Sanctions Reform Should Start with the Treasury Office Enforcing Them

In 2019, Hizballah called on its supporters to send donations. These calls came as U.S. economic sanctions impeded the group’s ability to access financial networks and forced it to cut salaries and other benefits to its employees. According to the U.S. Treasury, sanctions ultimately “degrad[ed] its malign influence” throughout the Middle East and weakened the influence of its sponsor Iran in addition. America’s use of and dependence on economic sanctions as a national security tool has been buttressed by successes like these, and the earlier combination of U.S. and E.U. sanctions and cooperation widely credited with bringing Iran to the negotiating table over its nuclear program in 2015.

But the increasing reliance on economic sanctions placed meaningful pressures on the Treasury Department in fulfilling its mandate and raised the risk of losing a useful tool to overuse — so much so that, when Joe Biden came to strength in January 2021, he promised that the United States would reevaluate its use of economic sanctions. Treasury just released the promised sanctions review, recommending five steps to modernize sanctions. The final recommendation, to shore up the offices charged with administering and enforcing economic sanctions, is the most crucial. Without first addressing Treasury and Office of Foreign Assets Control’s foundation — modernizing its sanctions technology, growing and maintaining its workforce and infrastructure — U.S. interests and security keep at risk, and any attempt to improve America’s use of economic sanctions will fail.

 

 

As the Oct. 18 report indicates, Treasury’s workload — and specifically that of the Office of Foreign Assets Control, or OFAC, charged with administering and enforcing U.S. economic sanctions — has only increased in the last four years as the United States has used its economic strength to using sanctions against not only Iran but also North Korea, Russia, and Syria. It also uses sanctions to combat drug kingpins and counter terrorism. OFAC sanctions designations have risen considerably, from 912 in 2000 to over 9,000 in 2020. U.S. sanctions regimes have also nearly tripled in number from 69 in 2000 to just under 180 in 2021. The Biden administration should prioritize the modernization of Treasury’s sanctions technology, grow its workforce dedicated to sanctions enforcement, and enhance its monitoring and compliance infrastructure so that OFAC and Treasury can manager this workload and cope with the challenges of enforcing a growing portfolio of economic sanctions.

While only seven pages in length, the report represents — at the minimum publicly — the new administration’s desired shift in the use of economic sanctions, departing from the Trump administration’s “maximum pressure campaigns” and “sanctions wall.” The four initial steps outlined in the report mirror changes in how the United States uses and applies economic sanctions to foreign policy and national security considerations. These steps impact the contours of economic sanctions. Step 1 urges the adoption of “a structured policy framework that links sanctions to a clear policy objective.” Step 2 advocates for multilateral coordination, when possible, while steps 3 and 4 recommend mitigating economic sanctions’ humanitarian impacts (in addition as political and economic impacts) and making sure that U.S. economic sanctions are easily understood, enforceable, and adaptable.

Beyond Treasury’s issues of modernization, without of human resources, and out of date infrastructure, the use of economic sanctions over the last several years has been complicated by several factors: their overuse, their humanitarian impacts, allies who want to see a more careful and judicious use of economic sanctions, and the development of special-purpose vehicles by the European Union to avoid U.S. economic sanctions. U.S. and E.U. policymakers have rarely seen eye-to-eye on the use of economic sanctions, with the European Union preferring a more targeted approach that minimizes the humanitarian impacts on a target state’s civilians. In June 2021, the Biden administration and the European Union held a virtual summit whose purpose was to repair relations between Washington and Brussels after four years of difficult relations with the Trump administration. The joint communication that emerged from the summit highlighted the need not only for deeper cooperation in the implementation and enforcement of economic sanctions but also greater coordination between the United States and European Union in their administration.

The without of harmonized sanctions regimes between the United States and the European Union is a historical problem. The United States’ decision during the 1990s to impose secondary sanctions, and extraterritorial applications of those sanctions, against Cuba and then Iran saw the European Union push back diplomatically against U.S. efforts to interfere with its trade interests, instituting a blocking mechanism that made it illegal for E.U. companies to comply with U.S. sanctions. Diplomatic efforts led the European Union to withdraw the blocking mechanism, but this mechanism returned during the Trump administration as the E.U. Commission sought to preserve the Joint Comprehensive Plan of Action and keep Iran compliant with the nuclear agreement. The European Union also then debuted the Instrument in sustain of Trade Exchanges, or INSTEX, a special-purpose means that allows trade to take place without the need for money crossing borders.

