Anti-Money Laundering – What has changed

Introduction

On 10 January 2020, the Money Laundering and Terrorist Financing (Amendment) Regulations 2019 (Regulations 2019) came into force in the United Kingdom. Regulations 2019 transposed the EU’s Fifth Anti-Money Laundering Directive (5AMLD) into national law and brought art market participants (AMP(s)), 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 are dealing with and the type of transaction they are entering into. The purpose of the Regulations is simple: to prevent criminals from using art as a vehicle to launder money. [1]

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 fell 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’ identity and training employees to identify suspicious transactions.

The BAMF Guidance

In late January 2020, the British Art Market Federation published a guidance note on the Regulations 2019 approved by HM Treasury (the “Guidance”). This is a long and detailed document (112 pages). Whilst helpful in many respects, the level of detail is overwhelming and on some issues, BAMF’s interpretation of the Regulations 2019 is somewhat adventurous.

The Regulations 2019

Under Regulations 2019, all AMPs who accept or make payments of €10,000 or more, whether in cash or otherwise, are in the regulated sector for anti-money laundering 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][2] and the value of the transaction, or a series of linked transactions, amounts to 10,000 euros 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 euros or more.

The Regulations require AMPs to:

register for supervision with HMRC as soon as practicable and no later than by 9 January 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 nominated 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 is explored below.

Registration

HMRC is designated as the supervisory authority for AMPs. All AMPs must register with HMRC by 9 January 2021.[4] Irrespective of whether they have registered, from 10 January 2020, AMPs in the United Kingdom are expected to carry out due diligence on their customers with whom they have 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 at €10,000 or more.

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.

Business and Customer 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 is 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 sold by the AMP.

Written Policies and Procedures

The Regulations require AMPs to develop and maintain 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’s risk exposure and have sufficient authority to make decisions to alter such exposure. Where the business is run by a sole trader, the sole trader will be deemed 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; where 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 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. Let’s also assume that the London gallery is an AMP as defined by Regulations 2019. If the London gallery is not the parent company of the New York gallery, the London gallery must comply with the Regulations, while the New York gallery does 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 is necessary not to interrupt the normal conduct of business and there is little risk of money laundering and terrorist financing. According to the Guidance, 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: one being a pro forma invoice not including the AMP’s bank details and, once CDD is carried out, issuing an invoice with the AMP’s bank details.

Who’s the customer? While the Regulations do not define “customer,” the Guidance describes 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 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 enquire and know the identity of the person who is 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 do not participate in the transaction (that is, do not give advice or play a part in negotiating or executing the transaction) do not qualify as customers even if they are paid an introductory commission for introducing the AMP and the customer.

Let’s take specific examples on 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 is not 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 is not the buyer’s customer.
When an auction house sells a work of art to a dealer, who is 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 the 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, a public corporation, a private corporation, a trust, a 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 AMPs 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 are not dealing in criminal property. Where an artwork is consigned to an AMP for sale, the AMP must, among other things, ensure that the seller is not selling the artwork at an artificially low or inflated price, that the seller is not secretive or evasive as to the origin, provenance and title of the artwork and that proper import/export licenses have been ascertained. Where the AMP is dealing in cultural artefacts 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 are 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 (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 a nominated officer (NO) and report suspicious activity

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 where 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 a SRA even if the transaction does not go through or the relevant parties suddenly cease all contact with the AMP. The NO must ultimately decide whether to make a SAR and must maintain records supporting its decision. It is a criminal offense for employees of AMPs to say or do anything that may tip-off another party that a 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. Where 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 have 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 a 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 AMP’s 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, the Regulations 2019 compelling more transparency within the art trade will take some getting used to on part of AMPs who are not accustomed to asking or answering questions in relation to their dealings.

Brexit is unlikely to lead to a relaxing of anti-money laundering rules. The Regulations 2019 are part of national law. For years, the UK has been at the forefront of the fight against money laundering and there is no sign that this will not longer be the case now that the UK has left the EU.

Whilst the Regulations 2019 significantly change the regulatory landscape for the British art market, it is essential to remember that compliance with the new regulations is only half of the story: art dealers who focus only on their customer identification obligations do so at their peril. Equally important, and often overlooked, are the offences set out in the Proceeds of Crime Act 2002, the need to identify suspicious transactions and to report them to the NCA. Anyone found guilty of one of these offences can be sentenced to 14 years in jail. If AMPs are offered training on anti-money laundering, and the training programme does not address the anti-money laundering offences, identifying suspicious transactions, making SAR to the NCA and the consequences arising from making a SAR, the AMP would be well advised to consider whether the anti-money laundering training programme on offer is fit for purpose.

AMPs in the UK might take comfort in knowing that the United States is also considering adopting similar legislation to extend the requirements of the Bank Secrecy Act to art market participants, and this legislation currently has bipartisan support in Congress.

Pierre Valentin and Azmina Jasani

[1] “Money laundering” in the United Kingdom is defined in section 340 of the Proceeds of Crime Act 2002 (POCA) 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 artworks 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 Government provides sufficient clarity to the art trade as to whether they fall within the scope of the Regulations. The definition of works of art in the VAT Act includes, among other things, paintings and sculptures, but excludes antiques and collectibles. This will cause confusion. For example, where the item is a 16th century Roman head, it can arguably fall within the definition of works of art under the VAT Act, as it is a form an “original sculpture or statuary”. However, some art dealers 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 is of zoological, botanical, mineralogical, anatomical, historical, archaeological, palaeontological, ethnographic, numismatic or philatelic interest, while the definition of antiques in the VAT Act is anything that is not a work of art or a collector’s item and that is over one hundred years old. Depending on its provenance, a 16th century Roman head can qualify as collector’s item of historical importance or an antique as it is over one hundred years old. An antique dealer could arguably take the view that the 16^th century Roman head is not a work of art, and hence the Regulations to do not apply to him, at least in relation to such works. The Government must clarify the definition of works of art. Another important fact is that the text of Regulations 2019 provides that where 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 below for details). This language suggests that Regulations 2019 did envisage 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, see www.gov.uk/guidance/register-or-renew-your-money-laundering-supervision-with-hmrc.