Treasury Report:  No Immediate Need for BSA Regulations for the Art Industry | Ballard Spahr LLP

But AML Concerns Linger As To “High End” Art and NFTs

On February 4, 2022, the U.S. Department of the Treasury published a study (the “Study”) on the facilitation of money laundering (“ML”) and terrorist financing (“TF”) through the trade in works of art.  The study was commissioned as a result of Section 6110(c) of the Anti-Money Laundering Act of 2020 (the “Act”), which required Treasury to examine art market participants and sectors of the art market that may present ML/TF risks to the U.S. financial system, and examine what steps regulators might take to mitigate these risks.

According to the press release accompanying the Study, “[s]everal qualities inherent to high-value art – the way it is bought and sold and certain market participants – may make the high-value art market attractive for money laundering by criminals. These include the high dollar value of transactions, transportability of goods, a longstanding culture of privacy and use of intermediaries (e.g., shell companies and art advisors), and the increasing use of high-value art as an investment class.”  As we will discuss, the Study proposes four scenarios—two regulatory and two nonregulatory—to mitigate money laundering risks in the art industry. Ultimately, however, the Study concludes that, “[w]eighed against other sectors that pose ML/TF risks, . . . the art market should not be an immediate focus for the imposition of comprehensive AML/CFT requirements.” (emphasis added).  Accordingly, any ML/TF regulation of the art trade will not happen soon.

Ironically, dealers in antiquities – an industry dwarfed by the size of the global art market – are not so lucky, because Congress already has subjected them to anti-money laundering (“AML”) duties.  As we blogged, the Act amended the Bank Secrecy Act’s (“BSA”) definition of “financial institution” to include those “engaged in the trade of antiquities, including an advisor, consultant, or any other person who engages as a business in the solicitation or the sale of antiquities, subject to regulations prescribed by the [Treasury] Secretary.”  The Financial Crimes Enforcement Network (“FinCEN”) still must issue implementing regulations for antiquities dealers.

Perceived Money Laundering Vulnerabilities of the Art Trade

The Study begins by acknowledging a basic definitional problem:  “whether a particular item qualifies as art is not always clear.”  Further, and although the Study focuses on “high-value” art as posing the greatest ML/FT risks, it fails to provide a clear definition for the term “high value.”  The Study cites to a 2020 report indicating that less than 20% of the work sold internationally by art dealers and auction houses had values of over $50,000, and suggests that high-value art includes tangible, visual art.  These parameters leave those in the industry and would-be regulators with little to no guidance on how to classify an object deemed to represent “art” as “high value.”

The Study walks through art market participants and their vulnerabilities to illicit activities.  A summary of some of the listed participants’ exposure is below:

  • Auction houses are firms that conduct the public sale of art to the highest bidder. Generally operating in the secondary market, auction houses sell pieces owned by clients—they do not represent artists.  This participant, especially a larger auction house, may already maintain voluntary AML-related procedures for due diligence on potential buyers, but may have less incentive to adhere to such procedures.  The fact that auction houses operate in the secondary market and are incentivized to raise prices during the bidding process increases their susceptibility to illicit activity.
  • Galleries are retail establishments that display art for purchase. Galleries are often incentivized to protect their artists, because they operate in both the primary and secondary markets, and to collect customer identifying information.  These businesses therefore are likely not the preferred venue for illicit activity.
  • Online market places provide a growing platform for the sale of art by both institutional art market participants, such as auction houses and galleries, and third-party markets, including social media marketplaces and peer-to-peer messaging. This participant presents ML/TF risks because of the difficulty vendors may have in verifying customer identities.
  • Art finance companies and other market institutions provide financial services in the art market through several lending and financing options, such as art-collateralized loans. Many of these firms are not subject to AML/CFT program requirements, and can be highly vulnerable to money laundering because asset-based lending can be used to disguise the original source of funds and provide liquidity to criminals.  These institutions should be subject to AML/CFT requirements, as their direct relationship with the customer places them in a better positions to identify the account holder and to report suspicious activity.

The Study found some evidence of ML risk in the institutional high-value art market – but found little evidence of TF risk.  According to the Study, the institutional high-value art market seems to represent a poor vehicle for laundering illicit cash proceeds due to the infrequent use of cash in the high-value art market, coupled with preexisting requirements for financial institutions and commercial businesses to report high-value cash transact actions on a CTR or Form 8300.

However, the Study found that the emerging online art market may present new risks – in particular, the Study focused on non-fungible tokens, otherwise known as NFTs, which are digital units on an underlying blockchain that can represent ownership of a digital work of art. In regards to NFTs, the Study found that they “can be used to conduct self-laundering, where criminals may purchase an NFT with illicit funds and proceed to transact with themselves to create records of sales on the blockchain.”  Moreover, the structure of transactions in the digital art market can create “perverse incentives” which increase ML/TF risks beyond those in the traditional art market.