Special-purpose vehicles are subsidiaries of firms utilized to keep risk off the parent company’s balance sheets. In the case of INSTEX, the special-purpose means is backed by E.U. member states, instead of any single firm, and allows E.U. firms seeking to trade humanitarian goods with Iran to trade instead with European importers and exporters of Iranian goods, eliminating the need to exchange payments directly with Iranian firms. Payments for E.U. firms are settled within the European Union by INSTEX. A separate special-purpose means in Iran settles transactions between Iranian importers and exporters for E.U. goods. While INSTEX has not handled meaningful volumes of trade, the creation of this rare mechanism showed it had the possible to undermine U.S. sanctions, as financial transactions occur domestically without crossing any borders. These different payment mechanisms — the consequence of the reality that the United States and Europe just cannot agree on what to do with sanctioned states — complicates OFAC’s mandate.

The sanctions review also recommended “calibrating sanctions to mitigate unintended economic, political, and humanitarian impact.” During the Trump administration, the “snapback” of economic sanctions against Iran and the “sanctions wall” that administration attempted to impose on Iran after the United States withdrew from the nuclear deal imposed meaningful barriers for humanitarian aid agencies and human rights groups. As Kolja Brockmann and I discuss in a recent Stockholm International Peace Research Institute publication, “overcompliance” — when firms cut all business and trade ties with Iranian counterparts in order to avoid any possible violation of U.S. secondary sanctions, already when some trade is nevertheless legal and permissible — has made it difficult for aid groups and other humanitarian relief agencies to buy supplies and medicines for sanctioned targets like Iran, as edges and other companies cease operations with the country to avoid the risk of being sanctioned. Responding to criticism that aid was unable to reach places like Iran, which had been hit by earthquakes and floods during the Trump administration, Treasury instituted a procedure that aid organizations could utilize to avoid OFAC’s enforcement and penalties. The new procedure, however, produced meaningful additional work for humanitarian groups and aid organizations, requiring anyone wishing to move humanitarian assistance to capture information on the identity of Iranian customers, account balances for those individuals and entities involved in the transaction, the business relationships of those individuals, written commitments from Iranian distributors that such aid would not go to sanctioned individuals or entities in Iran, and a litany of other documentation.

Figure 1. OFAC civil penalties since the Biden administration assumed office in January 2021. Dashed line indicates the average penalty imposed as of October 2021. Chart generated by the author.

The complicate, confusing, and often contradictory mechanism for sending aid worsened a dire humanitarian situation compounded by COVID-19. While it is unknown how many aid organizations and nongovernmental organizations utilized this humanitarian mechanism, the cumbersome character of the policy not only produced headaches for aid organizations but introduced additional layers of scrutiny for OFAC, which is already overworked and understaffed. The complexity and difficulty in keeping up with OFAC regulations and the United States’ use of economic sanctions also makes the Treasury’s recent report — especially step 4, which calls for “ensuring sanctions are easily understood, enforceable, and adaptable” — more basic. The amount of information required to send aid to sanctioned countries was itself a deterrent to providing aid and failed to mitigate the real or perceived risks foreign financial institutions felt in supporting humanitarian trade. As Bryan Early and I noted in a past contribution to War on the Rocks, in addition as in our research on OFAC’s enforcement of U.S. sanctions, E.U. firms, in particular, are sure to remember the staggering fines (nearly $1 billion in one case) the Obama administration imposed on Europe’s financial sector between 2009 and 2015 for violations of Iranian Transactions and Sanctions Regulations, among other U.S. sanctions regimes. These fines — the largest in OFAC’s history – served as a powerful deterrent against violating U.S. economic sanctions and U.S. foreign policy interests.

