On Jan. 10, 2020, the Money Laundering and Terrorist Financing (Amendment) Regulations 2019 (Regulations 2019) went into effect in the United Kingdom. Regulations 2019 transposed the European Union’s Fifth Anti-Money Laundering Directive into U.K. national law and brought art market participants (AMPs), including but not limited to qualifying dealers, auction houses, intermediaries and freeports, within the regulated sector for anti-money laundering purposes.
At its core, Regulations 2019 require AMPs to carry out due diligence on their customers and transactions to ensure they understand who they’re dealing with and the type of transaction at hand. The purpose of Regulations 2019 is simple: to prevent criminals from using art as a vehicle to launder money.1
Executive Summary
Regulations 2019 expand the scope of the existing Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (Regulations 2017). Pursuant to Regulations 2017, art market professionals and businesses fell within the regulated sector only if they qualified as high value dealers or if they provided financial or insurance services that fall within the regulated sector. Regulations 2017 define a “high value dealer” as any business or sole trader that accepts or makes high value cash payments of €10,000 or more (or its equivalent in any currency) in exchange for goods. They impose significant obligations on high value dealers, including registering with Her Majesty’s Revenue and Customs (HMRC) for supervision, determining and verifying clients’ identities and training employees to identify suspicious transactions.
Under Regulations 2019, all AMPs, irrespective of whether they qualify as “high value dealers,” are subjected to anti-money laundering regulations and must comply with Regulations 2017 (Regulations 2019 and Regulations 2017 shall be collectively referred to as the “Regulations”).
Regulations 2019 define an “AMP” as a firm or sole practitioner who:
• by way of business trades in, or acts as an intermediary in the sale or purchase of, works of art (as defined in s21(6) of the VAT Act 1994) and the value of the transaction, or a series of linked transactions, amounts to €10,000 or more;3 or
• is the operator of a freeport when it or any other firm or sole practitioner, by way of business, stores works of art in the freeport and the value of the works of art so stored for a person, or a series of linked persons, amounts to €10,000 or more.
The Regulations require AMPs to:
• register for supervision with HMRC as soon as practicable and no later than by Jan. 9, 2021;
• carry out a written risk assessment of their business and clients, including identifying low risk and high risk clients and transactions;
• develop and maintain written anti-money laundering policies and procedures;
• conduct customer and transaction due diligence prior to concluding a transaction;
• train staff on anti-money laundering regulations and the internal policies and procedures;
• appoint a nominating officer who, among other things, will be in charge of reporting suspicious activity to the National Crime Agency (NCA); and
• maintain records.
Each of these requirements, along with their practical implications, are explored below.
Registration
HMRC is designated as the supervisory authority for AMPs. All AMPs must register with HMRC by Jan. 9, 2020.4 Irrespective of whether they’ve registered, beginning Jan. 10, 2020, all AMPs in the United Kingdom are expected to carry out due diligence on their customers with whom they’ve established a business relationship (that is, a commercial relationship in which the AMP expects the relationship to have an element of duration) and/or on all customers to whom they sell works of art valued at €10,000 or more.
Beneficial owners and senior management of AMPs are subject to approval by HMRC to ensure that they’re the appropriate people to undertake the responsibilities of ensuring the AMPs’ compliance with the Regulations.
Foreign dealers who sell works of art in the United Kingdom at art fairs, for example, that are worth €10,000 or more, must also register with HMRC and conduct due diligence. Failure to comply may expose such foreign dealers to hefty fines and even criminal prosecution.
Risk Assessment
AMPs are expected to adopt a risk-based approach to preventing and detecting money laundering. This involves carrying out a written risk assessment of their business and customers to assess the risk of money laundering and terrorist financing. The risk assessment should be documented, kept up to date (with at least annual updates) and made available to HMRC on request. There’s no set criteria or model for carrying out a risk assessment, but any risk assessment must consider the size and nature of the AMP’s business, how often the AMP engages in qualifying activities under the Regulations, geographical risks, customer risks, including whether the AMP transacts with politically exposed persons (PEPs), channels of sale (auction, private sale, online-only, face-to-face, etc.) and the types of value of works of art generally offered by the AMP.
Written Policies and Procedures
The Regulations require AMPs to develop and maintain well-written policies and procedures to mitigate and manage the risk of money laundering and terrorist financing. These policies and procedures must be vetted and approved by senior management of AMPs who are aware of the business’ risk exposure and have sufficient authority to make decisions to alter such exposure. When the business is run by a sole trader, the sole trader will be deemed as senior management. The written policies and procedures must provide how and when due diligence should be carried out, including identification and verification requirements; how suspicious activity should be reported; the internal control procedures in place, including how cash and third-party payment are handled; when the AMP outsources due diligence to a third party, a clear description of the use of such reliance or outsourcing arrangements; and how the AMP monitors its ongoing activity. These policies and procedures must be updated regularly and must be relevant and proportionate to the size and nature of the business.
