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An art power rises in China, posing issue for reform

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Eight years ago, as personal incomes here soared, China Poly Group, a state-run conglomerate that began life selling weapons for the People's Liberation Army, decided to venture onto another sort of battlefield — the art market.

The corporation had already expanded into theaters, sports cars, real estate, even television sitcoms, and the new division, Beijing Poly International Auction, soon joined the others in Poly's imposing modernist, sand-colored office tower here, where visitors can shop for a painting on the third floor or a missile system on the 27th.

In its short life, Poly Auction has risen to become the third-largest auction house in the world, behind Christie's and Sotheby's. Its 2012 reported sales totaled nearly $1 billion, and its auction rooms now buzz with the energy of thousands of new consumers eager to buy a piece of their cultural history or invest in the recent art boom.

(Read more: Christie's sells $25 million of goods in its first China auction)

But while the art market in China remains robust — its $14 billion in sales last year make it the second-largest in the world after the United States — it is also rife with fraud, forgeries and payment defaults that, experts say, are undermining consumer confidence.

Fearing that buyers will flee the market, government ministries and the China Association of Auctioneers, are pushing corrective initiatives, including asking auction houses to report sales that fall through and training experts to better identify forgeries. At first glance, Poly Auction, as a state-backed business that accounts for 11 percent of the country's auction revenues, would appear to be an ideal place to start. But it is becoming clear that the powerful company, rather than serving as an instrument of reform, may pose a formidable challenge to it.

Beyond its 55 percent government ownership, Poly Auction is part of a company with a proud military heritage, expansive business interests and strong ties to China's highest echelons, all sources of influence that critics say help shield it from encroaching regulations.

An industry study found that last year Poly had one of the worst records of buyers who did not pay, a persistent problem in the Chinese art market. When auction houses do not always note these failed transactions, as was the case with Poly, their reported sales figures exceed reality. The study found that Poly's revenue was one of the most exaggerated among the top houses. And unlike major rivals, Poly has balked in recent years at allowing the auction trade association to publish full details of its sales.

Thomas Galbraith, a New York-based art market analyst and expert on the Chinese art world, said Poly's attitude is a hurdle for those trying to set standards. "Some in the industry and government want to introduce regulation into the market," he said, "while others see nothing wrong."

Poly has its defenders, even among trade association officials seeking to clean up the market, and company officials say the study and critics are being unfair. "The government has a stricter policy on state-owned enterprises than on private enterprises," said Zhao Xu, the executive director of the company. Either way, although Poly is just one of more than 350 Chinese art auction houses, its size and reach mean that no meaningful effort to address the irregularities can succeed without its participation.

(Read more: China's richest man snaps up $28 million Picasso art)

"In the Chinese art market," said Nancy M. Murphy, an expert on Chinese art law and a lawyer at the Beijing firm Jincheng, Tongda & Neal, "Poly is the 800-pound gorilla in the room."

An auction house with military roots

Poly Auction's influence in the art world stems in large part from its parent, a three-decade-old company whose founders include several lions of the Communist Party. One founder, Wang Jun, is the son of a close associate of Mao. Another, He Ping, is a former general who is married to the daughter of Deng Xiaoping, who led China for much of the 1980s and 1990s.

Though Poly Group's official ties to the military were cut in 1999, it is still staffed by former military officers and led by the relatives of senior Party officials. It still refers to its socialist mission, retains a stylized P from the People's Liberation Army as its logo and remains involved in arms trading. (In February, the United States imposed sanctions on Poly Technologies, the defense equipment division, accusing it of violating a nonproliferation policy that controls weapons traffic with Iran, Syria and North Korea.)

In the 1980s, the Poly Group began to reinvest its arms profits in other sectors of the economy, including hotels and office towers. As the Chinese grew wealthier, the corporation branched out into culture and opened theaters and performance halls.

In 1999, it established a presence in the visual arts when it opened the Poly Museum, stocked with national treasures. Some of these works, now on display in the ninth-floor galleries of its headquarters, have been reclaimed from abroad, an effort that earned Poly considerable good will in a country still harboring sour memories of looting by colonial powers.

When Poly entered the auction market a few years later, the sale of high-end Chinese art was largely the preserve of foreign houses operating from Hong Kong and an older, privately owned company, China Guardian. But China's market was expanding fast — auction sales more than doubled between 2004 and 2005 — and Poly Group, sensing an opportunity, brought in Mr. Zhao, a dealer, as executive director of its new auction business.

