Katie and Steve speak with Laura Patten and Michael Shepard about financial crimes, including money laundering, involving art. They discuss high profile examples of art-related financial crime, the reality and challenges of compliance for galleries, dealers and other art market participants, and the regulatory landscape in the U.S. and Europe.
Laura formerly worked with the CIA and FBI on high stakes art crime investigations. Michael has worked for years on anti-money laundering and financial crimes investigations and programs. Both now work with Deloitte’s art and finance initiative and financial crimes practice.
Steve Schindler: Hi, I’m Steve Schindler.
Katie Wilson-Milne: I’m Katie Wilson-Milne.
Steve Schindler: Welcome to The Art Law Podcast, a monthly podcast exploring the places where art intersects with and interferes with the law.
Katie Wilson-Milne: And vice versa. The Art Law Podcast is sponsored by the law firm of Schindler Cohen & Hochman LLP, a premiere litigation and art law boutique in New York City.
Steve Schindler: So, some of you have may have listened to our podcast on Technologizing Fine Art with Jason Bailey, and we’ve decided to take that on the road and Jason, Katie, and I will be in conversation on technology in the art world at the Moniker Art Fair, which will be in New York on May 1st at 6:30. We hope to see you there to talk more about digital art and artificial intelligence and generative art and all those great topics.
Katie Wilson-Milne: Hi, Steve.
Steve Schindler: How are you?
Katie Wilson-Milne: I’m doing well. I’m excited for today’s podcast.
Steve Schindler: Great. We’re going to be talking today about art crime and money laundering and how to prevent it. We’re fortunate to be joined today by two people who are experts in this area. We’re here with Michael Shepard and Laura Patten to talk about new laws and regulations imposing obligations on art dealers to investigate who their clients really are and where their money comes from. Laura Patten is a Specialist Leader in Deloitte’s Risk and Financial Advisory. She leads the firm’s art and finance initiatives in the United States. Laura is an authority on risk management and business intelligence, as creators of value and competitive advantage in the global marketplace. She works closely with Deloitte’s tax, strategy, research, and technology experts to provide a range of business services to the art world. Laura previously served in the U.S. government first as a CIA operations officer and later as the head of intelligence for the FBI’s art crime team. She holds a masters in international affairs from Columbia University and a masters in art business from Sotheby’s Institute of Art. Michael Shepard is Deloitte’s Global Financial Crime Practice Leader and he is an Advisory Principal in Deloitte Transactions and Business Analytics LLP. He has led a wide variety of anti-money laundering sanctions and financial crime-related projects and investigations at financial institutions and within other industry sectors. Previously, Michael was head of Financial Crime Compliance and deputy general counsel at a leading full-service retail national bank, a partner in a major law firm focused on white collar criminal defense, AML regulatory matters, asset forfeiture and internal corporate investigations, and a prosecutor for the U.S. Department of Justice, Tax Division. Welcome, Michael and Laura.
Michael Shepard: Thank you.
Laura Patten: Thanks.
Steve Schindler: So, before we get to some of these new laws and regulations, why don’t you just tell us a little bit about what you do and how you came to this kind of work?
Michael Shepard: Sure. Thanks, Steve. Thanks, Katie. I mean, you gave my background. So, how did I get to this type of work? I prosecuted tax crimes and related financial crimes, including money laundering. I was a defense attorney for a long time, defending those accused of such crimes. I was head of financial crime compliance, so I got to see it firsthand being on the frontline in a financial institution, and now for the last 14 years being a consultant in financial crime risk management, mostly for financial institutions, I have to think about and sit around and think about ways that I would launder illicit proceeds.
Steve Schindler: That must be fun.
Michael Shepard: It is fun.
Laura Patten: If you were so lucky to have so many illicit proceeds.
Michael Shepard: Exactly. If I can figure out how I would launder money, if I was a criminal, I’m in a better position to help my clients. And again, mostly financial institutions. Well, one of the ways, I’ve imagined over the last couple of years is art. And we’re gonna talk about that today.
Steve Schindler: Great. Laura?
Laura Patten: Well, you know, I spent 16 years with the federal government in intelligence and law enforcement and you know, part of my job as an operations officer was to figure out how to do things that people couldn’t necessarily see. Right, so while in that case you’re doing it for the interests of your government. You’re trying to obtain information and speak truth to power. You also have to think how would I move money, people and information across borders in a way that, you know, law enforcement probably isn’t going to detect. So, that developed my interest. Also, I studied art etc. and then when I was asked to come to the FBI, I did so because the bureau was running terrific tactical cases. I mean, their agents are the best in the world hands down. But there wasn’t anyone who could apply a sort of a macro-level view of these cases and these schemes. Because when you have a case in L.A, it mirrors the market, right. It’s probably not just in L.A, there’s probably part of it that’s happening in New York, or consider that Dali — there are many Dali prints that were sold that were fakes in Chicago. Well, those came out of Spain and Italy, right. So, it’s a network analysis and here I am.
Katie Wilson-Milne: So how, or when did you both encounter art in the intersection of your career? When did that first come into your professional scope?
Michael Shepard: So, we’ve been discussing trade based money laundering for years. Trade based money laundering is simply use — and we’re gonna talk about this more today — trade based money laundering is simply using goods, commodities, to transfer value. And art can be a valuable commodity and a good way to transfer value to someone maybe who you owe money to, you want to get money and, you know, use it for illicit purposes, you know, to transfer it over a border. We’re gonna talk about that more a little bit today. And so, you know, while I was imagining ways to launder money and art being one of them, trade based money laundering really came to mind. And that was really solidified when Laura came to the firm and you know, we had actually an art specialist and so, I’ve been able to learn a lot about the art world through her and talking to folks like yourselves who deal with the art world on a regular basis.
Katie Wilson-Milne: Great.
