There are some names that most players in the diamond industry have never heard of, such as R. Cassiers, B. Melis and L. Versteylen. They were the judges presiding in the Brenig case. These were the judges who refused to approve a settlement reached between 13 diamantaires and the Belgian prosecution, and they turned a fiscal infringement into a criminal conviction. The rest is history.

The first ones to act were the rough producers, who still may go through a pro-forma hearing process to allow the suspended clients to defend their case. The damage to the parties has already been done – or, maybe, they did it to themselves. In any event, by the end of this week, the DTC is expected to declare these Sightholder suspensions as definite. This is just the beginning of a snowballing process, which nobody knows where, when and how it will end. It may run out of control – for better or for worse.

Eyes are now on the diamond banks. There is no law or regulation that prevents diamond companies with criminal records from continuing to operate their bank accounts. Even though part of the conviction is for money laundering, these are not cases where banks supplied authorities with a suspicious activities report (SAR), nor did any authority demand the blocking or freezing of an account, as has happened already to some other companies, which were neither charged nor convicted of anything.

The criminal conviction is, however, something the banks will find very difficult to swallow. Some sanctions are expected to be taken. It is not just the fact that there is a conviction; it is hard for banks, which are engaged in the financing of exports, to accept that their clients admitted to having falsified export documents, invoices, etc. To such behavior, the banks are not merely “bystanders” – they are involved and abused. The proceeds that the banks received for these fictitious exports are (now) viewed as money without a clear origin. Technically, it represents laundering – and the judges did discuss their views on this.

A crucial mitigating circumstance is that it all happened well over a decade ago. The industry has changed, the norms have changed, time-honored practices have been abandoned – and the industry is far more transparent and accountable today. But, apparently, there is no statute of limitation on “normative behavior,” and the time that passed didn’t prevent the producers from taking action, nor is it likely to deter the banks. The Brenig case has become a catalyst for expediting change.

A Potentially Costly Decision

There is however, a major difference between banks and rough diamond suppliers. When one supplies rough diamonds for cash, one can easily terminate the relationship with little risk. However, if you are a bank, and you have a client that owes you tens of millions of dollars, it isn’t so simple to tell that client to go and bank somewhere else. If you do, you are likely to never see your money returned. So, while banks have, on the one hand, very strict rules about the kind of clients they would like to have, their maneuverability to act in order to protect their own reputation and to comply with their own ethical norms is quite limited. The credit that they have extended is largely “open credit” with no collateral. So, they will still depend very much on the goodwill of the departing clients, if that is the outcome of the current internal deliberation. For those who don’t owe the bank, a decision might be easier and probably more automatic.

There are other factors, however, to consider. The present investigation in the Monstrey case may also involve some of the very same parties who received a suspended sentence in the Brenig case.

One must remember that there are also a few dozen convictions that have been sealed by the court and whose names have not been made public.] If these are indeed similar names to those in the Monstrey case, the suspended sentences may still lead to prison terms. From a banking perspective, clients in prison are not great prospects to pay off borrowings. Though this should not be an immediate concern, it is a factor to take into account.

Waiting for the Market to Act

What is an immediate concern, however, is the behavior of the market. WFDB President Ernie Blom, in reply to a question, noted that “any individual member of a diamond bourse affiliated with our World Federation who violates the ethics, standards and norms set by our organization needs to be expelled from our bourses.” Blom talked in a generic sense; he wasn’t aware of the details of the Brenig case. It is up to the Antwerp bourses to take action. How will it impact the trade? Will DTC clients or any other diamantaire for that matter, who are obliged to do a know-your-client (KYC) due diligence exercise on its clients, feel at ease to continue to trade with these companies?

At the New Year’s cocktail party at De Beers, DTC Managing Director Varda Shine, in a brief reference to the client suspensions, noted that she was acting to protect the integrity of the industry at large. By implementing BPP, she was adhering to standards that would benefit all industry participants and ensure confidence in the diamond product. Some Sightholders reporting on the cocktail party expressed the view that the business will support the producers on this.

This gets us back to the banks. Will trade sentiments impact the ability of suspended parties to continue to operate competitively and profitably? Will or won’t there be damage to those companies’ reputations, which might impact their business results? Would a changed commercial risk profile of these convicted clients impact their ability to secure credit from the banks? Or, conversely, will the banks accept such risks?

