Iran Is *Really* Good at Evading Sanctions

Emanuele Ottolenghi

Emanuele Ottolenghi

Senior Fellow, Foundation for Defense of Democracies

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~ Also in this issue ~

~ Also by Emanuele Ottolenghi ~

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Whatever the international community is doing to keep Iran from building a nuclear bomb, it isn’t working. A detailed look at some of the regime’s sophisticated tactics of evasion.

Ever since Iran’s clandestine nuclear weapons program was first exposed in 2002, efforts to convince Tehran to abandon the program have focused on two strategies. One is diplomacy and dialogue between Iran and the five permanent members of the UN Security Council plus Germany, known as “P5+1.” The other is applying economic pressure through sanctions.

In the absence of any diplomatic progress, the world has come to rely on ever-stricter sanctions to try and bring Tehran to heel. At first, these sanctions focused on individuals connected to the regime and companies directly involved in procuring nuclear technology and raw materials. But over the last three years, sanctions have expanded to include large sections of the Iranian economy—such as its lucrative oil industry and most of its banks. Among other things, sanctions have banned Iranian oil sales, blocked the transfer of technology to Iran’s energy industry, severely restricted financial transactions, forbidden the insurance of Iranian cargo, and frozen the assets of individuals and entities connected to the Iranian regime.

Generally speaking, sanctions have severely retarded Iran’s economy; particularly American sanctions, because of their global reach. Essentially, they have forced business enterprises and financial institutions outside the U.S. to choose between doing business with Iran or America.

The Iranians are well aware of the economic damage sanctions have done. The selection of Hassan Rouhani in presidential elections this June was popularly seen as evidence of the sanctions’ success, because the campaign largely focused on domestic economic hardships, including rapid devaluation of currency, inflation, unemployment, and shortages of basic products. More likely, it was a reflection of the Supreme Leader’s strategy to do precisely what Rouhani himself brags about accomplishing for him when Rouhani was Tehran’s man at the nuclear negotiating table: smile and negotiate with Europeans for as long as possible, or necessary, while racing ahead with the military nuclear project.

It is far less clear, however, whether the sanctions that the U.S. and the West continue to impose have actually had the desired effect of actually stopping Iran’s nuclear weapons program, or in creating the needed pressure on the regime to force a different risk/reward calculus. There is no doubt that it is harder than ever for Iran to acquire the means and technologies it needs to continue developing its military nuclear weapons program, but there is also overwhelming evidence that the regime continues to find increasingly arcane means of doing so. In particular, the regime exploits a variety of loopholes and the openness of Western societies to procure banned technology.

The Iranian airline Mahan has been slapped with US sanctions. Photo: Aero Icarus / flickr

The Iranian airline Mahan has been slapped with U.S. sanctions. Photo: Aero Icarus / flickr

How this is accomplished is a fascinating, untold story. From the curious ways that funds are transferred, to the rapidity with which front companies are created, shut down, renamed, and reopened, nothing Iran does makes sense from a strictly business standpoint—but it is extraordinarily effective if the goal is to continue its nuclear program. While the complexity of these maneuvers must cause endless headaches for the Iranians, it’s far from clear that this is enough of a headache to force the Supreme Leader to end Iran’s pursuit of nuclear weapons, let alone the pressure to seriously contemplate a compromise with the West. If anything, Iran’s creative business practices show just how ineffective sanctions have so far been at pressuring Tehran to make such a choice.

Given Tehran’s consistently expressed willingness to engulf “the Zionist entity” and the entire region in flames if the West should intervene against the atrocities being committed in its client state Syria, it is worth considering how radically limited the West’s options might suddenly be if Iran actually had a nuclear weapon to back up those threats. If the world wants to avoid a dystopia in which the Bashar Assads of today and those of tomorrow enjoy perfect immunity to use chemical weapons against civilian populations as long as a nuclear-armed Tehran is on their side, figuring out how to dramatically and quickly ratchet up sanctions, before its too late, should be a major strategic imperative.