Laura Patten: When I was at the CIA, I spent a lot of time working in places where art is important. So, I became aware of the art market then. Really, I dug into it when I went to the FBI.
Katie Wilson-Milne: And maybe one more background question, you know, I think our listeners will be interested, when and why did the FBI start getting interested in art in less of a one-off crime way and more of a sort of subject matter expertise?
Laura Patten: Sure. So, there has always been one or two agents dedicated to this, you know.
Katie Wilson-Milne: Just to art related-crimes.
Laura Patten: Just art, right. In 2003, when the U.S. occupied Iraq and the Baghdad museum was looted with U.S. troops standing across the street protecting the oil ministry but they were not tasked with protecting the museum. The fallout from that was pretty severe, at least from a reputational perspective for the U.S. Those were not just Iraqi treasures, those were world treasures that were stolen. And so, the government responded with a, what we call a whole of government response where the state department, the FBI, the Department of Defense all came together — I guess, if we had a ministry of culture, they would probably have been involved — but the Smithsonian was involved to figure out, okay, how are we going to first, try to find all these objects, these cultural treasures that have been stolen and second, stand up a capability to try to avoid this in the future?So, it was around 2003 that the FBI art crime team was formally established, but that’s not to say that there weren’t agents working on it these issues before.
Steve Schindler: Sure.
Katie Wilson-Milne: So what kind of crimes are you seeing today in the art market, generally speaking?
Laura Patten: Sure. High-end authenticity frauds. It’s nothing new, right? We’ve seen those for years. Looting, which also includes terrorist financing, and that’s something that whether it’s new or we’re just more aware of it is clearly an issue. Theft and more complex financial crimes. So, I’m glad, we’re talking about money laundering. In the era of art as an asset, we need to start looking at fractional ownership. There is a lot of legitimate fractional ownership but it’s pretty opaque.
Katie Wilson-Milne: So, when you say money laundering, you know, I think people have an idea of what that means but maybe aren’t aware that there is a legal definition versus a colloquial definition and sort of what that legal definition is. So, I don’t know, Steve, can you talk a little bit about what money laundering actually is?
Steve Schindler: Sure, I mean, first of all, it’s a federal crime here in United States.
Katie Wilson-Milne: So, don’t do it.
Steve Schindler: Don’t. And it’s a serious federal crime. It’s found in the U.S. Code sections 1956 and 1957. It’s a crime that first of all requires intent. So, it’s not something that from a criminal perspective that you sort of accidentally walk into. But it generally requires knowledge that property involved in a financial transaction comes from some form of unlawful activity and that you have to know either that you are promoting the carrying out of that unlawful activity or at least knowing that the transaction was intended to disguise the nature of the location, the source, the ownership of those proceeds. And if you do that knowingly, you can be subject to substantial financial fines of twice the value of the transaction and you can go to jail for 20 years.
Katie Wilson-Milne: All right, so today, we are talking about how the art world is sort of implicated in a lot of these financial crimes, particularly money laundering and so, I guess, one thing we want to understand is how significant is this problem in the art world and if it is significant what is it about the art world that’s encouraging this or facilitating it?
Michael Shepard: So, let me start with just adding a few things to what Steve said and I will answer your question, Katie, which is really the three elements of money laundering, you know just putting it into its basics. So, as Steve said, it’s found in 18 USC section 1956 and 1957 and the way we think about it as practitioners, and you’ll see how this relates to the art world as well, are three terms: placements, layering and integration. Well, what’s placement? Placement is I have illicit proceeds, whether it’s from narco trafficking, embezzlement, theft, I need to place that money into the financial system, into a bank, into a financial institution or some other usable form. So, if it’s cash, they have currency transaction reporting requirements. I then may have to what we call smurf it into the bank.
Steve Schindler: What does that mean, smurf?
Michael Shepard: Using mules to structure transactions under the $10,000 threshold and depositing it into multiple accounts.
Katie Wilson-Milne: To break it up.
Michael Shepard: Multiple accounts, you can’t just use one account and then consolidating later. Now banks do monitor for all of this. Both for the structuring as well as having related accounts and then consolidating the money. Now, they only see a slice of it in their bank. They don’t see it across banks as you know. If it’s cash, I maybe able to buy goods. There is an IRS form that has to be filed, form 8300, if you receive over $10,000 cash in trade or business. So, if I did buy a piece of art, a gallery would have to file that form. So, let’s say, I place my proceeds into the bank. I succeeded in doing that. So, I’ve now placed the money. Now, I need to layer it. What’s layering? Layering is basically engaging in additional transactions that are designed to move those tainted funds, those illicit funds, further away from the source. It maybe transferring money, engaging in fictitious sales, having fictitious invoices, to nominee companies, shell companies. It could be just transferring the money into other accounts to move it away. And then lastly, integration. Integration into regular commerce. I would buy a home. I would buy a business. I could buy art at this point. Now, I’m integrating into the economy. So, if an agent ever showed up at my door, a government agent, I could show them this is from my business.
Katie Wilson-Milne: Right, this is from X gallery.
Michael Shepard: Right. It’s not from my, it’s not from some crime.
Steve Schindler: Right.
Michael Shepard: The initial premise is that most clients, buyers and sellers, are not money launderers. Okay, they’re few and far between. However, the art industry is newer to the concept that it might be susceptible and an unwitting player in money laundering or financial crime. It was traditionally, a handshake industry where privacy was respected, it was valued. You can imagine the scene, you know, in the movie or TV show where you have the intermediary bidding and he’s got his client on the phone, the unseen client on the phone. The price keeps going up. Perceptions become reality, whether or not that’s true or not. And you don’t see what’s going behind the scenes, that the auction house actually knows who that unseen bidder is on the phone and that they are doing know your customer. Also the art industry generally doesn’t think it’s, that money laundering is a real risk. But one really can’t make that conclusion until you perform a money laundering risk assessment and assess the controls in place that might mitigate that inherent risk for money laundering. There are fewer AML, anti-money laundering compliance professionals in the art world. Most are the banks. We have limited and inconsistent regulation. Art is easily moved across a border. In fact, today it’s probably more easily transferable across a border than a wire transaction in the bank, which is monitored by banks. The banks have gotten fairly sophisticated in this. It’s not perfect by any means, but you know, the money launderers know what the banks do. They track that. Money launderers listen. Today’s money launderers are more sophisticated. They are more agile. They are computer savvy. They are globally organized. They are borderless. They move money very quickly and they know how to do it. So, that makes the market susceptible to money laundering. There is a perceived risk. How much is it occurring? That is a different question.
