information from transaction to avoid detection. He identified two common methods, including the exploitation of trade finance transactions and the use of shell companies. He stated that financial institutions screen customers against the OFAC list in three areas, which include account openings, as transactions occur, and periodically as the OFAC list is updated. He highlighted challenges in complying with OFAC because compliance requires substantial resources, as banks must invest in people, policy, and training. He also stated that compliance programs are tested by independent parties and examined by bank regulators and urged that financial institutions should not be expected to comply with OFAC at every step because sophisticated bad actors and the complexity of transactions pose an increasing threat. He concluded that the evolution of sanctions influences the need for government outreach and that there needs to be an increase of cooperation among public and private actors so government can connect trends across industries and within the financial system.
Lakshmi Kumar, Policy Director, Global Financial Integrity
In her testimony, Kumar explained that the U.S. sanctions regime currently includes more than thirty different sanction programs, which grow at an annual rate of 6 percent and that sanction evasion techniques play an international game of “hide and seek” that exploit regulatory practices in the U.S. and globally. She added that the close connection to trade involves the use of TBML (trade-based-money-laundering) techniques. She discussed how TBML is challenging because there are no international standards or international regulations, which makes it a commonly used method for sanction evasions. She also provided examples of current actors that use TBML techniques, including Iran and Venezuela and described private actors within the U.S. and United Kingdom that use schemes to sell prohibited items from sanctioned countries to the U.S. She added that sanction evasion exploits the gaps of regulations and resources that enforcement agencies need to protect. Kumar concluded with four key recommendations, including strengthening beneficial ownership laws, ensuring that FinCEN has the requisite budget necessary to meet the illicit financial flow challenges facing the U.S. trade and financial system, advocating for international standards to be created and implemented on TBML, like AML/CFT, and improving gatekeeper regulation.
Jesse Spiro, Global head of Policy & Regulatory Affairs, Chainalysis
In his testimony, Spiro discussed how blockchain data and analysis can benefit investigations into sanctions evasion using cryptocurrency, examples of illicit actors and adversarial grouped that have used cryptocurrency to evade sanctions, challenges and successes under the current sanctions regime, and recommendations for ways to improve the current sanctions regime with regards to cryptocurrencies. He described how blockchain analytics allow investigators to trace cryptocurrency transactions, identify patterns, and crucially see where cryptocurrency users are exchanging cryptocurrency for fiat currency. He provided examples where blockchain analysis has confirmed adverse actors under U.S. sanctions and highlighted how OFAC and FinCEN have targeted these actors, including through FinCEN’s oversight and prescriptive crypto advisories, and OFAC’s enforcement actions and the addition of cryptocurrency wallet identifiers to designations. He concluded by recommending ways to improve current sanctions regime with regards to cryptocurrency, including encouraging collaboration and information sharing with international partners, increasing public and private partnerships, increasing OFAC’s resources to support more comprehensive targeting, and creating a national cryptocurrency targeting center.
Eric B. Lorber, Senior Director, Center on Economic and Financial Power, Foundation for Defense of Democracies
In his testimony, Lorber stated that while sanctions are a powerful tool for achieving U.S. foreign policy, the increase of strategies by adversaries blunts their impact. He explained that it is critical that the U.S. counters to remain effective at pressuring terrorist organizations, rogue regimes, human rights abusers, and the corrupt. He identified ways in which U.S. adversaries evade our sanctions, including maritime sanctions evasions and financial obfuscation. He urged the importance of understanding and mitigating the risks cryptocurrencies and innovation may present in order to better combat sanctions evasion. He provided a define-in-depth approach to effectively stop evasion, including effective intelligence collection, aggressive designation activity, providing the private sector with the right tools, identifying and tackling emerging areas of risk, and internationalizing the fight.
Question & Answer
Cryptocurrency and Illicit Transactions
Himes asked if there is a quantifiable amount of sanctions evasion occurring in crypto mechanisms and at what rate at sanctions evaders are migrating to those platforms. Himes also asked for ways to mitigate the use of crypto for this purpose. Lorber said the number of illicit transactions using Bitcoin is fairly low, and his main recommendation was to ensure centralized exchanges are developing sanctions compliance programs. Spiro said he also does not have information on illicit volume, but his recommendation was to also focus on the exchanges, arguing that they are the on-ramps and off-ramps to the illicit behavior.
Rep. Josh Gottheimer (D-N.J.) asked about the evolution of terrorism financing through the use of digital assets and how they may be used by illicit actors to evade terrorist sanctions. Spiro said there is incremental growth in relation to the illicit economy, that terrorism financing has seen a similar incremental adoption but noted that it is fairly small. Spiro said law enforcement has been effective domestically but still has seen a number of these technologies abused by several terrorist organizations.
