The Fine Art of Auction House Consignments: Art AML, Sanctions Compliance and the Fine Art Owner’s Conundrum**

Phillips Art Auction House London
Auction Houses are cornerstones of the fine art industry

While the spotlight has recently been on established auction houses anti-money laundering (“AML”), counter-terrorism and sanctions compliance, and the prospect of the United States, like the United Kingdom and the European Union before it, making AML compliance mandatory for art industry protagonists, there appears to be little focus on the broader reluctance of established auction houses to look beyond their relationship with intermediaries in contracts for the consignment of fine art.

“While auction houses may be eager to look beyond the identity of the intermediary to enforce its rights, they appear reluctant to do so when it comes to complying with their obligations.”

While auction houses may be eager to look beyond the identity of the intermediary to enforce its rights, they appear reluctant to do so when it comes to complying with their obligations.

This conundrum can prove problematic not only for sanctions compliance, but also for fine art owners who have relied on fine art intermediaries to consign their works of fine art with auction houses.

For art owners, navigating the complexities of this conundrum is, in itself, no less than a fine art, and to understand the dynamic it is helpful, first, to look at AML and sanctions compliance and the recent, renewed focus on the fine art industry.

Heightened Compliance Scrutiny

“…[c]ertain features of the market for high-value artworks make it attractive to those engaged in illicit financial activity, including sanctions evasion.”

The United States Senate Permanent Subcommittee on Investigations’ recent report on the “Art Industry and US Policies That Undermine Sanctions” (July 29, 2020) highlighted the risk inherent in the fine art markets for sanctioned or ‘blocked’ persons to use fine art as a means of evading United States (and other jurisdictions’) sanctions, anti-money laundering and counter-terrorism laws (the “Report”).

Its conclusion, that, “…[w]hile there are legitimate business reasons to retain confidentiality, offshore entities with nominee directors and shareholders pose a significant threat to the success of U.S. efforts to block sanctioned individuals from engaging in prohibited transactions…” (at page 147) may not be unique to fine art, this traditionally, transactionally opaque industry specifically lends itself to scrutiny given the role that agents or other intermediaries play in buying and selling fine art, coupled with the absence of broad regulation.

In fact, while fine art industry participants may be subject to general regulations and other laws, for example applicable data privacy laws, the fine art industry is considered, as the report points out, “…the largest, legal unregulated industry in the United States…” (at page 2), with the U.S art industry not being subject to the Bank Secrecy Act “…which “…mandate[s] detailed procedures to prevent money laundering and to verify a customer’s identity…” (Id.).

“…Congress should add high-value art to the list of industries that must comply with BSA requirements. Given the intrinsic secrecy of the art industry, it is clear that change is needed in this multi-billiondollar industry…” (at page 147).

As the Report, and the October 30, 2020 US Department of The Treasury’s Office of Foreign Asset Control’s (“OFAC”) “Advisory and Guidance on Potential Sanctions Risks Arising from Dealings in High-Value Artwork” (the “Advisory”) are quick to point out, although fine art market participants may not be subject to the Bank Secrecy Act and its anti-money laundering and counter-terrorism requirements, they, and other US Persons are prohibited from transacting with OFAC or other federally blocked persons, including persons on OFAC’s List of Specially Designated Nationals and Blocked Persons.

The Advisory pinpoints the fine market vulnerabilities and why it, specifically, is targeted. According to the Advisory:

“…[c]ertain features of the market for high-value artworks make it attractive to those engaged in illicit financial activity, including sanctions evasion. These characteristics include a lack of transparency and a high degree of anonymity and confidentiality, especially with respect to the sale and purchase of high-value artworks. Shell companies and intermediaries are also frequently used to purchase, hold, or sell such artworks, as well as to remit and receive payments. These avenues for maintaining anonymity allow blocked persons and other illicit actors to obscure their true identities from other market participants, and help to hide prohibited conduct from law enforcement and regulators. The mobility, concealability, and subjective value of artwork further exacerbate its vulnerability to sanctions evasion…”. [at page 1].

