This article is authored by Phoebe Kouvelas, LL.M. and has been first published in the Private Art Investor on April 30th 2018.
Art has become an attractive sector for making the proceeds of all types of illegal activity appear legitimate. High profile cases include Brazilian financier Edmar Cid Ferriera, the founder and former president of Banco Santos, who acquired dozens of works by blue-chip names with illegally obtained funds from Banco Santos, as well as Malaysian Prime Minister Najib Razak who siphoned part of a $1 billion fortune from the Malaysian sovereign wealth fund into paintings by Basquiat, Rothko, and Van Gogh.
The reason why the art market is increasingly vulnerable to money laundering is to be found in a number of inherent characteristics. High value movable goods that can easily cross international borders are key factors; couple that with market volatility and the fact that prices can be established, manipulated and altered at any time, the sector’s exposure to money launderers becomes obvious. Other key factors include a culture of anonymity/ secrecy where the seller and the buyer are often unknown to each other; deals usually close through the use of intermediaries or proxies. Finally, the common use of off-shore structures and accounts further facilitates the goals of those seeking to launder money.
Regulation is slowly emerging
Relative lack of regulation makes art even more appealing when it comes to laundering money; art is classed as non-financial asset and therefore lacks the regulation and rigid, standardized controls in place for the financial sector. In fact, according to Fausto Martin De Sanctis, author of Money Laundering Through Art: A Criminal Justice Perspective, “The more tightly the international financial sector is regulated, the more funds flow into the art world”.
Recommendations on combatting money laundering by the Financial Action Task Force’s (FATF) do not address art, as the sector is not mentioned in any of the 40 Recommendations. This is a notable omission, as the FATF Recommendations exert strong international influence on many countries because they are recognized by the IMF and the World Bank as international standards for combatting money laundering and the financing of terrorism.
Nevertheless, governments have started paying attention to this international phenomenon. The EU Anti-Money Laundering Directive (2015/849) now requires traders in high value goods to undertake protective measures (Customer Due Diligence) for payments in cash over €10,000 whether the transaction is carried out in a single operation or in several operations which appear to be linked. Some EU countries have adopted even stronger measures applying smaller thresholds for any art deal paid in cash (€1.000 in France & Italy, €3.000 in Belgium). Most importantly, this requirement is accompanied by specific reporting obligations; dealers suspecting money laundering must inform the relevant authorities and provide them with all necessary information.
In this context, two questions arise for parties facilitating an art transaction: (a) how can one know whether the purpose of the transaction is to ultimately launder money and (b) what can one do to avoid facilitating such transaction and consequently face potential criminal liability?
Red Flags & Showstoppers
Someone aiming to launder money through art is unlikely to reveal the real purpose behind the transaction to anyone who facilitates it. Keeping this in mind, all stakeholders (including art dealers, collectors and Freeport operators) must be aware of money laundering indicators. The following situations are considered red flags when it comes to money laundering through art:
· Art price is significantly below or above market value
· Artwork is an antiquity and/ or its source country has been in recent conflict
· Artwork is presented with no or very little documentation
· Buyer insists on paying large amounts in cash
· Buyer insists on paying for a single transaction through multiple low-value cash payments
· Client denies to provide adequate information in relation to their identity or property
· Agents acting on behalf of undisclosed buyers or sellers
· Buyer and/or seller wishes to process payment through a third party
Red flags do not necessarily mean that the transaction’s underlying purpose is money laundering or is otherwise illegitimate; rather, they indicate that further measures need to be taken in order to rule out such possibility.
Due Diligence Measures
If any one or more of the above indicators of suspicious activity are present, then stakeholders in an art transaction must conduct thorough due diligence and take action if and where required. The basic due diligence measures involve client ID checks, research of the artwork’s ownership and provenance, examination of the form and structure of the transaction as well as the source of funds (e.g. cash payments, third party payments, payments from bank accounts in non-AML regulated jurisdictions).
Referring one-by-one to the (non-exhaustive) list of red flags mentioned above, the necessary due diligence measures would vary. Specifically:
· Price. Where the artwork’s price is significantly below or above market value, it is necessary to examine the nature of the transaction and the source of funds. Undervaluation (usually accompanied by false invoicing) allows art to cross borders without the requisite customs documents that would be required if the true value of the item was reported. Inflated prices, on the other hand, enable one to liquidate art acquired with illegal funds and thus convey legitimacy to such funds. When faced with such price irregularities, answers to the following questions must be satisfactory: Is the client in need of liquidity? Does the client usually act spontaneously without regard to sales or is the acquisition consistent with the collection’s objectives? Or does the client bank in a non-AML regulated jurisdiction?
· Antiquity. Where the artwork is an antiquity or its source country has been in recent conflict, official export licenses must be provided or otherwise evidence that the artwork has been outside its country of origin for a considerable time; national heritage laws of the country of origin must be adhered to.
· Documentation. Where the artwork is presented with no or very little documentation, it is necessary to check State and private art loss databases, conduct provenance research looking for information on exhibition catalogues, catalogues raisonné, dated photographs and newspaper articles etc. Such research should be able to give information on history of ownership or suspicious ownership gaps.
· Payment. Where the buyer insists on paying large amounts in cash or insists on paying for a single transaction through multiple low-value cash payments, client identity must be established through verification documents such as passport or other State document. In the case of legal entities, valid company formation and operation documents must be demonstrated, as well as identification of beneficial owner(s). Further, the structure of the transaction should be examined (is it through intermediaries, online or over the phone?) and the source of funds should be scrutinized. In principle, only payments from reputable financial institutions in countries which have implemented measures to address money laundering should be accepted.
· Identity. Where the client denies to provide adequate information in relation to their identity or property, or the beneficial owner of the transaction is not identified, diligent ID checks must be performed; where the client’s identity cannot be verified against valid and updated documents, or the identity raises further suspicion, the transaction should be declined. In relation to identifying the beneficial owner, it is necessary to examine the various layers of intermediaries (usually offshore companies involving trusts, foundations etc.) until one of the following is identified: a natural person, a company listed in a publicly accessible register, or a company listed on a public stock exchange.
· Use of Proxies. Where an agent acts on behalf of undisclosed buyers or sellers, thorough ID checks must be performed for the agent. A written agreement engaging the agent, such as an Introductory Commission Agreement, must also be examined.
· Third Parties. Where the buyer and/or seller wishes to process payment through a third party, a legitimate link must be established between the buyer and /or seller and the third party through which the payment is to be processed. Where such link cannot be established, direct means of payment should be sought between the parties as an alternative.
If the due diligence measures discussed above do not satisfactorily explain the indicators of suspicious activity, stakeholders in an art deal must decline the transaction. Depending on the jurisdiction and applicable AML laws, they may also be obliged to report the transaction to the relevant authorities (in which case they might not remain anonymous) or they may risk future civil or criminal liability.
Author: Phoebe Kouvelas, LL.M.