Laura Patten: So pivoting off what you just said Michael, you know, one thing from an investigative perspective that I have always found challenging is that the traditional way of doing business in the art market, the practices and procedures are completely normal for people in the market. But for anyone outside, they’e big red flags. You buy a high value object in New York and then you send it to a free port in a third country for onward passage to a fourth country and the payment is coming out of Guernsey, the Panama. As a law enforcement or intelligence professional, you know, steam’s going out the ears. Someone in an auction house, this is just how you do business and to be fair, the ultrahigh net worth individuals and institutions that can afford the blue chip, top price art, they live lifestyles that are different than mine.
Michael Shepard: I’ve discovered that.
Laura Patten: Yeah. So, I mean, so it’s not crazy that a piece of art would move along that trajectory in these situations, right?
Katie Wilson-Milne: So part of what you guys are saying, which Steve and I certainly witness regularly, is that the art world — and let’s put the auction houses aside, because I do think there is a distinction to be made between the auction houses today and private sales where I think all these opacity issues are much more severe. But you know, the art world, it creates a lot of its value from secrecy and having many intermediaries who can take a slice along the way. So, there is a huge incentive in the way the industry has always operated and been structured and that has become normal for people inside of it, you know, we can query whether that is, that’s acceptable or not. But this is, you know, we don’t ask these kinds of questions. We don’t worry about where the money comes from, so…
Laura Patten: Right. But that’s a problem when you find out that it comes from some place bad. That’s, looking the other way might seem like a great idea until it’s not, right. I mean, consider the Knoedler case, right. I mean, tranche payments just below the $10,000 cash limit, I mean…
Michael Shepard: Yeah. There were a lot of red flags in that case. Yeah.
Laura Patten: The other thing is, I think consumers are becoming attuned to this. During the Armory Show, just a couple of weeks ago, I was talking to some very high level collectors who said, it seems like you know, everyone in the trade is afraid of instituting anti-money laundering, anti-financial crime procedures — and this guy worked on Wall Street. He said, “but in my experience, when you have greater policies, procedures, controls, there is more confidence in the market. The market goes up.”
Michael Shepard: Right.
Katie Wilson-Milne: Yeah, I mean, they’re worried about a friction in between those stages and that in between will weed out people who don’t have the ability or the resources to put in place these procedures and so there will be a shift, an inevitable shift, I think but…
Michael Shepard: And Laura makes a good point about structure of transactions and there’s actually a bank analogy. There may be good reasons to structure deals the way they are structured. I mean, we just may not understand them. There can be safety reasons. The banking analogy that I would make is a hold mail world. A Mexico client at a New York bank may ask the bank hold my mail, hold my statements. Don’t send them in the mail to me. For very good safety reasons. The postmaster, the mail person might open it, look at it, sell that information to someone, you know and then the wealthy family that’s asked for their statement to be withheld, now they are outed and they could be, you know, higher risk of kidnapping and higher risk of paying ransoms and things of that nature. So, there are reasons sometimes that law enforcement may not understand in the first instance, why a transaction is structured the way it is.
Steve Schindler: Can you talk a little bit also about the sort of subjective values of art? Does that sort of play into susceptibility, because unlike gems and other things that have been used for money laundering in the past, art is, the value is in flux and subjective.
Laura Patten: Absolutely. I mean, a border patrol or customs agent, 99.9% are not trained to even identify the difference between a poster and a piece of high value art.
Michael Shepard: A Basquiat, for example.
Laura Patten: Yes, I mean, for example, exactly. So, the subjective nature of it makes it easier to justify its value on either side of the transaction. Right? Because it’s not as though, there is a standard catalogue. It’s not like diamonds, right, where you have a scale, you know, with the market prices, you can grade them. You can’t just easily look at the cut, the clarity, etc.
Katie Wilson-Milne: Right, so you could pay a $100 million for something to try to move that money when you could have bought it for $50 million or something and it will be very hard to detect that gap.
Laura Patten: Right or consider not even the value but whether something is even art. Brâncuși. Right.
Michael Shepard: U.S. versus Brâncuși, first principles.
Laura Patten: That’s right.
Katie Wilson-Milne: Right. And you know, Dan Flavin’s had some of these issues, too. If you’re shipping a box of light bulbs to Europe, how does the customs, you know, authority look at that and you know, treat it in terms of custom duties and stuff.
Michael Shepard: And very few of the items at the border — they’re all supposed to be inspected but you know, it’s well known that most of them aren’t. The vast majority, they don’t have the capacity to do it. They try to use technology. The technology recently found, I believe, a huge shipment of cocaine. Technology found that. The subjectivity is in favor of the money laundering and it’s easily transferable. Gets across the border quickly. If I want to pay a bribe to a foreign official, which would be a violation of the Foreign Corrupt Practices Act here in the United States, why use money anymore? I could buy a piece of art, transfer it over, maybe sell it for a $100, sell it for $2000 and it could be you know, a very expensive piece of art that I bought for my corporation to hang in the boardroom. Maybe use that instead.
Steve Schindler: Right and then that can sit in a free port for some number of years and…
Katie Wilson-Milne: Then they could sell it.
Michael Shepard: Right.
