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When the New York Department of Financial Services (NYDFS) announced last month that it was seeking to impose a penalty of approximately $630 million on Pakistan’s largest bank for violations of federal and New York anti-money laundering (AML) regulations, it acted in the absence of joint action by federal authorities and with potentially significant effects on U.S. national security, signaling a nationally important trend for the state agency.

This action against Habib Bank Ltd. (HBL) has had effects far beyond the enforcement of financial regulations.  Occurring one week after the White House announcement on strategy in Afghanistan and South Asia that included a call for Pakistan to stop harboring terrorist organizations and the Taliban, it has affected U.S. relations with Pakistan and may turn out to be part of a shift in that relationship that will influence the course of the long war in Afghanistan.

Based on AML laws and regulations that are not widely understood, with effects on foreign affairs issues only distantly related to the original purpose of those laws and regulations, this New York state action has, not surprisingly, become subject to questionably accurate reporting and multiple interpretations.  Understanding the nature of both the NYDFS action and the foreign affairs context in which it occurs is necessary to comprehend its full impact both domestically and abroad.

$630 Million in the Air for the Big City

NYDFS is seeking to penalize HBL without joint action by federal authorities despite previous federal and joint federal/NYDFS actions against HBL.  In December 2006, there was a Written Agreement between HBL and the Federal Reserve Board (FRB) requiring HBL to remedy deficiencies in compliance by its branch in New York City with economic sanctions and with AML requirements under the Bank Secrecy Act.  The FRB and NYDFS later conducted a joint action that, on Dec. 15, 2015, concluded with an FRB Cease and Desist Order and NYDFS Consent Order requiring HBL to remedy AML compliance program deficiencies.  On Aug. 24, 2017, however, NYDFS issued a Notice of Hearing and Statement of Charges that announced its intent to seek a $629.625 million monetary penalty, without any joint action or public statement by the FRB.

The NYDFS has not actually imposed this approximately $630 million penalty yet, contrary to many press reports, but if it does so it would be the largest AML civil monetary penalty assessed by the NYDFS or any federal government agency.  The largest NYDFS penalty for AML violations is the $425 million penalty assessed on Deutsche Bank in January 2017, and the largest single federal penalty is the $500 million penalty assessed on HSBC by FinCEN and the OCC in December 2012.  For HBL, with $24 billion in assets and $458.5 million in reserves as of 2016 according to its 2016 Annual Report, an approximately $630 million penalty would have a far greater impact than the smaller penalties assessed on Deutsche Bank and HSBC.

Greenway to the Danger Zone for U.S. Foreign Affairs

The fact that this action is being brought by New York instead of federal authorities is a distinction made by not all U.S. observers and by few in Pakistan, but it is pivotally important to put this action into perspective.  It is part of an apparent emerging NYDFS policy to act independently of federal authorities in major AML enforcement actions.  The Deutsche Bank case earlier this year is another significant example.  NYDFS penalized Deutsche Bank $425 million in January 2017, with the FRB following in May 2017 with a separate penalty of only $41 million.

This assertion of state authority is significant not only for the timing and amounts of penalties, but also for its effect on U.S. foreign affairs.  In the Statement of Charges, which lists 53 distinct charges, NYDFS based its enforcement action primarily on the HBL correspondent relationship with Al Rajhi Bank of Saudi Arabia.  The stated basis for finding a “significant risk” in the Al Rajhi Bank correspondent relationship was a July 2012 U.S. Senate hearing about the HSBC case, which included testimony about alleged Al Rajhi Bank links to terrorism financing in the 1990s and 2000s.  There may be more information not disclosed in the Statement of Charges that the NYDFS is using as the basis for its action, which may come to light in further proceedings (more on that issue later), but if NYDFS is acting solely on the basis of information that federal authorities have not considered worth acting on for years, then it is establishing its own foreign policy in the financial sector over which it has regulatory authority.

Advocates of U.S. action against either Pakistan or Saudi Arabia may cheer in this instance, but there are broader dangers from state government actions uncoordinated with the federal government.  This New York state action has had effects overseas that a state government is not in a position to fully consider.  Perceived as a U.S. action, it has become part of a growing rift between the U.S. and Pakistan, with the timing of the action creating suspicion in Pakistan that it is part of a U.S. campaign of political and diplomatic pressure connected to the U.S. strategy in Afghanistan announced only a week before.  This perception has emerged although the idea of the U.S. federal government and the New York state government coordinating a complicated foreign policy action is absurd to those familiar with the U.S. government.

Within the federal government, the National Security Council and the federal interagency policymaking process exist to ensure that the full effects of an action receive consideration before a government agency takes it.  Regardless of any current problems in these federal bodies, state government actions focused on individual state interests – in this case, in the banking sector in New York – are far less able to take the full interests of the U.S. into account.  One does not have to be familiar with the “Cabinet Battles” in Hamilton to understand this basic principle underlying federal primacy in foreign affairs.

Forget About Who’s Right, When You’re Ready to Surrender – Not This Time

The record high monetary penalty sought in this case has made HBL the first financial institution to refuse to settle an AML enforcement action since the expansion of U.S. AML laws and regulations after 2001.  Financial institutions have been willing to settle AML enforcement actions by agreeing to pay monetary penalties and undertake corrective actions, without formally admitting fault, but the escalation of monetary penalties since 2009 has increased the likelihood that some will decide to refuse to pay the penalties sought by regulatory agencies and contest their allegations.  HBL has decided on this course of action.  As a result, HBL has announced that it will surrender its New York banking license and withdraw from New York and the U.S., memorialized in the bemusingly titled Tender to Surrender, and NYDFS has scheduled a hearing for Sept. 27, 2017.

HBL has stated that it will fight the charges in the administrative hearing and afterward in the courts if necessary.  It is possible that NYDFS and HBL will negotiate a lower penalty amount to end the dispute, but if not, NYDFS may face a protracted legal battle in the courts to enforce a penalty assessment.  The court would likely be federal, and arguments about federal vs. state authority and the significance of the federal government’s absence from this enforcement action may become factors in the litigation.

Sharif Won’t Like It

The Sept. 27 hearing may provide the most revealing look heretofore possible at alleged violations of AML laws and regulations, and arguments against them, in an AML enforcement action.  There may be revelations far more interesting than anything publicly released up to now in an enforcement action.

For example, domestic news in Pakistan has reported that millions of dollars sent from accounts at Al Rajhi Bank to HBL from 2007 to 2017 by relatives of recently deposed Prime Minister Nawaz Sharif, revealed in the Panama Papers, are part of the suspicious transactions that HBL failed to report that led to enforcement action by NYDFS.  These Panama Papers revelations led to Mr. Sharif’s resignation on July 28, after a Pakistan Supreme Court ruling to disqualify him from office for life.  In NYDFS’s Statement of Charges, the only indication of these remarkable events is in the short and formulaic phrase “(iv) politically exposed person activity” in the very last paragraph describing the findings of NYDFS’s investigation (paragraph 28). Sharif, HBL, and others involved in such actions probably will not like the exposure that they receive at the hearing.

It is possible that the Sept. 27 hearing will consist mostly of less colorful legal and regulatory interpretation arguments, but even if it does, that discussion will be an unprecedented debate over the meaning of AML laws and regulations.  It should be a precedent-setting event in the field.

With apologies to Jay-Z, Kenny Loggins, Jackson Browne, and surviving members of The Clash.

Source: BNA

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