Countering Proliferation Finance
Lessons Learned from the Chinpo Shipping Case
By Beatrice Müller
On 13 July 2013, the vessel Chong Chon Gang was intercepted for inspection by Panamanian authorities. The general cargo vessel, which was on its way from Cuba to the Democratic People’s Republic of Korea (DPRK), was seized upon suspicion of carrying drugs. No drugs were discovered on board. Yet, covered underneath 200,000 bags of sugar, the largest shipment of arms (and related material) in violation of the arms embargo on the DPRK was revealed. Among the military equipment, parts and whole MiG-21 aircrafts were found, along with small arms, light weapons, and ammunition.
The shipment was facilitated through the payment of transportation fees by a Singaporean company, Chinpo Shipping Company (Private), Ltd (Chinpo). Chinpo ended up getting prosecuted in Singapore for its financial involvement in the shipment.
As Chinpo was charged for the provision of financial services to a DPRK entity, the case could have been a flagship prosecution of proliferation finance. However, as will be discussed, the Chinpo case rather illustrates difficulties in preventing and prosecuting proliferation finance. Analyzing this case helps to understand how proliferation finance looks in practice and illustrates the importance of a comprehensive implementation of UNSC sanctions in order to ensure efficient prevention of nuclear proliferation.
1. Concealed financing of the shipment
We may ask how this large shipment violating an extensive sanctions regime could have been hidden from authorities. Apart from having physically concealed the military equipment, the DPRK also employed sophisticated methods to cover the financial transactions related to the shipment.
The Chong Chon Gang was operated and managed by the North Korean Ocean Maritime Management Company, Ltd (OMM), which arranged the shipment to take place. To avoid special monitoring in its daily business, OMM established a network of Southeast Asian companies and representatives. Among these companies was the Singapore-based Chinpo. Chinpo was instructed by OMM to pay the fees for the Chong Chon Gang’s passage through the Panama Canal. As instructed, Chinpo transferred these fees to a Panamanian shipping agent through its Bank of China account.
Chinpo was initially but a small shipping agent business and ship chandelling company, run by Tan Cheng Hoe and his family. Tan’s business relation to the DPRK dates back to the 1970s, when he started providing maritime trade services to DPRK entities. After OMM’s establishment in the 1990s, Chinpo provided ‘transportation-related services to OMM’. Soon, Chinpo started to act as OMM’s Singapore-based shipping and payment agent for all purposes – beyond only shipment-related services. As OMM was not able to open bank accounts in Singapore, OMM began to use Chinpo for its financial transactions. Financial services executed by Chinpo included the collection of payments due to OMM, paying OMM’s Singapore staff, as well as remitting monies to North Korean vessel owners, to OMM, or to other overseas entities as instructed by OMM. Chinpo did so without questioning the purpose of the remittances. It would later be assessed in the court proceedings that these actions constituted a remittance business without Chinpo having a related licence. Finally, Chinpo ceased to indicate vessel names in relevant transactions to prevent further questioning by foreign banks.
2. The court proceedings
In relation to Chinpo’s remittance on behalf of OMM in the Chang Chon Gang incident, Singaporean prosecutors filed two separate charges against Chinpo and its director in June 2014: firstly, carrying on a remittance business without the possession of a valid license; and secondly, transferring financial assets or resources that may reasonably be used to contribute to the nuclear related programs or activities of the DPRK. Chinpo was found guilty of both charges by the responsible Singaporean district court on 14 December 2015. However, the High Court rejected one of the charges on appeal.
Regarding the first charge, the district judge ruled that Chinpo carried out a remittance business without a valid license by applying for a total of 605 outward remittances amounting to $40 million between the years 2009 and 2013. On appeal, this conviction was upheld by the Singaporean High Court judges.
Secondly, Chinpo was charged with transferring financial resources that may reasonably be used to contribute to the nuclear program of the DPRK. This case constituted the first known prosecution of financing of proliferation-related activities. Accordingly, there were high hopes for this case until it was rejected on appeal.
The legal basis for the prosecution regarding the second charge was Regulation 12 (b) of Singapore’s so-called ‘UN Regulations 2010’. Singapore’s UN Regulations 2010 translate UN Security Council sanctions on the DPRK into Singaporean law. Reg 12 (b) reads as follows:
No person in Singapore and no citizen of Singapore outside Singapore shall—(a) provide any financial services; or (b) transfer financial assets or resources, or other assets or resources, that may reasonably be used to contribute to the nuclear-related, ballistic missile-related, or other weapons of mass destruction-related programs or activities of the Democratic People’s Republic of Korea.