A good illustration of how Iran bypasses sanctions is the regime’s activities in the German city of Düsseldorf and its environs. Düsseldorf is the capital city of the state of North Rhine-Westphalia, which sits astride a sinuous curve of the Rhine, Germany’s longest river and a major north-south waterway. Many of Germany’s most industrialized and prosperous cities lie along its banks.

Some of Germany’s best technology is produced here. Concentrated in a relatively small region, thousands of medium and small-sized family-run companies invent, assemble, produce, and sell some of the best machinery and industrial products in the world. It is an ideal place to go shopping for “dual-use” components—materials that are necessary for the manufacture of nuclear weapons but can also be used for civilian purposes, thus giving the purchaser plausible deniability.

Iran has established a dizzying array of front companies from Düsseldorf in the west to Frankfurt—Germany’s financial capital—in the south. Because most of these companies open and close within a matter of months, leaving little or no paper trail, it is difficult to say exactly what they do. Even when they last for a reasonable amount of time, they tend to operate under the radar, often based in the homes of their managers, with only scant information available to the public. Nonetheless, many of them seem to be engaged in industrial procurement, including, allegedly, for Iran’s nuclear and ballistic missile programs.

With financial constraints on Iranian businesses piling up and the country’s banks rendered impotent by sanctions, Iran must be creative in order to transfer and manage the funds necessary to finance its procurement activities. Two companies that have been very active in investing Iranian government money in Germany are IFIC Holding and IHAG Trading—both of which are subsidiaries of the Iran Foreign Investment Company (IFIC) and sanctioned by the US. IFIC is the investment arm of Iran’s Oil Stabilization Fund; its purpose is to use Iran’s oil revenues to offset the ups and downs of the oil market, which have been significant for Iran, given that Iranian oil is now a distressed asset (a product that has to be sold at below market price) due to sanctions. IFIC annually invests hundreds of millions of dollars overseas, mostly in Germany, where, according to its website, 56.9 percent of its investments are held. Despite American sanctions, which have targeted IFIC since July 2010, the company’s German subsidiary still manages a portfolio worth hundreds of millions of dollars. According to IFIC’s latest published financial returns (2011), its investments included owning 4.5 percent of the massive German conglomerate Thyssenkrupp and a minority share in a factory, IPM Industrie Plannung und Montage, which produces and assembles components for the energy industry.

Despite being a regime-owned company, IFIC Holding and its subsidiary IHAG Trading are incorporated in Germany. This means that unless German authorities can show proof of wrongdoing specific to its German subsidiaries, IFIC can continue to operate, invest, buy, and sell on German soil. IFIC’s Thyssenkrupp shares generate millions of Euros in dividends every year, which the company can then spend or reinvest as it pleases.

Thyssenkrupp is clearly not responsible for who owns its publicly traded shares; and to the corporation’s credit, it bought back 406 million Euros worth of shares from IFIC in 2003, in order to avoid potential U.S. sanctions. On the other hand, IFIC simply banked the money, and remains in control of a significant portion of Thyssenkrupp shares. These shares may not give IFIC access to German technology, but they provide a steady stream of Euros for the Islamic Republic’s overseas holding company. The same can be said of Iranian involvement in the IPM factory: A minority shareholder does not control company policies, but certainly enjoys its profits.

The nuclear enrichment facility at Natantz.

The nuclear enrichment facility at Natanz.

Sanctions experts routinely point out that Iran cannot repatriate most of these funds, and see this as proof that sanctions have been successful. While there is no doubt that such restrictions are a problem for the Islamic Republic and have contributed to its economic distress, the regime has devised ways of moving its revenue abroad and, in the process, conducting business and procuring technology without having to rely on its own banking system.

IFIC company papers show how this can be done. In 2010, IFIC Holding financed a Dubai-based company called South Isfahan Power Plant FZCO. The company was established for the sole purpose of buying and re-exporting components for a power plant in Iran, which was established with the help of IFIC Holding and World Bank funds in 2004.

