How Are US Chips Ending Up In Russian Weapons?

of war. We've talked before on this show about how the US and its European allies have imposed crushing economic sanctions on Russia that restrict its ability to buy and sell all kinds of products from other countries. Today, in concert with our allies, we would agree a massive package of economic sanctions designed in time to hobble the Russian economy. We will target strategic sectors of the Russian economy by

blocking the excess to technologies and markets. The DAKI for Russia Today, I'm authorizing additional strong sanctions and new limitations on what can be exported to Russian This is going to impose severe cost on the Russian economy, both immediately and over time. One of the most stringent of these restrictions is on microchips, a critical component in drones and missiles and other weapons. The Russian military needs to wage

its war in Ukraine. The sanctions explicitly prohibit the sale of microchips to Russia, and yet these chips, some of them US made, are finding their way into Russian arms used against Ukraine. The US has charged a Russian citizen and his alleged associates and what prosecutors say was an elaborate scheme to mislead chip makers into leaving they were selling to legitimate companies, when in fact, prosecutors alleged that

chips were destined for the Russian military. Then Bartenstein is one of several Bloomberg journalists who worked on a deeply reported story unraveling how this alleged enterprise worked, and he joins me now from Dubai Ben, your story focuses around a man called artem Us. Can you tell us who he is? He's a forty year old son of prominent governor in Siberia. Flashy's one way you could describe him. I mean, anyone who is a regular reader of Russian

media would see his name quite frequently. He owned a lot of fancy real estate, had a lot of luxury cars, was connected to a variety of Italian hotels. He spent a lot of time in Italy. He owned several hotels there, so he's a regular, in particular in the area around Milan. He was sort of a jetsetter type of frequently traveling

across Europe is our understanding. Aside from all of his jet setting, he was also alleged to be involved in an international scheme I suppose to smuggle chips into Russia. How exactly did that work? As the chip industry has become so crucial, in particular when it comes to sort

of the defense sector and Putin's war efforts. In the run up to the war, there were efforts by Moscow to try to tap up at stockpile to make sure that they had a lot of chips in supply, and there were a variety of sort of sophisticated networks that were put into place two route chips from the US to Russia. Because even before the invasion of Ukraine last year, the US Commerce Department had already started to clamp down

a bit on this trade. They were more concerned about sensitive jurisdictions that might try to acquire more chips Russia and China in particular, So there are certain additional export controls that were put into place, and then on the Russia side, of course, there are efforts then to try to navigate around these controls to still be able to maintain that supply. And that's where artem Use comes into

the picture. US prosecutors alleged that US set up this web of shell companies from the Middle East to Europe in Asia to help route chips from the US to Russia through these third jurisdictions. The chips trade has obviously become increasingly geopolitically significant, so even prior to the invasion, there was a bigger push by Moscow to make sure

that they had adequate stockpiles. Of course, now as the war has dragged on those stockpiles, as we talk to certain experts who track this trade, those stockpiles are starting to dwindle, putting even greater urgency on the part of Moscow to try to reinforce the supply chain and keep this supply going and moving forward. Why did the authorities

say that US allegedly set up these shell companies. The thing is that as these export controls have been ramped up by Washington, big US companies that are part of the chips trade have had to ramp up their own internal compliance efforts. However, there's still hurdles to get around that. So on the Russia side of the equation, the key component is establishing companies outside of Russia in jurisdictions that

US chipmaker wouldn't teem as sensitive. So at least on the initial compliance check, it would pop up a company in the UAE or Malaysia or Germany that wouldn't necessarily sound any alarms and checks that box, and it chipped outside of the US. At that point, it's sort of

outside of their oversight. Then you and our other Bloomberg colleagues report in this story that in court documents, the US prosecutors alleged the people involved in this operation went to all kinds of links to make themselves look legitimate. They allege that they used fake purchase orders and shipping documents that were supposed to fool the American chipmakers and hide where the products were headed. Exactly. Yeah, it's a classic layering technique that you see when you look at

