Following a two-year investigation, the U.S. Senate Permanent Subcommittee on Investigations recently released a Report entitled "The Art Industry and U.S. Policies that Undermine Sanctions." The investigation sought to uncover how certain high net worth (HNW) individuals were able to evade sanctions that the U.S. Government had imposed on them in March 2014 in response to Russia's invasion of Ukraine and annexation of Crimea. The investigation led to the discovery that the normal course of business in the art market had the unintended consequence of facilitating money laundering by these bad actors.
The Subcommittee uncovered a complex web of interrelationships involving offshore shell companies with hidden owners, intermediaries who mask purchasers and sellers, and lax money laundering safeguards by private dealers and auction houses that provide cover for evading U.S. sanctions. The Subcommittee recommended that the stringent anti-money laundering (AML) regulations that apply to the financial industry under the Bank Secrecy Act (BSA) be made applicable to the art market as well. Senator Robert Portman of Ohio, one of the co-authors of the Subcommittee's Report, stated in no uncertain terms in a press release announcing its findings, "It is shocking that U.S. banking regulations don't currently apply to multi-million dollar art transactions, and we cannot let that continue."
The Subcommittee's recommendations
The Report noted that although private dealers and auction houses are not legally required to implement AML policies, they must comply—like everyone else—with sanctions imposed by the U.S. Department of the Treasury Office of Foreign Assets Control (OFAC). To comply fully with OFAC sanctions, however, would require the adoption of robust AML policies. It is this disconnect—the inability of art market participants to give full force and effect to OFAC sanctions in the absence of mandatory AML policies—that is at the very core of the Subcommittee findings: the true identity of the ultimate beneficial owner in an art transaction is rarely, if ever, disclosed. The Report advanced eight reforms, four of which are directly applicable to the art market, to close this loophole in sanctions enforcement, thereby forever changing the way business is conducted in the art market:
Congress should amend the Bank Secrecy Act to add businesses handling transactions involving high-value art
Congress should require the Treasury Department to collect beneficial ownership information for companies formed or registered to do business in the United States (the Subcommittee recommended that this information be provided to law enforcement for investigatory purposes)
OFAC should issue comprehensive guidance on the steps art dealers and auction houses should take to ensure they are not doing business with sanctioned individuals or entities (the Subcommittee recommended that OFAC should clarify what steps auction houses and art dealers should take to determine whether a person is the principal seller or purchaser or is acting on behalf on an undisclosed client)
There should be no exception for works of art such as paintings, etchings and sculpture under the International Emergency Economic Emergency Powers Act, which otherwise allows the President to issue sanctions against specific categories of individuals and entities during a national emergency
Under the Subcommittee's recommendations, simply refusing to do business directly with a Specially Designated National (SDN) whom OFAC has sanctioned without determining whether a party is acting on his or her behalf will no longer satisfy compliance with Government regulations. The only question is not if, but when, the above recommendations will be implemented and what form they will take.
What should I do now?
The obvious first step is that every art dealer without exception should adopt an AML policy and training program that put in place guardrails even more robust than those of the current voluntary AML policies that the major auction houses have adopted. The typical protocols—such as refusing to accept third-party payments, relying on financial institutions through which funds flow to consummate a transaction to ensure the integrity of the funds used for a purchase, and performing due diligence on the intermediary art advisor only but not directly on his or her client—will no longer suffice. Rather, the new protocols to be established should have as their primary focus the disclosure of the identity of the ultimate beneficial owner in an art transaction. Although the Senate Subcommittee effectively passed the ball to OFAC to clarify for art dealers and auction houses what these new protocols should be, we can expect that the extensive recordkeeping and reporting requirements of the BSA will be made applicable to art transactions. Establishing effective due diligence systems and monitoring programs; reporting suspicious activity that might signal criminal activity; and independently verifying the source of funds used to purchase art are just a few of the basic steps that are likely to be required.
Unique to the art market and at odds with both the spirit and the letter of AML compliance is the reluctance on the part of art advisors and dealers to disclose the identity of their clients for fear of being cut out of a transaction. If art market participants wish to preserve any measure of the privacy and confidentiality aspects of the seller-intermediary-buyer structure of a typical art transaction while satisfying Government regulations requiring disclosure of the identity of the ultimate beneficial owner, they will have to come up with creative alternatives. One such way might be for the parties to enter into mutual non-disclosure and non-circumvention agreements with a carve-out for law enforcement. If the buyer or the buyer's advisor refuses to enter into these agreements or is unwilling to provide the ultimate beneficial owner information by some other means, the seller would be best advised to decline the transaction: running afoul of OFAC guidelines can result in the imposition of seven-figure monetary penalties.