Sanctions have targeted Iranian involvement in the European Union energy sector since 2010, so Iran can no longer buy parts directly from European manufacturers like IPM. But a Dubai-chartered company can; especially if, as IFIC’s annual financial statements show, its funding comes from an offshore banking unit incorporated in Bahrain. That banking unit, however, is owned by Iran’s Bank Saderat. In short, funds that technically come from Germany and Bahrain to finance an import-export operation in Dubai are, in fact, ultimately used to buy merchandise destined for Iran.

This is only one example of how Iran has adapted to the financial restrictions imposed by sanctions. A network of companies, intermediaries, subsidiaries, money collectors, and carriers ensure that, technically speaking, nothing and nobody is violating sanctions. These networks include a multitude of companies established by Iranian proxies in Jebel Ali, Dubai, and elsewhere in the region. From there, getting the procured technology to Iran can be easily arranged.

A variation on this method involves setting up front companies to take over contracts and businesses from a sanctioned Iranian entity. Such cases have surfaced repeatedly in recent years. In December 2011, the Wall Street Journal reported that the U.S.-sanctioned entity Sepanir, owned by Iran’s elite Revolutionary Guards, had established a front company for this purpose. Iran’s Bandar Abbas port operator, Tidewater Middle East PLC (not to be confused with the New Orleans-based Tidewater, Inc.) did the same when the U.S. Treasury linked it to the Revolutionary Guards in July 2011.

Given that Western governments need solid evidence in order to sanction a specific company, all Iran needs to do when one of its businesses is exposed is close it and transfer its activities to a new company. That company will then have a completely clean record, even if, as it is often the case, it has the same shareholders, managers, and even the same address as its sanctioned predecessor. Until Western governments can prove wrongdoing, the new company is free to do business.

IFIC is conveniently located on one of Düsseldorf’s most central and commercial streets. Its address is Königsallee 76, right next door to the local office of Bloomberg News. But Iran does not only invest funds, which perhaps requires a prestigious office in Düsseldorf’s financial and shopping district. Over the years, it has also shown a keen interest in the acquisition of factories, less in hope of making a profit than of gaining access to critical technology.

One such factory is MCS International GmbH, located in the small industrial town of Dinslaken, approximately 45 minutes outside Düsseldorf. Until its recent closure due to bankruptcy, MCS was a world-renowned producer of cylinders used in hybrid cars and missile fuel tankers. These products are made of carbon fiber and hardened steel—key ingredients needed for Iran’s nuclear program.

Due to its activities from 2002 onward, MCS International and its owner Reyco were sanctioned by the U.S. Treasury Department on June 4, 2013, after the American government concluded that they were part of an elaborate network of companies controlled by Iran’s Supreme Leader. The convoluted story of how the Iranian regime came to own this factory, and in the process to gain access to crucial dual-use technology, offers a glimpse at the sophisticated methods employed by the regime.

In 2003, two German-incorporated Iranian front companies bought a German company called Zweite Kalypso. The Iranians renamed it MCS International. Three years later, one of the two Iranian companies, Reyco, bought the other one out, becoming sole owner of MCS International. The shell company proceeded to acquire full ownership of the Dinslaken factory, then called Mannesmann Cylinder Systems. MCS International promptly changed the factory’s name to its own, retaining the initials of the factory’s original name and ensuring a façade of continuity. But while the new name conveyed an impression of business as usual, the new owners had something different in mind.

Around the same time, Reyco bought a Croatian company that was also on the verge of bankruptcy: Cylinder System. According to Cylinder System’s website, Reyco bought 50 percent of the company in 2006 and within a year increased its share to 68 percent. MCS International and Cylinder System continued to have the same owner and even shared a manager until late 2010. The U.S. Treasury found that, at one point, the Iranian regime considered using CSC as a conduit to buy a German bank. If that is the case, then the Iranian interest in these companies did not derive from their profitability. The regime saw them as tools in the pursuit of other goals.

