Expert Commentary

How the U.S. Financial Blacklist Shapes Foreign Policy

Adam Smith
Of Counsel, Gibson, Dunn & Crutcher

The U.S. government imposes sanctions on individuals, companies, and nations for a variety of reasons, but the practical consequences are always the same: U.S. sanctions make doing business as usual a lot harder. The Cipher Brief’s Bennett Seftel sat down with Adam Smith, partner at Gibson, Dunn & Crutcher, to discuss the American sanctions process and how individuals, businesses and nations can get off the sanctions list.

The Cipher Brief: How are individuals and companies sanctioned in the U.S.?

Adam M. Smith: Like so much in law and policy, the process depends on the situation.  As a general matter, when you read that a person or a company has been sanctioned, the process that would have led to that action works as follows: prior to any sanctioning, a sanctions authority must be created.  That authority, more often than not, is based upon the International Emergency Economic Powers Act (IEEPA) of 1977, which permits the executive branch to sanction specific individuals or entities in order to achieve foreign policy or national security goals. IEEPA is triggered by the promulgation of an executive order that identifies a class of potential targets that are eligible for sanctioning. 

For example, there is an executive order that authorizes the U.S. government to sanction peoples, companies, and entities associated with the development of nuclear weapons in North Korea.  There is also an executive order authorizing the sanctioning of entities associated with human rights abuses in Venezuela.  There is a wide breadth of sanctions programs in place, across a spectrum of foreign policy concerns.

Usually, once an executive order is in place, the President delegates responsibility to the Treasury Department’s Office of Foreign Assets Control (OFAC) to target individuals to be sanctioned.

The OFAC targeting unit writes up a package of evidence to demonstrate that the chosen entity meets the standards for designation as set out in the Executive Order and IEEPA. The required evidence has to meet certain thresholds of proof. Once it goes forward and is signed by the OFAC director, the specific entities are sanctioned and frozen out of the U.S. financial system.

Identifying a country as a state sponsor of terror, which is not actually a sanction but has sanctions implications, is, as a general rule, a State Department action. That process is somewhat similar to OFAC sanctions from the targeting perspective and trying to figure out whether or not countries deserve to be sanctioned.

While OFAC and the State Department appear to have distinct and discrete roles with respect to sanctions and the identification of State Sponsors of Terror, in reality, most of these decisions, especially ones with potentially serious repercussions, are undertaken on an interagency or “all of government” basis.  Even if OFAC, at the end of the day, holds the pen on sanctioning an individual, company, or bank, which it certainly does, before the agency finally decides to impose sanctions, it consults with other components of the Executive branch.  Many Executive Orders require such consultation, and even for those that do not, the practice is ingrained into the process.

TCB: What does it mean when we hear in the news that the U.S. sanctions a specific country, such as North Korea?

Smith: It depends. In the context of North Korea, we have effectively sanctioned the entire country of North Korea because we’ve imposed sanctions on essentially all exports to North Korea, meaning we can’t engage in the provision of services or goods to North Korea. That being said, there are also individual sanctions on North Korean citizens and on North Korean companies whose assets are blocked and that are unable to access global financial markets.

There are very few countries or jurisdictions that are comprehensively sanctioned in that fashion, but there are many countries that have residents or companies that are sanctioned. About 160 jurisdictions in the world have at least one, and usually many more, individuals or entities within their territory that are sanctioned by the U.S. government. But there are only half a dozen or so jurisdictions that are comprehensively sanctioned, including Iran, Cuba, North Korea, Syria, Sudan, and the Crimea region of Ukraine. 

One of the interesting things about the additional North Korea sanctions that were imposed recently is the targeting of entities outside of North Korea for providing support to North Korea.  The U.S. did this fairly recently with respect to the Dandong Bank in China, sanctioning it for its activities in North Korea. That’s a different model in some respects in going after the providers of the ballistic weapons or finances who, historically, have been located in the sanctioned country.

TCB: Are there any practical differences if sanctions are imposed on individuals or entities for nuclear proliferation activities, human rights violations or terror finance?

Smith: There was a time when the answer to this question would be very easy, and the answer was: it doesn’t matter. The consequences are the same. You are on what is called the Specially Designated Nationals and Blocked Persons list (the “SDN List”). If you search that list, you will see 5,000 or 6,000 entities listed, and in each case, the listing is followed by a tag that references why they are on that list (WMD proliferation, narcotics trafficking, etc.).  No matter why an entity is on that list, the broad consequences are exactly the same. 