sanctions policies over the years. It's just sort of a constant cotton mouse game. If one shell company is recognized and shut down, another one is set up it's a constant game of obfuscation to try to continue this really important supply chain. Could you take a moment to explain what exactly is a shell company? How do you set one up? In some ways their companies on paper only. There isn't necessarily a big office. Perhaps there's a door

with no employees inside. Perhaps there's a small office, or perhaps there is no office at all. But it's registered in a different domicile, and it allows the ultimate beneficial owner, who could be in a completely different country, to route goods in a way to circumvent sanctions, to circumvent export controls, or tax authorities, any range of reasons in which they

might get set up. You know, ultimately, if the authorities on the ground don't clamp down, then it can sort of hide the ultimate business that a completely different company might be doing. Where does the case against us stand? He's in Milan, Italy. What is the US seeking and where does it go from here? Officials in the US want us extradited. You would, of course very valuable source of information about how this alleged chip smuggling network works.

His lawyers certainly want to keep him in Italy. It's worth pointing out that it's not just the US that has clamped on its export controls, the EU has as well. That's where Italy comes into play, as well as the judicial system there. But US authorities certainly want to bring him to the US. A bit of geopolitics there as well as far as how much the US might be

pushing Italy to hand him over. And the US is accusing him of sanctions violations, Yes, accusing and his associates of violating US sanctions And what does US say about all of this? US says that he didn't do anything wrong, that he's not responsible for what his associates did, and he argues that he shouldn't be extradited. He doesn't think he would be treated fairly in the US, in particular given all the geopolitics since the Russian invasion of Ukraine.

We should note that those other dependants also deny wrongdoing. Our conversation continues after the break. What does it say about the state of Russia's military that they need to do all this? The experts we talk to who monitor this say that stockpiles of chips are running quite low in Russia, and of course chips are quite central to Moscow's efforts to continue the war, so they're making a real effort now to resolve those shortages. That's why this

alleged chips smuggling has become so important for them. And what are these chips used for. They can be used in a range of different weaponry, whether it's drones, whether it's other aerial devices. Part of the effort on the Ukraine side has been that there are different investigators who are actually getting the weaponry from the battlefield and taking them apart in these different military facilities around Kiev to

try to understand where these parts are originating from. So that's another part of this story is that as they're taking these military weapons apart, they're identifying the companies where they originated. And that's also where we're seeing some of these US companies come into play, that their parts are ending up in the battlefield. It's worth pointing out that some of these parts were acquired prior to the invasion and at that time there were different export controls put

in place. So you have the US trying to prosecute our toe US, you have Ukraine forcefully demanding stop to the export of these chips that go to Russia. What is the US now trying to do to cut off these supply lines. The US has been focusing more on these so called third jurisdictions, So those are the jurisdictions that are initially receiving the parts from the US and then ultimately on shipping those parts to Russia. A lot of the attention has been fixated now on China and

the UAE in particular. There have been several different trips from senior US officials to China to the UAE raising these concerns. The big question now comes again to these third jurisdictions. How forceful will the US Treasury be as far as enforcing potential secondary sanctions violations. That's something that we haven't seen too much of to date. But when we look at all these different entities that are popping up in China and the UAE in particular, how much

will there be additional restrictions on these entities? How much will these governments potentially face s additional repercussions. That's a step that Washington hasn't necessarily taken so far. It's been something that we've heard in the rhetoric, but we haven't necessarily seen the action. You know, it's always a question of strategic priorities in the diplomatic relationship, the bilateral US China relationship, the bilateral USUE relationship. Where does sort of

sanctions enforcement fall into the priority list. The fact that chips are national security concern though, could kind of bump it up the list. Ben Burtenstein, thanks for speaking with me today. Thank you. Clearly sanctions aren't entirely effective. So what can the US and its allies due to tighten the screws so they can't be evaded. Nick Wadham's leads Bloomberg's US National security coverage, and he knows more about how sanctions work and don't work than anyone I know.