In April 2013, an exposé in the Washington Post revealed Iran’s involvement in MCS International and exposed more of the Iranian regime’s methods. Before being bought out by the Iranian front companies, Mannesman Cylinder Systems owned a flow-forming machine to make cylinders, which can also be used to manufacture gas centrifuges for a nuclear enrichment program. Iranian emissaries tried to buy the machine in 2002, but then Mannesmann—which was under German private ownership at the time—went bankrupt. The shipment was blocked, caught up in the bankruptcy procedure. Iran needed the machine but could not import it; so Iranian procurement agents decided to simply buy the entire factory.

U.S. sanctions against MCS and its network of companies have revealed that Reyco was a German-incorporated subsidiary of Rey Investment Co., a holding company linked to the Shah Abdolazim Shrine. This Iranian religious foundation was until recently headed by former minister of intelligence Mohammad Reyshahri and staffed by former senior officials from the Ministry of Intelligence.

Rey Investment’s business interests are myriad, and include the car industry—a sector recently hit by U.S. sanctions. It has been reported that Rey Investment owns the exclusive BMW dealership in Iran. It also runs a company called Pars MCS, a producer of CNG cylinders for hybrid cars that looks strikingly like MCS in Dinslaken (photos of the factory are no longer available, because its website disappeared soon after media exposure in April 2013).

Such similarities suggest a curious scenario, partially confirmed by a former MCS employee. Over the years, delegations of Iranian engineers frequently visited the German factory to familiarize themselves with its machinery and technology. By the time Iran bought the factory in 2003, German export control authorities had become aware of Iranian interest in the factory’s flow-forming machine and denied a requested export license. Unable to export the machine to Iran, the Iranians tried and failed to lobby the Dinslaken mayor’s office in an attempt to get support from local authorities. The mayor’s spokesperson confirmed that the office checked the matter with the German Ministry of Foreign Affairs and was told that the machine should not leave Germany. It appears that, having bought the factory and failed to export its machinery to Iran, the new owners imported experts from Iran, who patiently copied it, bit by bit.

The Iranians’ lack of interest in turning a profit meant that MCS International performed poorly in financial terms. But when profits are not the exclusive goal of a business, normal rules don’t apply. It appears that, because the factory yielded important dual-use technology and raw materials needed for nuclear and ballistic missile programs, the regime decided to keep the factory running, whatever the cost—at least until they could get its copy up and running in Iran.

MCS international factory in Dinslaken. Photo: reingestlater / flickr

MCS international factory in Dinslaken. Photo: reingestlater / flickr

According to the U.S. Treasury Department, the Iranian regime audited the factory in 2011 and found it to be poorly run. It imposed a change in management and ownership because, it seems, keeping the asset was becoming too expensive. The audit lasted for some time, but could not prevent the resulting turmoil. Starting in October 2010, the turnover in management became embarrassingly frequent, with some lasting only a few months. In one case, factory workers at MCS testified that a manager’s early departure may have been caused by a disagreement over the company’s future. According to them, he wanted to sell the business; but the regime, to whom the managers ultimately reported, thought otherwise. It is possible that management did not see eye to eye with the Iranian owners on how to save their strategic asset from bankruptcy. In 2011, MCS underwent an insolvency procedure, which coincided with a labor dispute. The cash infusion received by the company could not, in the end, save it from closure.

In April 2013, MCS shut down for good. Company papers revealed that, in the last few months before closure, MCS sold some of its assets to Golden Resources Trade Company (GRTC) in Dubai for some six million Euros. According to U.S. Treasury designations from June 2013, GRTC was part of the same German network of companies that included MCS International. People familiar with the story claim that much of the money GRTC paid to MCS was not, in fact, a purchase but a loan funneled to MCS through the Dubai front company. In the end, it was not enough to save MCS from financial collapse. But by then the fate of the German factory did not really matter all that much: Iranian engineers had completed the task of copying the technology they needed.