The reason that answer has become a little more complicated as of late has to do with sanctions that we imposed on Russia in the wake of its annexation of Crimea and Moscow’s continued destabilizing activities with respect to eastern Ukraine. The United States imposed a unique set of sanctions on some large entities in Russia that are not SDN sanctions.  These measures impose more limited restrictions on their activities, but they are not fully “blacklisted.” Therefore, the consequences for these entities are actually different than the consequences for the vast majority of entities that are sanctioned under U.S. authorities.

There are also more serious consequences for a select few entities on the SDN list, including those Iranian entities associated with the Islamic Revolutionary Guard Corps.  These entities are not only blacklisted, like every other SDN listee, but also incur secondary sanctions risks for any entity – even those completely outside U.S. jurisdiction – that chooses to transact with them. 

TCB: How closely does the U.S. cooperate with foreign countries, namely the European Union, when implementing sanctions? Does the U.S. notify foreign countries prior to sanctioning a foreign entity?

Smith: It depends on the situation. Often for close allies, the U.S. will provide notice shortly before a sanctions listing will become live.   In some cases, the U.S. government actually wants the foreign counterpart to coordinate actions, and consequently, we may provide the foreign partner both notice and information in the hope that it will also issue sanctions or related actions, such as local indictments, to further pressure the sanctioned actor.

This sort of cooperation is a mainstay of U.S. counter-narcotics sanctions practice and is frequently seen throughout Latin America.  When the U.S. seeks to sanction an individual for narcotics trafficking, the jurisdiction in which the individual resides often follows suit. We have seen in Colombia, Mexico, Panama, and Honduras that the local governments have become adept at acting, shortly after an OFAC sanction goes live, to impose other restrictions. For instance, the governments may commence forfeiture proceedings, and they might begin some other suits against the target.

TCB: How often do U.S. sanctions align with UN-imposed sanctions?

Smith: Because the U.S. has the most capable sanctions investigation, enforcement, and administration bodies in the world, it is very common that entities sanctioned by the UN are proposed to the Security Council by the United States and are often already sanctioned domestically by OFAC. Other countries, at times, make proposals to the UN Security Council; but, of course, the U.S. can always veto such actions if does not agree with the proposals.

But even if an entity is sanctioned by the UN, the U.S. still needs to undertake its own domestic process to have those entities appear on the SDN list. As a legal matter, it can be confusing because once an entity is sanctioned under UN authorities, the U.S. government no longer needs to rely on IEEPA as its authorizing statute, but rather on the UN Participation Act (UNPA), which is the act that allows for the U.S. to participate in UN activities and comply with UN obligations. Though there are some differences in collateral effects with respect to sanctions imposed under the UNPA compared with those imposed under IEEPA, as a practical matter, the U.S. government still must go through the designation and sanctioning process on a domestic basis before it can put the individuals on the U.S. list even though the UN has sanctioned them.

Therefore, even though there is a large overlap between UN designated and U.S. designated individuals and entities, it is not 100 percent. There are some entities that the UN has designated that the U.S. has not, and of course there are thousands of entities that the U.S. has designated that the UN has not. 

TCB: What happens when a business that the U.S. wants to sanction is state-owned? What are the practical and policy differences?

Smith: There are two ways to think about it. One is the actual practicality of what happens when such an entity is listed. The other is the policy and the process that go into the listing.

In terms of the first factor, as noted above, as a general matter if you are on the SDN list, the consequences are exactly the same no matter who you are or why you are on that list. Anybody in the U.S. including natural and legal persons, financial institutions, and corporations cannot engage in financial transactions with someone who is on that list.

The impact of such ostracism can be huge given that the U.S. dollar is used in so many transactions around the world. Indeed the consequences of being listed are of greater or lesser impact depending on the exposure the target has to international finance and the U.S. dollar in particular. There are some state entities that have huge exposure to the U.S. and the U.S. dollar, and therefore, sanctioning them would be incredibly impactful. For example, when Iranian oil companies and the Iranian petroleum sector were on the U.S. sanctions list, it posed a huge problem because petroleum products are priced and sold in the U.S. dollar.

