International Auditing: The Next Phase in DTC’s Industry Behavior Modification

In Supplier of Choice (SoC), the DTC employs a client selection system based on the identification and accurate assessment of selected core competences (also called Sightholder criteria) of present and aspiring future Sightholders. One can only compare companies if there is an agreed objective – or corporate goal – to which all Sightholders must subscribe. In journalistic jargon, it has become commonplace to refer to SoC as the DTC’s marketing strategy aimed at building an effective distribution system that will (1) drive consumer demand for diamond jewelry, and (2) add value for diamonds along the value chain (and, especially, at the rough supply level). There presently exists a rather broad consensus in the business in support of these objectives – criticism, opposition, or outright rejections of the strategy are mostly based on doubts whether the DTC has the tools to manage this strategy in a fair and equitable manner.

Sometimes it is overlooked that the DTC has always clearly emphasized its specific intention to manage change in the diamond industry. It wants industry players to become more competitive by competing “on value” rather than “on price”. The DTC has unmistakably enunciated its intention to impose new business models on the diamond business.  Virtually all DTC Sightholders (but also non-Sightholders who wish to remain competitive) are forced to view their own business from a different perspective - to manage and organize it in new ways. This implies introducing profound changes of organizational structures and, most crucially, it requires principals, managers and employees to “unlearn” old concepts.

The latter is a painful process. There are many who resist change, and who would like the continuation of the status quo. The DTC has forced the industry into a “business process re-engineering”, which involves rethinking the core business processes in one’s company with a view to bring about fundamental changes to the way things are done. What the DTC tries to do is not to bring about some marginal improvements – its real objective is to achieve a breakthrough which gives a leapfrog position of competitive advantage.

However, it is hard to get rid of time-honored (proven) habits. One of the peculiar characteristics applicable to the DTC’s Sightholding community is the acute awareness of always “telling the DTC what it wants to hear”. Privately or publicly aired criticism, it was feared, would invariably lead to “sanctions”. In the autumn of 2000, after the launch of Supplier of Choice, when the “profiling” and “presentations” became a requirement, a large group of clients focused on telling the DTC what they felt the DTC wanted to hear. Weeks and months of management time was devoted to the completion of DTC profiles. Consultants and experts were brought in at great expense with one objective: how to optimize one’s placing in comparative scoring. I will never forget the Indian diamantaire who confided in me (in December 2003): “You don’t have to go downstream. The only thing you have to do is convince six people in London that you have gone downstream.” Actually, what many Sightholders were doing was exactly what had proven to be effective for many decades: tell the DTC what it wants to hear. They were fighting to keep their sights – as they had done for many decades. [Incidentally, the DTC is currently reviewing the need for a full profile assessment by Sightholders appointed in 2005 onwards, on an annual basis.  It may well be that it will introduce a “lighter” assessment during the interim years of the contract.]

I would do great injustice to many good companies by overly generalizing the profile issue. One must assume that the vast majority of profiles and presentations made to the DTC accurately reflect the state of the companies concerned. But “vast majority” isn’t good enough. This has nothing to do with liking or not liking SoC; it has everything to do with fairness. Good companies shouldn’t be denied a sight, or get a reduced score, because others know better how to answer questions 6 or 12, or whatever question provides the greater headache and requires the greatest creativity.

DTC Managing Director Gareth Penny indicated early in 2004 that he realizes that there were legitimate concerns among the Sightholders on the fairness of the implementation of SoC. He also promised (at the New Year’s cocktail in January) that the DTC would address these concerns. He made that promise – and has kept it. DTC Director of Sales Varda Shine has now sent a letter to all Sightholders, formally advising them of pending changes – and the following selective extracts demonstrate that Ms Shine has her finger on the pulse of the industry and knows what she is saying.

Writes Ms Shine: “A number of Sightholders and their representatives have expressed views during the current contract period relating to the degree of comfort that the DTC can have in relation to the profiles submitted by applicants for Sightholder status under the SoC trading arrangements.  As you know, during the 2003 contract period, we have relied on self-declarations by Sightholders and new applicants submitting profile applications that the contents of these submissions are a true and fair description of their business activities.  Where we have noticed anomalies or apparent errors in the profile applications that have been received, we have sought to clarify the position with the relevant applicants in order to ensure that we properly take into account the information submitted, to the satisfaction of those applicants and ourselves,” observes Varda Shine.

“However, we have also carefully considered the views that have been expressed and we agree that there is more that can be done in order to provide greater comfort and assurance of integrity to all those connected with the SoC assessment process. [Emphasis added.] Having informed the European Commission of our plans, we therefore intend to introduce an independent verification mechanism in 2005 and subsequent profile periods.  This means that a wholly independent verifier, (i.e. a forensic accountancy team) will be instructed by the DTC to verify Sightholder profile submissions. Although the finer details of the profile verification mechanism have yet to be finalized, it is envisaged that the verification team will carry out audits on a random spot-check basis.  In addition, should the DTC have reasonable grounds to question the data submitted in a profile application as inaccurate or untrue, and we are unable to gain comfort from the applicant that this is not the case, we will also instruct the independent verifier to look into the particular circumstances giving rise to the query on a particular submission.”   