Katie Wilson-Milne: So, it strikes us that the art world is uniquely susceptible to money laundering in a way that other industries, both because of their regulation but also because of just historic business practices, are not in the same way. And we have this perfect confluence of, you know, that culture of secrecy, of trust, of handshakes of not hiring lawyers or you know, experts to deal with transactions on the private sell side and a skyrocketing value of art and a heightened interest in art, you know, all coming together which are maybe making money laundering and financial crimes in the art world more prevalent today or more obvious today, I don’t know. What do you think about that?
Laura Patten: Well, from my perspective and hearing, you know, feedback from people who are at TEFAF and talking about this. Many gallerists do feel that they are being unfairly painted as criminals, right, and they don’t think it’s necessary and more seasoned collectors who haven’t had an issue, right, also think, it’s not a big deal. And they value that privacy. But, you know, looking at who are the new collectors and the collectors going forward, we’re talking about millennial generations, Z generations and they are all about transparency in everything. I mean, they live out loud. So, I think that while the acceptance of anti-money laundering regulations and good practices maybe starting slowly in the market, I think it’s gonna pick up.
Michael Shepard: I’m sorry, and I don’t think we’re saying that art galleries are criminals or knowing criminals. No one says the banks are criminals, you know, and complicit…
Katie Wilson-Milne: They’re just interacting with potential criminals.
Laura Patten: Right. Exactly.
Michael Shepard: Right, but that doesn’t mean that there is no risk.
Katie Wilson-Milne: Right, and I think that’s why galleries resent this because they feel like, look I’m not a criminal. I’m just in a client service industry. If someone comes to me, why am I being blamed for their illegal activity?
Laura Patten: Here’s an example. So, I talked to, I spent several hours with a prolific art forger and we were talking about his methodology, not just the material, the painting, but also the con, right. He, the con artist. Well, the whole point of a con artist whether they are trying to use you to get you to buy a fake Buttersworth or whether they are trying to use you to pass their dirty money through you, to launder their money, they have gained your confidence. And you know, this individual told me about the lengths, he would go to. It often took a long time, so that you would think he was your friend by the time you were being used. And often, you’re not gonna know that you’ve been exploited until the con is over and you’re stuck holding the bag. That’s why it’s so important for gallerists to try to mitigate the risk — there is always a risk — and it can be done within a reasonable cost and operational burden.
Katie Wilson-Milne: This is the challenge between, you know which we see a lot and I totally agree with that. I mean, we see our gallery clients as victims of this problem, not perpetrators of it, and framing it that way, I think is helpful to understand. One of the challenges is that, you know, there’s usually not a budget line for legal or professional advice like this. So, rather than paying, you know, a minimal amount of money compared to the overall budget up front to get some procedures, paperwork in place, you know, more often and this is changing a little bit. You know, galleries will not do that. They just won’t spend the money until something goes horribly wrong and then they will spend a hundred times that amount and you know the tax problems have sort of been a microcosm of that. And I think an example of the same problem happening in the money laundering setting which is that, you know, galleries forever would do whatever their customers want them to do about where to ship it, collect tax, not collect tax. And they were like, look, I’m just doing — I pay corporate tax on whatever happens at the end of the day and so I’m not, the sales tax, use tax, like I can, I’ll just, they give me a resale certificate, I won’t worry about it. But you know, state financial departments including the IRS for non-sales tax reasons but for sales tax, you know, state authorities started investigating this stuff with a lot more rigor in the last few years. And they subpoenaed the galleries to get information, you know, and they had to give grand jury testimony and so, they got brought into this world in a very abrupt way because of that laissez faire sort of approach. And I think there are some parallels, you know, and maybe a cultural connection between how that was handled and how they see money laundering issues.
Michael Shepard: If we’re serious about fighting money laundering and terrorist financing, it cannot be only the banks that are involved in that fight. If I were talking to a gallery, I would give example, because I’m always thrown back, well, we’re not a bank, why should we be doing this? And I would talk to them about other examples of industries that are subject to having anti-money laundering compliance programs, the gatekeepers, I call them. That would be one example. Gatekeepers are lawyers and accountants that are used by money launderers, by criminals to set up shell corporations, to help them move money, to create trusts that have nominee directors, you know, the shell game as we call it, so we can move the money. That’s a perfect example of another industry where, they are not criminals, they are not, you know, most of them. But they are being used by the criminals. In order not to be used, unwittingly by the criminals and just put your head in sand, you need to create a risk based financial crime compliance program and it doesn’t need to cost that much money. It’s certainly gonna cost less money in the end than it would to be fined or to be thrown in jail and charged criminally with aiding and abetting a money launderer.
Steve Schindler: Let’s talk a little bit about what galleries can do to identify risk and to mitigate those risks.
Michael Shepard: Well the first place to start, I believe, is always with performing a money laundering risk assessment. That involves assessing who are your customers both buyers and sellers. What types of products and services do you offer? What type of channels are used to provide those products and services? Are they in person? Are they on the telephone, are they on the internet? Are they through an intermediary? Each one of those channels will have different inherent risks. And what jurisdictions do you the gallery operate in? What jurisdictions are your customers in? So, after assessing what the inherent money laundering risk is across all those dimensions, you would assess what existing controls mitigate those inherent risks? And what’s the residual risk and by assessing the existing controls, one would also be able to determine and identify do I have gaps? Do I have to enhance existing controls or do I just not have a control in place? And then to remediate those gaps and develop the risk based controls. Also I have a feeling — this is a feeling, a sense of mine, that larger galleries are sitting on data. We’re computer based now. They’re sitting on data. They can make use of that data in order to do a lot of this and again you know, it doesn’t need to be expensive. Yes, it’s gonna be an added cost but it can be risk based.
