U.S. Gov't to Announce Final Anti-Money Laundering Rules For Diamond and Jewelry Industry

It seemed that re-elected U.S. President George W. Bush didn’t want to upset the American diamantaire and jeweler too much before Election Day. But as the voting is now behind us, FinCEN (the U.S. Treasury body that is responsible for the enforcement of anti-money laundering and anti-terrorist financing laws) will announce its final rules applicable to the U.S. diamond and jewelry industries within 30 days. Many of the laws and regulations which were earlier in this year imposed on the diamond industry in Belgium, will now – finally – have to be implemented by the traders, dealers and manufacturers in the diamond industry’s largest consumer market, implementing the provisions of the PATRIOT Act which designates diamond and jewelry dealers as “financial institutions” for anti-money laundering regulation purposes. 

Although diamond and jewelry dealers do not perform the same functions as banking institutions, the U.S. government believes that the industry presents identifiable money laundering risks. “Precious metals, precious stones, and jewels constitute easily transportable, highly concentrated forms of wealth. They serve as international mediums of exchange that can be converted into cash anywhere in the world. For these reasons, precious metals, precious stones, and jewels can be highly attractive to money launderers and other criminals, including those involved in the financing of terrorism.”      

The Patriot Act defines a ‘dealer’ as any person who is ‘engaged in the business of purchasing and selling jewels, precious metals, or precious stones, or jewelry composed of jewels, precious metals, or precious stones’. The proposed definition of dealer reflects the U.S. Treasury’s determination that all segments of the industry are vulnerable to money laundering and terrorist financing. Thus, the anti-money laundering requirement contained in the proposed rule covers entities including manufacturers, refiners, wholesalers, retailers, and any other entity engaged in the business of purchasing and selling jewels, precious metals, precious stones, or jewelry.

When the U.S. government published a draft of the rules in February 2003, the U.S. diamond and jewelry industry quickly saw an opportunity to lobby government to keep “unfair competition” from overseas diamond dealers out of the U.S. market – or make their operations more cumbersome. The leaders of the U.S. diamond and jewelry industry informed FinCEN that “the purchase of jewelry items by retailers from suppliers located outside the United States is a routine and growing practice. Transactions from dealers outside the United States may be viewed by Treasury as higher risk transactions for purposes of money laundering funds, since those dealers with no presence in the United States may not be subject to the provisions of these rules for jurisdictional reasons,” the industry leaders told their government.

It was suggested that one possible way to address this issue is “to require jewelry retailers who buy from overseas dealers not subject to the provisions of these regulations to receive written assurance that they have taken steps to prevent and detect money laundering.”

The industry, in elaborating this point, basically suggests that a large retailer should be considered a dealer (subjecting him to AML/CFT programs) if they purchase from “dealers that have not represented in writing that they either are in compliance with the provisions of this rule or, if not subject to this rule, have programs in place designed to prevent and detect money laundering. Further, retailers shall require in all cases the provision of a U.S. Tax Identification number from all dealers otherwise obligated to acquire such U.S. Tax Identification number.”

We don’t know whether these requests by the U.S. industry have been incorporated in the final rules; in any event we’ll know within 30 days. As regular readers of this weekly column undoubtedly know, the U.S. Patriot Act has “elevated” diamond and jewelry merchants to the level of financial institution, subject to rules which require the diamond and jewelry companies, with a few exceptions, to establish an anti-money laundering program that includes, at a minimum:

      The development of (written) internal policies, procedures, and controls for the company’s anti-money laundering program;

      The designation of one or more anti-money laundering program compliance officers;

      An ongoing employee training program; and

      An independent audit function to test programs to ensure effective operations.

The rules require that each diamond or jewelry dealer (above a certain threshold) develops and implements an anti-money laundering program reasonably designed to prevent the dealer from being used to facilitate money laundering or the financing of terrorist activities.

The program must be in writing and should set forth clearly the details of the program, including the responsibilities of the individuals and departments involved. To ensure that this requirement receives the highest level of attention throughout the company, it is required that each dealer’s program be approved in writing by senior management. A dealer must make its anti-money laundering program available to the U.S. Treasury or its designee upon request. While it is permissible for a dealer to delegate certain functions relating to its anti-money laundering program to a third party, the dealer remains responsible for ensuring compliance with these requirements. In any event, the owner of the company always remains ultimately responsible for the compliance implementation.

To whom will the new Rules apply? We believe the final Rules will encompass various precious stones and metal dealers, including:

      Those who trade in precious metals, including large scale metal suppliers and large and small scale refiners;

      Those who trade loose diamonds and precious stones;

      Large and small-scale manufacturers of jewelry; and

      Retail stores, including independent and chain stores of varying sizes, selling jewelry products to, and buying jewelry products from, the consuming public.

The size of businesses in each segment of the industry varies substantially from a single artisan jeweler to publicly traded commercial manufacturers employing hundreds of people and producing millions of finished pieces every year. The sources of supply vary as well, from large-scale producers of fabricated precious metals materials to small dealers selling unique and rare gemstones on an individualized basis. Further, there is an active secondary market for jewelry, loose diamonds and gemstones, and precious metals, with small firms selling used or antique pieces for scrap value or as unique works of art.

Prior to the Patriot Act the specific federal and state laws governing this industry were generally intended to protect consumers against misleading descriptions of the identity and quality of precious stones and jewels. Industry regulations hitherto were focused on consumer protection. This focus changed when the threat posed by the industry for potential abuse by criminals and terrorists was recognized.

