The DTC Brokers: Loyalties And Liabilities
October 23, 03One or more disgruntled DTC sightholders have now initiated legal steps against their DTC brokers. Reportedly, one broker is being sued for compensatory damages and for return of a few years of brokerage fees, on grounds that he preferred the interests of the DTC over the best interest of the client – who pays for his services. Unwittingly, this touches on a rather problematic issue – are those who pay for the services indeed the main beneficiaries of the services? In some instances the answer is clear; in most, however, the issue is far more complex.
The Supplier of Choice criteria don’t make the use of DTC brokers mandatory, but the DTC strongly encourages clients and potential clients to use their services. The DTC “controls” the brokerage fraternity, as one must meet the objective criteria in terms of infrastructure and expertise as set by De Beers. Except for all the DTC’s South African clients and a few isolated sightholders, contacts between the DTC and the client are conducted through ‘DTC Accredited Brokers’ – though lately some of these brokers have become de-facto “business consultants” providing a range of additional services (for which the clients are charged separately).
This viewpoint concerns the traditional broker’s role – and not addresses the “contemporary consultant”. If the DTC drops a sightholder, or refuses to appoint a potential sightholder, to what extend can this be considered a failure of the broker to perform? Traditionally brokers are responsible for formally introducing prospective clients to the DTC and look after their interests. (Under Supplier of Choice, which in spite of its shortcomings is a far more transparent system, brokers can “score points” on behalf of clients.)
Traditionally, requests for certain assortment allocations by any client are made through the broker and conveyed by the broker to the DTC. Decisions of the DTC that affect clients are communicated by the DTC through the broker to the client. The relative performance by each client under the Supplier of Choice “scoring system” was communicated to the DTC clients by the DTC brokers. The DTC makes optimum use of the services of the DTC broker.
Broker as extension of DTC marketing system.
From a legal perspective, it can be argued that the DTC broker in fact operates as an extension and part and parcel of the DTC’s marketing system. However, the broker obtains brokerage fees (about 1 percent of the sight allocation; some large dealers pay less) from the customer. When a client moves to another broker, or merges his business with another DTC client, brokers may share commissions).
One might argue that the term “broker” does not anymore factually represent the de facto situation. The DTC broker is the client’s representative. In the appointment letter, clients appoint brokers to represent their interests with De Beers. Basically, the client pays the broker to work on his behalf.
The term broker is confusing and maybe even misleading. Legally, one might argue that there is an agency-type of relationship in which, by mutual consent, the sightholder or prospective sightholder hires the agent/representative to act on client’s behalf and in client’s benefit with a third party. Acts which the broker undertakes on client’s behalf should be subject to client’s control and should require client’s consent.
Disgruntled sightholders seem to argue that, as their agent/representative, the brokers may have violated or failed their fiduciary responsibility by creating conflicting loyalties not only with De Beers, but also with other clients.
So the conflicting loyalties argument is not only because the broker is representing the interests of De Beers as well, but also because he has OTHER clients who all may want the same (limitedly available) goods.
That is something that industry players have always understood and accepted. But the loyalties/conflict of interest issue has never been put to a legal test – at least not as far as I’m aware. A negative judgment against a broker (even if only partial responsibility or guilt is found) would jeopardize the entire brokerage institution.
Who Pays for the “Free” Services?
Prospective sightholders don’t pay their brokers; only when the broker is successful, the new client starts paying a commission. That may well be an erroneous system. Brokers have expenses; they run offices; have large overheads. One may argue that some current sightholders lost their sights because with the money they paid to their brokers, their brokers introduced new parties to the DTC (at no costs to either the new party nor the DTC) and convinced the DTC to allocate these companies with goods from the (limited) available diamond supplies to these new sightholders, who are basically the competitors of their existing clients.
It can be argued that by virtue of this activity, the broker acts to the detriment of his existing clients.
Some observers view the continuation of the “brokerage” function under Supplier of Choice as an anomaly and probably as either a mistake or an oversight by the European Commission. SoC purports to make the distribution system more efficient, more streamlined, making all players in Gareth Penny’s “spaghetti chart” [showing the inefficiency of the distribution system] who “don’t add value” redundant.
