Diamonds are a banker’s worst friend

By Suzanne Kapner


(Fortune Magazine) — On the morning of Sept. 27, 2007, two Merrill Lynch bankers arrived at the Rockefeller Center office of Ralph Esmerian, a jewelry dealer and art collector, and boxed up tens of millions of dollars of rare jewelry. Armed guards loaded the jewels – including a 14-carat pink diamond ring worth roughly $15 million – into a Brink’s truck idling outside. Within hours the gems, some of which had been in Esmerian’s family for generations, had been carted away – seized as collateral for a loan gone bad.

Esmerian had borrowed the money two years earlier to finance the acquisition of Fred Leighton, known as the jeweler to the stars. Back then Fred Leighton consisted of a store on New York City’s Madison Avenue and a second boutique in Las Vegas, but Esmerian envisioned turning Leighton into an international brand with stores around the world.

It was a plan that tantalized a group of Merrill Lynch bankers. Heretofore, these bankers had made money collateralizing real estate, machinery, and other hard assets. But lately they had been making some less traditional plays: They had provided $500 million of financing to United Artists, which used the money in part to produce the Tom Cruise movie “Valkyrie.” The bankers also lent money to the Ranch, a custom-crush winery in Napa Valley.

For the Merrill bankers the deal with Esmerian was their introduction to the byzantine world of jewelry – a world they would regret entering. Jewels are funny things. Most people’s first brush with them is when they get engaged. It’s arguably the most idealistic and least objective moment in a relationship. Business deals – specifically ones consummated when credit is loose – are not all that different. And back in 2006, when Merrill Lynch and Esmerian hooked up, they were blind to each other’s faults. In Merrill, Esmerian (pronounced ess-mary-ann) thought he had found a partner who would stick by him in good times and bad. Instead, he says, he ended up with a bunch of “cowboys” who cared more about generating fees than building a business.

Similarly, Merrill felt comfortable with Esmerian because the deal was backed by millions of dollars of jewelry. In addition to Fred Leighton’s inventory, Esmerian had pledged his family’s cache of 101 jewels, known as the Special Collection, with an appraised value of $89 million. In a deal code-named Project Nile, the bankers agreed to lend Esmerian $176 million, payable over three years. What the bankers failed to detect was that they were funding a serial borrower who already had multimillion-dollar loans from Sotheby’s and Christie’s, and who would soon be accused by his siblings of playing fast and loose with, that’s right, the family jewels.

As with so many overheated romances, Esmerian and his bankers now find themselves in court. Merrill Lynch is suing Esmerian in an attempt to recover its money, an amount that the bank claims has ballooned, with unpaid interest, to $192 million. “We are in a dispute with Mr. Esmerian for one simple reason,” says Bill Halldin, a Merrill spokesman. “He failed to make monthly interest payments that he agreed to when he borrowed money.”

Esmerian, 68, is suing Merrill Lynch, contesting the bank’s ownership of the collateral and claiming the loan was faulty from the outset. “Merrill Lynch didn’t understand what they were getting into,” Esmerian says. “But I didn’t understand what I was getting into either. In my business, if you’re late making a payment it’s no big deal.”

Regardless of whose side you come down on, one thing is sure: The company is the real casualty. Fred Leighton has been operating under Chapter 11 bankruptcy protection since April 2008 and is running out of cash. In December the court stripped Esmerian of his powers and appointed a restructuring officer, who is evaluating bids for all or part of the company. Interested parties include Robert Pressman of Barneys New York fame and Michael Steinhardt, the hedge fund honcho, who is a longtime friend and supporter of Esmerian’s. Neither would comment.

The goal is to find an investor who will satisfy the various legal claims and fund the company’s operations until it can emerge from bankruptcy. But given the state of the economy, there is also the possibility that Fred Leighton will cease to exist. The whole sad saga – which features a cameo appearance by Martha Stewart’s former stockbroker – is a cautionary tale in the perils of trying to build a luxury brand from little more than a name. For every success like Burberry there is an Asprey, the jeweler to the British Crown that flamed out a few years ago.

Humble beginnings

Unlike Asprey, Fred Leighton never had an aristocratic pedigree. Instead the jewelry shop was the creation of a New York City cabdriver’s son named Murray Mondschein, who bought a store in 1959 that sold Mexican wedding dresses and artifacts. The store, located in Greenwich Village, was named Fred Leighton after its late owner. Believing that people would be more apt to buy from someone whose name was on the door, Mondschein changed his name to Fred Leighton.

Before long the store began stocking vintage jewelry, and by the 1970s, Leighton was fast becoming a legend in the business. At the time, estate jewelry was not as fashionable as it is today, but Leighton cultivated a celebrity clientele. “People went to Fred Leighton to buy from Murray’s hands,” says François Curiel, Christie’s jewelry specialist and the chairman of the auction house’s European operations.

