The practice of consigning diamonds and jewelry has been an institution in the industry for well over 100 years. In fact, the way jewelers conduct memo deals hasn’t changed much in that time; they’re still relying on the traditional trust relationships they’ve used for generations. But while this method has worked well for the trade overall, it can lead to lengthy court battles and loss of income when it goes wrong. In some cases, it can leave businesses completely devastated.
“The problem is, many jewelers think, ‘Our great-grandfathers did business together, so I can trust this person,’ and in the world of the jewelry industry, I think that’s fairly normal,” says Sara Yood, head legal counsel for the Jewelers Vigilance Committee (JVC). “But from the perspective of the business world, it’s really not. Our industry is one of the only ones left that still conducts business this way, and it’s archaic.”
The risks are well-known to the Jewelers Board of Trade (JBT), which has been around since the late 1800s. Its founders were manufacturers and wholesalers that sought an industry group that could share information on potential consignment partners. This, they believed, would at least mitigate the risks of what they viewed as a fundamentally unsafe practice.
“The practice of memo transactions is highly discouraged by the JBT,” says Jim Rocchio, the trade body’s manager of collections. “That was written in the [JBT’s] Essential Guide to Memo Transactions more than 130 years ago, and still holds up today.”
Those guidelines state that memo deals are “very risky” for suppliers, as the law may give the holder of the items the same rights and title to them as it does the supplier. “This becomes important if the holder fails to pay for the goods or enters bankruptcy proceedings while in possession of the goods,” the guide notes.
The importance of due diligence
A large part of the problem is that jewelers are entrusting their wares to strangers without first doing the proper due diligence, in an effort to secure a sale in a highly competitive industry.
“Memo deals are unlike anything else,” Rocchio states. “If I saw you on the street and we were strangers, and I stopped you and said, ‘Hey, can I borrow $10?’ you would look at me like I was nuts and tell me to take a hike. But if I’m a jeweler in California, and you’re a wholesaler in New York, and I said, ‘Can you send me $20,000 worth of diamonds, I have a customer,’ you’d ship them, which is crazy.”
Joseph Goldberg — a partner at law firm Hodgson Russ, which handles many memo cases — echoes this sentiment. “It’s a total disconnect between industry practices and the real world, and it’s about time the industry caught up a little in terms of allowing the consignors to protect themselves.”
The Diamond Dealers Club (DDC) is also aware of these memo risks. “We’ve been working on solving this problem for a really long time,” says William Zev Lerner, an attorney for the New York-based trade group. “It’s definitely an area of serious concern.... It is also uniquely harmful because it preys on one of the most crucial and unique aspects of the diamond industry.”
While trust is a cornerstone of the trade, jewelers need to take matters into their own hands and do thorough checks through a variety of sources, according to experts. This will help them determine how comfortable they are with a transaction and whether the risk is one they can afford.
“I can’t tell you how many claims I get from companies that have never pulled a credit report on a business, and they’re owed hundreds of thousands of dollars,” says Rocchio. “They mainly rely on their contemporaries in the industry for references, and it’s pretty sad.”
Tradition is one reason for this, but a large part of it is pure laziness, argues Robbie Friedman, president of I. Friedman & Son Jewelers in the New York diamond district. Many jewelers know the pitfalls but don’t believe it will happen to them, says Friedman, who acts as a liaison between community jewelers and the police in many of these cases. “You’re going down a road, and there’s a big sign that says, ‘Do Not Enter.’ But you’re texting someone and you don’t notice. So what do you do? You go into the main entrance the wrong way on a highway. I mean, come on, give me a break.”
Compiling information — whether through a JBT credit report, references from people you know and trust, or just a plain old Google search — can make a big difference in how much you open yourself up to risk.
Flaws in the system
No memo deal is ever 100% foolproof, but there are precautions you can take to ensure your goods remain as safe as possible. Foremost among them is sharing information within the industry — though Rocchio admits such information can sometimes be hard to come by.
“It’s a competitive business, and they’re all trying to outdo each other, and that’s their livelihood,” he says. “That’s why they are so secretive about who they have goods out on memo with, because they don’t want to let other people know they’re doing business with them. They don’t want them coming in and stealing their clients.”
