Kim Jong-un salutes as he watches a military parade in Pyongyang on April 15, 2012. (Ed Jones/AFP/Getty Images)

How North Korea Uses Front Companies to Help Evade Sanctions

October 3, 2017
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by Nicole Einbinder Abrams Journalism Fellow, FRONTLINE/Columbia Journalism School Fellowships

North Korea unleashed its most potent nuclear test to date in September, spurring the United Nations to agree unanimously on some of its toughest sanctions yet — the latest attempt to choke the regime off financially as it inches closer to a full-fledged nuclear and ballistic missiles program.

The sanctions — which set limits on Pyongyang’s oil imports, prohibit textile exports and ban the sale of natural gas to North Korea — added to an already extensive list of sanctions on everything from coal to copper to seafood. Nikki Haley, the U.S. ambassador to the U.N., said that over 90 percent of the country’s known exports are now fully banned by sanctions.

The question, now, is just how far sanctions will go to deter Kim Jong-un as his regime races to achieve full nuclear capabilities.

While the U.N. has imposed sanctions against North Korea since 2006, following the country’s first nuclear test, the regime continues to evade international pressure in order to bankroll its rapidly developing nuclear and missiles programs. And even as millions of North Koreans languish in poverty, U.N. data indicates that Kim Jong-un continues to spend millions each year to maintain his lavish lifestyle. In 2012 alone, he purchased almost $646 million worth of luxury goods, a 115 percent increase over his father’s reported spending.

The North’s ability to finance itself, despite growing international sanctions, can be credited to a broad range of illicit activity that spans the world, according to experts. For example, schemes employed by the regime to garner profits include currency and cigarette counterfeiting, insurance fraud, illicit drug production and trafficking, weapon sales and even wildlife and human trafficking, according to U.N. and Congressional reports.

A 2008 Congressional Research Service report estimated that North Korean criminal activity could rake in anywhere from $500 million to $1 billion per year.

But these activities represent just a fraction of the North’s profits, according to experts. Its most lucrative gains, they say, come from a complex web of illicit networks set up largely within China that allow it to maintain access to international markets.

“When you’re talking about these Chinese networks, you’re talking in the hundreds of millions or billions of dollars,” said David Thompson, a senior analyst at the Center for Advanced Defense Studies, a nonprofit research firm based in Washington. “The more small-scale illicit activity is definitely going to help fund their overseas presence, but I don’t think it’s anywhere close to the scale of these China-based networks.”

The proceeds from these networks are far-reaching: some help Pyongyang procure goods from abroad, while others help it maintain a stable economy.

Much of the rest is believed to finance weapons and missiles. As the Obama administration concluded in 2016, North Korea’s “state-controlled financial institutions and front companies” are used “to conduct international financial transactions that support the proliferation and development of WMD and ballistic missiles.”

To access the global financial system, North Korea has been known to establish business relationships with Chinese companies, which effectively act as middlemen for the regime and allow Pyongyang to mask illicit dealing under the cover of more legitimate trade activity. These companies sell North Korean exports, but rather than send that money back to North Korea — which is almost entirely cut off from international markets — the money is transferred to overseas bank accounts set up within established front companies.

When North Korea needs certain products — from raw materials for its nuclear weapons program to goods ranging from sugar to cell phones — these China-based companies can then buy the goods via the front companies.

“Almost all trade and finance, legitimate or illegitimate out of North Korea, flows through China on its way into or out of North Korea,” said Andrea Berger, a senior research associate at the Middlebury Institute of International Studies. “And that’s not just for the nuclear program — that’s for legitimate goods, that’s for sanctioned commodities, that’s for dual use goods, that’s for finance. And that pattern applies quite widely.”

Thompson described China as North Korea’s lynchpin, saying Pyongyang’s illicit procurement activity occurs under the façade of trade networks with China. He gave the example of an international luxury goods company doing business with a seemingly legitimate company based in a place like Hong Kong or Singapore.

“What’s going to set you off to think this is a North Korean company? It’s just some random guy trying to buy like a crate of Hennessey or whatever,” he said.

But that random company could actually be a front created by a middleman on behalf of North Korea. While the majority of these shell companies don’t engage in any actual business transactions, on paper, they have boards of directors and financial statements.

“And so that’s where the role becomes very strategic for North Korea, because you have a Chinese company bringing in tremendous amounts of revenue from North Korea, and then holding that overseas and acting as a financial institution on behalf of a sanctioned [North Korean] bank,” Thompson said. “That set-up allows for a number of layers of obfuscation.”

China is North Korea’s biggest trading partner, representing at least 90 percent of the regime’s total trade, according to data from the Council on Foreign Relations. For example, in 2015, North Korea imported $3.47 billion worth of goods, with $2.95 billion coming solely from China. By comparison, its second largest trading partner, India, traded $109 million with North Korea that year, according to figures from the Observatory of Economic Complexity.