Meanwhile Esmerian was cutting his teeth in the family business of jewelry wholesaling. Unmarried and without children, he is the last of four generations of jewelers. His great-grandfather was a lapidary in Constantinople in the late 1800s. His father, Raphael, was a respected jeweler and gem dealer in Paris and later New York City. Raphael designed one of the first fine jewelry lines for Neiman Marcus. After Raphael’s death in 1976, Esmerian, who grew up in Paris and New York, took over the family trade.

When Ralph talks about jewels he sounds like a boy showing off his baseball cards. A favorite piece is a pair of horse heads sculpted by Herbert Haseltine for the heiress Barbara Hutton out of 24-karat gold and embedded with diamonds, rubies, sapphires, and emeralds. The horses held a mythical place in Ralph’s childhood. His father supplied Haseltine with the stones. Esmerian bought the horse heads from a private dealer about eight years ago.

Esmerian first met Leighton at an auction in the early 1970s, and the two became friendly. Esmerian would drop by the New York store on Saturday mornings to sip coffee with Leighton. Before long he was loaning the store pieces on consignment. By 2005, Leighton was looking to retire, and Esmerian jumped at the chance to buy his company. Through a friend Esmerian had met a Merrill Lynch broker, who put him in touch with Josh Green and Ryan Bell, two young bankers who worked for a division called Merrill Lynch Mortgage Capital, which specialized in collateralizing loans against hard assets. (Green and Bell would not comment for this article.)

According to Esmerian, Green and his colleagues were “salivating” at the prospect of owning a luxury jeweler. And on Nov. 4, 2005, Merrill lent Esmerian $56 million to buy Esmerian’s sister, sister-in-law, and her children (his brother is deceased) out of a family trust that owned much of the jewelry that would be used to collateralize the debt. On March 29, 2006, the bank lent a further $100 million, which went to buy Fred Leighton, and also made available a $25 million revolving credit facility for working capital.

As part of the agreement with Merrill Lynch, Esmerian was to hire a seasoned CEO to run Fred Leighton. Overtures to Simon Critchell, a former Cartier executive, didn’t pan out. In December 2007, Esmerian threw his backers for a loop when he hired Peter Bacanovic, who had been Martha Stewart’s stockbroker at Merrill Lynch during the ImClone scandal. Bacanovic had subsequently served five months in federal prison and five months of house arrest for obstructing a government investigation into Stewart’s sale of ImClone stock. Bacanovic also had no retail experience. What he did have was connections, and Esmerian, who had met Bacanovic through his lawyer, hoped the socialite-broker would turn his wealthy friends into clients.

First, though, Bacanovic was tasked with opening a new store in Beverly Hills. According to Tom Shull, the court-appointed restructuring officer, the Beverly Hills store, which opened in December, four months behind schedule, was millions of dollars over budget. “That put a lot of financial pressure on the company,” Shull says. Nicol Bini, the architect who designed the store, says it opened on time and within budget. Bacanovic, who stepped down from Fred Leighton in January, declined to comment.

There were other problems. For years, the business had been largely dependent on Leighton and his daughter, Mara. When they walked out the door, so did a lot of sales. Esmerian had planned to keep the Leightons on as consultants for five years, at an annual salary of $175,000 each. But according to a lawsuit filed by the Leightons, Esmerian never paid them for consulting work and also failed to pay $374,000 owed to them as part of the acquisition. Esmerian says the Leightons were badmouthing him to customers, so he terminated their contract. Leighton says that Esmerian wanted to do things his own way.

The bill comes due

By late 2007, Esmerian was in serious financial difficulty. The loan was crippling for a company of Fred Leighton’s size. In its best year Fred Leighton had an annual profit of $7.6 million, yet Esmerian was required to make interest payments north of $10 million. So why would the bankers make that deal? Merrill Lynch says sales of jewelry from the Special Collection, a separate cache of stones that Esmerian controlled, were also earmarked to pay down the loan.

Nevertheless on Sept. 10, 2007, Esmerian missed debt payments totaling $2.7 million. On the 27th of that month, Merrill seized the collateralized jewels. On Oct. 3, the firm summoned Esmerian to its lawyer’s office for what one source called a “come-to-Jesus meeting.” On one side of a conference table at Cadwalader Wickersham & Taft sat Esmerian and his CFO, Satyajit Bose. On the other side sat Merrill’s workout specialists. The bankers listed 21 transgressions, including the missed debt payments, delinquent financial reporting, and the delayed opening of the Beverly Hills store.

Over the next few months attempts at a compromise proved futile. Merrill proposed temporarily suspending interest payments with the understanding that the missed sums would be rolled into the principal, but Esmerian, concerned that he wouldn’t be able to meet the new terms, never signed the proposal. Instead Esmerian spent the remainder of the fall reaching out to angel investors, including Apollo Management and Soros Private Equity, but found no takers. Apollo and Soros both declined to comment.

In January 2008, Merrill lowered the boom: It sued Esmerian and moved ahead with plans to auction the jewelry it held as collateral. Christie’s was hired and spent the next four months putting together a catalogue and traveling exhibition that featured the jewels, including a diamond brooch made for Empress Eugnie, the wife of Napoleon III.

