What does an auction house do when it has its best year in ages and still gets an earful from angry investors? Raise the commissions, that’s what.

In 2004, the art and auction market seemed unstoppable. Blame it on the billionaires, the hedge funders, the bouncing stock market, a strong euro, or the eternal quest to possess. In nearly every auction category, from Chinese ceramics to contemporary art, new records were set.

Sotheby’s reported total sales of $2.66 billion for 2004, a gigantic increase from the $1.69 million the house reported selling in 2003. Christie’s has not yet released its 2004 figures, but it led the market in 2003, with a $2 billion total. A Christie’s spokeswoman said yesterday the totals are very close to last year’s.

Still, if 2004 appeared to have been a banner year at the auctions, it remains questionable how much profit the houses actually made. The houses, especially Sotheby’s, have found themselves in danger of overextending to make the big sales, offering generous guarantees and pegging estimates sky-high. The recent sale of stocks by insiders has done little to quell investor concerns.

Both Sotheby’s and Christie’s hatched plans last month to squeeze more money from their clients, announcing commission increases effective this month.

Setting commissions in the post-collusion era was surely a highly charged decision. Recall that it was commissions fixing that brought shame on Sotheby’s and Christie’s in the 1990s – not to mention hundreds of millions of dollars in fines, and some prison time as well. In 2001, the Sotheby’s chief, Alfred Taubman, was convicted of price-fixing, which amounted to secret deals between Taubman and Christie’s British chairman, Anthony Tennant. Courtroom testimony revealed the houses conspired to fix commissions and cheat customers. Christie’s received amnesty for reporting the collusion, while Taubman trotted off to prison.

Today the motivation for changing commissions remains the same: Earn profits. The new increases attempt to make up for the loss of sellers’ commissions. In the past decade, sellers have become bolder about demands on the houses, to the point that today sellers of important works expect sweetheart deals with no seller’s commission. So it’s become imperative for the auction houses to figure out how to improve their revenues and their historically slim margins.

Another factor is the auction houses’ little-known practice of frequently paying “introductory commissions,” or finder’s fees, to dealers, advisers, or others who steer a seller to a particular house. In the old days, that money came from the seller’s commission. Today, with fewer sellers paying commission, the introductory commission comes out of the buyer’s commission – politely termed “buyer’s premium” in the auction rooms – and thus cuts further into the auctioneer’s bottom line.

Besides, because the market is essentially a duopoly, Sotheby’s and Christie’s are often at the mercy of any collector with great goods. “They try not to give away too much on the seller’s side, and the unfortunate reality is that they sometimes have to give away everything to get major pieces,” art adviser Wendy Cromwell, a former Sotheby’s art specialist, said. “The only way they can make a little up is to increase the buyer’s premium.”

Yet on November 9, during a third quarter earnings call with industry analysts and investors, Sotheby’s CEO and CFO faced tough questions about climbing costs. Investors complained about compensation and the increasing number of guarantees given to sellers.

They were particularly rankled by Sotheby’s deal with one collector, Hester Diamond, widow of dealer Harold Diamond. Her collection hit the block November 4.Two of her major paintings – a Kandinsky estimated at $20-$30 million, and a Picasso pegged at $8-12 million – didn’t sell. Yet Sotheby’s was forced to pay out an undisclosed amount of money to Mrs. Diamond, because the works were guaranteed.

Sotheby’s disagreed with investors who said the high-profile Impressionist and Modern art auction was a financial flop. “After you write those assets down,” Sotheby’s CEO, William Ruprecht, told investors during the call, “you still have a profitable sale.”

Investors interviewed this week said they were also startled last summer to read in newspaper reports that Sotheby’s star auctioneer, Tobias Meyer, had paid $5 million for a swanky pad at the ultra-luxurious Time Warner condominium. It was an address appropriate for a billionaire art collector, but a 30-something, gavel-wielding art expert?

One possible explanation is that Mr. Meyer was a member of the golden handcuffs gang, a group of Sotheby’s most valuable experts and executives, who received contracts with generous cash and stock incentives in exchange for promises to remain at the company for a certain period. These deals were made after the settlements made by the house in the wake of the price-fixing scandal.

And that’s a reminder of just how far Sotheby’s has had to climb to get back even to its current fiscal state. The house spent the year working hard to tidy up its balance sheet. Its sale of its American real-estate business to Cendant added $100 million to the bottom line. The firm also raised cash when it sold its York Avenue headquarters to RFR Holdings and arranged to lease it back. In addition, some high-profile sales – the famous trove of Faberge eggs and the equally astonishing collection of Impressionist and Modern paintings from the Whitney family collection – gave the company a big boost.

In general, those moves seem to have paid off. Sotheby’s share price increased a whopping 30% in 2004, well above the market average – and probably unsustainably high. They drew some criticism for this during the conference call in November.

“You have a nice ramp in revenues, but none of that flowed to the bottom line,” said David Rosen, a hedge-fund analyst with Whitney & Co. “Sotheby’s has a history of lumpy results,” said an analyst from Abington Capital. Rommel Dionisio of Roth Capital, criticized the house for stock-option exchanges and severance costs. “When are thesy going away?” he asked.

Other investors disagree. “I think there’s some up-side left,” research analyst Robert Goldsborough, of Chicago based Ariel Capital Management, said. Ariel is Sotheby’s largest institutional investor and owns about 9.55 million shares. “The auction market rebounded quite nicely this year, and Sotheby’s did a fine job of getting some of the most trophy-like property to auction. Everything went their way this year.”

Mr. Goldsborough said he was particularly pleased with Sotheby’s efforts to pay down its debt. He was also pleased that the last of the retention bonuses had been paid out. “It’s been a good year,” Mr. Goldsborough said. “As investors we’re really pleased.”

Evidently, stockholders inside the company are taking advantage of the run-up in price. According to SEC filings listed on the company’s Web site, members of Sotheby’s board and management have been selling from their own stockpiles of shares. On December 16, the day after he sent an e-mail notifying staff and investors of the increase in commissions, CEO Ruprecht sold off about $183,925, while the president of Sotheby’s Financial Services, Mitchell Zuckerman, sold about $819,000 worth, the head of Sotheby’s Asia and Europe, Robin Woodhead, sold shares worth about $459,000, and the company’s head lawyer, Donaldson Pillsbury, sold $92,000 worth. Unlike Christie’s, Sotheby’s is publicly held and therefore must disclose financial information.

Given the investment world’s perception that Sotheby’s needs to hammer down on costs and beef up revenue, the new buyer’s commissions hardly were a surprise. And if the auction houses are able to continue to attract star material in 2005, buyers shouldn’t object to the slight hike in prices. But if the market dips, look out.

That doesn’t mean dealers and collectors are pleased about the extra charges. The author of a book that chronicled the price-fixing scandal, Christopher Mason, has heard complaints recently from art collectors.

“People are grumbling about the new commissions,” Mr. Mason, whose book is “Art of the Deal,” said. “They say that one was following the other, then they turn to me and ask, ‘Are the auction houses at it again?’ I tell them that after a $500 million fine, probably not!”

Luxury Tax

The new commissions at Christie’s and Sotheby’s will make the most expensive lots just a little more so.

CHRISTIE’S The 19.5% commission charged on the first $100,000 spent at auction has inched up to 20% (the charge remains 12% on anything above $100,000). This change actually makes Christie’s commission equal to Sotheby’s old one.

SOTHEBY’S Sotheby’s now charges a 20% commission on the first $200,000 (not just the first $100,000) and 12% thereafter.