Assuring Confidentiality of Data

“Of course,” assures Ms. Shine, “these verifications will be conducted strictly confidentially and the DTC will not receive any information on the verifications conducted.  The verifier will only report back to the DTC in terms of confirming that the data in the applicant’s profile response were correct or to inform the DTC that the profile information needs to be changed and that such changes had been agreed with the applicant so that a revised profile can be considered.  We are still resolving the position that the DTC will take where the verifier and the applicant are unable to agree that changes need to be made in order to present a fair and true picture of the applicant’s business to the DTC.

“However, the DTC will be guided by the verifier’s recommendations in such circumstances and where the verifier expressly indicates to the DTC that it is not satisfied with an applicant’s explanations or documentation, the DTC may well decline to further consider that applicant’s profile under the SoC process. In the event that the DTC has actually made an offer of Sightholder status to the applicant prior to the verification process having been completed, the DTC may revoke that offer or terminate the Sightholder status, as relevant.”

That sounds pretty threatening – and I think it is important not to lose one’s perspective. Sightholders are honorable people – they are not cheats. They have been used to a certain behavior vis-a-vis the DTC and now have to come to terms to a significant degree of “behavior modification”, or what I called earlier “unlearning”. A decade ago, a DTC broker once defined one of his functions as being a “cultural translator”. He explained: “I would get a phone call from a furious client saying that his box was full of (unprintable word). It was my task then to communicate to the fifth floor at Charterhouse Street that ‘this client was slightly less than fully satisfied with his box’.” Communications between DTC and clients have changed quite a lot since then. Gareth and Varda can now reach each client in a split-second through the “send” button on their e-mail software.

DTC to Get Third Party Auditing of Clients

One of the more complicated plans announced by the DTC is the independent verification of accounts. The taxation structures in the cutting centers are different from country to country and in some countries specific bookkeeping agreements have been made with the industry to the joint benefit of both governments and industry. We have editorialized in the past that some of the specific SoC criteria may lead to the migration of the rough market to offshore centers which have near zero or fully exempt tax regimes. Some of the new measures announced by Varda Shine may expedite that process.

Writes Varda: “Closely related to the queries and views that have been addressed in relation to the DTC’s verification capabilities, is the issue of accounting practices within the diamond industry and, in particular, the level of comfort which the DTC can have in relation to financial accounts submitted by applicants for Sightholder status.  As you know, at present, Sightholders and new applicants are asked, when submitting their financial statements, to present audited consolidated or combined financial statements. Where applicants have genuinely struggled to provide these in previous time-frames, unaudited consolidated or combined financial statements supported by a letter from a duly qualified, internationally recognized auditor, or from a first-class lead bank, confirming the applicant’s financial standing have been accepted by the DTC. 

“With many concerns being expressed about financial accounting practices across a number of industries, including our own, and the additional obligations imposed on us all as a result of anti-money laundering legislation around the world, the DTC shares the concern with those of you who have expressed it, that unaudited accounts may be less reliable than the data set out in audited accounts.  By contrast, the audit process is stringent and it provides an additional level of comfort that the accounts submitted are a true and accurate picture of an applicant’s business.  We have therefore reached the view that it is appropriate to require all applicants, including existing clients, to submit accounts that have been audited to international accounting standards by an accredited accountant.” 

Varda Shine shows great pragmatism and realism when the implementation of this requirement is delayed for a few years. Says Varda: “We recognize that this does initially present logistical challenges for some of our clients and new applicants and that there is little time to address this change to the SoC requirements in readiness for next year’s assessment process. In view of this, to avoid imposing an unreasonable burden, we are not proposing to introduce the requirement to provide audited accounts until the assessments underpinning the next Sightholder contract period.”

We expect that this seemingly “minor” requirement will lead to many discussions within the diamond industry. It is too early to predict its ramifications. I would hope – and expect -- that the industry will support the desire for greater accountability and transparency. The world is vastly changing and high corporate ethical and financial standards have become international benchmarks underpinning good corporate behavior. The diamond industry cannot afford to be “left out” and this initiative by De Beers deserves the widest possible praise and support.

Varda Shine also officially informed clients that the next DTC client contract will run for two-and-a-half years (though she does not say that thereafter it will be three years, which is our present understanding.)

The change was made over concern about “the ability of clients to establish effective business relationships and successfully implement marketing activities”. This means that the next contract will expire not in 2007, but in January 2008.  This longer contract period also allows for more time to adjust to the auditing requirements. Explains Varda: “Audited accounts will become a mandatory requirement in the assessment process that will help to determine eligibility for the contract period beginning in January 2008.  The present arrangements will continue, whereby DTC will request for assessment applicants’ two most recent years of financial statements.  In the case of the contract period beginning in January 2008, the two most recent years of financial statements will be 2005 and 2006.”

Somehow, at the beginning of 2005, the treasured historical character of the diamond business – the trusted handshake and verbal agreement involving multimillion-dollar transactions – seems light years away. Transactions have always been recorded, one way or the other. Books have always been kept, and auditors have always audited books. For the rough supplier to bring in an outside international auditor who is to independently verify one’s own auditor is unprecedented as a pre-condition to get rough supplies from De Beers. Somehow, I suspect, ten years down the road we’ll all be grateful that the DTC has taken this initiative – even though in the short term it may create some pain and some discomfort. It’s all part of the industry transition process – and, probably, a welcome and essential reputational imperative.