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By Mimi Yang , David Zhang and Nathaniel Lai
Mimi Yang is a partner of Ropes & Gray LLP, and a senior foreign legal consultant in the Hong Kong office. She has represented companies, board committees, and individual officers and directors, and has conducted numerous internal corporate investigations involving complex accounting and disclosure issues, whistleblower claims, and potential violations of the Foreign Corrupt Practices Act (FCPA).
David Zhang is a Shanghai-based counsel in Ropes & Gray’s government enforcement practice. His practice concentrates on advising clients on internal investigations, due diligence, and compliance programs, particularly with a focus on anti-corruption and anti-bribery matters in China.
Nathaniel Lai is a Hong Kong-based associate in Ropes & Gray’s government enforcement practice. Nathaniel’s practice is focused on internal investigations, including FCPA investigations, as well as international arbitration and other litigation matters. Nathaniel has also previously served as a U.S. capital markets associate at a leading international law firm. There, he represented issuers and underwriters in a variety of debt and equity transactions.
The U.S. Department of Justice (the DOJ) recently proposed legislative amendments to expand U.S. law enforcement’s ability to access documents located outside the United States. The proposals were made alongside global revelations of illicit transnational fund transfers across the financial system to escape detection, as highlighted by the 1MDB scandal and the Panama Papers leak. In response, the DOJ publicly emphasized that accessing records held outside U.S. territorial jurisdiction is critical to effective enforcement against financial and cyber crimes.
On May 5, 2016, as part of the Obama Administration’s efforts to combat money laundering, corruption and tax evasion, the DOJ released its “Proposals Regarding the Illegal Proceeds of Transnational Corruption,” a set of five proposed legislative amendments designed to expand the DOJ’s enforcement powers in investigating and prosecuting international corruption and money laundering (Proposed Amendments) (See DOJ, Anti-Corruption Legislative Proposals, May 5, 2016). The Proposed Amendments have been sent to the relevant Congressional committees for consideration, including the House Financial Services Committee and the House Judiciary Committee. (See Executive Communications, etc., Congressional Record 162:81 (May 23, 2016)). While it is not clear when (or if) the Proposed Amendments will be up for a vote, they could potentially be enacted in the near future.
Among other things, the Proposed Amendments would enhance U.S. regulators’ abilities to subpoena financial records from foreign banks and require them to authenticate those records for use as evidence in criminal proceedings. This expansion of extraterritorial subpoena powers is not surprising – in 2014, it was predicted that the U.S. Treasury would take further steps to subpoena overseas records following the passage of the U.S. Foreign Account Tax Compliance Act (FATCA) (See e.g., Patrick S. Sinclair and Timothy V. Capozzi, “Ready for Uncle Sam to Subpoena Your Overseas FATCA Documents?” BNA Corporate Accountability Report, Dec. 12, 2014). Indeed, the newly proposed legislation could result in real implications for foreign banks: it could signal the DOJ’s intent to increase issuance of subpoenas to foreign banks and alter the leverage of those banks in their interactions with the DOJ. Depending on where the foreign bank records reside, this new legislation could exacerbate the already complex legal issues faced by financial institutions operating in certain foreign jurisdictions with strict data privacy and state secrecy laws
Whereas banking and money services have become significantly more globalized over the last decades, law enforcement powers have traditionally limited jurisdictional reach. This has, in turn, limited U.S. enforcement agencies’ ability to investigate transnational movement of money in furtherance of illicit activities ( See DOJ, Anti-Corruption Legislative Proposals, May 5, 2016 at p.9.). Modern criminals make extensive use of the global financial system to channel funds across borders for terrorist financing, corruption, and tax evasion. This has posed challenges for foreign banks subject to various money-laundering laws, as well as to national governments attempting to investigate such crimes. In response, U.S. law enforcement agencies are increasingly taking the view that effective criminal enforcement requires being able to access information and records held in foreign jurisdictions. As the DOJ noted in its proposal, “Kleptocrats use the global financial system to launder corruption proceeds. These illicit funds are predominantly processed by large, global financial institutions which have U.S. correspondent accounts. Given the worldwide presence of those financial institutions, records that are relevant to a U.S. investigation may exist overseas.” ( See DOJ, Anti-Corruption Legislative Proposals, May 5, 2016 at p.9.).
