* Chairman of Malta's Pilatus Bank arrested
* Move prompts fresh criticism of Malta for inaction
* Authorities respond with controls on Pilatus
By John O'Donnell
FRANKFURT, March 22 (Reuters) - Malta's regulators have imposed a freeze on the business of Pilatus Bank after its chairman's arrest on charges of breaking U.S. sanctions prompted a fresh wave of criticism of the island's authorities.
Earlier this week, the bank's chairman Ali Sadr Hashemi Nejad, 38, was accused in an indictment filed in a federal court in Manhattan of involvement in a scheme to evade U.S. economic sanctions against Iran, prosecutors have said.
Sadr was arrested on Monday, according to court papers. A lawyer for Sadr has declined to comment.
That prompted criticism of the Maltese authorities for inaction, including from the children of a journalist murdered in Malta last year. Daphne Caruana Galizia had reported on corruption and accused Pilatus of money laundering.
Some lawmakers had also questioned whether Pilatus Bank, which is registered in Malta, should keep its licence.
The developments prompted new protests by anti-corruption activists outside the bank's headquarters near the capital of Valletta, who placed a washing machine on a plaque marking the opening of Pilatus Bank by Prime Minister Joseph Muscat.
Malta's police said the alleged sanctions busting did not involve Maltese citizens or institutions and that no transactions passed through Malta.
Malta's financial supervisors nonetheless responded by imposing controls on Pilatus that effectively freezes the bank's business.
"The bank has been directed not to transact any business whatsoever," the Malta Financial Service Authority said in a statement, adding this applied to "all deposits and withdrawals and any disposal of the bank's assets."
It was not clear how long the controls would stay in place. The bank has not responded to requests for comment.
The events unfolded after a former employee of Pilatus, who ignited a political scandal in Malta after she became a source for the murdered journalist, surrendered herself to Greek police.
Maltese prosecutors have filed a European warrant for the arrest of Maria Efimova, a Russian who left Malta for Greece last year with her family, on suspicion of fraud. A Greek police official said she had been arrested at Malta's request.
Efimova was employed for three months in 2016 by Pilatus. Caruana Galizia named her as the source of internal bank documents which she said indicated that Michelle Muscat, wife of Prime Minister Joseph Muscat, owned a secret company in Panama.
Joseph Muscat and his wife have denied the accusations. (Reporting by John O'Donnell Editing by Mark Potter)