By 2007, Poly, the upstart, had come to rival Guardian in sales. Its deep pockets meant it could offer consignors cash advances, and the company's wide web of contacts helped lure the new rich of China to its auction floor, experts say.

"Individual buyers, they recognize us as part of the government," said Mr. Zhao, who is 44. "They trust us, since we are part of the state-owned enterprise."

Many credit Poly's ascension to Mr. Zhao's energetic, personal way of doing business. Associates say he operates his own private club next door to the Poly headquarters, where he wines and dines important collectors, though Mr. Zhao said such meetings are strictly social. In other instances, he has pursued a customer who failed to pay by donning a towel and tracking him down in a sauna.

(Read more: Art auction to test India's demand for luxury)

Though Poly has no shortage of state-connected overseers, there is a bustle in Mr. Zhao's third-floor office that one might expect at a tech start-up, not at an arm of a sprawling, state-owned company with $61 billion in assets. Spare shirts hang in a closet, and paintings and photographs, including several of Mr. Zhao with the former Chinese President Jiang Zemin, line the walls.

Mr. Zhao presides regally, constantly checking his smartphone as aides come and go, some carrying the antiquities and traditional paintings and calligraphy that are the mainstay of the market. At one point, a worker unrolled a scroll in front of his desk.

"We will not be able to auction this," Mr. Zhao declared, waving it away dismissively.

"Zhao is like a general," Yang Bin, a wealthy businessman and art collector who counts Mr. Zhao as a friend, said in an interview.

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Mr. Zhao personally owns about 18 percent of the auction house, according to company records, with other private investors owning about 27 percent.

The Poly Group is overseen by the State-owned Assets Supervision and Administration Commission, which monitors 113 of China's biggest state-run companies. But even experts who specialize in the workings of these companies don't know just how Poly functions as a corporation, how power is shared internally, to whom its executives are really accountable or how its revenues and benefits are distributed.

Mr. Zhao said that despite the large state stake in his company, he feels largely autonomous. He operates two private businesses of his own, a gallery and an online auction site. "To work for Poly," he said, "is to work for myself."

Meg Maggio, who runs a Beijing art gallery and has done consulting for Poly, described Mr. Zhao as an innovative leader. "It took Guardian 20 years to achieve what Poly accomplished in less than 10 years under the strong directorship of Zhao Xu," she said.

For all of Mr. Zhao's savvy and influence, though, it is Poly's relationship with the state and the reach of its affiliated businesses that have fostered its ascension in the art world, experts say. They claim that, because of Poly's ties to elites in the Chinese government, it enjoys greater freedom in moving cultural relics in and out of the country and more leeway from the tax bureau. Poly also can be more dismissive of recent efforts, led by the trade association, with the of commerce and culture ministries, to reform the Chinese art market, the experts say.

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"It's a privileged institution that is more powerful than what we would consider some of the lesser state agencies," said Tai Ming Cheung, director of the Institute on Global Conflict and Cooperation at the University of California, San Diego, and an expert on Chinese state companies.

Though reported revenues for last year suggest that Poly has eclipsed Guardian, the first major art auction business on the mainland, Guardian has not complained about Poly's government connections and has some of its own. State-run companies own about 10 percent of Guardian, which has long had a reputation for a more cautious approach to business.

"Our styles are different," Kou Qin, Guardian's director and vice president, said of the two auction houses.

Poly officials said the company's power and ties to military elites are often overstated. "We are just a normal business company," Mr. Zhao said. "We have no P.L.A. backing," he added, referring to the People's Liberation Army.

Modernizing a market

There is no question, though, that Poly has not been as compliant as other houses with the industrywide effort to improve the accuracy of sales reporting.

Auction houses clearly want buyers to pay. But when they don't — which happens routinely here for reasons that include the buyers' becoming leery that they've purchased a fake — it is in the house's interest to obscure the problem by treating the defaults as sales. As well as exaggerating revenues, this practice props up prices and promotes the market as being hotter than it is, experts say.

Unlike Guardian and other houses, Poly refused for the past two years to allow the auction association to publish data on the individual works whose sales had not been paid for completely. On top of that, the auction association's studies ultimately found that Poly is increasingly struggling with a nonpayment problem. In 2012, for example, the association found that, because of nonpayments, only 34 percent of the sales Poly reported for works valued at more than $1.6 million each were actually completed by May of the following year.