Given the formulation of Reg 12 (b) the prosecution had to argue that Chinpo’s financial transfer may reasonably be used to contribute to the nuclear- or ballistic missile-related program of the DPRK. Yet, the vessel was carrying conventional weapons. The district court argued that the arms and related material onboard the Chong Chon Gang, while not being nuclear-related themselves, may be used to protect the DPRK’s nuclear weapons program. It was further argued that the remittance for the Panama Canal fees was considered a necessary payment for the transportation. Thus, the court argued that the remittance could reasonably be used to contribute to the nuclear program of the DPRK, finding Chinpo guilty of violating Reg 12 (b).
This line of reasoning did not convince the High Court. It criticized the district court’s decision on the grounds that the latter should have analyzed whether the transfer itself could reasonably contribute to the nuclear program of the DPRK, rather than proving the link of conventional weapons to the nuclear program. The High Court not only rejected the claim that the conventional weapons contributed to the nuclear program. Based on a very restrictive interpretation of Reg 12(b), the High Court also stipulated that the financial transfer could not reasonably be used to contribute to the nuclear weapons program of the DPRK. According to the High Court, Reg 12(b) exclusively regards financial transfers that can be used to acquire assets that have a direct contribution to the development of nuclear weapons in the DPRK, such as a transfer going to the acquisition of a nuclear warhead. Even the transfer of payments for the transportation costs of the nuclear warhead may not fall under the realm of Reg 12 (b). Accordingly, the prosecution of proliferation finance was not successful, demonstrating some of the difficulties involved in prosecuting such cases.
3. Countering proliferation finance: Lessons learned
3.1 Incomplete implementation of UNSC resolutions in national legislation
Among these difficulties was the incomplete implementation of UN Security Council resolutions. Reg 12 (b) was based on UNSC resolution 1874 (2009), yet the resolution had only partially been implemented into national legislation. Paragraph 18 of resolution 1874 (2009) called on member states to prevent the provision of financial services that could contribute to the DPRK’s nuclear-related, ballistic missile-related, or other weapons of mass destruction-related programs. As Reg 12 (b) was exclusively based on this paragraph, other relevant paragraphs were ignored. Particularly relevant would have been the implementation of paragraphs 9 and 10 that banned financial transactions related to conventional weapons. Thus, a comprehensive implementation of the relevant UNSC resolutions would have enabled the prohibition of financial services contributing to the transfer of conventional weapons.
Reg 12 (b) of the UN Regulations 2010 has since been amended to address some of these shortcomings. The amendments introduced the prohibition of the provision of financial services contributing to other prohibited activities. This meant that a financial contribution to the transfer of any designated export item became prohibited in national law, i.e. including the financial contribution to the transfer of conventional weapons.
Despite UNSC res 1540 (2004) and its call on Member States to criminalize proliferation financing activities, many countries do not implement all DPRK-related financial sanctions in their respective national legislation. This results in a situation in which DPRK entities are able to continue operating with impunity in many jurisdictions. A full implementation of UNSC resolutions would therefore help to prosecute cases like Chinpo.
3.2 Activities through non-designated individuals or entities
When the shipment took place, OMM was not listed on the UNSC sanctions list. It took more than a year after the interception of the shipment for OMM to be added to the UN Consolidated List of Sanctioned Individuals and Entities. Chinpo, however, has never been listed. Further, in spite of being designated, OMM continued for several years to operate through established evasion tactics.
This illustrates the limits of countering proliferation through a list-based screening approach. The FATF notes that while “the screening of names and addresses against the consolidated list of designated persons and entities […] is necessary in ensuring compliance with certain elements of targeted financial sanctions […] the screening would not be sufficient on its own, as targeted financial sanctions are also applicable to persons/entities acting on behalf of or at the direction of designated persons/entities”. Notably, this was the case with Chinpo acting on behalf of OMM, without being designated itself. While the screening for entities or individuals who act on behalf of designated entities or individuals is recommended, it remains a challenge, as the latter names are unlikely to appear in financial transactions.
3.3 Activity-based compliance
Furthermore, the suggestion of the FATF to screen for names of persons or entities acting on behalf of designated persons and entities does not fully solve the problem associated with list-based screening approaches. In practice, list-based screenings remain ineffective if individuals not listed on UN sanctions are involved in the proliferation finance activities. Even for detecting listed individuals the screening methods applied by financial institutions have their inherent shortcomings: The automated software which is usually used to screen a transaction’s parties against UN sanctions lists returns very high number of false positives due to typing errors or name similarities.
