Consider a hypothetical question:  Will you buy diamonds from Frank T? Frank T. is exploring for diamonds in Sierra Leone. His company’s diamond concession areas exceed 12,000 square kilometers (almost half of the country’s diamond fields) and it seems a sure bet that Frank may well become a major source of high quality rough diamonds one day. Anti-money laundering (AML) and anti-terrorist financing laws require you to conduct a “due diligence” on your supplier. Your company is fully AML compliant and you have adopted practices and procedures designed to identify those transactions that, although they may not be violating any laws or policies, may be of special concern to your company for reputation, compliance or legal reasons.

What criteria and standards will you apply to decide whether to buy Frank’s diamonds? Let’s assume that Frank does not smuggle and he exports the rough diamonds legally – with duly signed Kimberley certificates. The Kimberley certificate confirms that the diamonds are not conflict diamonds – and, therefore, Kimberley has little to do with the due diligence exercise which you are conducting. The exercise doesn’t center on the diamonds – but rather on the people and companies trading the goods. You must ask yourself whether these people pose a money laundering or terrorist financing risk. So, do they?

In your due diligence exercise you are expected to examine if there is a “risk” – it isn’t necessary to prove to yourself that the supplier is indeed a money launderer (in which case you know what to do), but rather to check whether there are suspicions.

One of the main problems of most laws (including the new anti-money laundering rules for the diamond industry that will take effect on January 1, 2006 in the United States), is that there are no clear definitions as to what constitutes a “suspicious activity”, or, in the context of Know Your Client (KYC), what type of knowledge should ring the alarm bell.

The laws simply require that you do a due diligence exercise on companies and the people who control the business of your trading partner. Especially in Africa, where much of the trade is still conducted in cash, the laundering risks are not insignificant. Moreover, when buying rough, you must make sure that the seller has not bribed any government official in order to mine or purchase the goods. Looking “the other way” is called “willful ignorance” – and is an offense by itself. Banks are becoming increasingly cautious when financing diamond trade with alluvial artisanal diamond countries.

Fortunately, your company has a good AML/CFT compliance officer and trained personnel who are skilled in using publicly available information sources to do a thorough check-up. Back to Frank T. Your compliance people checked his background and decided to let you, the owner of the firm, make the final decision. You are looking at a memo from your compliance officer that says: “There are a lot of rumors about Frank T., but we decided to ignore these. We’ll only give you the proven facts as supplied by Frank’s diamond company. Frank T. owned some 45% of the diamond company; after dilution caused by going public and raising money on the AIM in London, Frank’s own (indirectly held) share ownership still remains 30%. Clearly, he is “the boss”. His background is thus surely of interest,” explains the memo by your compliance officer, which then provides the following summary data on the controlling shareholder:

“Frank T. was born in Romania. He received a number of penalties and sanctions in Australia relating to various minor and largely driving related offences and two narcotic related offences, an assault charge and a charge of failing to store explosives correctly. In the first narcotics offence in 1990, Frank T. was convicted of selling/supplying heroin and fined Aus. $10,000. In the second narcotics offence in 1991, Frank T. was charged with possession of approximately 17 grams of heroin with intent to sell or supply it to another. Frank T. was convicted of possession with intent to sell/supply and fined Aus. $17,000 in 1994. Under Australian law, possession in the amounts stated carries a presumption of intent. In September 1996, while Frank T. was a Director, Gabriel Resources NL, an Australian company, was the subject of a voluntary administration procedure under which the company made an arrangement with its creditors to discharge all liabilities. Following the administration, the company changed its name to Evanston Resources NL and is currently a wholly owned subsidiary of International Goldfields Limited. In 1984, Frank T was rendered bankrupt in Australia in respect of a debt of approximately Aus. $10,000. He was subsequently discharged,” says the compliance memo. Nice homework — maybe too nice.

But, surely, this is all history. There is no rule that says “once a trafficker – always a trafficker.” But narcotic charges (and convictions) are extremely problematic. Government anti-money laundering regulators never fail to stress that almost 50% of all criminal money laundered each year (i.e. about half of $1.5 trillion!!) is drugs related. Frank T. was convicted on narcotics charges over ten years ago. Surely, that shouldn’t bother anyone today, argues the compliance officer, eager to find a justification to deal with Frank. Now that’s an interesting observation.

When doing “due diligence” – how far do we look into history? There is very little guidance on that question. It seems that if someone gets on the “black list” of a bank, there is little chance they’ll ever get removed – there is no redemption, no forgiveness. You ask yourself: Should you deal with a company your banks would stay away from? You are not a bank – but the law requires you to “know your clients” and to do due diligence on suppliers just as if you were a bank.

