Opting out of the Legal System: Extralegal Contractual Relations in the Diamond Industry Pt. 2

Diamond Industry: Extralegal Contractual Relations

• Diamond Dealers Club (DDC) traders in New York primarily use verbal contracts and private arbitration
• The research question asks why DDC traders rely on verbal contracts and private arbitration instead of formal contracts and the public court system

Structure of the Diamond Industry

• DeBeers cartel controls 80-85% of the global raw diamond supply
• Raw diamonds are sold to four brokers
• These brokers then sell "sights" to 150-200 selected diamond dealers (sight holders) in London 10 times a year
• Prices for these sights remain fixed, creating “take-it-or-leave-it” offers
• Dealers sell to smaller retailers
• Trading mainly occurs in organized diamond markets worldwide
• The most prominent trading place in the U.S. is the New York Diamond Dealers Club (NYDDC)

New York Diamond Dealers Club (NYDDC)

• The NYDDC has around 2000 members with highly demanded membership
• Historically, the NYDDC was largely dominated by orthodox Jews
• Members must agree to arbitrate all claims with fellow DDC members and members of Diamond Bourses within the World Federation of Diamond Bourses (WFDB)
• The DDC's mission is fostering the interests of the diamond, colored stone, and jewelry industry
• The DDC provides a facility, encourage principles, establishes standards for disclosure, and provides arbitration tribunals
• Serves as a trading place, information exchange, and dispute settlement center
• The right to trade on the DDC trading floor or online is exclusive to members who meet strict ethical and financial standards
• DDC Membership is a comprehensive set of rights and privileges
• Eligibility requires those wishing to engage in the gemstone industry to be at least 21 and employed in the associated fields for at least two years
• Members can buy and sell diamonds and jewelry on a 17,000 square foot floor in New York City
• Members get access to a secure online trading platform
• Members can network with dealers, brokers, and manufacturers
• Members are granted arbitration and are affiliated automatically with the WFDB

Business Practices and Dispute Resolution

• Transactions typically occur without written contracts, using practices, such as a handshake sealed with "mazel u broche"
• Savings on transaction costs are the reason to not use formal contracts, to avoid writing and enforcing the contracts
• Disputes, often concerning payment delays, are settled through non-public arbitration within the NYDDC
• A key advantage is the speed of this private arbitration system, which is important for managing liquidity
• The average court case in New York takes about three years by comparison
• NYDDC by-laws have few explicit specifications; decisions rely on trade custom, common sense, Jewish law, and common-law principles
• Cases are typically settled before judgement
• Those not adhering to arbitration may have their photo publicly displayed in the NYDDC
• Jewish rabbi courts may exclude traders from their community
• This penalty is most effective within close-knit ethnic groups

Payment and Financing

• Payment targets of 30-60 days are used instead of bank credits due to insiders having more information than banks
• Diamond dealers need short-term financing to polish and sell raw diamonds

Additional Points

• The largest raw diamonds are sold in auctions
• Trade rules are evolving due to globalization and easier access to information
• Reputation, reputation bond, and social bonds are key to the market
• The NYDDC offers several benefits like social support
• Homogeneous groups work best with social bonds
• Contracts are primarily useful to define the end of relationships due to disagreements
• Out-of-court settlements are more common than formal trials
• Complex technology and transactions cause the 'relational contracts' to become essential along with identity of trading parties
• Jewish people historically specialized in the diamond business because diamonds were easy to transport during persecution
• The NYDDC still has many orthodox Jews. There is ethnic homogeneity found within each bourse

Theory of Inspection

• Over investing into searching for the proper activities to do
• The object is goods and services that are hard and costly to measure, and that are sold at joint average prices
• Heterogeneous sights are offered to the selected buyers
• Allows customers fair sights in the short-term
• Advertising helps search costs, and suppressed information stops searching