To access these financial records, the U.S. relies on Mutual Legal Assistance Treaties (MLATs) and Mutual Legal Assistance Agreements (MLAAs), with various foreign jurisdictions. The terms of such agreements vary, but generally allow U.S. law enforcement to request assistance from the foreign jurisdiction to obtain evidence and assist in investigations. By way of example, the U.S. entered into such a treaty with China in 2000. ( See Agreement between the Government of the United States of America and the Government of the People’s Republic of China on Mutual Legal Assistance in Criminal Matters, June 19, 2000). In practice, there are difficulties in relying on MLATs to obtain information and documents, particularly when such records are subject to local data protection or secrecy laws, and therefore prohibited from being transmitted offshore. Those situations can result in significant negotiations and delays. As a result, U.S. law enforcement agencies might prefer to unilaterally issue subpoenas directly to banks for their records held abroad.
Generally, U.S. law enforcement can subpoena banks for records kept outside the U.S. in two ways. First, a subpoena can be issued directly to a bank’s U.S. branch, which is within U.S. jurisdiction, for documents kept by the bank outside the U.S. – this has come to be known as a “Bank of Nova Scotia subpoena,” after the eponymous case. ( See In re Grand Jury Proceedings (Bank of Nova Scotia) (11th Cir 1984)). In 1984, a grand jury subpoena was served against the U.S. office of a Canadian bank – the Bank of Nova Scotia – seeking documents located in the Bahamas. The Bank of Nova Scotia argued that it was subject to countervailing state secrecy laws of the Bahamas, and thus could not produce the subpoenaed documents without violating local law. The U.S. courts conducted a so-called “comity analysis,” balancing the law enforcement interests of the U.S. against the interests of the Bahamas in enforcing its state secrecy laws. The court found that U.S. law enforcement’s interests prevailed and that the subpoena was enforceable. Although the comity analysis turns on the specific facts of each case, in other similar cases, courts have repeatedly come to the same conclusion in upholding Bank of Nova Scotia subpoenas in favor of U.S. law enforcement.
Separately, the Patriot Act enacted in 2001 further granted U.S. regulators the power to unilaterally and directly subpoena records held by banks in foreign jurisdictions. These “Patriot Act subpoenas” are broader than Bank of Nova Scotia subpoenas, as they may be issued directly to any foreign bank, so long as that bank maintains correspondent banking relationships in the U.S. Such Patriot Act subpoenas can broadly cover any records relating to the U.S. correspondent account. ( See 31 U.S.C. §5318(k)(3)). If the foreign bank does not comply with the Patriot Act subpoena, the U.S. Government can require financial institutions in the U.S. to terminate any correspondent banking relationships they have with the foreign bank.
According to the DOJ criminal resource manual, the U.S. recognizes that foreign governments “strongly object” to Bank of Nova Scotia subpoenas and Patriot Act subpoenas because those governments view these subpoenas as improper extraterritorial exercise of U.S. jurisdiction. Accordingly, since the use of such subpoenas can adversely affect law enforcement relationships with other countries, federal prosecutors must obtain written approval from the DOJ’s Office of International Affairs (the OIA) before they can be issued. ( See U.S. Attorney’s Manual, Criminal Resource Manual, CRM 279). Prosecutors need to justify the subpoenas based on the importance of the records to the investigation. In evaluating such applications, the OIA will also consider whether there are other available methods for obtaining the records, such as through the use of MLATs, tax treaties, or letters rogatory.
Even when such subpoenas are issued, however, U.S. regulators have still faced difficulties in obtaining bank records and using the records effectively in court. The existing legislation, though expansive in its reach, does not explicitly address the authentication of records obtained from subpoenas. Authentication is necessary for those records to be produced as evidence in court. In practice, separate from exercising these subpoena powers, U.S. regulators have to convince the foreign banks to voluntarily authenticate those records produced under subpoena. At present, U.S. regulators have few tools available to compel banks to do so. While U.S. regulators may require other financial institutions in the U.S. to terminate any correspondent relationship with non-complying banks, this is a drastic measure with collateral consequences on parties other than the non-complying bank, thus making it difficult to employ in practice. These factors weaken U.S. regulators’ positions in taking enforcement action and reduce its leverage in negotiating settlements. As the DOJ put it, obtaining such records as legally admissible evidence can result in protracted negotiation and litigation, and can ultimately result in them not being able to obtain the records. ( See DOJ, Anti-Corruption Legislative Proposals, May 5, 2016 at p.9).