To the best of my information, banks are following the developments very closely and have not yet decided anything one way or the other. One official mentioned that he was waiting to see how the diamond bourses would react. Would those convicted diamantaires lose their membership of their respective Antwerp bourses? Will they be entitled to continue to use the much heralded WFDB Mark? And what about the Diamond High Council?

Going beyond Brenig

The issues are quickly going far beyond the Brenig case. One might be able to show decisively that the book-balancing transactions, which were really the purpose of the fictitious invoicing scheme, represented acceptable trade practice well over a decade ago. In none of the court papers have I seen a coherent discussion on what “motivated” the defendants. The court failed to recognize that in the 1990s, the Belgian government, in fact, made an agreement with the industry through which taxation would be based on a presumptive tax basis. This presumptive tax arrangement came about because of the government’s inability to effectively valuate inventory, and the fiscal authorities collected virtually no corporate income tax from the sector.

A presumptive tax is based on an assessment and is premised on an understanding that companies will report profits within the agreed guidelines of the assessment. In fact it means that a diamond company that may have faced losses in a given tax year is still incentivised and motivated to declare profits and pay taxes in accordance to the agreed mechanisms. This result [i.e. the payment of taxes] cannot be achieved without some degree of balancing books. Though the mechanism may have varied, there was virtually no company in the Belgian diamond sector in those years that was not engaged in some form of account balancing.

Government-Condoned Practices?

In a speech given in 2002, former HRD Managing Director Peter Meeus explained the mechanism as follows: “An agreement was made between the diamond sector and the Administration of Direct Taxation in respect to the control method mechanism to be applied for the diamond industry. The purpose of the agreement was, on the one hand, to bring about a substantial increase of the tax revenues collected by the government and, on the other hand, to provide the sector with greater legal certainty on the basis of the calculation used for the tax assessment. The control method mechanism doesn’t prejudice (waive) any legal provision of the Income Tax Code, but provides for an additional reference framework on which basis tax assessments can be made.” The Belgian Premier, who ordered a revaluation of inventory in 2006, noted that the tax mechanism of the 1990s had led to discrepancies in companies’ books.

There was not a single instance in the entire Brenig case which points to an attempt to decrease business turnover which would have indicated an attempt to reduce taxes. The opposite is true. All activities had the final objective to increase the relevant companies’ taxable income by moving values that were “hidden in the inventories” to actual revenues. That unmistakably proves that, basically, in a different way, the very action that then Belgian Premier Guy Verhofstadt mandated in 2006, was done in a different way more than 10 years earlier.

The failure by the government in the 1990s to properly align the tax laws with the de facto co-existence of presumptive tax agreements has created a legal situation in which virtually every diamond company operating in Belgium could potentially face similar charges and could potentially be convicted. It is an unfair, untenable and unsustainable situation, which in practice, say some Antwerp players, will only lead to two scenarios: either the entire industry will migrate to other countries or all industry participants will meet in jail. In either scenario, the industry would not continue to operate in Belgium, and the refusal by producers to supply diamonds to these companies will not only expedite that process, it will lead to the eventual inability of the producers to sell a single diamond to any company in Belgium.

The Preferred Scenario

That may be too pessimistic. We expect, or rather hope, that at the end of the day some sanity will prevail. For the first time since De Beers talked about Best Practice Principles, we are witnessing now a tremendous preoccupation with the ethical and legal conduct of the business as never before. This by itself is quite an achievement and must be supported. It was triggered by the producers. The choice for the trigger may not have been the best or the right one. An important London source called the DTC suspension “an exercise of tokenism”; a few small companies were picked on because the larger ones, with far greater legal infringements, are apparently untouchables. There is no justice, fairness or joy in such a state of affairs. But something good may come out of it. The genie is out of the bottle. Producers, banks, bourses, HRD and other industry participants now have an opportunity to make their positions clear. This will have a ripple effect throughout the industry – for the better.

Looking forward, one can actually be positive and believe that transparency and good governance will prevail. Oddly enough, the one party that has the power to force the quick disintegration and migration of the diamond industry from Belgium is the Belgian government itself. Instead of looking toward the future, it is zealously pursuing the sins of the past. That may be its prerogative, but it also may paralyze and stifle any return to normalcy, stability and growth in the Belgian diamond industry. The Belgian government seems mum on the subject. With over $150 million of confiscated diamonds in government vaults and dozens or more raids planned for the future, there is probably little the government wants to say. Let’s just wait to see what tomorrow will bring.

Have a nice weekend.