BRASILIA (Reuters) -Brazilian Supreme Court Justice Alexandre de Moraes, who recently had sanctions imposed on him by the U.S. government, told Reuters that courts could punish Brazilian financial institutions for seizing or blocking domestic assets in response to U.S. orders. 

Those remarks raise the stakes in a standoff that has hammered shares of Brazilian banks caught between U.S. sanctions and the orders of Brazil's highest court.

In a late Tuesday interview from his office in Brasilia, Moraes granted that U.S. law enforcement regarding Brazilian banks that operate in the United States "falls under U.S. jurisdiction." 

"However, if those banks choose to apply that law domestically, they cannot do so - and may be penalized under Brazilian law," he added.

His remarks underscore the potential consequences of a Monday ruling by fellow Supreme Court Justice Flavio Dino, who warned that foreign laws cannot be automatically applied in Brazil. 

That ruling was followed by a sharp rebuke from the U.S. State Department's Bureau of Western Hemisphere Affairs, which warned on social media hours later that Moraes was "toxic" and that "non-U.S. persons must tread carefully: those providing material support to human rights abusers face sanctions risk themselves." 

The U.S. Treasury Department slapped the sanctions on Moraes last month under the Global Magnitsky Act, a law designed to impose economic penalties on foreigners deemed to have a record of corruption or human rights abuse. 

The order accused him of suppressing freedom of expression and leading politicized prosecutions, including against former President Jair Bolsonaro, a staunch Trump ally on trial before Brazil's Supreme Court on charges of plotting a coup to reverse his loss in the 2022 election. Bolsonaro has denied any wrongdoing and denounced the case as politically motivated.

In his interview, Moraes said decisions by foreign courts and governments can only take effect in Brazil after validation through a domestic process. He said banks therefore cannot seize assets, freeze funds or block the property of Brazilian citizens without following those legal steps.

The global reach of the U.S. financial system means foreign banks often restrict a wider range of transactions to avoid secondary sanctions. 

Moraes said he was confident that the sanctions against him would be reversed via diplomatic channels or an eventual challenge in U.S. courts. But he acknowledged that for now they had put financial institutions in a bind.

"This misuse of legal enforcement places financial institutions in a difficult position - not only Brazilian banks, but also their American partners," he said. 

"That is precisely why, I repeat, the diplomatic channel is important so this can be resolved quickly - to prevent misuse of a law that is important to fight terrorism, criminal organizations, international drug trafficking and human trafficking," he added. 

A Treasury Department spokesperson said Moraes had "engaged in serious human rights abuse," adding: "Rather than concocting a fantasy fiction, de Moraes should stop carrying out arbitrary detentions and politicized prosecutions."

The State Department cited comments from Deputy Secretary of State Christopher Landau on Wednesday reiterating criticism of the judge for alleged censorship of U.S. citizens and companies.

NO CHOICE 

The clash could have serious consequences for Brazilian financial institutions, said two bankers in Brazil, who requested anonymity to discuss the matter candidly. 

Most large banks are supervised by the U.S. government in some way due to their international presence or exposure, either through a foreign branch or issuance of foreign securities, said the former director of an international bank in Brazil. 

The choice for these banks, under pressure from the U.S., may be to invite sanctioned clients to seek a different institution to keep their assets, the banker added. 

The director of a major Brazilian bank said that, in practice, Monday's court ruling means any action taken by Brazilian banks based on rules involving the U.S. Treasury's Office of Foreign Assets Control, which oversees U.S. sanctions, will need approval from Brazil's Supreme Court.  

At the same time, he added, failing to comply with an OFAC decision could cut a bank off from the international financial system. 

"Brazil doesn't really have a choice," said the banker. "Given how interconnected everything is, and the disparity in economic power between the U.S. and Brazil, we're left in a position of subordination. There's not much we can do."

He stressed that the court would need to come up with a solution "that doesn't put the financial system at risk." 

Shares of state-run lender Banco do Brasil, where most federal officials including judges receive salaries, fell 6% on Tuesday, the largest drop among Brazil's three biggest banks.

The bank said in a Tuesday statement it was prepared to deal with "complex, sensitive" issues involving global regulations.