Nevertheless, the FATF Recommendation concerning proliferation finance remains narrowly focused on the requirement to implement targeted financial sanctions. Targeted financial sanctions are also referred to as ‘list-based sanctions’ as they require freezing funds or assets and imposing other restrictions on designated entities and persons. The Chinpo case has shown that the DPRK’s ability to act through front companies and non-designated middle-men will not be hampered by focusing exclusively on targeted financial sanctions.
Financial institutions wishing to avoid proliferation financing should therefore also focus on implementing prohibitions of financial services which contribute to prohibited activities. Activity-based financial prohibitions are further-reaching than list-based sanctions. They aim to prevent transactions even if no sanctioned entity or individual is directly involved in the transaction. Thus, activity-based controls are better suited to prevent cases like Chinpo.
Implementing activity-based screenings is a challenge as they are significantly more difficult and time-intensive, i.e. more expensive for financial institutions, than automated list-based screening methods. In order to apply activity-based screening methods, financial institutions need to know how to identify proliferation activities. Yet, financial institutions lack the capacity to determine which activities are proliferation-relevant.
In order to make activity-based screenings work, the capacity of financial institutions to identify proliferation activities must be enhanced. This can be done by providing guidance on proliferation typologies. It has been suggested that financial institutions should invest in risk-management practices that incorporate proliferation risk indicators, and in the education of their compliance officers. Further, financial institutions should upgrade their automated screening processes to go beyond list-based screenings. Collaboration between financial institutions, financial intelligence, financial regulators, but also customs and export control authorities may help to bring together the needed expertise to assess risks of contributing to proliferation activities. Financial institutions need not only to inquire if transactions involve designated entities, but also if the end use and the purpose of the transaction is legitimate.
3.4 The need for risk-based compliance mechanisms
The involved financial institution failed to comply with the necessary due diligence regarding the transactions of Chinpo. The investigations into the case brought to light that the large-scale transactions were executed without Bank of China (BoC) officers expressing concerns. Several “red flags” should have been identified by BoC: Chinpo suddenly omitting vessel names from transactions; bulk cash withdrawals of up to $500,000 from Chinpo’s account by a North Korean diplomat; and Chinpo having a close relation to the DPRK. Given these red flags and the companies’ shipping business, it should have been handled in a high-risk category. Remarkably, BoC failed to inquire about Chinpo’s remittances on all but one occasion. The only inquiry that took place was in relation to the Chong Chon Gang’s passage to Cuba, which had triggered an alert regarding US sanctions on Cuba. The reasons for this inquiry were therefore not, as they should have been, concerns regarding the DPRK sanctions.
In order to counter these compliance failures, financial institutions should be required to apply enhanced due diligence for transactions with higher risks of contributing to nuclear proliferation. In order to identify risks, a risk-based approach to counter proliferation finance should be applied. Financial institutions should be required to assess, evaluate and monitor their risks of contributing to proliferation finance and take measures to mitigate those risks. Risk factors can be identified through assessments of customers, countries or geographical areas, products, services or business channels engaged with.
The first FATF recommendation requires countries to apply a risk-based approach and to take measures to prevent and mitigate money laundering and terrorist financing risks. Yet, the recommendation does not extend these requirements for countering proliferation finance. As a risk-based approach is equally relevant to countering proliferation finance, this is a serious shortcoming of the FATF Recommendations.
In particular, recommendation 1 calls for countries to ensure that their anti-money laundering and countering the financing of terrorism regime adequately addresses and mitigates high risks. Countries should require their financial institutions to apply enhanced mitigation measures if high risks have been identified. This requirement – which the FATF does not explicitly recommend for countering proliferation finance – would have been necessary for the treatment of Chinpo’s transactions.
Recommendation 1 should therefore be extended to countering proliferation finance. What is more, a risk-based approach should not only be applied to countering proliferation finance, but also to counter financing of conventional arms trade with the DPRK. The Chinpo case illustrates that a broader application of a risk-based approach by financial institutions is required to effectively prevent the circumvention of UNSC sanctions.
About Beatrice Müller
Beatrice Müller holds a bachelor’s degree in Political Science and a master’s degree in Middle Eastern studies from the University of Geneva. She is currently working in the field of arms control, non-proliferation and disarmament, while also serving as a foreign policy co-editor at the Swiss think tank foraus. Previously Ms. Müller has interned and worked for a human rights NGO and the Inter-Parliamentary Union.