Given these considerations, and the fact that there are alternative ways to obtain the evidence sought, Bank of Nova Scotia and Patriot Act subpoenas have not been frequently used. To date, they are meant to be a “last-resorts” option within the DOJ, particularly where cooperation with the foreign government is not feasible. However, the Proposed Amendments could signal a change from the status quo and possibly lead to more active use of unilateral subpoenas by U.S. regulators to obtain offshore records.
In its “Proposals Regarding the Illegal Proceeds of Transnational Corruption,” the DOJ set out five proposed amendments that would, in its view, assist it in more effectively combating transnational financial crime. One proposal in particular seeks to bolster U.S. law enforcement’s ability to enforce Patriot Act subpoenas and require foreign banks to authenticate documents produced in response to Patriot Act subpoenas.
The Proposed Amendment requiring foreign banks to authenticate records produced under the subpoena might have the potential for significant impact. It would amend the current statute by requiring that the subpoenaed foreign bank “produce all requested records and authenticate the same with testimony or in the manner set forth in Rule 902(12) of the Federal Rules of Evidence or 18 U.S.C. §3505.” This would essentially require foreign banks to authenticate any records produced in response to Patriot Act subpoenas. Such authentications would be in the form of testimony by bank officials or signed certifications attesting to the authenticity of the records. If banks refuse to provide the requested certification, U.S. regulators would be permitted to apply to the court for orders compelling authentication, and courts could hold banks in contempt if they continue to refuse. Contempt findings could result in further sanctions from the court.
If found to be in contempt, the Proposed Amendments also permit U.S. regulators to seize any funds held in the subpoenaed foreign bank’s correspondent accounts with U.S. financial institutions to satisfy penalties for contempt. In other words, if a foreign bank refuses to comply with the subpoena, even if it is because such compliance would result in a violation of foreign data privacy laws, it may be held in contempt of court in the U.S. and have any funds belonging to it held by U.S. banks seized by the DOJ or Treasury. These powers could give U.S. regulators more leverage in compelling foreign banks to produce the requested records and documents. Essentially, this amendment would obviate the need for U.S. regulators to negotiate with and convince the subpoenaed bank to authenticate records produced, and remedy a “flaw” in the current subpoena powers.
It is also worth noting that, while the title of the proposals suggests that the Proposed Amendments narrowly target combating international money laundering and corruption, the actual language of the statute and the Proposed Amendments suggests that U.S. law enforcement agencies could use the expanded subpoena powers when investigating and prosecuting a variety of criminal activity. This would include terrorism financing and tax evasion, but also situations where criminal proceeds are transferred overseas or when criminal activity is funded from accounts held abroad. In essence, U.S. regulators could potentially employ such expanded subpoena powers in a number of enforcement contexts, and Patriot Act subpoenas could potentially become a more powerful and less time-consuming tool for U.S. regulators.
The Proposed Amendments give foreign banks one line of recourse: the proposed language provides banks with the right to challenge Patriot Act subpoenas in federal court and federal courts are granted the power to modify or set aside such subpoenas. The Proposed Amendments do not, however, contain any guidance as to how courts are to analyze and decide such challenges to the subpoenas. Thus, just how much protection banks will have under the Proposed Amendments is unclear, and if courts adopt the comity analysis used in previous litigation challenging Bank of Nova Scotia subpoenas, then it might still be an uphill battle for foreign banks and the U.S. banks that hold their correspondent accounts.
The Proposed Amendments were offered by the DOJ under the Obama administration, which generally took an aggressive approach towards combating global criminal activity. The change in administration introduces uncertainty for the Proposed Amendments. Some commentators predict that the Trump administration will be favorable to banks and big business, and will curtail regulations and enforcement actions. However, we would caution against taking this to mean that the Proposed Amendments, if passed, would have minimal impact on banks, particularly for non-U.S. banks.
First, although these subpoenas are issued to banks, they are actually investigation and prosecutorial tools in general. So long as criminals and criminal enterprises, whether in the U.S. or overseas, make use of the international financial system to fund themselves or dispose of their proceeds, large banks with cross-border businesses remain at risk of being subject to subpoenas from U.S. authorities. This is particularly true as financial networks continue to become more globalized and interconnected. Investigations of money laundering, terrorist financing and white-collar crime more generally involve probing the movement of funds internationally, as highlighted in the Panama Papers leak and the recent 1MDB scandal. Issuing subpoenas for bank records held abroad would allow U.S. law enforcement to more effectively track such movement of funds, and we expect that a major use for such subpoenas would be in these types of cases.