Steve Schindler: Right. So are you saying to some extent a small gallery on the Lower East Side of New York who basically deals with clients in New York, are they at a lower kind of risk assessment than say a large international gallery that is dealing with clients all over the world and going to art fairs all over the world? Is that a different kind of operation and do I need to sort of address these things differently?
Michael Shepard: My answer would be, it ought to be and the reason, I say it ought to be is because it’s domestic, meaning here in the U.S., but New York is a higher risk city for money laundering within the United States.
Laura Patten: The other thing, if you look at how, say, frauds in general are perpetrated in the New York market — say a stolen object, right, say you have a stolen object, you want to clean it and you always sell it first, the criminal sells it to a small auction house or to a small gallery and then it builds provenance before it gets to the big galleries or auction houses.
Katie Wilson-Milne: Smart.
Laura Patten: So, to answer your question, maybe.
Steve Schindler: Right, right.
Laura Patten: There are some free resources out there for galleries. The Responsible Art Market, for example, which is a non-profit has published some very, I think, I asses them as being very common sense step by step procedures that galleries can…
Katie Wilson-Milne: And those are sort of best practices.
Laura Patten: Best practices, yeah.
Katie Wilson-Milne: Right. Because one thing, you know, when I’m listening to Michael talking about these risk assessments, I think, you know, for your average dealer, let’s take the top five galleries out of this, they have no idea what any of that means. First of all, they are not asking their clients where the money comes from and the idea of that is so off-putting to them that they can’t, you know, they don’t know what the risk assessment is. They don’t, they are not gonna be able to track the stuff.
Laura Patten: So the gallery owner, not the individual dealers, that’s where it seems to come from. It needs to come from the top down and say, if your dealer in my gallery because they have all sort of their own businesses within the galleries. These are the procedures thou shalt follow.
Katie Wilson-Milne: But there a lot of dealers who are not tied to galleries, right, in fact…
Laura Patten: Well that’s true. Yes, so I can see that it sounds intimidating absolutely. But the alternative of not doing that is…
Katie Wilson-Milne: I mean, people aren’t even, no one’s doing OFAC searches all kinds of things that should already be done and are required.
Laura Patten: What do you think? What do you hear from your clients about — and it’s two questions. Are they asking for help around money laundering number one and number two, there has been talk about a consortium among galleries to address this. What are your thoughts on that?
Michael Shepard: I mean, I’ve had ad hoc questions. You know, and the questions come in just not so much, you know, we want to revamp or adopt guidelines. But here is this transaction and here is where the money is coming from and there is where the art is going. Does this sound funny to you, right? And so there — some are at least sensitized to the idea that they need to ask these questions. I think the next step would be to encourage them to engage with it in a more systematic way. So, I think, you know, my experience is a sort of, they’re getting it. They are getting it when it’s really, when the red flags really sort of pop up but you know, I think what’s a little scarier when you don’t have a program and I think you had mentioned before, Laura, that the typical con artist works over time. So it may not be just the very strange transaction that walks in, off the street that you’ve never heard of this person before. You don’t know anything about where they got their money from but it’s someone who you’ve known for a longer period of time. And then it’s harder to ask those questions like where did the money come from for this transaction? And frankly, you know, because we deal with the auction houses, they ask those questions. So, it’s not inconceivable but it does seem, I think to Katie’s point, if someone walks into my gallery and wants to buy a piece of art, then I say, well where did your money come from? You know, it’s a very intrusive sounding question in a business, any kind of business contact.
Katie Wilson-Milne: Yeah and maybe it’s worth now drawing this distinction between the major auction houses and dealers because the major auction houses do carry risk and they deal with the consequences of that risk on a regular basis. So, it’s not to say, it doesn’t exist there. But auction houses today are both regulated externally and internally in a way that leads them to have detailed contracts, to do provenance research, to want to find out who the beneficial owners are to some extent in a way that is very different than the gallery and non-gallery private dealer setting. And so, when you know, I think about the biggest concerns I have in this space, it’s often for, you know, clients or parties who have the least resources and expertise to deal with it, which are the private dealers versus the auction houses which have staff already putting these kind of procedures in place and look at it all the time. So…
Michael Shepard: And they’ve hired money laundering compliance professionals —
Katie Wilson-Milne: Right. They have people who do this.
Michael Shepard: Whether they’re former assistant U.S. attorneys from the United States attorney’s office, from the Manhattan district attorney’s office, from banks, they’ve already gone through that journey and they have in place and continue to enhance their anti-money laundering compliance programs. It is the level below that where a lot of the concern ought to lie because there is less expertise. It’s costly. It’s intrusive as Steve mentioned, it’s not the way they do business. On the other hand, we’ll talk about some examples of some cases later where the art dealer was caught up in, in laundering money and to Steve’s point about the con artist working over time. That was the same thing with the gatekeepers, with the lawyers in Jersey and Guernsey, the accountants, the criminals, would work with them on legitimate deals, over time. But then they would start increasing and then they would start expanding but then they would also stuck dealing with that client.
Katie Wilson-Milne: Right. So let’s talk about some specific red flags and at the outset of this, I think it’s worth noting that some things that are red flags, are also absolutely normal and the way, you know, dealers have always done things, which include things like buying through shell companies or trusts or, you know, all kinds of entities that build a barrier between the transaction and the real person on the other side and the source of funds and that’s been true forever. And so I think there is a sense of, there is a comfort with some things that are also — could be seen as red flags that complicate this. But let’s talk about some of those.
Laura Patten: Right. That’s what I was saying about the policies and procedures. The way, the business practices of the art market from an investigative perspective is always challenging because if you’re used to investigating white collar crimes in another industry and you are on your first case in the art market, oh, my God, there are red flags every where. You really have to parse those. So, you know, let’s look at red flags across people, transactions, and the objects and I’ll start with people. If they are reluctant to provide information and documentation. If you’re unable to verify the beneficial owner identity and income source, if the individual, the counter party lives works or banks in high-risk locations. If the individual is a sanctioned politically exposed person.