On the other hand, if a sanctioned entity is a purely domestic concern with little or no exposure to the U.S. or broader global finance, the impact would be significantly less. Some argue that this has been the failing of the significant North Korean sanctions in place. The ability and willingness of the North Korean government to remain outside the global financial system, even at the expense of impoverishing its people, means that traditional U.S. sanctions have had a comparatively minimal effect. 

In terms of policy, there is a difference between going after a major state-owned company from an important economy and going after a narcotics trafficker, an individual, or a smaller concern.  In the former, there will be significant inter-agency equities that need to be managed; in the latter, the concerns will be less, and OFAC will have much greater freedom to sanction on its own.

It is important to remember that almost all sanctions are implementations and manifestations of U.S. foreign policy. If the U.S. is dealing with a company or country that is important, the policy process surrounding the debate of whether or not to sanction is much more charged and contentious, especially if a target country will likely object, and even more so if that country will attempt to retaliate against U.S. interests.

From a policy perspective, the U.S. must also consider the appetite and ability of other countries to go along with U.S. sanctions policy.  It’s certainly true that the U.S. dollar is without equal with respect to its use in the world, as a reserve currency, and in global trade, but the U.S. does not have a monopoly on trade, and sanctions are much for effective diplomatically and economically if other countries, and certainly major money centers such as those in Europe and Asia, impose similar sanctions.

So, if we want to sanction an individual, entity, or a country and our allies do not, we have to think about if we want to act on our own and what sort of consequences for sanctions effectiveness and diplomatic relations such unilateral actions might have. That realization may not change the actual process, but it does change the policy calculus and the contentiousness with which the decision is reached.

TCB: What is required for an individual or company to be removed from the sanctions list?

Smith: Sanctions removals are challenging. Getting off the SDN list requires proving a negative – that you are no longer and will not return to engaging in certain activities for which you were sanctioned in the first place.

The imposition of sanctions is not a judicial determination, as there is no judge involved in imposing sanctions, declaring  guilt or innocence of a party.  Rather, sanctions are an administrative tool of the executive branch designed to encourage behavior change on behalf of targets. If an individual is sanctioned for being a narcotics trafficker, for example, in order to be removed from the sanctions list, he needs to demonstrate to OFAC’s satisfaction that he is no longer a narcotics trafficker.

OFAC, to its credit, has focused a lot of attention in the last five or six years on removals. The agency realized that there is an issue of good governance regarding people who are on the list who probably shouldn’t be there anymore. Certainly, the number of removals has gone up significantly in the past five or six years.

But removals remain a difficult process. There are lots of people who want to get off the SDN list, and frankly, many of whom may deserve to get off the list, who have a hard time demonstrating to the satisfaction of the U.S. government that they are not only not engaged in that activity and are not a high risk for recidivism either.

The counter-narcotics sanctions program is the most successful with respect to de-listings.  This is in large measure due to the unique features of narcotics traffickers who often work at the intersection of illegal and legal activities.  Many people who have been in targeted under these sanctions like to have a foot in both the legal world and the illegal worlds; they hold legitimate jobs, sources of income, and investment and simultaneously augment their lives with illegalities associated with narcotics trafficking. Thus, narcotics traffickers have a lot to lose if they are shut out of the U.S. market, whether it’s property in the U.S., children being educated in the U.S., or their desire to undertake legitimate business in the U.S.

One other way to potentially be removed from the SDN list is to sue OFAC for reconsideration.  Such suits are filed frequently but rarely succeed.  Judges will be hard-pressed to overturn OFAC designations.  This rarity is due to the way sanctions work. Sanctions are not judicial determinations; they are administrative determinations, and judges often give deference to administrative determinations, especially within the foreign policy/national security space. Add that to the fact that OFAC can use confidential and classified information to designate somebody, and you realize that it’s a very challenging act for someone to come in and question OFAC’s determination.

The Author is Adam Smith

Adam Smith recently joined Gibson Dunn's Washington, D.C. office after five years in the Obama Administration at the White House and Treasury working as a senior sanctions official.   He spearheaded the Administration's efforts to implement Congressionally-mandated secondary sanctions on Iran, developed sanctions relief strategies in the context of the Iran nuclear agreement, authored industry guidance and advisories, and negotiated parallel sanctions measures put in place by the European... Read More

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