BPP and Paying Bus Drivers in HK
May 29, 08The guilty verdict against Tse Sui-luen, founder of the listed Tse Sui Luen Jewellery (TSL) empire, and four others, for paying illegal commissions to travel agencies, bus drivers and tour guides to ensure a flow of customers to the company's showrooms, has become another fascinating “test case” for De Beers. More specifically, it allows one to understand the length to which De Beers will go to relax its Best Practice Principles (BPP) to gradually find a new common denominator that will be so all-inclusively broad that Diamond Trading Company (DTC) Sightholders will always be able to deal with the TSL Company and any other retailers in comparable situations.
Recently, after a more than three-month long, well-publicized district court trial, Hong Kong Judge Kevin Browne convicted the five defendants – all members of TSL's top management, including founder Tse Sui-luen’s son – on eight conspiracy charges to which they had pleaded not guilty last year. The offences included conspiracy to commit false accounting, offer illegal advantages, theft and defrauding the Inland Revenue Department.
TSL is a major Hong Kong jeweler engaged in jewelry design, retailing, export and manufacturing. The firm was established in 1971 and listed on the Hong Kong Stock Exchange in 1987. Currently, TSL has more than 120 stores in Asia. It is one of the fastest growing jewelry chains in its part of the world and gets some of its diamond supplies from a number of DTC Sightholders.
It is also – until the end of June – a holder of a De Beers Forevermark contract. It is through companies like TSL that the Forevermark was able to develop a $240 million market in its pilot program, representing 10 percent of the Hong Kong retail market. Once it was kicked out the Forevermark program, TSL was given a grace period of a few weeks to sell its current stock.
The Forevermark people do things – including contract termination – with style. De Beers Group Marketing’s (DBGM) commercial director, Merlie Calvert, recently informed the company, “Forevermark is underwritten by an obligation on participants to ensure that the highest professional and ethical standards are met. An integral part of TSL’s obligations according to the DBGM Forevermark Terms and Conditions (as varied and extended) by which TSL are bound…is that TSL must satisfy, and continue to satisfy, the Best Practice Principles and the associated assurance programme (the ‘BPPs’).”
Calvert’s April 30, 2008 letter to TSL continued, “The reported convictions are in direct contravention of this fundamental requirement of the contractual arrangements that TSL has with DBGM.”
Inconsistent and Weird BPP Application
The sentence that concerned most stakeholders, including DTC Sightholders, was Calvert’s unequivocal finding that there has been “a material non-compliance with the BPPs.” This would seem exceedingly problematic to a number of DTC Sightholders who are diamond suppliers to, or otherwise stakeholders in, TSL. The BPP itself and the DTC contract doesn’t seem to prevent continued trading with TSL, as “the principles are formulated to ensure that De Beers and its customers encourage adherence to them at all levels of the supply chain down to the consumer.” But non-adherence apparently doesn’t trigger sanctions. Nor, and that confuses people, does it impact the integrity of the value chain to the consumer. A company is not good enough to use Forevermark, but it is good enough to purchase from DTC Sightholders? Does that make sense?
After reading and re-reading the 141-page Supplier of Choice (SoC) contract for the 2008-2011 period, I concluded that there is nothing – absolutely nothing – that prevents DTC Sightholders from doing business with clients who have been found to violate BPP. The contract merely says that “Sightholders shall use their best endeavors to ensure that their clients in turn (save for consumers) comply with the Best Practice Principles and provide such information as is reasonably necessary to verify compliance.”
This is quite confusing: if the DTC’s clients are not required to adhere to BPP, why would Sightholders need to supply tons of information that would enable verification of the (non-essential) compliance? If a retailer has been found in serious violation of BPP and, therefore, it cannot sell Forevermark branded diamonds, why would it be OK for such a retailer to sell other diamonds supplied by DTC Sightholders? What then is the value and the meaning of the chain of warranties? Whom are we kidding?
To avoid my misinterpretation of this issue, I asked DTC Managing Director Varda Shine for clarification. As Varda was beyond the reach of e-mail in Botswana, De Beers Group Services (DBGS) Executive Director Stephen Lussier was kind enough to reply on her behalf, and he specifically confirmed that “the material breach of BPPs referred to in the letter to TSL is a breach of the Forevermark BPPs (not DTC BPPs) in an agreement directly between Forevermark and TSL and relates to the potential for recent events to have a negative impact upon the public brand perception of Forevermark.” In his statement, Lussier differentiates between Forevermark BPP and DTC BPP.