In its lawsuit Merrill alleged that Esmerian double- and triple-pledged the collateral and accused him of secretly trying to sell some of the jewels and pocket the proceeds. One eye-opening moment came when Merrill executives stumbled across a catalogue for a jewelry auction that Sotheby’s was holding in Hong Kong. In the catalogue was a diamond butterfly brooch that was part of the Special Collection that made up the collateral on Merrill’s loan.

Esmerian argued that Merrill’s plan to unload all the jewels at one time would result in a fire sale. Merrill was unmoved. So, hours before the auction was to begin on April 15, 2008, Esmerian played his trump card. He filed for Chapter 11 bankruptcy protection, essentially freezing Fred Leighton’s assets and halting the auction. (With the court’s approval, Esmerian has since sold Empress Eugnie’s brooch to the Louvre for $10.5 million, more than double its estimated value in the Christie’s catalogue.)

Esmerian’s financial problems leading up to bankruptcy created additional headaches for him. Over the past three decades he had run up big debts with Sotheby’s and Christie’s, which serve as de facto bankers to estate jewelers. Traditional banks tend to shy away from the industry because they find it difficult to value the inventory. In January, Christie’s sued Esmerian in an attempt to recover a $7.75 million balance on a decade-old $25 million loan. Three months later Sotheby’s seized the Edward Hicks painting “Peaceable Kingdom,” which Esmerian had pledged as collateral against an $11 million loan, and sold it for $9.6 million. The painting, along with 200 other works, had been promised as a gift to the American Folk Art Museum in New York City.

By the fall, Esmerian’s own family had joined the fray. In October 2008 they filed a suit accusing him of misappropriating money from a family trust as far back as 1992. By 2001, the suit alleges, the trust had loans of $28 million. When the stock market crashed that year Esmerian liquidated the entire trust portfolio to satisfy margin calls. The lawsuit says Esmerian never received the proper consent from his siblings for this financial engineering.

In an effort to make his siblings solvent again, Esmerian pledged 101 pieces of jewelry, called the Siegman Collection, to the trust. There was one problem: The Siegman Collection, the siblings charge, is identical to the Special Collection that Esmerian pledged as collateral to Merrill Lynch. To them it appeared that he was double dipping. Esmerian says his siblings gave him permission to borrow from the trust and that he paid them $12 million each to buy out their holdings.

The fate of Fred Leighton

There are, of course, two sides to every breakup. While Merrill’s lawsuit portrays Esmerian as a mountebank who was running a shell game, Esmerian accuses the bankers of knowingly inflating the value of the collateral to win approval from the bank’s internal credit committee. In Esmerian’s suit, which he filed in October 2008, he also raises questions about the loan’s economic viability. One internal Merrill Lynch document cited in the suit warns, “Interest is too high, resulting in insufficient cash flow.”

Esmerian further claims the bankers told him he’d never be able to repay the loan until he took the company public. A spokesman for Merrill Lynch says that charge is untrue and that the loan was later modified to require Esmerian to kick in additional equity to provide a cushion against the debt.

On Dec. 18, 2008, Esmerian suffered a heartbreaking setback. Following a scathing review of Esmerian’s leadership by a Merrill Lynch-paid consultant, the court stripped Esmerian of his management role and installed Tom Shull. A turnaround expert who helped steer Macy’s and Barneys New York out of bankruptcy, Shull immediately slashed $2.5 million in costs by paring advertising, reducing travel budgets, and otherwise tightening belts. He strengthened the inventory management systems and simplified the commission structure. He also started cutting prices. Fred Leighton, which had never before run big sales, in March marked everything in its cases down 40%. (Attention, Kmart shoppers!)

It may be too little too late. Since peaking in 2003, sales at Fred Leighton have halved to $20 million, and after bankruptcy expenses the company is barely breaking even. While Shull acknowledges the high-end jewelry market is likely to remain depressed for a while, he is hopeful that the company will find an investor to keep it alive. Of course, if Merrill Lynch has its way, Fred Leighton’s precious jewels will be liquidated to pay debts. Merrill, now part of Bank of America (BAC, Fortune 500), has bigger problems than the fate of a few high-priced baubles. It has disbanded the division that made the Fred Leighton loan, and most of the bankers involved in the deal have left the firm.

And what of Esmerian? At best he was careless; at worst he was cunning. Perhaps it was his privileged upbringing that led him to have so little respect for other people’s money – even his own family’s. To Esmerian the jewels he collected were as precious as living things, and it mattered to him a great deal that they reside with those who appreciate their beauty. The downside to such snobbery is that no one is more deserving than the beholder.

In Esmerian’s case, what was his was his, but what was yours was also his. People who know him, however, say his motives were pure. “Ralph is a true lover of jewelry,” says Gail Freeman, a private dealer who has worked with him for over two decades. “He cares more about the art than the business.”

That’s why he needs a good business partner, says Shull, who is recommending that any new owner retain Esmerian as a creative director. “Ralph needs someone who will push back and say, ‘If we take 20% off this item, we’ll sell it.’ In retail you need to move the goods.” That’s true even if those goods are damaged.  

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