And he's here with me in our Washington studio. Nick, despite sanctions, Russia has managed to get micro chips, and the case Ben Bartenstein described is just one example of how Russia allegedly has done this. US authorities say Russia has found other ways too to sneak chips into the country. Can you start by telling us how the US sanctions are supposed to work, how they're supposed to stop that from happening. Well, there are a few things happening here.

One is the export controls, So the US limits the type of technology, chiefly semiconductors that companies can export to Russia. So that's one thing they're not allowed to buy, the semiconductors that they would need to put into high tech armaments, hypersonic missiles, the kind of thing they've used in Ukraine. The other thing they've done is put severe limits on

Russia's banks, so company's ability to get financing. Basically, if you're a Western bank, it's become all but impossible to do any sort of financial transaction with a Russian bank. And then the other thing they've done is put a ton of sanctions on individual Russian companies and people CEOs of companies, primarily in the defense sector. So if you're a Russian company, you can't really do any foreign trade.

If you're a CEO of that company, you can't even have a bank account in the West, you can't travel to the West. So it's essentially on paper, designed to be a massive economic squeeze on every sector of the Russian economy, but primarily the defense sector. Sanctions come with heavy penalties if they're violated. What happens to companies or individuals who are found to be in violation of a

US or EU sanction. Well, this is the sort of crazy thing about sanctions because enforcement is a huge question mark. So you impose these sanctions, you say, okay, you a Western bank can't do business with this Russian company, or you Russian company, you don't have access to the Western

financial system, whatever it may be. When they start then doing transactions with companies or banks based in Turkey or the United Arab Emirates or ever it else it may be, there's a big question of who is actually on the lookout for, whether those transactions are actually happening, and then what you do in response. So we know that Treasury's department that handles sanctions is pretty understaffed, so they don't have a lot of the folks who are actually basically

minding the store. The other thing is the system in the past has been designed to impose very very steep punishments, you know, potentially billions of dollars. If you're a Western bank that does business with a sanctioned entity. The likelihood that you're going to get caught is actually pretty low. If you do get caught, we're going to come after

you really hard. How effective have those sanctions been, by and large, the way that you figure out how sanctions have worked is a matter of huge debate within the international community. What we can say is that they have had a very large effect, But whether they've actually been effective in constraining Rush's ability to wage war in Ukraine is an entirely different matter. So we can say, yes,

there's definitely been a huge effect. These companies have not really been able to do business with any Western partners that they had remaining. Their cash flow has been severely restricted, but what we see is that they are finding other

ways to get the material that they want. We are also seeing, obviously that Russia's ability to wage war in Ukraine, though it has been constrained, we're still seeing that Russia is able to wage that war, and for example, the fighting around buck Moot, Russia just went back on the counter offensive. You have not had the sort of devastating, crippling impact that Western policymakers said would be the result

of these sanctions. How has Russia been able to get hold of technology that they're not supposed to have to use against Ukraine when there are these big sanctions in place and everyone is watching, Well, they have done so

in a lot of pretty creative ways. So one example we learned about in the last couple of weeks is that via other countries around Russia's periphery, Central Asia, Turkey, the United Arab Emirates, what's happening is that they are importing what would seem like harmless items, washing machines, pumps so that women can express breast milk, refrigerators, and then they're stripping those items down four parts basically, and taking the microchips out of them and then using them for

whatever ends it deems it needs to, whether that's in the defense sector or something else that it's lacking. So they're actually bringing in fairly you totally innocuous goods and stripping them down for parts. The thing that sanctions have not really been able to contend with is what happens when you have a country that's perfectly willing to ignore them but is basically too big to punish in any meaningful way, like China. China has been very willing to

do business with Russia. The US has not found that it's directly supplying Russia's war effort through weapons and guns and bullets, but they are finding that China is perfectly willing to do business with Russia, and obviously you have countries like Iran as well, So they're able to get those chips in a surreptitious way by breaking down innocuous goods. They're also just able to get them from countries like