Art dealers and auction houses: how the system failed
Explaining how these (HNW) individuals were successful in evading U.S. sanctions, the Senate Subcommittee's Report painted a picture of lax voluntary AML policies and haphazard compliance throughout various sectors of the art market.
In the context of private art sales, the Subcommittee found troubling that compliance with OFAC guidelines and sanctions relied almost exclusively on prior relationships, obvious red flags, "gut" instincts and sometimes advice of counsel. (In reaching this conclusion, the Subcommittee surprisingly interviewed only one private art dealer in New York and two art advisors located overseas—hardly a comprehensive sampling—and extrapolated its findings to all private art transactions.) The New York dealer did not have a voluntary AML policy in place, had not undergone any formal AML or sanctions-related training, rarely questioned the source of funds used to purchase art and professed to know the identity of the ultimate beneficial owner in a majority but not in all transactions.
Even with self-described vigorous voluntary AML protocols in place, the four major auction houses interviewed—Christie's, Sotheby's, Phillips and Bonhams—fared little better in unmasking the true identity of the ultimate beneficial owner in an auction sale. The Subcommittee determined that there was not one transaction when dealing directly with the HNW individuals art advisor where any of the auction houses were able to learn the true identity of the ultimate beneficial owner. Instead, the auction houses considered the art advisor himself to be the principal purchaser and performed due diligence only as to him, recognizing that the ultimate beneficial owner was in fact someone else.
Furthermore, information released in 2016 from the Panama-based law firm Mossack Fonseca—known as the infamous "Panama Papers"—linked the (HNW) individuals to certain offshore shell companies involved in the purchase of high-value art at these auction houses and through private dealers. The true identity of the parties behind these shell companies and the source of the funds the companies shielded went undetected in these transactions both before and after the imposition of U.S. sanctions.
The HNW individuals
To illustrate the ease with which foreign bad actors are able to take advantage of the relative lack of transparency in art market transactions to evade U.S. sanctions, the Subcommittee presented a case study involving two HNW individuals s, Arkady and Boris Rotenberg, and Arkady's son, Igor. The study exposed the unintended role that the major U.S. auction houses, as well as private dealers, play in facilitating the evasion of sanctions.
Following President Obama's March 2014 Executive Order sanctioning "any individual or entity that is owned or controlled by, that has acted for on behalf of, or that has provided material or other support to, a senior Russian government official," OFAC officially designated Arkady and Boris Rotenberg as SDNs. U.S. individuals and businesses are prohibited from obtaining goods, services or technology from SDNs or otherwise transacting business with them. Notably for purposes of art market transactions, this prohibition extends to business conducted through third-party intermediaries (which is relevant, because in art transactions, buyers and sellers can remain anonymous through the use of third-party agents or representatives). The Subcommittee found that the Rotenbergs continued to participate actively in the U.S. art market by purchasing over $18 million in art even after the imposition of the March 2014 sanctions. To mask their identities in high-value art transactions, the HNW individuals used shell companies created and managed by a lawyer who is a Russian-born British citizen and whose organization is registered in multiple foreign jurisdictions. The Rotenbergs also relied on an art advisor and dealer who is a Russian-based U.S. citizen and who acted as their intermediary with U.S. auction houses for the specific purpose of concealing their identity as the ultimate beneficial owners of the artwork.
Change is coming soon
Because of the loopholes in the voluntary AML protocols that the major auction houses have instituted and the near total lack of transparency in private art sales, it is a forgone conclusion that Congress will enact legislation imposing BSA-type compliance requirements on the U.S. art market. Senator Tom Carper of Delaware, the other co-author of the Subcommittee's Report, vowed in a press release to "ensure that the same rules that apply to our financial institutions apply to the art industry." When that happens, law enforcement agencies will be in a position to target auction houses, galleries, private dealers and art advisors who run afoul of the new regulations by imposing hefty financial penalties designed to enforce compliance.
The Withers Art Team remains available to advise you on any questions or concerns you may have about business as usual or to navigate an AML policy and training program.
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