An AMP that’s a parent company must ensure that its policies and procedures are adopted and implemented by its subsidiaries, including non-U.K. subsidiaries. To put this in context, let’s say Gallery X has two gallery spaces—one in New York and one in London. Let’s assume that the London gallery operates as a separate legal entity to its New York gallery and isn’t the parent company of the New York gallery. Let’s also assume that the London gallery is an AMP as defined by Regulations 2019. In this case, Gallery X’s London gallery must comply with the Regulations and establish written policies and procedures, among other things, to comply with the Regulations, while Gallery X’s New York entity wouldn’t need to comply, unless there’s evidence that Gallery X doesn’t treat its New York and London galleries as separate legal entities and, for example, engages in commingling of funds between them. If, however, the London gallery is the parent company of the New York gallery, then both galleries would need to have consistent anti-money laundering policies and procedures in place.
Due Diligence
AMPs are required to carry out due diligence on their customers and transactions.
Customer due diligence (CDD). This is the process of identifying customers and verifying that they are who they say they are.
CDD must be carried out when:
• establishing a business relationship with a customer (that is, a commercial relationship in which the AMP expects the relationship to have an element of duration);
• carrying out an occasional transaction that amounts to €10,000 or more, whether that transaction is carried out in a single operation or in several linked operations;
• a member of staff knows or suspects money laundering or terrorist financing. Suspicion is based on some foundation/requires a degree of satisfaction not necessarily amounting to belief but at least extending beyond speculation as to whether an event has occurred or not; and
• there are doubts about the veracity or adequacy of previously obtained customer identification data.
According to the Regulations, CDD must be carried out before the establishment of a business relationship or the carrying out of the transaction. CDD may be completed during the establishment of a business relationship if it’s necessary not to interrupt the normal conduct of business and there’s little risk of money laundering and terrorist financing. According to the British Art Market Federation’s Guidance on Anti-Money Laundering for UK AMPs, approved by HMRC (the Guidance),5 in the context of an art transaction, CDD should be carried out before the artwork is released to the buyer. The risk of concluding CDD after receiving the funds but before releasing the work is that the funds could be proceeds of a crime or coming from a tainted source, and the AMP will only arguably discover this information after carrying out the relevant CDD. Further, the AMP will be obliged to report the receipt of such tainted proceeds to the NCA and will be unable to return such proceeds to the payor without the NCA’s consent. For these reasons, the AMPs should conduct CDD before accepting funds. To get around this issue, the AMP could consider issuing two invoices: a pro forma invoice not including the AMP’s bank details and, once CDD is carried out, an invoice with the AMP’s bank details.
Who’s the customer? While the Regulations don’t define a “customer,” the Guidance describes a customer as: (1) a purchaser of a work of art and any broker or agent acting for such purchaser, or (2) a seller of a work of art when the AMP provides a service to, and receives financial value from, the seller.
When a customer is acting as an agent for its principal, the AMP is obliged to carry out CDD on the agent and on the agent’s principal. This is because the Regulations require the AMP to inquire and know the identity of the person who’s ultimately paying for the work of art or ultimately benefiting from the service. The AMP must also verify that the agent is authorized to act on behalf of its principal.
Introducers who don’t participate in the transaction (that is, don’t give advice or play a part in negotiating or executing the transaction) don’t qualify as customers even if they’re paid an introductory commission for having introduced the AMP and the customer.
Let’s look at specific examples regarding for whom CDD should be carried out, and let’s assume that the galleries, dealers and auction houses in the examples below qualify as AMPs pursuant to Regulations 2019:
• When a gallery buys a work of art from a seller, the gallery doesn’t need to conduct due diligence on the seller because the seller isn’t a customer of the gallery. The gallery would nevertheless need to comply with other pertinent regulations that require it to report knowledge or suspicion of money laundering to the NCA and prohibit it from dealing with the seller or the seller’s agent if either was on a sanctions list.
• When the seller consigns a work of art to an auction house, the auction house must carry out due diligence on the seller, as the seller is the auction house’s customer. If the seller consigns to the auction house on behalf of its principal, the auction house must carry out due diligence on the principal as well.
• When a dealer is selling a work of art consigned to it by a seller to a buyer, the dealer must carry out due diligence on the seller and the buyer, as both qualify as the dealer’s customers.
• When a gallery sells a work of art to another gallery, the selling gallery must conduct due diligence on the buying gallery, as the buying gallery is its customer. The buying gallery has no obligations to carry out due diligence on the selling gallery, as the selling gallery isn’t the buyer’s customer.
