The Law and Economics of Blacklisting

The crackdown on Tornado Cash, a crypto mixing service, continues a recent trend of regulators using blacklisting as a key enforcement tool. Tornado Cash was blacklisted by the Treasury Department for allegedly helping to launder over $7 billion in cryptocurrencies, some of which are believed to be the proceeds of cybercrimes, and Americans can no longer legally use Tornado Cash as a result.   But U.S. authorities are far from being alone in using blacklisting as a regulatory tool. Blacklisting individuals, business entities, and even autonomous codes, as was the case with Tornado Cash, to achieve policy outcomes, has also been relevant to the international community’s attempts to stop the Russian war against Ukraine, as demonstrated by the addition of Russian companies to the US trade blacklist.   This can help improve compliance with or advance the goals of the administration’s agenda without material sanctions or threats. However, blacklisting does not always work as intended.

In a recent article, we examine the law and economics of this practice, including the impact of any related sanctions. Blacklists result in immediate and explicit sanctions, such as those imposed by the U.S. Commerce Department’s Bureau of Industry and Security (BIS). Such sanctions usually interfere directly with the blacklisted companies’ ability to purchase American-made materials. However, blacklists also result in additional, implicit sanctions that make them even more effective. Such sanctions include reputational damage and, increased difficulty getting credit.

The first type of implicit sanction relates to reputation signalling, with reputation playing a central role in compliance with international standards. For example, the United States Financial Crimes Enforcement Network (FinCEN) issued advisories against St. Kitts and Nevis, the Cayman Islands, the Cook Islands, and Liechtenstein one month after they were blacklisted by the FATF in June 2000. These advisories were only withdrawn after the jurisdictions began to comply with the FATF’s anti-money laundering recommendations and were removed from its blacklist.

A second type of implicit sanction concerns mistakes. Once an entity has been added to a blacklist, confusion concerning what type of blacklist this entity is on can arise. Indeed, it is not unlikely that, when investors consider whether to invest in a firm, they will confuse the blacklist of BIS for that of the FATF’s list for being non-compliant with anti-money laundering regulation. The third implicit sanction relates to difficulties in raising credit and problems with the lowering of credit ratings – once added to a blacklist, it is extremely likely that the credit rating agencies are going to lower the credit score of the entity on the list, resulting in difficulties in raising new credit.

In addition to analyzing different types of sanctions, we argue that, when using corporate blacklisting, regulators should be aware of the important distinction between corporations that would become blacklisted after participating in illegal activity, or failing to comply with binding legal requirements, and corporations that would become blacklisted for moral or ethical reasons. In the first instance, other sanctions beyond the obvious ones should be emphasized and included. After all, regulators need to be able to make business entities view breaking the law as not worth it. Therefore, additional sanctions can and should include policing and punishing the individuals responsible for initiating, directing, or committing the crimes on behalf of the relevant business. In the second instance, however, regulators should focus on making clear their expectations for compliance, before resorting to blacklisting.  Otherwise, moral standards can often be unclear, and it can be confusing to understand where we should draw the line. For example, should the Burger King parent company be blacklisted for not closing its restaurants in Russia during the war with Ukraine, as many other American businesses did?

Moreover, given how unclear moral standards can be, we argue that, in the second instance, when dealing with moral or ethical standards, regulatory blacklisting is similar to regulation by enforcement, which has long been criticized, and rightfully so. Indeed, in cases of regulatory blacklisting based on vague reasons, regulators and administrations could more effectively deter entities and persons from engaging in undesired behavior by making sure that the factors that drive decisions to blacklist are clear, transparent, and able to be challenged before blacklisting is imposed.

This post comes to us from Professor Nizan Geslevich Packin at the City University of New York’s Baruch College, Zicklin School of Business, and a senior lecturer at the Faculty of Law at the University of Haifa, and Dr. Hadar Y. Jabotinsky at the Hadar Jabotinsky Center for Interdisciplinary Research of Financial Markets, Crises and Technology. It is based on their recent paper, “The Law and Economics of Blacklisting,” available here.