Joseph Metsopulos knows all about the trouble this secrecy can cause. As a detective with the New York Police Department’s Major Case Squad, he’s investigated about 75 memo bust-outs — in which the consignee makes off with the goods — of over $100,000 in the last two-and-a-half years alone.
“People don’t want to give up their connection,” he says. “Let’s say I have an avid buyer, and you have the goods they want. Why would I let him go straight to you? Eventually you two would have a conversation and cut me out. No one is going to do that, so I’m going to make sure you don’t work directly with him.”
This attitude can lead to multiple problems. For one, a supplier offering goods on memo may get declined by a potential dealer because the companies the supplier cited as references choose to give negative reviews to keep the supplier from doing business with other jewelers. Conversely, a potential consignee on the brink of bankruptcy or with unlawful intentions might get approved using a false reference that makes them look stable and trustworthy, because someone in the industry vouched for them in order to try and hedge their own losses.
A jeweler who’s been misled by a client will often avoid telling the trade, because “he’s basically forfeiting the ability to get it back,” explains Friedman. “If he lets people know, that guy will never have the ability to make back what he basically screwed you out of from somebody else. So it’s kind of like he’s become a thief in the system until he makes good. But at the same time, you don’t know if he’s screwing other people.”
Becoming a “hostage reference” like this can also prevent consignors from reporting the loss in a timely manner.
“I’ve learned from the people I’ve spoken to that part of the reason they wait so long is because the [consignee] is sort of stringing them along and saying they will pay them shortly, as soon as another deal they are working on closes,” relates Goldberg. “And they’re hoping against hope that they’re going to get their money from that deal, because they don’t want to lose it, and if they go to the authorities or a lawyer, they believe that automatically cuts off any possibility they’re going to get paid back from that person or company.”
Ashish Karnavat, president of diamond wholesaler Belgium New York, is all too familiar with this dilemma. His company fell victim to a memo-fraud scheme despite taking precautions to protect itself.
“We always ask for at least three references, and we call up each individual reference to get an idea of how long they’ve been working with a prospective memo client, the maximum credit they’ve extended them, and what their payment history is,” he maintains. “If we’re not satisfied with the three names given, we ask for more references.”
But if you can’t trust what the reference is telling you, such measures aren’t good enough. “For this to work, people have to be open with their information regarding credit history for particular clients,” Karnavat continues. “And a lot of people give you improper references or false references because their money is stuck, or they’re embarrassed that they’ve been taken advantage of. That’s the biggest problem. People need to be more forthcoming, and it’s a trade-wide issue.”
Simple measures
The flaws in the system must be addressed so jewelers can better protect themselves, the experts say.
Not all preventative measures require a large investment of time, effort and money, either. Sometimes it can be as easy as picking up a phone.
“What I tell my clients is, an ounce of prevention is worth a ton of cure,” says Goldberg. “What does that mean? It means know who you’re dealing with, ask them about their company, ask them about who owns the company, and understand what their corporate structure looks like. Ascertain whether the risk is worth the reward.”
Beyond asking for references, says Lerner, “a simple Google search can often tell you a lot, and it takes 30 seconds. There’s so much you can do online. From looking them up on Facebook and LinkedIn, you can often find links to jewelers they’ve worked with that you know and trust, but aren’t on their reference list.”
The language of a memo contract is another common problem that’s easy to remedy. Jewelers often leave out necessary wording that can establish ownership, timelines and other important information, or else they word it improperly, which can nullify their intentions.
“I’m always astonished at the number of businesses that don’t even have the consignment agreement properly drafted,” Goldberg comments. “They just do a short, one-page memo which has language in it they borrowed from another form created 20 years ago.”
Goldberg advises going to a lawyer to get a proper memo drafted. Paying for one visit to update the wording can yield many benefits, he points out, as the jeweler can reuse the form multiple times.
Rocchio, too, has seen many cases land on his desk for collection due to improper contracts. “Spell everything out in the contract: These are my goods, these are the terms of the contract, this is how long you have to either return it or pay for it. You have to cross every ‘T’ and dot every ‘I.’”
Metsopulos recommends taking it a step further by recording yourself on a Zoom or Skype call with the person to whom you’re sending the goods, outlining the terms of the contract and getting both parties on record agreeing to abide by them.