Lussier stresses that, “Sightholders selling to TSL, which remains a legally compliant operating company in Hong Kong, does not constitute a breach of DTC BPPs as they relate to Sightholders. There are no DTC BPPs that apply directly to non-Sightholder retailers, such as TSL.”
What is even more intriguing is that I very naïvely always believed that the De Beers Group had one set of Diamond Best Practice Principles, well publicized, for everyone to know. While Lussier makes a distinction between Forevermark BPP and DTC BBP, we have not been able to find out what differentiates these two sets of principles by press time – and we don’t expect to discover them after press time either. Varda Shine, after returning to London, confirmed, “There is no difference between the BPPs of DTC and Forevermark.”
BPP Not Required for Retailers
To make a long story short: in recent weeks, some inconsistent signals on this issue have emanated from Charterhouse Street 17. From one perspective, Lussier’s unequivocal finding that there are no DTC BPPs that apply directly to non-Sightholder retailers must be greatly welcomed. The BPPs are an invention by De Beers; it has set the rules, and it is also its prerogative to change the “goal posts” – to relax or toughen its requirements. BPPs are of no concern to retailers (except for those selling the Forevermark brand). The “good or bad behavior” of retail clients can not legally damage one’s DTC Sightholding status. What is essential, however, is to avoid market uncertainty. Varda Shine explained specifically that “DTC doesn’t contract with non-Sightholder retailers. We do, however expect our Sightholders’ best endeavors in dealing with their clients.”
What I have learned from off-the-record briefings is that this should not be interpreted as a “blank check” to sell diamonds to just anyone. The requirement of “encouraging adherence” implies that DTC Sightholders, who suspect BPP violations by clients, are expected to engage with such customers and see to it that they reconstitute themselves in terms of governance, and thus provide a level of confidence to Sightholders that the infringement practices are not ongoing. But if a DTC Sightholder’s client continues to launder, evade taxes, pays bribes, etc., the DTC Sightholder’s good status is not at risk (provided that he doesn’t infringe anti-money laundering and other laws).
Let’s fine tune this: It is my understanding that a DTC Sightholder must ask themselves whether a certain commercial relationship can negatively impact a consumer’s confidence in the trade. Some instances may be self-evident; most are not. The situation requires judgment. But there is no penalty attached to a lack of judgment. Since the initial launch of SoC, DTC Sightholders have been encouraged to go downstream, to get as close as possible to the consumers. The verticalization process has led major DTC Sightholders to invest in some of their customers’ businesses.
I was given to understand that when a downstream partner is found seriously violating BPP, different issues arise: how much of a DTC Sightholder’s rough allocation was based on that specific relationship? This has to do with offering a level playing field to all DTC customers.
One major Belgian-based Indian Sightholder, Rosy Blue, holds a minority ownership in one of TSL’s holding companies. London made it clear to me that this equity stake was not a part of the relevant Sightholder’s profile impacting its ranking at the DTC. As a minority shareholder, it did not exercise control. Furthermore, there has been no suggestion that the Sightholder was involved in any wrong doing. From a DTC perspective, the Sightholder can continue to supply polished and hold on to its equity stake. Said Lussier, “DTC Sightholders can continue to supply or purchase from DTC companies with an equity stake in TSL.” Clear skies for all DTC Sightholders.
Factors Impacting Decision-Making in London
What applies for the DTC is that “the company remains legally operating and compliant with Hong Kong law.” At TSL, founder Tse Sui-luen, 70; his son Tommy Tse Tat-fung, 38; finance director Chung Yuen-ling, 45; deputy chairman and chief executive Peter Gerardus Van Weerdenburg, 47, and business promotions general manager Wong Ting-fong, 59, have all received jail sentences. [They are appealing the verdicts so the last word hasn’t been said.]
De Beers increasingly makes a differentiation between company and individuals. In this case, it is argued, the offenses were made by the individuals, not the company. Thus, the company is OK and one can trade with it. This is a standard that I find as mind-boggling as puzzling. I don’t remember ever having seen a company in jail. So can there ever be a company that is non-compliant? And who makes the final determination?
