If diamonds are a girl's best friend, then a gemologist's grading certificate is the soul mate of the diamond dealer and the retailer. That certificate of quality, which defines the four C's of a stone -- carat, clarity, color, and cut -- serves as the support beam for the massive diamond-marketing machine. Call into question the authenticity of that certificate, and you may as well have just given a woman a piece of paste. Neither situation would be pretty.
That's why the inquiry of federal prosecutors into an alleged bribery scheme at the Gemological Institute of America has shaken the diamond industry and has it looking at the situation through a jeweler's loupe. The case carries the potential to expose the industry's fragile underpinnings.
On the surface, this looks like a simple investigation of fraud. A Saudi family purchased two diamonds -- one a 103.78-carat pear-shaped pendant, and the other a 37-carat ring -- that were supposed to be "flawless," the top of the chart on the clarity scale, and were given a top-rated color "D." Both received an institute certificate guaranteeing their quality. The family paid $15 million for the two rocks. The buyer then took the diamonds to an independent appraiser, who found them to be of inferior quality and worth much less than that. The Saudi family demanded their money back and refused to do business with the dealer again.
In the elite world of diamond dealers, reputation is everything. The dealer sued. The GIA conducted an internal investigation looking at transactions going back as many as 10 years ago and found that a supervisor and four employees had been accepting bribes to inflate the grades of diamonds from "a small community of dealers." The employees were fired, and the results of the investigation have been turned over to prosecutors.
Yet the diamond industry is huge, with some $64 billion worth of diamonds sold worldwide and half of them sold here in the States. A scandal going back a decade could call into question the credibility of the diamonds appraised by the GIA, though it says just a small number might be questioned. It has agreed to recertify any diamond for the next six months free of charge.
While there are a number of independent labs aside from the GIA that certify the quality of diamonds, the institute is essentially an industry monopoly, with an estimated 98% of the world's diamonds certified by its lab. The largest diamond retailer, Tiffany (NYSE:TIF), recognizes GIA labs only. Online purveyors, such as Blue Nile (NASDAQ:NILE), might have several labs certifying their diamonds, but the GIA is always one of them. Founded in 1931, the institute is credited with creating the four C's that are now used to market diamonds to the masses.
The diamond industry is under fire on a number of fronts -- from the DeBeersantitrust scandal and its so-called "conflict diamonds" (gems sold to fund military and terrorist operations) to flawless, synthetic diamonds grown in a lab that are indistinguishable from "real" ones but cost just a fraction to make.
A scandal involving the quality of diamonds being sold might not make it acceptable for a man to ask for a woman's hand in marriage while proffering a piece of cubic zirconium -- like gold, diamonds will always hold a certain allure -- but it might loosen the stranglehold that diamonds have on the engagement industry and return a sense of sanity to pricing.
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Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can view his holdings here. The Motley Fool has a disclosure policy.