• When an auction house sells a work of art to a dealer who’s acting as agent on behalf of the ultimate buyer, the auction house must conduct due diligence on the dealer and the ultimate buyer.
• When a dealer sells to another dealer but suspects the purchasing dealer is acting as agent for the ultimate buyer, the selling dealer must conduct due diligence on the buying dealer and carry out enhanced due diligence to ascertain where the funds are coming from. If in carrying out its enhanced due diligence, the selling dealer discovers that the buying dealer is buying on behalf of its customer, the selling dealer must also conduct due diligence on such ultimate buyer.
Three levels. There are three levels of CDD, namely standard CDD, enhanced CDD and simplified CDD. The level of CDD to be carried out will vary depending on the customer profile, the nature of the business relationship or the transaction and geographical risk factors. If the customer profile, the business relationship and/or transaction or the geographical risk factors point to a greater level of risk, enhanced CDD should be carried out, including understanding the source of funds, obtaining additional information about the client, the nature and purpose of the transaction and/or the business relationship and obtaining approval of senior management to continue the business relationship. Specific enhanced due diligence measures must also be applied when a transaction involves a high risk third country (such as Syria, Afghanistan, North Korea and Iraq) or a PEP, as defined by the Regulations. The type of information for CDD to be requested will vary depending on the customer’s profile (that is, whether the customer is a private individual, public corporation, private corporation, trust, partnership, etc.).
While the Regulations permit AMPs to rely on a third party to fulfill their CDD requirements, the Regulations make it clear that any such reliance is at the AMP’s own risk. Reliance is authorized only if the third party conducting the CDD on whom the AMP relies is also regulated for money laundering. In practice, the AMP relying on the confirmation of a third party needs to:
• know the identity of the customer or beneficial owner;
• understand the level of CDD that’s been carried out by the third party;
• seek confirmation of the third party’s understanding of its obligation; and
• request copies of the verification data, documents or other information.
Transactional Due Diligence
AMPs must also conduct due diligence on the transaction at hand to ensure that they’re not dealing in criminal property. When an artwork is consigned to an AMP for sale, the AMP must, among other things, ensure that the seller isn’t selling the artwork at an artificially low or inflated price, that the seller isn’t secretive or evasive as to the origin, provenance and title of the artwork and that proper import/export licenses have been ascertained. When the AMP is dealing in cultural artifacts or items related to protected species, or other items of archaeological, historical, cultural or religious significance or of rare scientific value, it must conduct enhanced due diligence.
Train Staff
AMPs must regularly train their staff to ensure that they’re aware of the risks of money laundering and terrorist financing and their obligations under the Regulations. Well-written policies and procedures that are accessible to all members of staff play a critical role in this exercise. Any training offered must be fit for purpose. The type of training should be specific to the employees’ duties. Client-facing employees must understand how to conduct CDD, including spotting any red flags in connection with the information provided, while employees handling transactions and payments must be trained to identify whether the transaction makes sense and/or is unusual and whether there are any red flags pertaining to the source of funds. All employees should be able to identify red flags and be able to report suspicious activity to the nominated officer (NO) (see details below). Training must be repeated each time the policies and procedures are amended, new employees are hired and/or the laws are amended. Training can be provided by specialists or internal compliance officers online or via a face-to-face session. Larger AMPs are also required to screen their employees before hiring them.
Appoint an NO
All AMPs are required to appoint an NO of appropriate seniority so that the AMPs’ staff can report all suspicious activity to the NO. Pursuant to the Regulations and other applicable money laundering regulations, such as the Proceeds of Crime Act, the NO is required to make a suspicious activity report (SAR) to the NCA using the information that becomes available to the AMP within the course of its business when the AMP knows or suspects or has reasonable grounds for knowing or suspecting that an individual is engaged in money laundering or terrorist financing. If the NO has reasonable grounds of knowing or suspecting suspicious activity, then the NO should file an SAR even if the transaction doesn’t go through or the relevant parties suddenly cease all contact with the AMP. The NO must ultimately decide whether to make an SAR and must maintain records supporting its decision. It’s a criminal offense for employees of AMPs to say or do anything that may tip off another party that an SAR has been filed with the NCA, if such disclosure is likely to prejudice any investigation. The NO must have access to all files, records and information to be able to make such decisions and liaise with law enforcement. If possible, a deputy NO must be appointed. Larger AMPs (such as international auction houses) must also appoint a compliance officer to ensure that the business is overall compliant with the Regulations and the policies and procedures in place are being adhered to.