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By contrast, Guardian's payment rate has improved, with 83 percent of sales completed last year, up from 53 percent.

Mr. Zhao complained that the association's analysis is biased, arguing that the statistics are incorrect, since Poly auctions take place later in the year than others, giving it less time to corral recalcitrant payers. In addition, although the study found that two-thirds of the high-end sales were never completed, it also showed that Poly had received at least some money in many of those cases.

Poly said it believes in more flexible payment schedules for clients with good credit. Otherwise, it said, it has been dutiful in participating in corrective programs run by the auction association, a position the group did not dispute.

"Poly is one of our very important and supportive members," the association said in a statement.

But Mr. Galbraith, the analyst, said officials from the association and other auction houses have complained to him that Poly shows little interest in overhauling a system under which it has done so well. Mr. Galbraith spoke last spring at the Chinese auction association's major conference, where problems in the market were a focus. Poly, he said, was represented by a low-level official who did not stay long.

"Here is the most important meeting for Chinese auction houses," he said. "Someone from Poly showed up at some point for the drinks session and then left. Meanwhile, the rest of the room is filled with the C.E.O.s of other auction houses."

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Auction houses account for an estimated 70 percent of the art sales in China, compared with roughly 50 percent in the United States, according to Arts Economics, a research company that studies the international market. And the top houses, lavish considerable attention on their customers, more so than their counterparts in the West, according to people who have worked in both settings.

"Experts are expected to be full-time milkmaids at times," said Mike Bruhn, a consultant who worked at Guardian for two years as an adviser on international business.

Satisfying this Chinese thirst for respect and attention can mean an auction house expert might accompany important buyers to exhibitions, or perhaps provide tickets to a sporting event, or even refrain from chasing them if, as so often happens here, they are slow in paying.

Many of the Chinese art market's problems stem from how young it is, economically speaking. The culture of bidding is still novel, newly wealthy buyers are inexperienced, and the auction houses themselves are figuring things out as they go along. Certainly, the style of auctions at Poly and Guardian, and other top Chinese houses, is distinct from their high-tier counterparts in the West.

In New York and London, evening art auctions are discreet, air-kissing affairs. Buyers are typically veteran, elegantly dressed collectors who know one another and signal bids subtly to auctioneers conducting business in soft tones.

At auctions here, despite the presence of well-trained, white-gloved attendants, casually dressed buyers munch on snacks from paper bags and chat on cellphones, creating a low-level din throughout the bidding. Purchasers of expensive paintings have been known to roll up their canvas, tuck it under an arm and stroll out into the night air.

The competition for buyers is expected to intensify in coming years with Western auction houses entering the Chinese market more fully. Sotheby's has formed a joint venture with a state-owned Chinese company and held an auction in Beijing this month. Christie's has won a license to operate independently in China and this fall held its first auction.

(Read more: Chinese look abroad to preserve wealth: Report)

Both are significantly larger than Poly in manpower — Sotheby's has more than five times as many employees worldwide as Poly Auction's 260 — and carry a reputation for probity which, while hardly ironclad, could be a competitive edge in the fraud-ridden Chinese art world.

For now, though, both Christie's and Sotheby's remain on a tight leash, permitted to auction only watches, wine, jewelry and contemporary Chinese art, not the more lucrative relics and traditional Chinese painting and calligraphy.

Poly officials, however, speak confidently of their ability to ward off the competition and are focusing instead on their company's expansion. Last year, Poly staged its first auction in Hong Kong, where the Western houses do significant business, and opened a New York office to help it secure consignments in the United States, celebrating with a party at the Harvard Club. One indication of Poly Group's ambition is a plan to sell shares in its cultural division on the Hong Kong Stock Exchange in the near future.

"They don't want to be one of the great auction houses of China but one of the great auction houses of the world," said Laura B. Whitman, a specialist in Chinese art formerly with Sotheby's and Christie's.

Asked in an interview whether the foreign competitors concern him, Mr. Zhao shrugged. To do business in China, with its unique customs and cultural tics, is not as easy as simply setting up shop, he indicated.

"They are not qualified," he said of Christie's and Sotheby's, "to be our rivals for now."

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