Decentralized Finance (DeFi)
Rep. Anthony Gonzalez (R-Ohio) asked if DeFi by design does not allow for monitoring sanctions compliance and how that capability can be built into OFAC. Spiro said vulnerabilities exist with DeFi around transaction monitoring, which allow for evasions to occur. Spiro added that OFAC is studying this kind of activity, but to what degree the focus is being applied is something to consider because the advancement of technology in DeFi is rapid. Lorber said firms coming to the DeFi space do not have a sense of their OFAC obligations, so he suggested additional regulatory clarity and education.
OFAC Enforcement
Barr asked what type of feedback OFAC and Treasury provide to banks with respect to implementing and enforcing sanctions. He also asked for ways to improve that private-public partnership with banks. Lorber said he supports the OFAC exchange idea, similar to the FinCEN exchange, in which OFAC would get together with financial institutions who they believe were exposed to the illicit activity and provide unclassified and scrubbed information to get them to harden their systems.
Rep. Warren Davidson (R-Ohio) asked if individuals or entities added to OFAC’s specially designated nationals list are regularly monitored and if there is an end goal in mind when someone is added to that list. Lorber said the end goal is to either prevent them from engaging in illicit activity or get them to change their behavior. He added that OFAC does review certain designations to see if they remain current or are no longer in existence.
Rep. Jake Auchincloss (D-Mass.) asked what steps Congress should take to influence OFAC’s measures. Spiro recommended applying more resources specifically in relation to the risks associated with crypto and sanctions evasions so OFAC can produce more designations that include cryptocurrency wallets.
Cyber-attacks
Rep. Roger Williams (R-Texas) mentioned the increase in ransomware attacks against American businesses and asked if Congress can do anything to help small businesses defend against cyber-attacks. Spiro recommended improving domestic cyber hygiene and disrupting the supply chain. Spiro explained that a lot of additional intelligence can be born from the supply chain, such as the money-laundering networks, identifying administrators and affiliates associated, and the procurements vehicles used.
Private-Public Sector Cooperation
Rep. Madeleine Dean (D-Penn.) asked how the U.S. government can better communicate with financial services industry actors and gatekeepers about the risks they may encounter or how they should be making decisions in looking for sanctions evasions. Garces said there is a good amount of outreach when FinCEN provides general information to financial institutions. He said these institutions would benefit from information that is collected at the national level rather than only seeing data from within the walls of their organization.
Know Your Customer (KYC)
Auchincloss asked if KYC is harder with blockchain for technical reasons, political reasons, or not at all. Spiro said KYC is now a different challenge because we have pivoted from brick and mortar to digital finance, and so, synthetic and fraudulent identities are problematic. Auchincloss confirmed that blockchain is a vector for bad actors to evade KYC because of blockchain but that it is more difficult to do KYC for political reasons.
Machine Learning
Williams noted that banks in the private sector play a critical role in keeping bad actors out of the system. As banks are beginning to invest in machine learning, Williams asked what benefits or pitfalls may come from using machine learning versus manual screening. Garces said there is much to gain from automation in this process but that there is still a large human burden in the investigating process.
North Korea
Barr mentioned the Otto Warmbier North Korea Nuclear Sanctions Act, noting that North Korea still continues to evade sanctions, and asked how to better shut down North Korea’s efforts to obtain hard currency. Lorber pointed to his suggestion for a “defense in depth” approach because North Korea is extremely sophisticated in their evasion. He said this approach would call for information to be provided to U.S. and European financial institutions, as well as providing information to firms about specific entities that are tied to North Korea as front or shell companies. Lorber also said there needs to be political pressure put on those who are supporting North Korea, citing China as an example for having created a permissive environment for North Korea.
Geographic Targeting Orders (GTO)
Dean said the U.S. real estate industry plays a large role in sanctions evasion regimes and asked Kumar to speak to the issues that arise from a limited metropolitan list covered by GTO. Kumar said the sanctions program does not only target big actors but also individuals involved in drug trafficking who often hide assets in real estate. Kumar said commercial real estate continues to be unrecognized and that the solution involves rethinking how to apply the GTO and identify gatekeepers and lawyers as pressure points on the investors.
China
Rep. French Hill (R-Ark.) asked if the U.S. is not doing a good enough job on the secondary punishment arena as it relates to Russian and Chinese actors, adding that this is where the choke point of weakness is. Lorber stated that North Koreans find a lot of access to the U.S. financial system and called out Russia and China for providing extremely permissive environments in which North Korean trade-based money laundering and fraud shell companies can operate without consequence. Lorber said there is a need to figure out how financial institutions are working to reduce trade-based sanctions evasion.
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