Katie Wilson-Milne: And how would you know that?
Laura Patten: That information is publicly available. You can Google it on the treasury’s website. I would also add and this may seem very obvious, people who have the capability of producing art or accessing art and that may seem obvious but I’ll just give you an example of an art fraud. It was not money laundering per se but John Ray, who is in prison now for forging and selling as authentic numerous Jackson Pollocks. Before he launched this scheme, he spent five years in federal prison for counterfeiting U.S. currency. A person who can counterfeit U.S. currency can definitely make splatter paintings. I mean, that’s just, right. That was a high risk and that information was publicly available. But you don’t think about that. Right, you don’t think, oh, I’m gonna enter this person’s name in the bureau of prison website and see if they were ever in prison. So, anyway.
Steve Schindler: Well now, it’s on a checklist.
Katie Wilson-Milne: That’s a great example.
Steve Schindler: Just tell us a little bit — I want to go back to a couple of the categories. Unable to verify the beneficial owner in a transaction is a red flag, but just what do you mean by that?
Laura Patten: So what I mean is, we were talking about the tradition of using trusts, right or an agent to conduct a transaction for you. If you don’t know, if the agent is unwilling to tell you who they are representing, that’s a concern. Now, I know historically that was fine. Well the auction houses are now saying that’s not fine. So, I posit that it’s gonna be a value proposition, right and increasingly the buyers who want to make sure that they are transacting at the highest standards are gonna go to the auction houses and the global, I’m talking about the blue chip highest and international galleries, you know, they could hire one person to be, to run compliance and that’s not going to break their budget.
Steve Schindler: Now, the other question I wanted to ask was, when we talk about politically exposed persons, what does that mean and why do we not want to be transacting business with such people?
Michael Shepard: So in the United States, what we mean by it, at least in the financial institution world and under the Bank Secrecy Act and anti-money laundering regulations is a senior foreign political figure. Someone high up in the government who may be influential, who may be corrupt, may be trying to move the proceeds of corruption out of their country. They’re generally higher risk for money laundering. Higher risk for corruption. Globally you can take out the “foreign” and it’s just a senior political figure.
Steve Schindler: If someone is a senior political figure and they’re all of a sudden, you know buying a lot of high end art, that there is at least a question to be asked whether the funds have come from some corruption in their countries?
Michael Shepard: There are many cases out there about corruption involving dictators. You can read about it. There is the sons and daughters and the close relatives of the dictators who may be pillaging the natural resources of the country, taking the money for their own corrupt objectives, and not giving it back to the country where they are. Though they have a government job, where they are paid $200,000 yet they have accounts in the United States with billions of dollars in it. Well where did that money come from?
Laura Patten: Yeah, I agree. I just was, you know, putting my hat on thinking well, if I’m a dealer, I’m thinking wait, but it’s rich people who buy my work. I mean, these are the people I’ve always sold to. So, what are you trying to kill my business?
Katie Wilson-Milne: Yeah, well that I think you will hear that. I mean, that is a concern. Are there other red flags that are specific to, you know, the transactions and the object that people should be aware of?
Michael Shepard: I will leave the object to Laura but with regard to the transaction, remote deals and not face-to-face. They are higher risk. That’s why I mentioned earlier when assessing risk what are the channels? Is it over the internet, is it on the telephone, non face-to-face. Face-to-face, you get to face off with the person, ask the questions, you know, you know who you’re talking to, you know, who you’re dealing with. Cash transactions can be suspicious, even in offer to pay a substantial cash payment for a work of art might raise red flags. Illogical offshore accounts, Laura covered that earlier today. Those can be red flags. Structured payments below government reporting thresholds. Shipping art unexpectedly to a jurisdiction unassociated with the client. Laura mentioned that earlier. That should raise a red flag and might cause pause. If the purchases exceed a client’s known resources, the example would be the dictator that I just used who’s government job is on the internet, it says, he makes $200,000 a year, yet they are buying art for, you know, tens of millions of dollars. Where are they getting that money from? That ought to raise a red flag. You know, ought to cause someone pause before entering into a transaction. And while someone may consent well, that’s killing my business. It’s not killing your business. It’s helping you do business that’s legitimate, because you don’t want to enter into a transaction where you become the target of a government investigation. Multiple sales of recently purchased art that could be layering, that could be trying to transfer the art to transfer value. You’ll need to monitor that. And, obvious, you know, over and underpricing. That could be a red flag too.
Laura Patten: Yeah, you’re right. The flipping of art is definitely a red flag. It’s also something that the trade does not like because it messes up the value of the artist. For objects, the very first question is the hole in the provenance for any kind of investigation into art, including money laundering. That’s the number one question. Also there are certain types of objects that could be more susceptible to money laundering. For example, antiquities. We know for a fact that antiquities have been looted en masse in Syria, Yemen and other places where the Islamic state and other terrorist organizations have been active. That’s not an opinion. That’s a proven fact based on satellite photos and evidence seized during the raid on Abu Sayaf’s compound. Abu Sayaf was the minister of finance and the minister of antiquities for the Islamic state Daesh. And when U.S. forces raided his compound, they found not only antiquities, freshly looted antiquities, they also found western catalogues, price lists, bank numbers. Now, you can also look at, and I have not looked at this particular piece of information but it’s been widely reported, that imports into the U.S. of antiquities from the Middle East just writ large — and by that, we define that as anything that’s a hundred years old or older, increased during the same period, starting soon after ISIL took over most of Syria to the time they lost most of it. That’s not saying those particular objects are being sold here but we do know that the types of objects that terrorist organizations in the middle east are selling to raise hard currency are very popular among certain collectors in the United States and western Europe. So, you know.