Second, the new U.S. Attorney General, former Alabama Senator Jeff Sessions, should be expected to take a decidedly “law and order” approach to investigations and prosecutions. Sessions stated that “Corporate fraud is an important thing, and millions of people have lost their whole life savings as a result of fraud by corporate officers. . . . [A] prosecutor cannot be a weak-kneed person going up against a major corporation in a fraud case.” (See Examining Approaches to Corporate-Fraud Prosecutions and the Attorney-Client Privilege Under the McNulty Memorandum: Hearing Before the S. Comm. on the Judiciary, 110th Cong. 8 (2007) (statement of Sen. Sessions)). Attorney General Sessions has also advocated for a very active Department of Justice, noting in 2010 that “[w]e have added a lot of prosecutors and Assistant United States Attorneys around the country. They are paid big salaries. They need to be producing day after day.” (See Nomination of James Michael Cole, Nominee to be Deputy Attorney General, U.S. Department of Justice: Hearing before the S. Comm. on the Judiciary, 111th Cong. 99 (2010) (statement of Sen. Sessions)). Those remarks have also been echoed by Trevor McFadden, the U.S. Deputy Assistant Attorney General. Deputy Assistant Attorney General McFadden stated that the DOJ “remains committed to enforcing the FCPA and to prosecuting fraud and corruption more generally”, suggesting that the DOJ will continue to take a tough stance towards money-laundering and related criminal conduct. (See Anti-Corruption, Export Controls & Sanctions 10th Compliance Summit).
Similarly, the new Treasury Secretary under the Trump administration, Steven Mnuchin, appears to take a tough stance on money laundering enforcement. While Mnuchin has an extensive history in the private financial sector, having previously worked at Goldman Sachs and as a hedge fund manager, he has also stressed continued enforcement of anti-money laundering rules and increasing transparency in beneficial ownership behind shell companies (See Hearing on the Nomination of Steve Mnuchin to be Secretary of the Treasury Senate Finance Committee, Questions for the Record, January 2017.). Although Mnuchin has not specifically mentioned the use of subpoenas, it should not be a surprise if subpoenas for overseas bank records become an increasingly important tool in effectuating his policy goals. Accordingly, banks might expect to see more subpoenas under the new administration.
Additionally, and perhaps most salient to non-U.S. banks, the Trump administration’s focus on encouraging business has carried undertones of protecting U.S. businesses. The expanded enforcement reach granted by the Proposed Amendments could similarly impact non-U.S. banks, irrespective of those banks’ presence in the U.S. In contrast with U.S. banks, enforcement actions against non-U.S. banks’ business and operational interests may be weighed differently by the new administration
When complying with Bank of Nova Scotia and Patriot Act subpoenas for records held abroad, banks could be at risk for violating data privacy, bank secrecy and state secrecy laws of the jurisdiction where those records are kept. This is particularly the case where the subpoenaed records are held in jurisdictions with expansive or nebulous data privacy, bank secrecy and state secrecy laws, such as China. Such conflict between U.S. subpoenas and local laws have already arisen, but are relatively exceptional. However, the Proposed Amendments indicate U.S. regulators’ intention to expand their use of subpoenas, which could in turn lead to banks facing such conflicts in the future. Banks with operations outside the U.S., such as foreign and international banks, could be particularly exposed to such risks.
Data protection, bank secrecy and state secrecy laws in certain jurisdictions outside the U.S. can be complicated. As an example, Chinese law contains extensive bank secrecy, data privacy and state secrecy restrictions. Under regulations enacted since the 1990s, and more recent regulations, banks operating in China have an obligation to keep information relating to depositor accounts secret, unless consent is given or disclosure is otherwise required by Chinese law. ( See Articles 5, 32, 34, Regulations on the Administration of Savings; Articles 29, 73, Commercial Banks Law.) Compliance with Bank of Nova Scotia and Patriot Act subpoenas to Chinese banks would entail disclosing bank records to U.S. regulators and result in violation of bank secrecy requirements. Such violations could attract enforcement action by local regulators, including the People’s Bank of China (PBOC) and China Banking Regulatory Commissions (CBRC). Violations could result in suspension of the bank’s operations and revocation of its banking license and potential criminal liability as well.