To mitigate these risks, some institutional art market participants, such as certain auction houses and galleries, maintain procedures for conducting due diligence on potential buyers and sellers. The Study also concluded that institutional art market participants generally have inherent economic incentives, such as credit risk issues and reputation maintenance, to collect this information, and that these business practices can collect information that may help reduce ML/FT risks. However, these programs are purely voluntary, and these programs are less common in certain areas of the online art market, such as with exchanges that host digital art transactions.

The Study emphasizes the role of corrupt third parties – specifically, the risk that illicit actors may manipulate or bribe merchants, financial services employees or other professionals to circumvent policies and best practices to consummate a desired transaction. According to the Study, a significant portion of money laundering in the high-value art market is likely conducted with the help of such complicit professionals. Further, the historically private nature of the high-value art market makes it difficult for authorities to identify and investigate potential money laundering.

Nonetheless, the Study also concedes that ML/TF risks in the art market will be mitigated by the forthcoming and broader, cross-industry beneficial ownership information reporting requirements of the Corporate Transparency Act (“CTA”), which will address independently, “to some extent,” the use of so-called shell companies to conduct transactions in the art market.

To Regulate, or Not to Regulate – That is the Question

Overall, the Study presents four scenarios—two regulatory and two nonregulatory—to mitigate money laundering risks in the art industry.  As noted, the Study concludes that Treasury should focus its attention on other, still-pending AML issues before turning to regulating the art market.

First, the Study recommends providing government support for the creation and enhancement of private sector information-sharing programs to foster transparency among art market participants.  Market participants often engage with peers to determine if a prospective client is suspicious or disreputable.  They also do not have a standardized method of reporting identified irregular or potentially suspicious activity.  A standardized process to easily facilitate information-sharing requests among private actors—creating a registry of buyers and sellers—would provide increased transparency, and potentially allow law enforcement access to such information during investigations.  The information-sharing mechanism needs to account for privacy requirements and potential significant liability concerns of art industry participants if they do not benefit from a safe harbor provision to protect information sharing between institutions.  FinCEN is also encouraged to increase its communication and information sharing with the art industry.

Second, updates to guidance and training for law enforcement, customs enforcement, and asset recovery agencies could help identify the unique risks and opportunities presented to criminals by the art market.

Third, the Study suggests that targeted recordkeeping and reporting requirements under the BSA could help support information collection and enhanced due diligence to disincentive criminals from attempting to launder illicit funds through the institutional art market.  FinCEN could request certain covered businesses to provide the identity of natural persons that are purchasing art, which would increase transparency.  Obviously, this would be similar to the CTA reporting requirements regarding the beneficial owners of defined entities, as well as potential beneficial ownership reporting requirements that may be imposed upon the real estate industry for non-financed deals.

Fourth, more comprehensive AML/CFT requirements (such as full AML compliance program requirements, suspicious activity reporting and know-your-customer procedures) could apply to certain art market participants. The perception that the art industry is unregulated itself may incentivize criminal activity.  Therefore, it may be worthwhile for the Treasury to consider the costs and benefits of applying full AML/CFT requirements to certain art market participants.  The Study notes the goal of harmonizing U.S. regulations with existing global regulations regarding the art trade, and suggests that certain AML/CFT requirements could be tied to certain monetary thresholds for either individual transactions or the annual sales of institutions and art dealers.

Conclusion?

After canvassing the field, the Study ultimately punts, and in effect notes that FinCEN already has its hands full attempting to fulfill the other dictates imposed upon it by the AML Act of 2020 – including the CTA and potential regulations for the real estate industry and investment advisors.  Moreover, some agency – perhaps the IRS? – would need to be designated as the examiner for art market participants covered by any regulations, and implementing an effective regulatory, examination and enforcement regime regarding the art trade would be a resource-intensive project:

While high-value art and the market in which it is traded can be abused by illicit financial actors to launder funds, the imposition of additional regulatory obligations on this sector should be made while considering other gaps and vulnerabilities in the U.S. AML/CFT regime that Treasury has prioritized under its risk-based approach to applying AML/CFT requirements and that may generate a significantly greater amount of illicit proceeds. For example, high-risk real estate transactions can include those involving the purchase of high-value property, the use of legal entities to conceal the ultimate owner, all-cash purchases, and the use of intermediaries who are not covered by AML/CFT obligations. In 2020, the median price of a home sold was approximately $309,800, while more than 80 percent of high-value art sold that same year was priced at $50,000 or below. Further, seizures of bulk currency at the U.S. border indicate that billions of dollars in illicit proceeds are likely being moved in U.S. currency in the United States alone, let alone in the rest of the world. It is also important that sufficient supervisory and enforcement resources be identified and allocated so that any new regulatory regime can be effectively implemented. As such, it is recommended that Treasury complete its ongoing work to close outstanding gaps in the U.S. AML/CFT regime related to beneficial ownership, real estate, and potentially investment advisers and nonfinancial gatekeepers before potentially turning its attention to the high-value art market.

Accordingly, it may be years until some portion of the art industry is subject to BSA regulations.  But the issue is not going to disappear, and art market participants still need to navigate current, real-world risks created by specific transactions that may involve money laundering schemes.  Regardless of the BSA, the federal criminal statutes prohibiting money laundering remain in effect.

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