Phillips Auction House London
Auction Houses provide the necessary fine art industry market making

The Report, in its conclusion recommends that the United States follow suit with The European Union and The United Kingdom and that “…Congress should add high-value art to the list of industries that must comply with BSA requirements. Given the intrinsic secrecy of the art industry, it is clear that change is needed in this multi-billiondollar industry…” (at page 147).

While the Report goes on to detail apparent attempts by the Rotenberg oligarchs, as members of Russian President Putin’s inner-circle, to evade United States Crimea-related sanctions by buying and selling ‘safe-asset’, high-value fine art through a network of intricately structured shell companies, and intermediaries (particularly dealer Gregory Baltser and entities controlled by him), it is the traditional role in fine art markets that art dealers and other fine art intermediaries can play in concealing the identity of their ultimate clients which appears, primarily, to set fine art markets apart in scrutiny.

After all, any industry participation can be structured through entities and using nominee directors and shareholders.

The Mechanics of Fine Art Consignment

“When examining the mechanics, what we see, as reflected in the Report from a compliance perspective, is not only the auction houses’ general reluctance for compliance purposes to examine the contractual fine art consignment relationship beyond its direct contractual relationship with the dealer or other intermediary, but also in relation to its other obligations.”

And while the Report and the Advisory focus on the role that these intermediaries could play in evading United States sanctions, and anti-money laundering (“AML”) and counter terrorism, primarily in light of Sotheby’s, Christies and other major international fine art auction houses voluntary ‘Know-Your-Customer’ (“KYC”) policies and procedures, it only touches upon the actual mechanics of how dealers or other intermediaries represent fine art sellers in consigning works of fine art to established auction houses.

When examining the mechanics, what we see, as reflected in the Report from a compliance perspective, is not only the auction houses’ general reluctance for compliance purposes to examine the contractual fine art consignment relationship beyond its direct contractual relationship with the dealer or other intermediary, but also in relation to its other obligations.

What we also see is that this has implications for fine art collectors, and other fine art owners beyond general AML, KYC and sanctions compliance, and which reach into the very heart of fine art owners’ rights opposite the intermediary and the auction house itself.

Contracting with Auction Houses through Intermediaries: The Two Avenues

There are generally two avenues through which intermediaries acting as agents may engage with fine art auction houses for the consignment of fine art.

Traditionally the first is where the intermediary acts as direct consignor of the work opposite the auction house, and is the ‘consignor of record’ as far as the auction house is concerned.

In other words, as far as the auction house is concerned, the intermediary is the contracting counter-party, with the discretion, and the authority to contract with, and instruct the auction house implicit in his capacity as consignor of record, even where the auction house knows that the intermediary is acting as agent on behalf of a disclosed or undisclosed principal.

The intermediary, being active in the trade, generally is charged a reduced, no selling commission at all, or, even sometimes an ‘enhanced hammer price’ on the sale. The intermediary would pay any selling commission out of the higher commission he charges his client; the difference being his ‘profit’.

Absent any contrary arrangement with the fine art owner, the intermediary, as consignor of record, if free to instruct the auction house as he chooses. In fact it appears that it is only the consignor of record’s instructions that the auction house will listen to

“The distinction between the two avenues highlights the opaqueness in the consignment relationship when the intermediary acts as consignor of record, and tends to underscore the Report’s documented limitations in auction houses’ willingness to identify ultimate beneficial owners (“UBO’s”) and source of funds for AML and sanctions purposes.”

The second avenue is for the intermediary to receive a referral or introductory commission for referring the artwork to the auction house.

Although, generally, still acting as the artwork owner’s agent, the intermediary refers the work of fine art to the auction house, but does not act as consignor of record. Instead, the owner consigns the work directly to the auction house, is party to the consignment agreement as consignor of record, and pays, generally, a higher selling commission, from which the auction house would pay the introductory commission or ‘IC’ to the intermediary, subject to the terms of its IC agreement with the intermediary.

A variation of the first method could be where the intermediary, wishing to keep the identity of the work’s owner confidential, acts as principal opposite the auction house and does not disclose that that he is acting as agent.

The distinction between the two avenues highlights the opaqueness in the consignment relationship when the intermediary acts as consignor of record, and tends to underscore the Report’s documented limitations in auction houses’ willingness to identify ultimate beneficial owners (“UBO’s”) and source of funds for AML and sanctions purposes.