I don’t necessarily share that view. I believe that (some) brokers provide their clients with tangible value. Under SoC the “lobbying on behalf of clients” has become more sophisticated, more complex, and less straightforward. Brokers who understand how the new system really works can still be exceedingly useful to the client. Some DTC brokers have invested considerable resources in the provision of value added services: they provide non-DTC rough to clients, they have retained superb marketing expertise that is made available to clients, they have set-up outsourcing facilities for the processing of clients’ goods in low labor cost environments, etc. By creating added value services, these brokers have gone beyond their “core” business and created a situation in which they provide tangible benefits to clients – as well as additional revenue streams to themselves.
Many decades ago, brokers received a commission from both the client and from the DTC. This was in due recognition by the DTC that it is certainly a beneficiary of the broker’s services; it was also consistent with customary industry usage.
It is interesting that throughout history, the role of the DTC broker has changed. The brokerages were established in the early part of the 20th century, when De Beers feared oversupplies of rough and worried about its inability to find clients.
In those days De Beers sold diamonds already “in series” (which means assortments containing goods needed by the market together with goods for which there was no or little demand) and it wasn’t always easy to find buyers. In the 1930’s, for example, brokers would often extend financing to the buyer, in order to secure sales. This all changed after World War II.
The DTC Used its Power to Get Rid of Commission Payment
It was only after World War II, when it became apparent that demand would exceed supply, and that De Beers was fully in control of the market through the artificial creation of rough shortages, that De Beers decided not to pay the broker any commission any more for the service it was providing. It continued to receive the broker’s services as if they were still paying… That’s quite an achievement – and it got away with it.
Indeed, not paying the broker was tantamount to saying, “we really don’t need you”, but, with the benefit of hindsight, and taking a legal view on this, it appears more as a possible misuse of its dominant power, because it continued to insist to enjoy and rely extensively on the services of the broker. As there were always dozens of potential clients waiting for a chance to become sightholder, the DTC could get away with its unilateral decision not to pay brokers any more. No clients rebelled. So while the role of the broker [literally: “one who for a commission or fee brings parties together and assists in negotiating contracts between them”] remained the same, the sightholder ended up also paying for the services the brokers were providing to the DTC.
So the present situation is indeed an anomaly: the sightholder pays for the services the DTC is getting as well as for the services potential sightholders are getting. The last part is probably most disturbing, as the sightholder pays for creating greater competition for the goods that he would like to get from the DTC.
The DTC still “encourages” present and potential sightholders to use brokers. The DTC should recognize that, by looking for new clients, the broker may well act to the detriment of the existing clients. The DTC really imposes on the broker a situation in which the broker – without having much choice – may be violating his fiduciary responsibilities to his clients.
DTC Must Overhaul System – to Protect itself and its Brokers
If we were a brokerage sued by a client, we would probably quietly pay the client and present the bill (plus interest and compensation for “mental damages”) to the DTC. It is the DTC that has put the brokers in an untenable situation – and probably also in legal jeopardy. DTC clients and future clients do need the services of consultants. If we were the DTC, we would use the “window” created by the complaints that have been filed with the European Commission to voluntarily review the relevant sector in the sightholder criteria.
The following changes seem imperative:
(1) Get rid of the term “broker” – because the DTC brokers have long ceased to fill the legal definition of brokers. They are diamond industry consultants or client representatives. They are de-facto agents of the clients and owe their full, undivided loyalty to their clients. [They could be DTC consultants; or DTC liaisons; the DTC legal team may come up with some innovative names.]
(2) Let the client decide who should represent him at the DTC. Today, the DTC provides a list of “accredited brokers” and imposes upon the client an obligation to make a choice. Open it up. Let the client decide who he wants as a broker. Trust that the client will not send someone to represent him if he thinks that representation will not be successful. Let that be the clients’ choice. Just as the DTC encourages the use of marketing consultants, IT experts, etc., it should encourage the use of a “client liaison with the DTC”.
(3) By “opening” this up, the DTC will create true competition among brokers and eliminate conflict situations, as clients can also go to someone who would become his exclusive representative or go to someone who doesn’t represent clients who want competing boxes. For all practical purposes, the existing DTC brokers would still hold most of the business - but open it up.
(4) Don’t impose on clients or prospective clients the semi-mandatory use of brokers and/or consultants. First of all, since some sightholders don’t use brokers, the DTC is discriminating among clients. Secondly, DTC has set its sightholder criteria. Let the client decide how he wants to present his performance to the DTC. Allow him to operate without a broker or consultant – and be fair and honest about the way you treat these clients.