The definition of parties who are required to set up an anti-money laundering compliance program in the U.S. contains an explicit minimum dollar threshold to carve out small businesses that may, on a part-time basis, deal in precious metals, stones, jewels, or jewelry. This is done in recognition of the fact that programs are costly and time-consuming – quite a burden on small companies.

Thus a person is only considered a ‘dealer’ if, during the prior calendar or tax year, the person (1) purchased more than $50,000 in jewels, precious metals, diamonds or precious stones, or jewelry, or (2) received more than $50,000 in gross proceeds from the sale of jewels, precious metals, precious stones, or jewelry. In addition to the minimum dollar threshold, the definition of ‘dealer’ contains two exceptions. The first exception provides that a retailer is a dealer only if it purchased more than $50,000 in jewels, precious metals, precious stones, or jewelry from persons other than dealers during the prior calendar or tax year. Thus, a retailer that purchases jewels, precious metals, precious stones, or jewelry from a dealer (for example, from a wholesaler or a New York diamond dealer), would not fall within the definition of ‘dealer’, even if its gross sales of jewels, precious metals, stones, and jewelry exceeded $50,000 in the prior calendar or tax year and thus will not have to make its organization AML compliant.

What the Treasury is suggesting is that even the largest jewelry chains, irrespective of the size of their turnover, will not have to implement AML compliant programs if they make their purchases from other domestically recognized (and thus compliant) dealers. As compliance programs are cumbersome and expensive to implement, this provision is seen as a considerable incentive for retailers to make their diamond and jewelry purchases only from U.S. domiciled parties. There have been various interesting industry reactions to this. The organized U.S. diamond and jewelry industries fear that the exclusion of their foreign colleagues and suppliers from the AML compliance requirements would heighten the domestic money laundering and terrorism financing threat. However, the creation of discriminatory rules to foreign suppliers may violate WTO or GATT provisions; they may also invite retaliatory actions by other governments against U.S. exporters.

The diamond and jewelry trade organizations are acutely aware that major diamond countries (India, Israel) don’t have similar laws on the book -- and therefore, assumingly, they favor “written declarations of compliance”.

We haven’t seen the U.S. final rules yet, but we expect that at a minimum a diamond or jewelry dealer’s money laundering program must incorporate policies, procedures, and internal controls based upon the dealer’s assessment of the money laundering and terrorist financing risks associated with its line(s) of business. Policies, procedures, and internal controls must also be reasonably designed to ensure compliance with U.S. Bank Secrecy Act (BSA) requirements. The only BSA regulatory requirement currently applicable to a U.S. dealer is the obligation to report the receipt of cash or certain non-cash instruments totaling more than $10,000 in one transaction or two or more related transactions.

To assure reasonable compliance, the program should be reasonably designed to detect and report not only transactions required to be reported, but also activity designed to evade this reporting requirement. Such activity, commonly known as ‘structuring’, may involve payments of more than $10,000 with multiple money orders, travelers’ checks, or cashiers’ checks or other bank checks, each with a face amount of less than $10,000. Such methods of payment may especially be indicative of money laundering, when the payment instruments were obtained from different sources or the payments were made at different times on the same day or were made on consecutive days or close in time.

Payment through third-party checks, endorsed checks made out to third parties, etc. should always raise an alarm bell.

For purposes of making the risk assessment required under U.S. laws – and this would also apply to situations in other countries -- a dealer must consider all relevant factors, including those listed in the rules. First, the dealer must assess the money laundering and terrorist financing risks associated with its products, customers, suppliers, distribution channels, and geographic locations. In addition, a dealer must take into consideration the extent to which the dealer engages in transactions other than with established customers or sources of supply. Finally, a dealer must analyze the extent to which it engages in transactions for which payment or account reconciliation is routed to or from accounts located in jurisdictions that have been identified as vulnerable to terrorism or money laundering. The proposed rule is intended to give a dealer the flexibility to design its program to meet the specific money laundering and terrorist financing risks presented by the dealer’s business, based on the dealer’s assessment of such risks.

Factors that may indicate a transaction is designed to involve use of the dealer to facilitate money laundering or terrorist financing include:

      Unusual payment methods, such as the use of large amounts of cash, multiple or sequentially numbered money orders, travelers’ checks, or cashiers’ checks, or payment from unknown third parties;

      Unwillingness by a customer or supplier to provide complete or accurate contact information, financial references, or business affiliations;

      Attempts by a customer or supplier to maintain a high and unusual degree of secrecy with respect to the transaction, such as a request that normal business records not be kept;

      Purchases or sales that are unusual for the particular customer or supplier or type of customer or supplier; and

      Purchases or sales that are not in conformity with standard industry practice. 

The U.S. diamond and jewelry industry representative bodies have recommended to the U.S. Treasury to add an additional factor:

      Lack of, or refusal to provide U.S. Tax Identification number.[1]

The stated reason for adding that additional factor is that “companies doing business in the United States but domiciled outside the United States by law must acquire a tax identification number from the Internal Revenue Service. The compliance of a company to this provision of US law is a good indicator of their legitimate status.” It is not clear yet whether the Treasury will accept that industry recommendation, as this may lead to repercussions with the nation’s trading partners. In Europe, fiscal issues are not automatically covered through the AML/CFT legislations.

The period of waiting is now over and we’ll know now soon how FinCEN director William Fox and the U.S. Treasury wants the diamond industry to become compliant. One thing is sure – it will make the cost of doing business more expensive. But protecting the industry from abuse by money launderers and by those who want to finance terrorists is probably worth the price. Let’s wait and see.