A credit to their name
Once you’ve collected basic information on a prospective memo client, the JBT’s credit reports are a great way to glean information on their consignment and payment history, Rocchio says. They will also let you know whether the business discontinued operations with any outstanding debt, if there were any legal crimes committed, if it ever filed for bankruptcy, or if there have been other recent inquiries into that client.
“It’s unfortunate when people don’t take advantage of what we offer to protect themselves,” says Rocchio. “We provide a really good service. It’s just about getting the members to pay attention to what we do and how we can help them. A lot of times, I have to bite my tongue when someone calls me up to talk about a collection claim, and they’ve never pulled a JBT report. I look at the report and see the consignee was a security risk from day one, with a bunch of unpaid obligations and bankruptcies.”
Steve Gonzalez, a special agent with the Federal Bureau of Investigation’s major theft task force in New York, agrees that consignors should try to verify that the memo client has the financial means to pay them. Asking for collateral or secured credit — in which some sort of monetary or other assurance is provided — can also work well.
“Items of value could be held as collateral if ownership can be documented, or funds could be held by a third party in escrow until the transaction is completed,” suggests Gonzalez.
Karnavat asks new consignees to issue a cash deposit at the beginning of the relationship. “I ask them to give me a check up front. If the item doesn’t sell, I’ll give the money back. We then convert those who have continuously done well for us into credit clients, but if we can’t establish a level of trust with someone, we just won’t work with them. I don’t care about the business.”
Legal intricacies
Another way for consignors to protect themselves is with a Uniform Commercial Code (UCC) filing. These documents establish ownership of goods and make it easier to prevent losses if the consignee files for bankruptcy. Not only does the UCC inform other creditors that the goods in the consignee’s possession — or their monetary value — belong to you, it also marks you as a secured creditor, says Yood.
“Let’s say you sign a memo deal with a company, and you ship them 1,000 pieces of jewelry, and they sell five before filing for bankruptcy,” says Nilesh Sheth, president of the Indian Diamond & Colorstone Association, as well as jeweler Nice Diamonds. “The UCC announces that you still retain ownership of the 995 unsold pieces, effectively barring them from being used to pay off the consignee’s debts.”
However, both Yood and Sheth recommend using a lawyer or a specialized service to make sure UCC filings are correctly processed.
This is another failure in the system, according to Goldberg: Many jewelers are reluctant to pay for a lawyer when it comes to memo issues.
“The margins in the diamond business are so tiny,” says Karnavat. “Anybody going to a lawyer would have to give up maybe a couple percentage points, and I don’t think anybody is willing to give that up, because you would be spending too much money. Especially if the stone is not sold, and you’re stuck with all those fees. And if you’re not selling at the best prices, obviously customers don’t come to you.”
Indeed, Goldberg estimates that the number of clients who come to him after a memo deal has gone wrong is about 80%, and only about 20% seek his assistance before making a deal. People often feel it’s an unnecessary expense and don’t expect to get burned.
“I try and explain to them that by seeing an attorney, they’re investing in their own future, because by spending a relatively modest amount of money, they’re protecting these huge transactions,” he says. “People think nothing of sending out gemstones worth literally millions of dollars on memo, but they won’t spend a few thousand dollars to protect themselves.”
It can also be difficult to get people in the industry to take the time to fill out a UCC filing, despite the value of the goods.
“I’m always shocked at the number of folks who will say they don’t need to file a UCC because industry custom is based on personal relationships,” Goldberg remarks.
Karnavat admits that his company doesn’t usually do UCC filings “because we aren’t able to. A lot of the customers we deal with think it’s too much of a process, and they really don’t want to go through with it when they need a diamond. And since memo is really based on references, if their references are strong, we feel it’s really unnecessary.”
The insurance route
While many of these extra steps offer a degree of protection, they do not represent a perfect plan, experts stress — especially when people are unwilling to implement them.
“Let’s be candid,” says Friedman. “At the end of the day, there is nothing that obviously is going to be a bullet-proof type of security guard for memo.”
The exception, he says, might be an insurance policy. “That would probably be the only way you could definitively cover yourself.”
However, insurance for memo deals is not so easy to come by. Many insurers refuse to cover memo because jewelers are willingly entrusting their goods to someone else — unlike in a robbery, scam or theft, when the loss of the goods is beyond their control.