Iran does not keep all its eggs in one basket, however. Its procurement methods are based on diversification. For every Iranian-owned factory exposed, there are countless others waiting to be discovered. IFIC’s minority share in IPM has been mentioned above. The owners of MCS also held a minority share in another factory in the area. Still another case is a factory just outside Düsseldorf, in the small town of Nettetal. Breyeller Stahl Technology is a subsidiary of Ascotec, Iran’s sanctioned holding company for metal procurement based in Düsseldorf. The U.S. Treasury has defined Breyeller as “part of Iran’s foreign trade network.” Despite U.S. sanctions, the metals, mining, and steel conglomerate is still operating from its Düsseldorf offices on Teerstegenstrasse, not far from other Iranian businesses.

Not every Iranian ploy succeeds, however. Last year, Tadbir Investment, a company controlled by Iran’s Supreme Leader, sought to purchase the bankrupt French refinery Petit-Couronne. The takeover failed because Tadbir did not produce proper financial guarantees. More recently, Mapna—an Iranian company cited by the British government for its role in WMD procurement, with suspected links to Iran’s Revolutionary Guards—unsuccessfully sought to buy Führlander, an insolvent German producer of wind turbines.

Mapna has a widespread overseas procurement network with subsidiaries in Shanghai, Dubai, Istanbul, Genoa, and Düsseldorf. Its local concern, Mapna Europe, is connected through its personnel to another Düsseldorf company as well as a Swiss concern. Düsseldorf appears to be the epicenter of all these procurement networks. Company papers show that Mapna’s subsidiaries are awash in cash, and are lending millions to one another without ever repatriating the funds.

Mapna is not the only Iranian industry giant to have offices in Düsseldorf. Iran Khodro, Iran’s largest car manufacturer, has also settled there. Alongside its official subsidiary, IKCO Trading, several import-export businesses have emerged. They deal in spare automobile parts and are run by current or former managers of Iran Khodro.

It is sometimes hard to tell where Iranian government business ends and the private interests of their foreign managers begin, especially because many of these import-export businesses employ the managers’ children and spouses as well. But many of the procurement networks that have been exposed operated well under the radar, often out of the private homes of lonely middlemen—so it is not inconceivable that some of these businesses serve the regime as well as the individuals who run them.

What is certain is that most of these businesses are based in Düsseldorf, with a few in nearby locations such as Nettetal and Cologne. There is little doubt, then, that Düsseldorf looms large in Iran’s calculations. Alongside Cologne, Frankfurt, and Hamburg, it is a flight destination for two Iranian airlines—Iran Air and Mahan Air. Mahan Air is under U.S. sanctions for ferrying Revolutionary Guards’ Qods Force operatives and weapons to war-torn Syria. Predictably, Mahan has a network of companies based in Düsseldorf working to circumvent the U.S. embargo on airplane spare parts. And just as predictably, U.S. sanctions have thus far failed to stop them.

A temporary denial order issued by the U.S. Department of Commerce in 2011 against Mahan employees and front companies shows that sometimes the good guys win. But Iran keeps trying. It is working to establish an airline in Germany with direct flights to Iran. An Iranian company has tried to buy a low-cost European airline. In another case, a private airline based in Europe was bought by Iranian investors suspected of links to the regime. It flies to both Tehran and Düsseldorf.

With dozens of companies in distress across the recession-ridden Eurozone, Iran’s regime now has an unprecedented opportunity to lay its hands on dual-use goods it cannot buy directly due to sanctions. And with large financial resources that banking restrictions have made difficult to repatriate, Iran can best spend its money by keeping it overseas. Across the continent, Iranian agents are scouting businesses and seeking investment opportunities that can serve their proliferation needs. And because there are no restrictions on this type of Iranian investment in Europe, Iran is still able to buy state-of-the-art facilities and exploit their technology for its own purposes.

That Iran succeeds frequently enough to keep its nuclear ambitions afloat was made painfully obvious by recent revelations of a procurement network that supplied German spare parts to Iran’s Arak heavy water reactor by way of Turkey. The network was broken up, but not before hundreds of pieces of sensitive material had been transferred to Iran.