Steve Schindler: I think, if I were engaged in the business of buying and selling antiquities, I would have two lawyers and two consultants from Deloitte at my side at all times. It seems fraught, so fraught with danger. Maybe we can talk more concretely about a couple of recent examples where people have been caught up in money laundering schemes, and I’m thinking initially of Matthew Green.
Michael Shepard: Yeah, the Matthew Green example is an excellent one. The U.S. Department of Justice charged a U.K.-based art dealer, Matthew Green, with a scheme to launder money through high-end artwork. This was actually a sting operation that was targeted at U.K. brokerage and penny stock market manipulation. Not the art market. So you had undercover agents posing as criminals who needed to launder money and they were proposing a stock fraud scheme with the U.K. brokerage. Well, after the stock fraud, they would need to launder the money because they would be illicit proceeds. Well, the brokerage house introduced — allegedly, these are all allegations to date. They allegedly introduced them to Matthew Green and Mr. Green, who is a well known art dealer, I believe in the Mayfair section of London, agreed to sell art to the agents to launder the money. And the agents allegedly told him the purpose. The purpose was we’re selling the stock. You know, this is gonna be the proceed of stock fraud, penny stock market manipulation and allegedly he agreed to do this. So, he’s under indictment right now.
Steve Schindler: And it was a Picasso, which is a nice round sum. I think it was about $10 million.
Laura Patten: That reminds me, when we were talking about objects that are more vulnerable to money laundering. In the cases, I’ve seen, in the U.S. at least, the mid-level works by well known artist. Right, for example a Picasso, not the best Picasso but a good Picasso tend to be involved because the really high, the splashy objects get a lot of attention. Now, there could be a case that comes, you know, to the fore soon that throws that, you know, theory out the door but.
Steve Schindler: What I remember now about the Matthew Green case is that the idea would be that he would sell them the Picasso and then he would arrange to buy it back in a couple of years and the launderers were proposing a commission to him of 5%, and he said, “no, it needs to be higher, because if it’s 5%, it will look like I’m laundering money. Like, why would I be doing this transaction for 5%? It has to be — realistically, it has to be higher.” And you know, when I said earlier that money laundering requires intent, if all of these things are true, that’s sort of the classic case of showing intent. That he knew exactly what he was doing, and what he was doing was trying to hide the proceeds of an illegal act.
Michael Shepard: And most money launderers would be willing to lose more than a 5% commission by the way.
Steve Schindler: So let’s talk about scenarios now where we are not talking about people who are intentionally engaged in money laundering, but how is it that both in Europe and in here, governments are trying to impose some of these what we’ve been talking about as best practices on dealers of art and antiquities?
Laura Patten: Well, in Europe, the Fifth Directive on Money Laundering requires art sellers dealers, auction houses, basically art vendors of any type to be compliant with a new higher level of anti-money laundering practices and procedures and that’s 2020. It’s just around the corner.
Katie Wilson-Milne: And that’s anyone selling in Europe. So even if you’re a U.S. gallery but you have a gallery arm in London, or I mean sorry, a gallery arm in Paris now?
Laura Patten: So that is my understanding but I am not the lawyer in the room. So, I’m going to let the lawyers in the room answer that, but yes.
Steve Schindler: Yes and we’re not European lawyers but I think, but there is also, there is the threshold as well right, 10,000 pounds or 10,000 Euros.
Laura Patten: Yeah and if you go to Maastricht or Basel, everything is above 10,000 Euros. So that’s in Europe. In the U.S., there is H.R. 5886 which is the Illicit Art and Antiquities Trafficking Prevention Act. It was introduced last year. It seems to have stalled but there is certainly ongoing interest and conversation, both on the executive branch and the hill side of Washington about this issue.
Katie Wilson-Milne: And that proposed legislation which again has not passed, would extend bank secrecy regulations to the art market and in the state it is now, just generally to the art market.
Laura Patten: I don’t think the mechanics of how that would happen are clear. For example, financial institutions, and Michael can talk more about this, are required to file suspicious activity reports. I can see from a gallery’s perspective that this is brand-new territory for them. They would, if I were able to recommend something, I would say that they should have one person dedicated to that in part so that it doesn’t damage the relationships between the dealers and the buyers. But you know also galleries, the resistance I hear is wait a minute, we have to spy on our clients? No, that’s not exactly and Michael maybe you can talk a little bit about what a suspicious activity report is.
Katie Wilson-Milne: Yeah and also just what the bank secrecy act does generally so people can have a sense of what now dealers and art market players would have to do if this type of legislation has passed.
Michael Shepard: Well, we’d have to see what the legislation would entail but for financial institution and covered entities — money services businesses are covered, jewelry industry is covered in part and you have other industries as well. One, you have to have an AML compliance program. Okay, that would be the first thing.
Katie Wilson-Milne: Like a written policy.
Michael Shepard: A written policy and procedures and controls in place. Okay, it’s not just the written documents, it’s what’s the control?
Laura Patten: Can you define control for people in the art market?
Michael Shepard: Sure, control would be for instance a KYC form, a know your client form that’s actually filled out. Another control would be monitoring. Another control would be sanction screening, which I would love to come back to because every art dealer is subject to OFAC right now and if they are not screening, that’s a huge risk. So we can come back to that. So an AML compliance program. They do have to have a bank secrecy act officer, someone who is qualified to oversee the program. There needs to be training and there needs to be —
Katie Wilson-Milne: Training of all staff.
Michael Shepard: Training of all staff on what is anti-money laundering and what are our procedures? How do we comply with it? Fourth, there has to be independent testing. A third-party that didn’t put the program in place coming in to assess the program, whether it’s adequate under the law and whether it’s working.
Katie Wilson-Milne: Like an audit.
Michael Shepard: It’s an internal audit. There is now fifth pillar which is KYC which is the beneficial owner and testing of the program might or might not be required. I suspect it would be because you know, it’s something that proves that the program is working as intended.