Yet, a recent report by the Center for Advanced Defense Studies noted that the North’s entire trading system with China relied on little more than 5,200 companies between 2013 and 2016, indicating that a relatively small number of firms make up the network that allows North Korea to disguise its illicit trade activity.

“There’s a very limited amount of firms that are engaged in this trade that are doing a very large amount of it,” Thompson said. “If you can start to target those specific nodes, you have a real opportunity to start to choke out the illicit networks because that’s where all the money is coming from.”

Farley Mesko, CEO of Sayari Analytics, a Washington-based financial intelligence firm, said there is somewhere between 100 and 300 Chinese companies that have joint ventures with North Korean companies. Of those, several dozen work specifically with sanctioned North Korean entities.

For example, in September 2016, the Justice Department filed criminal charges against Ma Xiaohong, owner of the Dandong Hongxiang Industrial Development Company (DHID), an industrial machinery and equipment wholesaler in China, and several associates, for working on behalf of a sanctioned North Korean bank, Korea Kwangson Banking Corp, to help them evade U.S. sanctions.

According to the criminal complaint, DHID used at least 22 different front companies, spanning from the British Virgin Islands to Hong Kong to England, to engage in U.S. dollar transactions. Names of front companies ranged from “Go Tech Investment Ltd.” in the Seychelles to “Blue Sea Business Co. Ltd.” in Wales, according to the complaint. The location of Blue Sea “appeared to be a nondescript walk-up apartment with no signage and no exterior number, and, according to public database information, was the incorporation address for many other companies.”

All in all, the Justice Department said that DHID’s illicit network consisted of 43 total business entities across four continents. Ma has since disappeared, The Los Angeles Times reported in August. FRONTLINE was unsuccessful in its attempts to contact her.

Specific products purchased by DHID and sent back to the regime included urea fertilizer, pesticides, coal, chemicals and other general supplies, according to legal documents. In total, DHID allowed the North Korean bank to engage in over $1.3 billion worth of undetected transactions.

“If you are looking to procure items that you need as a priority for your WMD program, then going directly to the Chinese marketplace, identifying a well-connected local Chinese company, and doing what [Ma Xiaohong] did … that’s the model,” said John Park, director of the Korea Working Group at Harvard University’s Kennedy School of Government.

While Xiaohong has been indicted by the Justice Department, Sayari Analytics said it has identified around 35 active companies and vessels that remain majority owned by her or her sanctioned associates. Despite being controlled by sanctioned individuals, the majority of those companies were never publicly named by the U.S. federal government, Mesko said.

“Now that becomes an issue because basically the guidance in the U.S. says that if an entity is owned 50 percent or more by someone who is on the [sanctions] list, even if the company is not publicly named, it’s legally blocked,” Mesko said.

That means there are dozens of companies out there legally blocked from doing business with anyone in the U.S. that no one really knows about, he said, adding, “And that’s true of companies and networks all over the world.”

Instead of strictly targeting North Korean entities, which have learned to adapt to increased sanctions, experts like Thompson argue that a better solution would be to increase pressure on these third-party facilitators.

“If you continue to only sanction North Koreanbased entities or individuals, your sanctions list is going to remain relatively short,” Berger said.

China has been critical of North Korea’s missile tests and escalating rhetoric, yet despite calls for more action by U.S. officials, it has traditionally shown reticence toward cracking down more forcefully on business with North Korea.

Park said that from a Chinese perspective, secondary sanctions are often viewed as an extension of U.S. laws that Washington seeks to impose within China — a direct violation to the country’s sovereignty. Beijing is also wary of destabilization along its border with North Korea or even a refugee crisis.

Last week, however, China ordered all North Korean-owned businesses within its border to close, in accordance with U.N. sanctions. The ministry of commerce said that it was giving North Korean businesses and individuals based in China, as well as joint ventures between China and North Korea, 120 days to shut down.

Park said that while he suspects North Korea has already procured and stockpiled the necessary items for its weapons programs — largely from billions in slush funds amassed via the coal trade with China during the 2000s — the regime will remain reliant on its networks within China for future acquisitions.

China’s recent actions, Park added, continue to ignore what he described as the real culprits — the North Korean diplomats who establish these business partnerships in the first place. These individuals are unique because they don’t need visas to travel between the two countries, and essentially act like ex-pat businessmen operating within China.

“To actually see results from the ban on joint ventures and other activities, there’s a lot more going on in terms of getting to the bone,” Park said. “And the bone is the expulsion of the North Korean diplomats because they are the key agents in terms of making these business partnerships operate.”

Going forward, Park said that targeted Chinese companies may be incentivized by the increased risk of dealing with North Korea. These middlemen will only continue to monetize that risk and become better at evading the law — like antibiotics.

“As you apply more and more sanctions, think of the North Korean regime as a super bug. It has become a super bug, and with that drug resistance it creates spaces where it can adapt,” Park said. “So, this is the irony that we’ve unintentionally made the North Korean regime better at procuring by applying more sanctions.”

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