Nevertheless, in all of the described structures, the relationship between intermediary and owner remains one of agent-principal with attendant agent fiduciary responsibilities.

The Art Owner’s Conundrum

Which of these two avenues are used may depend on the particular circumstances.

“What acting as consignor of record does entail is control. Sometimes, as we will see, to the detriment of the owner. It can give the intermediary the ability not only to control the relationship with the auction house, but also to direct the flow of funds following the auction sale.”

An intermediary may adopt the first method, and contract as consignor of record to keep the owner’s identity confidential. “…Secrecy is pervasive in the art industry…”as the Report points out at page 3 , continuing that, “…[i]n a typical transaction, a purchaser may not ask who owns the piece of art they are purchasing; the seller may not ask for whom it is being purchased or the origin of the money. And in general an art advisor would be reluctant to reveal the identity of their client for fear of being cut out of the deal and losing the business…”

It may simply be that an owner prefers the intermediary to deal with all aspects of the consignment and sale, and its administration and logistics, and it may be neater in this way, depending on the relationship between owner and intermediary, for the intermediary to act as consignor of record.

But how this owner-intermediary relationship is structured may be a trap for the unwary owner.

Versions of each of Sotheby’s and Christies Consignment Agreements provide that if the consignor is acting as agent, then both him and his principal (i.e. the owner) are jointly and severally liable for the consignor’s obligations under the Consignment Agreement. This is the case even where the owner’s identity is undisclosed

Intermediaries have been heard to say that acting as consignor of record ‘shields’ the owner from liability opposite the auction house.

The standard auction house consignment agreement includes representations, warranties and indemnities from the consignor, for example as to the consigned fine art’s title and authenticity, and the argument advanced is that the intermediary, acting as consignor of record ‘shields’ the owner by giving these as principal under the Consignment Agreement, leaving the owner out of the picture, hassle and potential auction house recourse for breach.

“And therein lies the conundrum: while auction houses may look to the owner to enforce its rights, they may well refuse to deal anyone other than the consignor of record when it comes to the consignment of the work of fine art, and the auction houses contractual responsibilities and other obligations.”

However, as we have seen, this isn’t always correct as the owner, under the Consignment Agreement, may be (and in the case of Sotheby’s and Christies is) held jointly and severally liable with her consigning agent, and if there is a breach, no doubt the auction house will look to the owner too.

What acting as consignor of record does entail is control. Sometimes, as we will see, to the detriment of the fine art owner. It can give the intermediary the ability not only to control the relationship with the auction house, but also to direct the flow of funds following the auction sale.

And therein lies the conundrum: while auction houses may look to the owner to enforce its rights, they may well refuse to deal anyone other than the consignor of record when it comes to the consignment of the work of fine art, and the auction houses contractual responsibilities and other obligations.

“For auction houses, it seems, the sacrosanct rule is that their obligations stop at the intermediary consignor of record, so much so that we have seen a major auction house, absent the intermediary’s consent, refuse to deal with the owner, even where his identity has been disclosed.”

That Sotheby’s focusses on the agent as the client with regard to its obligations is born out, in the context of sanctions and AML compliance, in the Report’s (at page 51) quote from Sotheby’s “Worldwide Policy on Money Laundering. Terrorist Financing and Tax Evasion” (which the Report (at page 50) references as the “2018 AML Policy”):

‘In the context of ordinary auction and private sale transactions with an agent who you know or believe is acting on behalf of a principal whose identity is not disclosed, we must treat the agent as our client for the purposes of customer due diligence and verification of identification. Before you engage in transactions with agents for undisclosed owners, (e.g., dealers who wish to keep the names of their clients confidential from us), you must ensure that we know and trust the agent concerned . . . In addition, you should confirm that the agent knows personally and/or has conducted appropriate due diligence on its clients’ identities and activities.’

This appears to apply equally in the context of taking instructions on an auction sale, and to whom the auction house views it owes its contractual obligations.

For auction houses, it seems, the sacrosanct rule is that their obligations stop at the intermediary consignor of record, so much so that we have seen a major auction house, absent the intermediary’s consent, refuse to deal with the owner, even where his identity has been disclosed.