Katie Wilson-Milne: Yeah, and do you think financial thresholds for application to the art market are likely or would be appropriate? I mean, I can see that if you’re a dealer and you stand to make $50 million off a transaction, you know, I personally perceive that person as having an obligation to do this type of due diligence and even if it costs something, it’s gonna be small relative to the overall up side. Whereas if you’re selling, you know, one work a month for $20,000, and you know, you have one staff member that’s gonna be a lot more onerous and challenging.
Michael Shepard: My personal view is that there ought to be thresholds. And they should be, you know, fairly substantial in the tens of thousands of dollars.
Laura Patten: Right because I don’t think anybody wants to make barriers to entry higher, you know, it’s already hard for small businesses in the art market to get up and running.
Katie Wilson-Milne: Right and to get people, you know, I think there’s two challenges. One is getting more people who are not art market sophisticates interested in the art world so they’ll buy a $5,000 work of art, a $10,000 work of art, if they have some excess capital and you know, the other is the survival of these small galleries and dealers who are really one or two staff member businesses. Who are trying to make a go at selling relatively lower priced works of art to a broader array of people and engaging a larger number of people in an art market that was, you know, traditionally has been very elitist. So…
Michael Shepard: You know, we are seeing an increase, and maybe not in the higher end of the market, other than antiquities, in internet deals. So, that’s another dimension and another channel, another, you know.
Steve Schindler: Does that raise the risk factors?
Michael Shepard: Yes.
Katie Wilson-Milne: It raises, you know, apart from these financial crimes issues, you know, Steve and I have talked on another podcast about all kinds of risks that come from internet sales and not seeing an object, not seeing its provenance in person. So, that’s in general people should be wary. So, the European regulations are definitely coming into effect.
Laura Patten: Yes.
Katie Wilson-Milne: We don’t know about the U.S. regulations but the general question that remains to be seen is to what extent can players in the art world act like banks and both are they able to, is the law gonna really treat them that way and you know, what’s in between?
Michael Shepard: Again, there will be, I keep going back to this term risk-based compliance program. If you assess your risks, and then put controls in place to mitigate those risks. You have a justifiable program. That if something does go wrong, you can say to government, I had a program. It’s a one off. That’s a mitigant against you know, facing large fines, facing prosecution. So, again risk-based programs. It should be documented. There should be training. It should be assessed on occasion to make sure it’s working as intended and that the employees are doing what they are supposed to do. That’s really what’s required.
Steve Schindler: So, with all of these, you know, potential risks can technology help? Is there anything on the horizon that you think might be useful in trying to prevent some of these problems? We can’t not talk about blockchain.
Laura Patten: Yes, I was gonna say blockchain is the hot word, right? So, I mean, look, distributive ledger technology is not new. Blockchain, this is a variation on that, and it can, it’s a double edged sword from my perspective. On one hand, it can verify that only these four parties are allowed to, or these are the right parties making the transaction. On the other hand, it can be used by money launderers to identify that yes, I’m the right person. It doesn’t say whether I’m, you know, have clean money or not.
Steve Schindler: Right, and obviously, you know, potentially the use of cryptocurrency is also a concern and something that’s certainly being addressed in Europe as you know, part of the money laundering initiatives.
Laura Patten: Right, and certainly, I mean, there are systems that look at risk across entire enterprises, specifically looking at money laundering. There are some systems in development that are specific to the art market. You know, these are new to the art market and so, will need to be curated accordingly.
Michael Shepard: Everything else that has been developed is for the financial institutions specifically and new products for the larger art industry companies, they’ll be forthcoming.
Laura Patten: Michael, you mentioned that the big galleries are sitting on so much data, right. I mean, if data, if the imperfect information of the market is what gives some people advantages, right? It’s always been that way. So, the large galleries could — and I don’t know to what extent they already have. Well, I know, a couple but not all of them can take all this data, start running it through analytics, and you know, there is machine learning that can make actually predictive analytics about deals that, they can say, hey, this is gonna be risky. Do you want to do this even before you do it?
Katie Wilson-Milne: Yeah, we talked a little bit about that in a different setting with Jason Bailey who is our last guest talking about, you know, blockchain and technology in the arts that, that really hasn’t yet been a huge push to build this predictive analytic technology but there is certainly should be and about all kinds of things about art — how much it will sell for, how much it will resell it for.
Laura Patten: Yeah, and there are a lot of different entities out there working on that. You know, we’ve been trying to put together a way of — we have put together a way of looking at art transactions and holdings but bringing together the object, counterparty, and transactional operations and bringing all those disparate pieces of data together to get a better understanding of potential risk.
Katie Wilson-Milne: If someone hires Deloitte to do a risk analysis, you’ve built those tools internally to do it?
Laura Patten: Yes.
Steve Schindler: Okay. Great, well, thank you Michael and Laura for being with us. This was fascinating and we look forward to…
Michael Shepard: Thank you for having us.
Laura Patten: Thanks. This has been great.
Katie Wilson-Milne: Yeah.
Steve Schindler: And that’s it for today’s podcast. Please subscribe to us on iTunes or wherever you get your podcasts and send us feedback at firstname.lastname@example.org. And if you like what you hear, give us a five star rating. We are also featuring the original music of Chris Thompson, and finally we want to thank our fabulous producer Jackie Santos for making us sound so good.
Katie Wilson-Milne: Until next time, I’m Katie Wilson-Milne.
Steve Schindler: And I’m Steve Schindler bringing you the Art Law Podcast, a podcast exploring the places where art intersects with and interferes with the law.
Katie Wilson-Milne: And vice versa. The information provided in this podcast is not intended to be a source of legal advice. You should not consider the information provided to be an invitation for an attorney client relationship, should not rely on the information as legal advice for any purpose and should always seek the legal advice of competent counsel in the relevant jurisdiction.
Music by Chris Thompson. Produced by Jackie Santos.