For Treasury and OFAC to realize the administration’s ambitious goals — to make sanctions clearly connected to a policy objective, multilateral, easily understood, and calibrated to prevent unintended humanitarian or political effects — OFAC should first address its resource deprivation. Exact numbers about OFAC’s budget and staff are hard to come by, and the agency has declined to release that data. edges and other entities have sought OFAC skill by poaching Treasury personnel, and OFAC lost at the minimum 7 percent of its staff (14 out of 200 personnel) to the private sector between 2013 and 2014. Andrew Desiderio has also highlighted how OFAC became “depleted” at a basic time when the Trump administration indicated it was leaving the Joint Comprehensive Plan of Action and reimposing sweeping sanctions against Iran. Russia and its meddling in the 2016 election spurred efforts by Congress to compel the Trump administration to take a harder line and impose further sanctions with H.R. 3364, The Russia, Iran and North Korea Sanctions Act. North Korea, too, required constant monitoring, especially as it was revealed recently that North Korea continues to make use of “correspondent banking” in the United States to ease its money laundering and proliferation finance activities.

Since Biden assumed office in 2021, there have been 14 civil enforcement actions against entities inside and outside the United States. While the first year of the Biden administration featured approximately the same number of enforcement actions as Trump’s first year in office, the average penalty issued during Trump’s first year was considerably higher, more than ten times higher than those enforcement actions issued this year. The without of resources identified by Desiderio and others likely impacts OFAC’s ability to enforce economic sanctions effectively by the imposition of penalties. It takes time and staff strength to hunt for violations, and more time and staff strength to determine whether the violations were egregious and consequently punishable with higher fines. This inability to impose stiffer penalties undermines Treasury and OFAC’s main deterrent in stopping domestic and foreign firms from undermining U.S. economic sanctions and foreign policy prerogatives.

Figure 2. Average penalty across voluntary disclosure of OFAC violations during the first term of the Trump administration in 2017. Chart generated by the author.

This decline in the average penalty goes to the heart of step 5 in the Treasury’s report and further underlines the need to modernize OFAC, grow its ranks, and enhance its infrastructure. Figures 2 and 3, which show the average penalty for violations voluntarily disclosed, are further evidence of OFAC’s without of resources. Historically (between 2003 and 2019), voluntary disclosures have accounted for 25 percent of OFAC’s total publicly released enforcement activity. Voluntary disclosures during the Biden administration are double the historical trend at 50 percent. Why is voluntary disclosure meaningful? Voluntary disclosure refers to those instances cited in enforcement actions where entities self-report their violations and alert OFAC to having violated U.S. laws and regulations. Entities that include in this behavior often get lower penalties on average and typically enjoy better outcomes. while those that fail to voluntarily disclose their violations run the risk of their sanctions violations being listed as egregious, which increases the penalty significantly.

In Figure 2, which shows the average penalty in the first term of the Trump administration by whether the penalty resulted from a voluntary or non-voluntary disclosure, the average penalty is 89 times higher for violations that had not been voluntarily disclosed. This indicates that, in 2017, OFAC found and punished a lot of violations that were not voluntarily disclosed — relying on its own resources or investigations, or those of other U.S. agencies, to discover entities, both foreign and domestic, violating U.S. sanctions.

Figure 3 shows the average penalty across voluntarily and non-voluntarily disclosed violations during the first year of the Biden administration. As the figure shows, OFAC now relies more heavily on voluntary disclosures. It may indicate an under-resourced OFAC as the average penalty for voluntarily disclosed violations is 27 percent higher than violations not voluntarily disclosed. One might attribute this shift to the late start of the Biden administration, but OFAC sanctions enforcement activity during these first ten months is comparable to the Trump administration’s. OFAC is handling approximately the same number of violations as it did in 2017, but most of the violations in 2021 are voluntarily disclosed and consequently receive lower penalties.

Figure 3. Average penalty across voluntary disclosure of OFAC violations during the first term of the Biden administration as of Oct. 22, 2021. Chart generated by the author.

The without of resources (i.e., a staff of approximately 200 personnel) method that OFAC relies on foreign and domestic companies to police themselves. In 2019, Andrea Gacki, speaking before the American Bar Association in Washington, D.C., discussed OFAC’s new compliance framework, which places greater emphasis on the presence and development of compliance programs, shifting the onus of sanctions enforcements onto entities themselves. While OFAC publicly states that these changes mirror efforts to signal its “compliance expectations,” the without of resources likely played a meaningful role in the development and debut of this framework that shifted the responsibility and costs to the private sector, which likely contributes to their overcompliance and de-risking behaviors.

