November 18, 2016
By Daniel Calloway, Legal Content Writer, SanctionsAlert.com
It’s really dangerous for a financial institution to operate as a third party conduit for fraudsters. That appears to be one lesson from the recent placement on a “do not touch” list by Treasury’s Office of Foreign Assets Control (OFAC) of Pacnet Group.
On September 22, 2016 OFAC designated the Vancouver-based PacNet Group as a so-called ‘significant transnational criminal organization.’
PacNet was placed on the blacklist because according to the government, it was part of an international network that has stolen hundreds of millions of dollars from elderly victims.
The designation by OFAC was unprecedented, because it places a payment processor on the government’s “do not touch” list in the company of deadly and criminal organizations like the Japanese Yakuza, and the Mexican Los Zetas.
As a result of the action, US banks, businesses and citizens are now prohibited from doing business with PacNet and its US-based assets have been frozen.
‘Payment processor of choice’ for criminals
OFAC said in its lengthy news release that PacNet had a history of knowingly processing payments on behalf of a wide range of mail fraud schemes that largely targeted vulnerable individuals such as the elderly and impoverished. The conduct was so pervasive that OFAC described the company as the “third party payment processor of choice for perpetrators of a wide range of mail fraud schemes.” PacNet’s international network members, which consisted of 12 individuals and 24 entities across 18 countries, were also designated.
Executive Order confronts global crime groups
PacNet’s designation was pursuant to Executive Order 13581 “Blocking Property of Transnational Criminal Organizations”.
The rationale for the Executive Order, issued in 2011, is that foreign criminal organizations were becoming increasingly sophisticated, and thus posed a serious risk to the security of the US. These organizations are fully entrenched in foreign governments and the international financial system which undermines the rule of law, economic markets, and, ultimately, democratic institutions.
Crippling criminal organizations
The Executive Order was created to combat the overall effectiveness of such criminal regimes.
Specifically, EO 13581 freezes the property or interests in property of designated individuals or entities (1) within the jurisdiction of the US; (2) within the control or possession of “US persons”; or (3) that may come into the possession or control of any US person, including any overseas branch.
Criteria for designated individuals or entities:
- A foreign person that “constitutes a significant transnational criminal organization (TCO)”;
- Any person that has materially assisted or supported any person whose property interests are blocked pursuant to the EO;
- Any person “owned or controlled” by, or acts on behalf of, a person or entity whose interests in property are blocked pursuant to the EO.
Defined in the EO, a TCO is a group of persons that includes one or more foreign person; that engages in an ongoing pattern of serious criminal activity involving the jurisdictions of at least two foreign states; and that threatens the national security, foreign policy, or economy of the United States.
The names of individuals and entities listed under Executive Order 13581 are incorporated into OFAC’s Specially Designated Nationals and Blocked Persons List (SDN List) with the identifier ‘[TCO].’
A designation under Executive Order 13581 prohibits:
- US persons from engaging in any transactions or dealings in which such designated persons, or any entities owned or controlled by them, have an interest.
- US persons are not allowed to transfer, pay, export, withdraw, or otherwise deal in such property.
- Making any contribution or provision of funds, goods, or services (including charitable donations) by, to, or for the benefit of any blocked party.
- The receipt of such funds, goods, or services from blocked parties.
Also, it is forbidden to take any action to evade or avoid these prohibitions.
Conduit for criminal organizations
Prior to this designation, OFAC hadn’t used its power on a mainstream commercial business not affiliated with a well-known organized criminal group.
The past six designations, for example, included operations like Japan’s well-known criminal organization, Yakuza. According to a Fact Sheet accompanied with the original Executive Order, the Yakuza, at the time, were located in no less than 17 countries with an estimated 80,000 members. The group had a variety of legitimate international businesses in construction, real estate, and finance. Because of the intertwining of the Yakuza’s criminal and legitimate businesses, the OFAC designation was swift and intuitively understandable. They were a well known foreign criminal entity with far reaching arms that disturbed national security domestically and abroad, fitting the precise definition of a TCO.
