Staying Clear of Industry Madoff-ization
January 01, 09Today we are starting a new year. While my inbox is cluttered with many wishes for a better 2009, there is also an alarming pile of “bad news.” This latter category refers to the phenomenon – which I hope is only marginal in our business – where diamond dealers under stress and in pain decide to try to survive by deceiving and, in some instances, even defrauding their colleagues or their banks.
We are not judging these people. After all, if the impact of the economic crisis doesn’t hit home personally, it is hard to imagine how one would conduct his/her business if confronted with a Madoff scandal-type of shock. How far would one go to stay in business?
Let’s start with this example: a major jewelry retailer, associated corporate-wise with the industry’s largest rough supplier, has been repeatedly delaying payments to other suppliers. He actually started doing this well before the economic crisis but the situation has grown increasingly worse. In one instance, when a major supplier made a rather high-level complaint, he was told that he could “get his diamonds back if he wanted.” It’s quite indecent – and this is an understatement – to offer to return diamonds whose prices have fallen up to 50 percent since the time they were originally purchased.
The Responsible Jewellery Council’s silence on this matter is actually deafening. It’s amazing how an organization can make itself so totally irrelevant at a time when it actually could do some good. It seems that the industry’s best practice principles are no longer relevant. And while this concept has been dying for quite a while, I think the time has come to formally declare best practice principles to be officially dead. I hope that one day the concept will re-emerge and with conviction, but that won’t be soon, especially as more and more examples of “bad news” emerge.
At one of the world’s diamond exchanges this week there were two diamantaires who defaulted on some $1.8 million debts to colleagues and banks. Their claim: “We lost the diamonds in a robbery or theft in London.” However, they had omitted to make a complaint in London to authorities, so the relevant bourse brought in local police, and the diamantaires were arrested and left the bourse in handcuffs.
Many local diamantaires were shocked by this spectacle. How come the bourse leadership involved the police? Couldn’t this situation have been handled internally among the bourse members? The answer is no. But the fact that many believe otherwise is significant and should not be ignored.
Another similar type of questionable behavior also occurred a few days prior to the above-mentioned scenario. This particular situation has been unfolding for about a year. A DTC sightholder sold goods to the son of a brother living in a different country. The nephew then subsequently sold those goods to a rather unknown company whose principals were not members of the diamond exchange in the company’s respective country.
Quite incomprehensibly, this supplier had allowed the debt owed to him to increase to somewhere between $35-$42 million before he personally came to find out what happened to his money and diamonds. What is relevant in this story is that the supplier waited seven to 10 days, agonizing over whether he should or should not go to the police. In the end, he did and an arrest followed.
In yet another example of “bad news” plaguing the industry since the start of the economic crisis, a report surfaced of a company that called in its creditors and entered into an agreement with each of them stipulating that they could either take diamonds instead of money, premised on 50 cents to the dollar, or they could forget about their money. Quite a few diamantaires agreed to this proposition and thus entered into a written agreement to this effect. The practical meaning of this is that the defaulting company is preferring one creditor over another without the normal pooling arrangements. Also, the “defaulting” company is not even in default because it is making agreements with its creditors and can continue business as usual while having offloaded its debt.
In this instance, the relevant bourse came out with a warning to its diamantaires that such agreements may not be legal nor would they be condoned by the bourse. Even those who signed an agreement “under pressure” should not be bound by it.
Subtle Spillover Effects
While these aforementioned scenarios are bad for the diamond industry in an obvious way, most of the negative spillover from them plays out in a more subtle matter. There is hardly a single diamantaire that doesn’t have cash-flow problems these days since accounts receivables are coming in with great delays – if at all. As diamond industry financing on a global scale is activity-based rather than asset-based, the reduction in activities impacts both the diamantaires’ collateral base and borrowing-facility base with bankers.
There are two ways to remedy this. One way is through transparency in diamantaires’ relations with banks and through trying to work things out with the banks. The second way is by providing the bank with “false” collateral. The latter is done very easily.
For example, two parties give each other a post-dated check for 45 days for $1 million, and both parties deposit those checks in their respective bank accounts. By the time the due date comes, these checks are cancelled or the respective accounts will be credited and debited for the same amount. What happens however, if minutes before the due date arrives, one party cancels this “goodwill check” without telling the other party? This scenario has played out recently, and banks have started to create their internal black lists for checks that can no longer serve as collateral.
Some trade organizations concerned about the industry’s relationship with the banks have warned their members that this type of behavior will have repercussions on membership. One might argue that these practices aren’t new – that they are almost a time-honored practice. What is new, however, is the credit-crunch crisis environment in which there is so much at stake for the entire industry to maintain the trust of its bankers.
The Industry’s Madoff Phenomenon
We know fully well that this undesired behavior is taking place on the fringes. Thankfully, the vast majority of players will not engage in it. But the problem is that we don’t know who may hit us or when because, often, the players involved have a good reputation. It is almost as if an unexpected Madoff phenomenon is taking root in the diamond industry. People who have always been trusted suddenly display a behavior that in many instances is literally “out of character.”
True to our journalistic style, we have focused on some concrete examples here in this memo. But certain practices, such as offering goods in lieu of money at grossly discounted values, is becoming more and more prevalent and is worrying. When a diamantaire makes a sale – which is not easy in any event these days – he should have the confidence that it’s final and that he will not be confronted with a whole series of improper options a couple of months down the road.
Safe-Guarding the Fabric of Trust
As we wrote above, one shouldn’t judge people under stress or in pain. But it is absolutely essential to speak out in the strongest terms against practices that undermine the fabric of trust in the industry’s trading relationships, which is a prerequisite to our industry’s recovery.
In September and October there were good banks that actually went bust because the borrowing among banks had abruptly stopped; uncertainty and distrust prevailed. This is why governments assumed the role of lender of last resort.
In the diamond industry, there is no lender of last resort. And there will be no government bailouts. The strongest possible action must be taken against those who jeopardize the industry’s fabric of trust. This may well be one of the industry’s more difficult challenges for 2009.