Istanbul may turn out to be an even more promising center of regime activity than Düsseldorf, given that Turkey, a NATO member and candidate for accession to the European Union, is under fewer restrictions on imports of dual-use goods from Europe. In November of 2012, the Turkish Ministry of Trade and Commerce published a list of Turkish-registered companies established by foreign capital. They include 2,337 companies with Iranian investors. No doubt, many of these are ordinary Iranians in search of a refuge for their savings. But, as the exposure of an Iranian procurement network shows, at least some of these companies may be involved in nefarious activities.

It would be wrong to assume that the occasional failure in Europe is forcing Iran to transfer its efforts to other countries. Turkey is more important as a transit point for European merchandise than as a primary source. And as sanctions get tighter, evasion routes become more circuitous. Rather than selling directly to Iranian partners, European-based middlemen set up additional import-export companies in Turkey and other countries. The game is the same, only with higher costs and more complex methods.

Hassan Rouhani, Iran's new president, has a history of confusing the West. Photo: Wikimedia

Hassan Rouhani, Iran’s new president, has a history of confusing the West. Photo: Wikimedia

Although most of this article has focused on one specific city due to its high concentration of regime-connected Iranian businesses, procurement networks usually have multiple entry points and extensions. In Europe, these include other German cities such as Cologne, Frankfurt, and Hamburg; as well as London, several Swiss locations, and Italian ports and industrial hubs. Ultimately, they all converge on transit jurisdictions where controls are lax or authorities are corruptible. From there, after a circuitous journey, technology can finally be loaded onto ships, cargo planes, trucks, and trains headed for the Iranian border.

Because sanctions are getting tougher and the corporate world is becoming more alert, Iranian procurement agents need to be more creative and their operations more elaborate in order to elude Western authorities. That is why Mahan has sought to buy technology from the United States through a string of front companies. That is why MCS’s elaborate network included a company in Croatia and its sales went through a Dubai-based front company.

This creativity will continue to characterize Iranian efforts. There have been repeated attempts to acquire control of financial institutions, some of which have been reported publicly. Iran’s relentless diplomacy in Latin America may win little in technological terms, but a great deal in terms of access to financial institutions and transfer points. The Far East is still largely open to Iran, and so is China.

Iran’s main problem is getting access to high quality goods, which are usually only available in Western countries. Their obfuscation will grow more elaborate, but the middlemen in Düsseldorf and other European cities will continue their activities, as there is no substitute for the technology they can buy there.

Are Western sanctions succeeding?

Obviously, the answer largely depends on your definition of success. What is clear from all the twisted, meandering procurement networks employed by the Iranians is that sanctions have made it increasingly difficult and expensive for Iran to obtain what it wants. Moving money in bags is risky, costly and inefficient. For every courier caught, however, there may be dozens more who cross borders undetected. Sanctions, in other words, do make procurement harder, but they have not forced Iran to change its mind about its nuclear program. Nor have they completely blocked the flow of cash needed to purchase strategic assets. Iran may be increasingly forced to act like an international crime syndicate, but it does not seem to mind, if that is the price of success.

Buying technology is equally difficult unless Iran does it in a circuitous way, which requires more resources, time, and middlemen. But the incentives for those involved may be increasing. More risk means their services are more desirable and will yield more profit. And it is hard, when one looks at these networks, to ascertain where government business ends and personal profits begin.

What is obvious is that sanctions have forced Iran’s efforts to go underground, adapt, and become more intricate as time goes by. Sanctions are successful in the specific sense that the more strict they become and consistently they are enforced, the harder it is for Iran to achieve its goals. It is not enough, however, to simply add companies to the sanctions list. Authorities must rigorously enforce sanctions by going after the individuals and companies who help evade them, seizing their assets, and even arresting and extraditing those involved. They must also constantly update their lists to reflect the ever-changing corporate structure of Iran’s overseas procurement networks.

Nothing is straightforward in these operations, except the Iranian leaders’ dedication to their goal of acquiring nuclear weapons. And whether sanctions will successfully deter them or it will require different measures to do so is still very much an open question.

Banner Photo: The skyline of Dusseldorf. Credit: U Kersting / flickr