PacNet’s designation, on the other hand, has made headlines because it is not an outright criminal entity itself. Instead, it is, according to OFAC, a foreign commercial company that operated as a third party conduit for other known criminal groups.
Before designating the company, US authorities warned PacNet of its criminal business partners and requested that they cease business dealings with those entities.
For example, PacNet received subpoenas in 2014 from the Iowa State Attorney General regarding the victimization of the elderly and other Iowans by fraudsters they identified as PacNet clients. Despite the warnings, PacNet did not cease the transaction until law enforcement eventually shut down the fraudsters.
This case serves as a harsh lesson. If financial institutions, despite warnings from authorities, knowingly continue to conduct business with criminal organizations that utilize their institution to launder money or evade sanctions, they will be subject to large fines, criminal prosecution, or, as it turns out, a possible SDN designation.
Comparison with HSBC case
In other financial crime cases, federal and state authorities have taken a more lenient approach. For example, in the 2012 HSBC case, the government alleged that the London-based bank laundered more than US$800 million, and evaded sanctions programs.
Regardless, it did not designate the London-based bank as ‘transnational criminal group’, nor indict it on charges of vast money laundering and sanctions evasion charges. Reportedly, this was for fear that criminal prosecution would topple the bank, and in the process, endanger the financial systems. The bank reached a $1.9 billion settlement to resolve the money laundering accusations.
It appears from the Pacnet case that OFAC not only thinks that assisting foreign criminal entities is just as much a national security threat as the foreign criminal threat itself, but will also take measures that will cut off a financial institution from the US financial system.
OFAC’s decision to designate PacNet will no doubt have an effect on other financial institutions ‘know your customer’ and sanctions screening programs.
Financial institutions and other corporations involved in international business frequently conduct automated screening of customer databases and/or transactions as part of their sanctions compliance program. This screening process assists in detecting individuals, entities and countries subject to OFAC sanctions.
Typically, the provider of the sanctions screening tool to screen customer lists against sanctions lists will add any newly listed entities to the file that is scanned against customers or business partners.
It is reasonable to forecast that US financial institutions and other corporations will consider voluntary reviews of their previous interactions with PacNet, and any other related entities, as a matter of traditional sanctions screening process. If they find a hit, they must report this to OFAC.
Large financial institutions often have ‘correspondent relationships’ with foreign financial institutions. These correspondent accounts, often called a nostro or vostro accounts, are established by a banking institution to receive deposits from, make payments on behalf of, or handle other financial transactions for the foreign financial institution.
Due to the OFAC designation, US financial institutions are well advised to conduct a review to determine if they have a direct or indirect correspondent relationship with Pacnet, and, if so, wind down the relationship as soon as possible.
False positives due to common names
Not only PacNet Corporation, also its subsidiaries, and specific individuals received the TCO designations. The listed individuals were major executives in PacNet’s chain of command, including president, partner and corporate director Paul Davis.
Because the OFAC designation to an individual carries the same prohibitions that it does for a corporation, every time any ‘Paul Davis’, a common name, attempts to open an account or a transaction at a US financial institution, or otherwise wants to conduct business with a corporation, it will be flagged by the institution’s or corporations’s OFAC screening software. As a result, the transaction will be stopped, and the person will be blocked from doing business with that bank or corporation.
Because the name is very common, this obviously may generate false positives triggered by the software tool.
Good guy list
After Paul Davis designation, financial institutions and corporations are well advised to develop a “false hit list” comprised of individuals and entities whose characteristics trigger a screening match to one or more entries on the SDN List or other sanctions criteria, but who, after a thorough review, are determined not to be blocked.
Once an individual or entity is added to the false hit list, sometimes called the ‘good guy list’ the screening software typically will suppress an alert (or will otherwise bypass an alert) associated with the individual or entity, thereby eliminating any transaction hold on, or prompting further manual review of, such parties in the absence of other alerts.