Remember Geoffrey W.? His DRC-based company was cited on reputation issues – but neither charged nor convicted. That didn’t change the fact that companies buying diamonds from the DRC mine which he managed also got into reputation trouble. Now, after shareholding alterations and corporate restructuring, name changes, etc., Geoffrey W. is on the verge of attaining some highly unconvincing “exoneration” for his company from a much pressured mid-level U.K. government official. It is probably too little, too late and too irrelevant to make a difference. Suspicions have ruined much of his diamond business – probably forever. Shouldn’t we wish him well and afford him the benefit of the doubt? Strict interpretation of compliance rules would probably say: no, you cannot. Is that fair? Probably not – it is more a matter of “playing safe”.

Back to Frank T. I have never met this 41-year old Romanian-born entrepreneur who has a cunning knack for getting into the news for the wrong reasons. [Earlier this week he had to resign from an oil exploration company he founded and whose shares trade on one of the London stock exchanges. The relevant company boasted a market value of more than £500 million as recently as March this year. Then, last week, Frank T. disclosed that an oil exploration property (in Greece) that he first believed might produce one billion barrels of oil was, after all, not going to be commercially viable. Share prices collapsed by some 60%.] Frank T. claims that the market overreacted; he didn’t do anything wrong, and, in an interview with the Sunday Times, blamed, among other things, a “press vendetta” against him.

The reason we are concerned about this story is that many investors have also bought shares in his diamond exploration company. Could Frank T. one day come to the conclusion that there are no viable deposits in his concession areas, after having raised some $40 million from the public earlier this year? The share performance isn’t going great and, even more worrisome, another major shareholder and director in that diamond company is, according to reliable market sources, quietly trying to sell off some of his shares – just a few months after the listing.

But our concern here is not with conjecturing whether shareholders in a diamond exploration company have invested in a great company or are being taking for a ride. To the contrary – we hypothetically assume that diamonds have already been found – and that you have to decide whether to buy them or not.

Why does the question arise to begin with? Is the fact that a company has duly received exploration licenses from a producer government and the fact that a London stock market allowed the listing not sufficient and convincing proof that Frank T. must be o.k.? What I find patently unfair – and exceedingly confusing -- is why banks and diamantaires are subjected to stricter AML/CFT compliance rules than governments and stock exchanges.

Surely, a government that allowed Frank T.’s company to take out the exploration licenses ought to conduct a minimum due diligence. If the governments approve – why does a diamantaire need to double guess that judgment? Surely, if past convictions for narcotics trafficking didn’t bother the stock exchange authorities, why should we be concerned with it? I am concerned because I have great fears that the diamond industry finds itself in an imbroglio – and may well be slipping into a “mission impossible”. Governments are not giving sufficient guidance – something that is greatly exacerbated by the lack of uniformity and the absence of rule harmonization among countries.

The industry must not deal with people – or accept moneys or diamonds – if there is a risk that money laundering may have taken place. Money laundering “crimes” increasingly involve tax evasion, bribery, drug offences and a host of other illegal practices. Globally, laundering is increasing to epidemic proportions – well above the $1.5 trillion we wrote about last year.

Many diamantaires, in deciding with whom to do business and from whom to stay away, are viewing the dilemma as a “legal risk”. I almost wish it were that simple – because then lawyers could advise management if a trading partner meets the test. Dealing with people with a questionable present or past are far more likely to represent a business risk. Preventing these risks is not merely a matter of legal compliance. It is not enough to meet the technical requirements of the applicable local rules – which, in some instances, may not be very tough. Rather, diamantaires should assess their own “exposure” to commercial and business risk situations.

When one looks at situations such as Frank T. – and the issue is hypothetical because he isn’t selling diamonds yet – the legal considerations may well become irrelevant. We all know that there are some companies within our midst whose names have been ruined – even though the affected parties have never been charged with any wrongdoings in a court of law. So what do you do when dealing with someone who has been convicted? Someone who has been convicted on crimes which are seen as money laundering “predicate offenses”? [A “predicate offense” refers to the criminal activity from which the proceeds of the crime are derived. Money laundering is a derivative crime. Its status as a crime depends on the genesis of the funds involved. So if a business uses money that may have been earned through drug trafficking, etc that business is at risk – and so is anyone dealing with it.]

In an industry which may well be heading for rough supply shortages, there is a great temptation to purchase rough coming out of the blue (with Kimberley certificates) without enquiring too closely about the sources of money (or the provenance of the funds) applied in mining or in the acquisition of the goods.

Though I can lament the absence of clear rules (and that’s what I am doing), it doesn’t change the fact that each individual diamond company is required to make a judgment – without, in the process, deterring legitimate business opportunities. This is not an article about Frank T. – and I don’t jump to any conclusion. Frank T. isn’t selling yet – but it may be an interesting exercise to ask yourself – or your compliance staff – how you would act when offered diamonds by someone that fits the described circumstances.

That is not an easy call to make – and its business ramifications may well be enormous. Something to ponder about over the weekend – and beyond.