China that are willing to provide them. Are they importing washing machines and other common appliances with the express intent of breaking them down for the chips, or are they just comman daring a lounge of washing machines and stealing the chips. It's early days still, but it looks like

they are actually doing that. I mean, Secretary of State Tony B. Lincoln went to Kazakhstan and Uzbekistan a couple of weeks ago with the express message, Hey, we know your country is a transshipment point for items that Russia is taking and stripping for parts. So you guys need to do more to crack down on that practice because it's a big problem. So this is a big enough issue that the Secretary of State of the United States goes to the countries where the shipments are happening and

tells them to knock it off. If they're able to get chips from countries like China, why do they have to go through these extraordinary measures to import appliances to get the chips inside them, because China, for one thing, has been very careful in testing the limits, So especially early on in the invasion, there was a real sense from US policymakers. I talked to several of them myself, who felt, listen, we are actually seeing China obey the sanctions.

They are very interested in the letter of the law. They want to make sure they don't get on the wrong side of those sanctions. It was in that environment where you had China still trying to figure out which way it was going to go on this thing, where you really started to see those flows. Now though, what we're seeing particularly is the US and China get into

a much bigger rhetorical battle in almost every sector. China has been increasingly willing to push those boundaries and not necessarily open the floodgates, but maybe look the other way as companies provide dual use items that Russia could use. Just to note here, an official from the UAE said in a statement to Bloomberg that the UAE adheres to and strictly enforces international laws and un mandated sanctions alongside

agreements established with international partners, including the US. China's Foreign ministry said that it isn't aware of the details surrounding the chips issue and said the US has frequently spread false information on the subject of China's relations with Russia, and a Kremlin spokesman said that Russia doesn't consider the restrictions placed by the US quote legal from the point

of view of international law. All that said, more with Nick Wadham's When We come Back, you mentioned Iran A moment ago, we had done an episode of the show talking about how Russia has turned to countries like Iran to create an entirely new supply chain in trade routes that are out of reach of US sanctions. Are there other avenues that Russia is using can use to essentially trade in technology that the US just can't see or

even reach. That's one of the fascinating things that's happening with sanctions, where you now have so many countries that are sanctioned like Iran, mean, mar North Korea, Venezuela, that it's creating essentially an entirely alternate global economy. I mean, obviously much smaller, but it's almost like a shadow economy

where the US is not able to do anything. But then on the other hand, you also have these sort of in between countries, the UAE, for example, where they say, hey, if you the United States come to us with a name of a company or a person and you say this person is violating sanctions, you got to do something about them. Will help you out. But otherwise all that enforcement stuff, the monitoring, that's not our job. We're not

going to pay attention to those things. So you start to see situations where if Russia wants to do business with companies based in places like the UAE and others that are putatively US partners, they're able to do that because those countries essentially have no enforcement mechanism in place to go after sanctions on their own without explicit instruction from the United States, and that's basically then just open

season for Russia. One other thing that we see sometimes is that legitimate companies who try very hard not to evade sanctions get caught up in a situation where the chain of custody of these illegal goods that do break sanctions is so long that they don't even know that they're part of a sanctions busting supply line right. That has happened with some frequency. And it's really interesting because in the past the US has said that's not an excuse,

So that can't save you. If you're a US company and your products when their way through the supply chain and eventually enter into or come into contact with the sanctioned entity, they can still be punished. So that is one way that the US has tried to enforce these things. But again, when you're dealing with China, you know some

company that's providing aerospace parts. I mean, the US just tried to sanction a Chinese company because supplying aerospace parts for an Iranian company that makes the drones that then go on and have been used by Russia in Ukraine. It's like they can impose sanctions and say, all right, you have no access to the US financial system, but those companies still have plenty of access to the Chinese financial system and they're able to do that trade basically unimpeded.

Are sanctions then more effective at putting pressure on politicians, putting pressure on people in a country against the government to effect change than they are at actually stopping goods

from moving around the world. You're getting into an area that is just so ripe and full of debate at the moment, and it's a bit of a hobby horse of mine, because what you see over the last many, many years is that successive administrations roll out these big sanctions packages and they say, Okay, we're going after Russia's Wagner Group, the paramilitary group that's basically fighting alongside Russian forces in Ukraine, or we're going after the junta in Myanmar,

and they come out with these big, splashy announcements and they say like, Okay, this is it. This is going to be the thing that really nails these guys and gets them to cut it out, and it never does. I mean, you look at the Wagner Group. They are essentially operating unimpeded in Ukraine even though they've been under these crushing financial sanctions. It has worked in some cases.