In London, there are three separate divisions of De Beers. There is the DTC (which handles sales and Sightholders); there is the DBGM (which handles the Forevermark) and there is the DBGS (which handles the legal, financial and external corporate affairs). BPP falls under the responsibilities of Lussier, as already mentioned, the director of DBGS.
The BPP violation was determined by the commercial director of DBGM. The interpretation of how it impacts Sightholders was issued by Lussier of DBGS and not by the DTC. The DTC’s Varda Shine, most eloquently, says, “As far as DTC is concerned, there is issue. TSL are a legally compliant operating company, they are not a Sightholder. We do not have a contract with them and would not be in a position to comment on their operations. You would need to approach Francois [Delage, CEO of DBGM] for his comments on the decisions of the Forevermark team in relation to TSL.”
Though no one will confirm this, De Beers is obviously shifting or re-thinking the application or reach of BPP criteria, I would suggest looking at a “proportionality” issue, i.e., not all crimes are alike. Let me be precise: no crime can be justified, but there should be more than one template for the DTC’s or the DTC Sightholder’s response to different situations. At the time of the Brenig-case judgments in Belgium, involving fictitious invoicing to balance the books of account, we argued that it is difficult for De Beers to apply BPP, as the infringements referred to a common practice in the mid-1990’s, which was even quietly condoned by the Belgian government. The norms have changed since then.
Just think for a second about an ex-U.S. governor having a date with a prostitute. All hell broke lose. If it would have been anyone else, there might not have been a story. The same is applicable to the TSL principals. They represent a new, local business elite in a complex fabric of power players. For various reasons, the public “loves” to see them remanded in custody. But what exactly was the crime? A hundred days of court hearings, involving 70 witnesses, may cause one to lose sight about what actually happened in Hong Kong.
Analyzing the Court Charges
Basically, the jewelry store paid bus drivers (and tour guides) some cash in order to get them to take tourists to their stores. This is common practice in all tourism centers around the world – from Amsterdam to Antwerp to Johannesburg. The jewelry store recorded the payment as a deductible expense, but the bus drivers did not report their income. Thus it became fiscal fraud – as the tax authorities were denied their share of the bus drivers’ income. To protect themselves, some bus drivers subsequently claimed that they hadn’t received any of the money, so then the question became one of who took the money that the store had listed as payment to bus drivers. TSL also used offshore vehicles to make some of the payments.
No jewelry shop owner is going to “fight” with bus drivers (or guides) who create the lion’s share of the traffic in the stores. So the TSL management created offshore vehicles to hide the trail of the money. They also lied. The court heard a scheme codenamed "the James Bond Project" through which TSL paid about HK$170 million (about US$22 million at today’s prices) in illegal rebates to travel agents over ten years, between 1996 and 2005. Judge Browne said in his verdict that "lies had become the corporate policy after the scheme was introduced." A local paper wrote that “the defendants implemented the scheme to sustain the business by luring more tours to visit the company's showrooms – the business of which formed a significant part of the company's annual turnover.”
We must, of course, not forget the economic and social environment in which these offenses have taken place. Hong Kong is a major international financial center. It is also a “money laundering” center, where the primary sources of laundered funds are derived from tax evasion, fraud, illegal gambling and bookmaking and intellectual property rights violations. In short – it is a tax haven for a large part of the world. It hardly makes any sense for the government to conduct a multi-year investigation to discover what a few bus drivers and tour guides put in their pockets without paying taxes. No, it isn’t right – but let’s not exaggerate.
Some of the Forevermark people including its director Francois Delage may be new to our diamond business. They should consider the following: if jewelry retail chains that pay incentive fees to bus drivers and tour guides will become ineligible to sell diamonds branded with the Forevermark (unless it is proven that the Hong Kong drivers and guides paid taxes on this income), it will probably be hard to ever find Forevermark-eligible jewelry retailers in a tourist paradise. That, however, is not our concern.
We just don’t understand how the industry’s chain of warrantees, which is aimed at consumer confidence, can remain credible if certain parts of the chain are not good enough to carry the Forevermark but are still allowed to trade with DTC Sightholders or be owned by them. What message does this give to the consumer? Or is this an intentional attempt to position the Forevermark brand on a higher standard than the one set for DTC clients? Let’s say no more.
Have a nice weekend.