U.S. Gains in Fight With Chinese Banks Over North Korea Sanctions

(Bloomberg) -- A judge has handed U.S. authorities a potent weapon in a long-secret battle with China over alleged evasion of sanctions on North Korea, finding three Chinese banks in contempt of court for refusing to produce evidence in a criminal investigation.

The ruling could give the U.S. new leverage in its confrontation with China over its assistance to North Korea -- power that officials have previously been reluctant to use against large Chinese financial institutions for fear of global shocks. With U.S.-China relations fraying over trade policy and national security, analysts say, that outcome just got likelier.

U.S. law enforcement officials “are not just going to accept that the Chinese government is going to do something about North Korea,” said Jeremy P. Paner, a former Treasury official who is now counsel at Ferrari & Associates, a Washington-based firm specializing in sanctions cases. “They’re willing to be much more aggressive.”

It isn’t clear what form that harder line might take. Barring one or more of the banks from the U.S. financial system would be among the most draconian.

North Korean Front Company?

The decision, by U.S. District Judge Beryl A. Howell in Washington, is rooted in a series of court cases and investigations dating back to 2017, in which U.S. prosecutors seized $1.9 million in bank accounts belonging to a Hong Kong company, Mingzheng International Trading Ltd., that allegedly operated as a front for North Korea’s state-owned Foreign Trade Bank.

The forfeiture case suggests the banks are China Merchants Bank Co., Bank of Communications Co. and Shanghai Pudong Development Bank Co., three of China’s top 10 banks by assets. All three issued statements Tuesday saying they weren’t under investigation for sanctions violations.

“The U.S. is putting these banks between a rock and a hard place,” said Jesse R. Morton, a specialist in money-laundering countermeasures at the Stout consulting firm in Atlanta. He said the requested documents may show that the banks broke sanctions laws.

Read about analyst estimates on impact for the three banks

Morton likened the case to U.S. efforts to go after tax evaders hiding money in Swiss bank accounts. When those banks argued that revealing their customers would violate the country’s privacy laws, authorities threatened to cut them off from the U.S. market, leading to a change in Swiss law.

Heavy Hand

“Whether that happens here is yet to be determined, but prior experience shows us that when it comes to foreign banks that knowingly facilitate fraud, money laundering, tax evasion and a host of other crimes, the U.S. will take a heavy hand,” Morton said.

Representatives of the Treasury Department and the U.S. attorney’s office in Washington declined to comment on the ruling.

The U.S. has hesitated to impose severe penalties on Chinese banks over North Korea, even as Pyongyang has ratcheted up hostilities with Washington, for fear of disrupting trillions of dollars in trade. But much has changed in the past year. Chinese tech giants Huawei Technologies Co. and ZTE Corp. have incurred Washington’s wrath for aid to another perennial foe, Iran. A trade war has escalated. And talks to dismantle North Korea’s nuclear program have gone nowhere.

In that atmosphere, the U.S. may be more willing to pursue aggressive enforcement, as President Donald Trump meets with Chinese President Xi Jinping at the G20 summit in Japan this week.

Winner for Trump

“There’s a lot of political support for this, and politically it’s a winner for Trump,” said Judith Lee, a partner in Gibson Dunn’s international-trade practice in Washington. “He can show his constituents that he’s getting tough on China.”

In addition to its part in the power struggle between Washington and Beijing, the case is notable for the relatively large sums involved. The three banks, which are owned or invested in by the Chinese government, facilitated more than $160 million in transactions for the Hong Kong company from 2012 to 2015, including $100 million funneled through the banks’ own accounts at U.S. financial institutions established to handle dollar-denominated payments, according to one ruling by the judge.

The banks have declined to comply with subpoenas from prosecutors in Washington, saying Chinese law prohibits them from producing client records in response to foreign government investigations. At a news conference Tuesday, Chinese Foreign Ministry spokesman Geng Shuang said the country takes sanctions enforcement seriously but that it opposed “U.S. long-arm jurisdiction against Chinese companies.”

In Shanghai trading, shares of Merchants dropped 4.8%, Bocom 3% and Pudong 3.1%.

Secret Proceedings

The cases have proceeded in secret for nearly two years, but two rulings by Howell have now been unsealed. In the first, dated March 18, she ordered the banks to comply with the subpoenas and produce the records and testimony by late March. In the second, dated April 10, after they failed to do so, she found them in contempt. News of the rulings was reported earlier by The Washington Post. The banks are appealing the rulings.

Mingzheng was one of at least four front companies used by North Korea’s Foreign Trade Bank to send and receive U.S. dollar payments, according to prosecutors. They say they couldn’t find any evidence that it was ever used as a legitimate business. Among the records sought by the government were signature cards used to open the accounts and any due diligence materials showing the banks performed know-your-customer reviews.

Many of the events at issue in the investigation occurred after the Foreign Trade Bank was blacklisted by the U.S. in 2013. In August 2017, the Treasury Department’s Office of Foreign Assets Control added Mingzheng to its list of sanctioned individuals and entities. The company is now defunct.

The contempt ruling on its own probably wouldn’t be enough to trigger a sanctions designation blocking any of the banks from the U.S. financial system. But if authorities gathered other evidence showing the banks knowingly aided or engaged in sanctions violations, it could become part of a blacklisting case.

Elizabeth Rosenberg, a former Treasury official and a senior fellow at the Center for a New American Security, in Washington, cited the standard.

“You have to engage in activity that violates sanctions,” she said, “and is reviewed and passes the legal sufficiency test of agencies of the U.S. government.”

--With assistance from Andrew Harris.

To contact the reporters on this story: Christian Berthelsen in New York at cberthelsen1@bloomberg.net;Tom Schoenberg in Washington at tschoenberg@bloomberg.net

To contact the editors responsible for this story: David Glovin at dglovin@bloomberg.net, Peter Jeffrey, Peter Blumberg

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