INSIGHT: The U.S. Probe of Chinese Banks—What Counterparties Need to Know

The U.S. is investigating hundreds of millions of dollars in financial transactions involving three Chinese banks that allegedly helped finance North Korea’s nuclear weapons program. Kirkland & Ellis attorneys offer critical considerations for counterparties to evaluate if dealing with these banks.

As part of an ongoing criminal investigation, the Department of Justice issued subpoenas to three Chinese banks in July.

The banks’ identities are not disclosed in publicly available court filings, but according to certain press reports, the banks are: Bank of Communications (BOC), China Merchants Bank (CMB), and Shanghai Pudong Development Bank (SPDB) (collectively the Banks).

How the investigation plays out, and subsequent court decisions, may have a signaficant effect on those doing business with the Banks.

The DOJ apparently gathered evidence indicating that a Chinese entity (the Company) acted as a front operation for a sanctioned North Korean-owned entity (NKE). The NKE purportedly used the Company—which, in turn, utilized the Banks’ correspondent accounts—to carry out U.S. dollar transactions that the NKE was prohibited from engaging in directly. The Company’s actions purportedly allowed North Korea to generate revenue to support its nuclear weapons program.

The DOJ served grand jury subpoenas on BOC and CMB, and SPDB received a “5318 subpoena.”

DOJ’s Authority

Pursuant to the USA PATRIOT Act, the DOJ and Treasury Department are authorized to issue 5318 subpoenas to obtain records from foreign banks maintaining correspondent accounts in the United States, including records maintained outside of the United States relating to the deposit of funds into the foreign bank.

The subpoenas seek the Banks’ records from 2012 through 2017 “concerning all correspondent banking transactions associated with certain accounts linked to the Company.” Through these subpoenas, the DOJ seeks to “grasp the full scope of the Company’s operations” and “to learn whether the Company or any other entities have committed various federal crimes.”

On April 10, a district court judge concluded that the Banks failed to comply with the subpoenas, held them in civil contempt, and imposed monetary penalties of $50,000 per day on each Bank (that were stayed pending appeal). Following the Banks’ appeal, the D.C. Circuit affirmed the district court’s ruling on Aug. 6.

The DOJ’s investigation—and the Banks’ failure to respond to the subpoenas—could have significant consequences for the Banks and third party financial institutions, as well as operating companies and private investment funds that do business with the Banks.

What’s Next?

It is difficult to draw definitive conclusions given the limited public information on this matter. Nevertheless, we make the following preliminary observations.

1. The DOJ’s investigation appears to be focused on the Company. The D.C. Circuit opinion states that the “government does not currently suspect the subpoenaed Banks of any wrongdoing.” However, the DOJ’s position could change if additional evidence suggests the Banks knowingly participated in, or knew of, the Company’s illicit scheme. Indeed, the Banks may risk disclosing incriminating information by responding to the subpoenas.
2. If any Bank participated in a money laundering scheme involving North Korea, it could face significant criminal or civil penalties for violating U.S. sanctions or anti-money laundering laws. The Banks’ potential risk of sanctions violations appears to be particularly high, given the Company’s alleged use of the Banks’ correspondent accounts on behalf of the sanctioned NKE.
3. In addition, various Treasury Department divisions could impose non-monetary punitive measures. The Office of Foreign Assets Control (OFAC) potentially could sanction the Banks, and/or the Financial Crimes Enforcement Network (FinCEN) could levy special measures upon them. OFAC is authorized to place secondary sanctions—including blocking sanctions—on foreign financial institutions that engage in significant transactions with sanctioned North Korean entities. FinCEN could designate any Bank as a primary money laundering concern and impose various “special measures” that would subject covered financial institutions to certain recordkeeping, reporting, or information collection requirements when dealing with the Banks, and/or prohibit covered financial institutions from opening or maintaining correspondent or payable-through accounts for the Banks. OFAC has sanctioned banks that have aided North Korea to evade U.S. sanctions, and FinCEN previously targeted China’s Bank of Dandong with special measures for facilitating North Korean transactions. OFAC and FinCEN may proceed more cautiously in these circumstances because the Banks are all larger than Bank of Dandong and participate extensively in the global financial system.
4. SPBD’s failure to comply with a 5318 subpoena could lead to severe consequences as well. If the Secretary of Treasury or attorney general determines that a foreign bank has not complied with a 5318 subpoena, they can issue a written notice to “covered financial institutions” (i.e., banks and other regulated entities) requiring them to terminate their correspondent relationships with that foreign bank.

Tread Lightly

Neither the secretary of Treasury nor the attorney general has previously issued a written notice in this context, so such action against SPDB would be unprecedented. BOC and CMB received grand jury subpoenas and thus do not face correspondent account penalties for failing to respond.

Given the Banks’ noncompliance with the subpoenas and potential involvement with the Company’s illicit scheme, global counterparties should carefully evaluate new, long-term arrangements with any of these Banks, particularly those involving dollar-denominated transactions. Of the three, SPDB may merit special caution, given its exposure as a recipient of a 5318 subpoena.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information
Michael S. Casey is a partner in the Government, Regulatory & Internal Investigations group in the London office of Kirkland & Ellis International LLP. His practice focuses on representing clients in investigations, transactions, and regulatory matters related to economic sanctions, export controls, money laundering, international corruption, customs, and the CFIUS review process.

Cori A. Lable is a partner in the Government & Internal Investigations practice in the Hong Kong office of Kirkland & Ellis International LLP. She advises multinational clients throughout Asia on international risks related to cross-border investments and operations, including corruption, money laundering, economic sanctions, and financial fraud, and defends clients facing U.S. criminal and regulatory investigations on these issues.