This risk is not merely theoretical. In 2015, Gucci sued a number of defendants for violation of its trademarks and, as part of its suit, obtained a subpoena against the Bank of China (“BoC”). ( See Gucci v. Weixing Li (S.D.N.Y. 2015)). The subpoena required BoC to produce the defendants’ bank records, including records of their accounts in China. BoC objected and refused to comply, arguing that production of records relating to the defendants’ accounts in China would violate Chinese bank secrecy laws. As part of its objection, BoC also produced a memorandum issued by the PBOC and the CBRC, noting that they had issued a severe warning to BoC and were investigating to determine what sanctions would be appropriate. The court in that case performed the same comity analysis established under Bank of Nova Scotia and held that the balance of interests weighed more in favor of the U.S. enforcing its trademark laws – the court upheld the subpoena and imposed a coercive penalty of $50,000 per day on BoC for non-compliance. BoC eventually complied and produced the records. The judge in Gucci noted that despite the existence of strict bank secrecy laws on the books, BoC “could point to no case where a Chinese bank was subjected to liability for disclosing the type of bank account information sought by Gucci.” In other words, the court was of the opinion that Chinese bank secrecy laws, although strict, are not often enforced, at least in situations where banks are required by U.S. courts to produce the records in question. However, it can be difficult to assess the particular risks of violating bank secrecy laws, and attempting to comply with U.S. subpoenas could involve extensive negotiations and communications with bank regulators. The process could seriously impact banks even if no penalties are ultimately imposed.
In addition to conflicting bank secrecy requirements, sending documents from China to the U.S. government could also result in banks violating Chinese state secrecy laws. Violations of state secrecy laws result in severe penalties, including potential individual criminal liability and imprisonment. ( See Article 31, Law on Protection of State Secrets). Under Chinese state secrecy laws, state secrets may not be exported outside of China or viewed by any unauthorized person, such as U.S. law enforcement personnel, even if they are within China. ( See Articles 26 and 27, Law on Protection of State Secrets). Among other things, state secrets include matters to do with national economic and social development, activities relating to state security and the investigation of criminal offenses, as well as “other matters that are classified as state secrets” by the Chinese government. ( See Articles 2 and 9, Law on Protection of State Secrets). In practice, it can be difficult to determine what information and records might be considered state secrets. This uncertainty can put banks in a difficult position when faced with a U.S. subpoena from U.S. regulators for records kept in China.
As noted, U.S. regulators are not unaware of the potential legal conflicts. In fact, the DOJ’s notes to the Proposed Amendments specifically highlight potential conflicts with local bank secrecy and data protection laws, and maintain a rather apathetic tone: U.S. law would sanction obtaining bank records located abroad through unilateral subpoenas, “even where production of the records would violate the foreign country’s bank secrecy or data protection laws.” The language suggests the continued policy stance that U.S. enforcement agencies will push forward despite conflicts with local legal requirements.
With this in mind, foreign banks and U.S. banks with foreign subsidiaries and branches should actively monitor the Proposed Amendments. This way, banks would be ready to respond to any legislative changes and discuss response plans to ensure readiness. As discussed above, the Proposed Amendments have already been sent to Congress. We expect the incoming administration to continue to support this legislation, and if it does, we might see the Proposed Amendments becoming effective in the near future.
Banks may also consider reviewing document and record retention systems to streamline recordkeeping in jurisdictions with strict bank secrecy, data privacy and state secrecy laws, which could reduce their exposure to potential conflicting legal requirements. For records kept in jurisdictions that are high-risk for such conflicts, banks may consider including conflicting legal risks as part of their risk management discussions. Also, given that U.S. regulators might use subpoenas more actively in policing international money laundering, banks might also consider leveraging their know-your-customer (KYC) programs to preemptively identify and limit potential subpoena targets. Having a plan in place could better position banks in responding to subpoenas from U.S. authorities.
DOJ’s Proposed Amendments indicate U.S. law enforcement’s intent to bolster its access to foreign bank records. This is hardly surprising, given the increased use of the global financial system by money launderers, terrorist financiers, kleptocrats, and other types of criminal enterprises to place their financial transactions beyond the reach of law enforcement. If enacted, the Proposed Amendments could have three significant impacts on banks: first, banks might expect an increased number of requests for the production of documents to U.S. authorities; second, given the compulsory authentication requirement and the stronger enforcement powers, banks may have less leverage in negotiating their cooperation with U.S. authorities; and third, banks might face even more pressure from U.S. regulators when faced with conflicting local bank secrecy, data protection or state secrecy restrictions. Both foreign banks and U.S. banks will be well served to proactively monitor these Proposed Amendments.
The views expressed in this article do not necessarily represent the views of Ropes & Gray LLP or its clients, and are not intended to, and do not, constitute legal advice.
Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.
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