The US points to the Iran nuclear deal that sanctions on Iran were instrumental in pressing the Iranian government to come into that deal. But otherwise there's a real growing feeling amongst some skeptics about sanctions that they're basically a signaling move, a way to express disapproval about something that someone's doing. But the sense that there's actually a follow up and ability to bring about some sort of change or new calculus and how a policymaker makes a decision.

People are a lot more skeptical about that. Is there a way that sanctions would be more effective, Is something that they're not doing that they could well. This is always the challenge because US policy makers, for example, they know a lot of things they could do that could truly devastate Russia's economy, but obviously then you have blowback

on Western economies. So it's always finding that balance between what's the thing that is going to hurt Russia the most, that's not going to have blowback and tank the US financial systems. One example would be if you barred all sales of Russian oil and gas anywhere in the world. You put a total embargo on Russian petroleum part of it. So you just said RUSSI is not allowed to sell any of its crewed anywhere in the world or natural gas.

That would cause the price of oil to spike, and that would potentially have massive effects on the US economy. So what the US is doing in the case of Russia is saying, Okay, we're going to try to impose a price cap, so we don't want other countries to buy Russia's petroleum products above a certain price. So they still want Russia to be able to sell, they just don't want Russia to be able to profit as much for it. And you see, it's an enormous song and dance.

They're really trying to put pressure on companies to buy below that cap. India is a big example. But again, what the result is is that Russia still gets a ton of revenue from those sales. Looking forward, where does all this head? Do you think sanctions continue to be a widely used tool. The political pressure for administrations to use sanctions is so high because they're very easy to impose.

Congress can impose them, the administration can do so on its own without needing to get approval from anyone else. They have a strong signaling effect. That's a way to show, Okay, we disapprove of this person. If they can impose sanctions, it makes it look like they're doing something. That person also then no longer has access to the US financial system, so there's a ton of pressure to keep using this tool. The question arises, though, well does it actually work and

does the US end up actually losing leverage. I mean, you look at a country like North Korea, probably the most sanctioned nation on the planet, but Kim Jong un is more entrenched in power than he's ever been. He shows no sign of going anywhere. His nuclear program is running basically unchecked. The US now has no leverage to try to get anything from that regime. So there's a real question of efficacy. Okay, you impose these sanctions, Well,

does that actually help you get what you want? Or do you just end up shooting yourself in the foot? Looking more specifically at Russia's war in Ukraine, do you see the US imposing more sanctions? Is there anything left to sanction? Well, this brings us around to what you were saying at the beginning. So what they are saying now is the first year was about imposing the sanctions. The second year of the war is about enforcing them.

And that's where you're really seeing the administration's attention turn. So they've maxed out a lot of what they can do without getting the blowback on Western economies. What they want to do now is really pushed to make sure that the sanctions they have in place are being followed. So the microchips, for example, restricting those flows of technology or whatever else it might be to Russia. And they continue to maintain that, Hey, this is a long term proposition.

This is not something that we ever expected to work overnight. But what we want to be able to do is gradually, over time, tighten the screws to really restrict Vladimir Putin's ability to wage war. They're racing against his ability to adapt and find new sources of chips or whatever else. But that's the calculus that they're trying to make. They say, listen, don't judge us by what's happened in the first year. Judge by what happens three or four or five years.

Nick Wadhams, thanks for being here, Thank you, thanks for listening to us here at The Big Take. It's a daily podcast from Bloomberg and iHeartRadio. For more shows from my Heart Radio, visit the iHeartRadio app, Apple Podcasts, or wherever you listen, and we'd love to hear from you. Email us questions or comments to Big Take at Bloomberg dot net. The supervising producer of The Big Take is Vicky Burgolina. Our senior producer is Katherine Fink. Federica Romanello

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