“Even people who basically have insurance policies and are operating under the premise that they’re covered sometimes find out that it’s not always the coverage they anticipated,” notes Friedman. “And sometimes people who deal with brokers and insurance companies just assume that they’re covered, and later find out they weren’t. You can have a relationship with a company for 30 years, but when that one time happens that you need them, you find out you really weren’t covered the way you thought you were. You can’t take anything for granted.”
Berkley Asset Protection provides policies for memo deals through its jewelers block insurance, but these offer lower coverage limits than regular jewelry insurance. They also require the jeweler to vet consignees, check their JBT ratings, and confirm all transactions in writing prior to sending anything out.
That’s because in addition to its own client, the insurer is essentially “being asked to insure a third party, potentially without knowing them,” explains Greg Smith, executive vice president of claims at Berkley. “The difficulty as an insurer is that you do not get the chance to vet this third party most of the time. You don’t know what their business practices are, nor do you know what security is in place. This is why insuring a memo is much more risky.”
Additionally, Berkley’s memo coverage only extends to diamonds that are damaged or stolen while in the consignee’s possession, not those lost when the consignees themselves commit fraud or go bankrupt.
“Memoing jewelry to another jeweler is akin to giving someone an unsecured loan,” affirms Andrew Chipman, vice president of Berkley’s jewelers block division. “Should the other jeweler declare bankruptcy, go out of business, or abscond with the item, there may be little protection for the jeweler to recoup their loss.”
For its part, Jewelers Mutual offers the same memo coverage, protecting the stone only if it’s damaged or stolen while in another party’s custody. And even that insurance isn’t part of a jeweler’s general policy; getting it “typically requires a little bit more of a premium,” according to Don Elliott, Jewelers Mutual’s director of claims.
“And the coverage isn’t any broader than what the jeweler would have were the stone at his premises,” he adds. “So sometimes people think memo insurance just covers everything, but if you’re entrusting that piece to someone, and they do something intentional or criminal or fraudulent, insurance typically doesn’t respond to that.”
A helping hand
If a jeweler does become the victim of a bad memo deal — whether by fraud, bankruptcy, or a contentious debate over ownership — there are a number of recourse options available.
The JVC offers mediation services if there is a dispute between two parties over a diamond, says Yood. The process is one level below arbitration — a private dispute resolution procedure the DDC provides for its members.
“If you go through the court system, you could be looking at years, and most dealers don’t have the means to have that capital tied up for years,” explains the DDC’s Lerner. “And even if you win, you’re going to spend at least a third of your money getting that win, so if you’re lucky, you end up with $0.25 on the dollar. But arbitration is compulsory for any member of the bourse, and it’s as good as a court judgement.”
Another option is to turn a memo contract into an invoice if the other party doesn’t meet the terms and if payment isn’t forthcoming. That allows the JBT to take action on behalf of the consignor.
“We can’t collect on memos,” says Rocchio. “Companies will try to turn us into a collections agency for memo goods, but we can’t [do that] until they’re invoiced. Once that happens, and they appear as past due, then we can collect on them.”
Seeking out legal advice is also a viable option — and Goldberg urges people not to wait. “I’ve had clients who will literally come to me, and I ask them how long the memo has been outstanding, and you can knock me down with a feather when they tell me it’s been a year and a half or two years. The sooner you do it, the better, because the money may still be there, whereas if you wait, who knows if the company is going to still be operating.
Or they may have taken all the money they had and put it somewhere else out of reach.”
Here to stay
Considering its standing as a staple of the industry, memo is unlikely to go away.
“I still think memo works more often than not,” says Lerner. “I think memos are one of the things that makes our industry work and gives value to dealers. It gives them the unique ability to move relatively fungible goods at high speeds to customers. I think it would be unbelievably bad for our industry if that was something that went away for good.”
But that doesn’t mean the trade shouldn’t tweak the way such deals are carried out, Lerner adds. “I think it’s incumbent upon people to do the best they can to protect themselves by using all the means at their disposal.”
Friedman agrees. “Depend only upon yourself,” he advises. “Don’t depend on the law, don’t depend on an insurance company. Do your due diligence. If there’s something that I always look at, it’s what I stand to lose versus what I stand to gain. If I can’t live with the loss, I’m not going to take the risk.”
Article from the Rapaport Magazine - November 2020. To subscribe click here.