As the United States adds entities and individuals to its list of “specially designated nationals” and increases the number of countries and non-state actors targeted, the private sector faces meaningful pressure to modernize its compliance framework. While Treasury has made efforts to incentivize these investments, firms may find it cheaper to abandon sanctioned markets. Small and medium-sized firms may find sanctions compliance costly and challenging, making it more advantageous to extent back overseas trade.

If the Biden administration and the U.S. Treasury under Secretary Janet Yellen is serious about reforming the use of U.S. economic sanctions, step 5 in the Treasury report should take precedence over all the other steps outlined in the report. An OFAC that is properly funded by Congress and supported by the executive branch will permit the Biden administration to address steps 1-4 more adroitly. OFAC cannot rely on the deterrent effect of punishing foreign firms with heavy fines as financial institutions, particularly foreign ones, have become more mindful of compliance to avoid blistering penalties from the Obama era. As Bryan Early and I point out, those financial “whales” may have been fished to extinction. OFAC can no longer rely on easy targets to fulfill its mandate or to unprotected to deterrence and should now go after the smaller fish, which requires more personnel, time, and resources.

Second, the targeting of foreign firms, especially European ones, only complicates OFAC’s mandate and jeopardizes U.S. partnerships and the ability of the United States to realize short- and long-term foreign policy goals. The use (and sometimes abuse) of economic sanctions comes in part from the strength and dominance of the U.S. dollar in the global financial system. But the United States’ (over)use of economic sanctions may paradoxically end up weakening the dollar: t led Europe to develop special-purpose vehicles like INSTEX, and though it is largely untested, Russia and China are likely to use it as a form in their efforts to distance their economies from the U.S. dollar. Firms once preoccupied with running afoul of U.S. authorities and facing millions of dollars in penalties can now take this risk off their ledgers and pass that risk to  INSTEX, an attractive proposition for countries looking to avoid U.S. secondary and extraterritorial sanctions. The special-purpose means — in theory — provides a protect to E.U. firms seeking to provide humanitarian aid. However, if it proves helpful and develops into a less cumbersome mechanism for the settlement of trade, other goods, such as oil, may soon be exchanged by it. If successful, U.S. economic and financial sanctions would be jeopardized and threats of being secluded from the U.S. banking system would have little effect. U.S. leverage would decline considerably.

Any reforms or adjustments to the United States’ use of economic sanctions to preserve this leverage are likely to fail without first mitigating Treasury’s resource deficit. It is unsurprising that step 5 is last on the list of changes policymakers at Treasury plan to pursue. Steps 1-4 are simpler to realize and can be done within the executive branch alone. A large increase in Treasury’s annual appropriation to increase hiring and add meaningful resources to the budget not only requires congressional involvement but is likely to compete with the pandemic, the president’s infrastructure bill, and the Democrats’ focus on “Build Back Better,” as these initiatives garner considerably more attention from the public than sanctions enforcement.

The best way to strengthen and preserve U.S. interests and national security is an approach that revitalizes all U.S. agencies like OFAC that enforce U.S. sanctions — such as the Bureau of Industry and Security at the Commerce Department and the Office of Economic Sanctions Policy and Implementation at the Department of State — with the necessary human and technological resources to fulfill their missions. Doing so will put sanctions enforcement on a sound and substantial foundation, which matters given policymakers’ frequent recourse to use sanctions as a way to unprotected to U.S. interests and protect national security. Step 1, which calls for a structured policy framework, probably already exists and only requires minor tweaking or truly employing it. Multilateral coordination (step 2) and sanctions calibration (step 3) are sorely needed and easy to implement. Making sanctions easier to understand enhances compliance but duplicates past efforts at Treasury at improving outreach to the private sector. These first four steps disguise the immense challenges facing the United States when it comes to using economic sanctions as an effective policy instrument. Economic sanctions first require investment and political sustain from both the executive and legislative branches of the U.S. government. Taking the path of least resistance will only undermine U.S. economic dominance and security for the Biden administration and future administrations.

 

 

Keith A. Preble is a Ph.D. candidate in the department of political science at Rockefeller College of Public Affairs and Policy and is a graduate research associate with the Center for Policy Research’s Project on International Security, Commerce, and Economic Statecraft (PISCES).

Photo by Mark Pouley



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