As with its AML and sanctions compliance obligations, auction houses appear reluctant to look past their intermediary contracting counterpart, and knowledge of the existence of a principal UBO for whom the agent is acting and to whom the agent is, by law, conferring rights, appears to make little difference.

Owner-Intermediary Disputes Do Happen

This conundrum is especially relevant for an owner who has fallen out with his intermediary.

“Disputes happen. Owners and intermediaries fall out. It is not very uncommon for the terms of the owner-intermediary relationship to go undocumented, emails or telephone conversations to contain bold sale promises and discussion of commission rates and structures, but never confirmed or reduced to writing.”

Disputes happen. Owners and intermediaries fall out. It is not very uncommon for the terms of the owner-intermediary relationship to go undocumented, emails or telephone conversations to contain bold sale promises and discussion of commission rates and structures, but never confirmed or reduced to writing.

Overly-zealous intermediaries may rush to arrange delivery of the artworks to the auction house, execute auction house consignment agreements without disclosing their terms to their clients, all without documenting the terms of their own relationship with the client.

Or, potentially worse. Intermediaries may abscond or go bankrupt.

And when the relationship unravels, perhaps over a commission disagreement or otherwise, an agent’s fiduciary responsibilities to their principals may be short lived when it comes to matters of money and payment of commissions.

And here, as consignor of record, the intermediary holds the cards with the auction house.

In fact, so much so, that some auction houses ,although aware of the agency relationship, will refuse to communicate with the owner absent the intermediary’s consent. And absent any owner-intermediary resolution, the auction house may, refuse to withdraw the work from a sale or, at best, refuse to release the proceeds.

Here the owner stares the fine art consignment conundrum squarely in the face.

On the hook with the auction house for his intermediary’s actions, but unable to direct, or even communicate with the auction house where he is the owner of the fine art up for auction, and by law the beneficiary of the rights the intermediary confers on him by entering into the consignment as his agent.

The Moral of the Story

So what is the moral of the story?

“It may also be, as owner, not only to select your intermediaries wisely, but also how you structure your intermediary’s representation.”

It perhaps is that fine art auction consignment is a fine art in itself: all is not what it seems, and what should be a relatively easy undertaking entrusting a valued work of fine art into the expert hands of an established auction house may become ever so more complicated when an intermediary enters the picture.

It may also be, as owner, not only to select your intermediaries wisely, but also how you structure your intermediary’s representation.

While there is, no doubt, added value in certain circumstances, whether for secrecy, administrative, logistical or other reasons, in having an intermediary be the consignor of record, one has to ask whether it is necessary or even warranted to not contract directly with the auction house.

After all, retaining control over your prized assets and its process is an important consideration, and doing so does not have to deprive you of having an adviser to lean on where the adviser may be adequately compensated through an auction house introductory commission.

“But however this may turn out, one thing is certain: having auction houses look beyond their consigning intermediaries for AML or sanctions compliance purposes is only one side of the coin. The other is going beyond the intermediary in recognizing the fine art owner’s rights.”

And of course it resolves a number of compliance issues for the auction house: it only has the UBO to vet and deal with.

And finally, a key lesson, for both owner and intermediary is to clearly document the relationship before the art leaves the owner’s hands. Doing so can only be a good prescription for the ills that may eventuate when temperatures rise.

And what will become of this largely unregulated industry?

Perhaps the United States will follow the lead of the United Kingdom and the European Union by bringing art market participants directly within the framework of the Bank Secrecy Act.

But however this may turn out, one thing is certain: having auction houses look beyond their consigning intermediaries for AML or sanctions compliance purposes is only one side of the coin. The other is going beyond the intermediary in recognizing the fine art owner’s rights.

** This article is intended to be informational only, and does not constitute legal advice. Competent, specific legal advice from a suitable, licensed attorney, should always first be obtained before taking any action, and the information in this article should not be relied upon independently of that advice.

Founder: TheFineArtLedger.com, blockchain powered fine art title and authentication platform, art collector, Rimon P.C. corporate finance attorney. Venice, CA