Maintain records
AMPs are required to maintain records evidencing the customer and transactional due diligence they’ve carried out for at least five years. They must also maintain records of internal and external suspicion reports, including details of the internal suspicion reports in relation to which the NO decides not to make an SAR. AMPs should maintain records of training and other forms of compliance, including details of the date and nature of training provided to staff and reports made by the NO to senior management of AMPs. AMPs are also required to keep records for a 5-year period of evidence supporting their reliance on a third party to carry out the relevant due diligence and records of when a third party has relied on the AMPs’ due diligence. Records should be kept in accordance with the applicable data protection regulations and must be easily retrievable. Failure to maintain records in accordance with these standards can result in prosecution, including imprisonment for up to two years and/or a fine or regulatory censure.
Adapting to Transparency
For a market that thrives on confidentiality and anonymity, these Regulations compelling transparency within the art trade will take some getting used to on the part of AMPs who aren’t accustomed to asking or answering questions in relation to their dealings. The good news is that the Regulations require compliance on the part of all AMPs, which will likely make it easier for everyone to comply. There’s always a risk that some AMPs choose not to comply with the Regulations, but that choice is hardly a competitive advantage as it exposes such AMPs to criminal liability, heavy fines and reputational damage. AMPs in the United Kingdom should also take comfort in knowing that the United States is also considering adopting similar legislation to extend the requirements of the Bank Secrecy Act to its AMPs, and this legislation currently has bipartisan support in Congress.
Endnotes
1. “Money laundering” in the United Kingdom is defined in Section 340 of the Proceeds of Crime Act 2002 and covers a wide range of activities. It includes, among other things, the concealment of criminal property; arranging or facilitating the acquisition, retention, use or control of criminal property; and acquiring, using and/or possessing criminal property. Forms of money laundering can include turning dirty money (that is, money acquired through criminal means such as sex trafficking, drug trafficking, dealing in stolen property, etc.) into clean money by investing in artwork and other luxury assets; enjoying or facilitating benefits of tax evasion, fraud and theft; possessing or transferring stolen property; being directly involved with any criminal or terrorist property; or entering into arrangements to facilitate the laundering of criminal or terrorist property.
2. There are serious questions around whether the definition of “works of art” chosen by the U.K. government provides sufficient clarity to the art trade in determining whether they fall within the scope of the Regulations and whether the decision to leave out collectors’ pieces and antiques is a well considered or an artificial distinction. By way of context, in January 2020, the U.K. government issued a response to the consultation it carried out in 2019 in relation to the European Union’s Fifth Anti-Money Laundering Directive, which, in relevant parts, says: “[t]he government will define ‘work of art’ … in accordance with the views of the vast majority of responses in favour of the Value Added Tax Act 1994 (VAT Act) definition of work of art in section 21(6)
to 6(B) of that Act.” The definition of works of art in the VAT Act includes, among other things, paintings and sculptures, but excludes antiques and collectibles. This distinction can be confusing. For example, when a work of art at issue is a 16th century Roman head, it can arguably fall within the definition of works of art under the VAT Act, as it’s a form of an “original sculpture or statuary.” However, some art dealers may not see it as such and could instead deem it to be a collector’s item or an antique. The definition of a “collector’s item” in the VAT Act includes anything that doesn’t fall within the definition of a “work of art” and that’s of zoological, botanical, mineralogical, anatomical, historical, archaeological, paleontological, ethnographic, numismatic or philatelic interest, while the definition of “antiques” in the VAT Act is anything that isn’t a work of art or a collector’s item and that’s over 100 years old. Depending on its provenance, a 16th century Roman head can qualify as a collector’s item of historical or archaeological importance or an antique as it’s over 100 years old. An antiquities dealer could arguably take the view that the 16th century Roman head isn’t a work of art, and hence the Regulations don’t apply to him, at least in relation to such works. The U.K. government must provide better clarity on the definition of “works of art.” Another important fact is that the text of the Money Laundering and Terrorist Financing (Amendment) Regulations 2019 (Regulations 2019) clearly provides that when a transaction relates “to oil, arms, precious metals, tobacco products, cultural artefacts, ivory or other items related to protected species, or other items of archaeological, historical, cultural or religious significance or of rare scientific value,” enhanced due diligence should be conducted (see section on due diligence above for details). This language suggests that Regulations 2019
envisioned items of archaeological, historical, cultural and religious significance to also fall within the regulated sector for anti-money laundering purposes. Hence, the decision to leave out collectibles and antiques is confusing to say the least and is likely to create room for error among art traders.
3. The value of the art sold is to be calculated by the final invoice price, inclusive of all taxes, commissions and ancillary costs.
4. For details on how to register, seewww.gov.uk/guidance/register-or-renew-your-money-laundering-supervision-with-hmrc.