The Future of SoC Depends on Verdict in London High Court
December 14, 06The Supplier of Choice (SoC) Ombudsman has ruled that the DTC is in contractual breach with its long-time client Jayam N.V. As the alleged infringement applies to each and every Sightholder, a “guilty verdict” in the current lawsuit Jayam filed against the DTC may set off a flood of new lawsuits. De Beers is confident that the whole issue is a marginal, technical matter and that the Ombudsman fundamentally erred in his opinion. The final word is left to the High Court. It has gone beyond Jayam versus DTC – on “trial” is the status and position of the European Commission EC approved SoC Ombudsman.
The court case unfolding in the Chancery Division of the High Court in
After painstaking investigative journalism over a period of almost two years, we have reached the conclusion that the issue at stake goes far beyond a “supply decision” to a particular Sightholder. From a diamond business perspective, the issue strikes at the essence of the integrity of SoC and the agreements between Sightholders and the DTC. However, in court it will be reduced to a verdict on the interpretation on the meaning of specific wording of the SoC sightholder documentation.
The cautious conclusion that we have drawn from our research, and on which we will elaborate in this article, is that it seems that the DTC had set “application ceilings” for the initial applications under SoC which were unrelated to, and made prior to, the DTC Sightholder profiles submitted by the applicants. This would mean that the profiles had no bearing on the “entry levels” into SoC in terms of the size of the Sights.
We are not saying that the profiles had no influence whatsoever since clearly they played a role when considering the new applicants. However, we have concluded that their role may have been less significant than generally perceived. We have concluded that sometime in 2001 or 2002, the management of De Beers had ranked all its clients. The allocations to the clients under the PPP mechanism that preceded SoC were squarely based on a specific ranking of clients and the allocations were made accordingly. In this ranking, the first name gets the largest allocation and the last gets the smallest.
When the first list of clients was announced under SoC, and some 35 existing Sightholders were dropped, it became clear quite quickly that all those who were dropped were the smaller clients. De Beers says that this isn’t the case – but if there are one or two exceptions, we are not aware of them. It seemed to many that the DTC had taken its existing client list, decided on a cut-off point, and dropped anyone below that threshold. We argued at the time – and shared these sentiments also with the DTC – that it is statistically impossible that when a totally new scoring system is introduced, based on specific criteria, that there are not a few, small Sightholders who, qualitatively, have had a superior operation, greater manufacturing skills, better marketing or larger financial resources than some of the larger ones. The list didn’t make sense to me – and it made me wonder. It both puzzled and troubled me.
I, then, envisioned a nightmare scenario. That, God forbid, SoC was born-in-sin, that the initial allocations were not solely based on the profiles and that the DTC had deviated from the principles agreed upon with the EC and formalized in agreements with its clients. These are issues which, in the past, were totally irrelevant. The DTC could sell to anyone it pleased and didn’t owe anything to anyone.
What changed with SoC is that, for the first time in the history of De Beers, it had solid legal agreements with its clients, precisely outlining the legal rights and obligations of each side. The EC had approved the function of the Sightholder profile as follows: “This document is a questionnaire, which is sent to applicants to solicit information to fill in the ‘evaluation and allocation model’ on the basis of which applicants will be selected and evaluated. The requested information is designed to assess all applicants (including in relation to each other) against the pre-established ‘Sightholder criteria and other considerations’ and therefore pertains to detailed aspects of their business.”
It is clear that the only information (data) that the DTC is allowed to feed in its computerized “evaluation and allocation model” is information derived from the profile. No other information. If, for the purpose of the determination of the first allocations under SoC in the second half of 2003, other information was used (by “other” I specifically refer to the initial application ceilings based on historical sales and not on the profiles), this is arguably an infringement of the agreements with its clients – with all its clients, with all its ex-clients, and with each and every unsuccessful applicant.
That, as I said before, could be the DTC’s and industry’s nightmare scenario. If the initial allocations under SoC were set in breach of the agreements with clients, all the subsequent allocations suffer the same fate, because of the “capping mechanism” – the ceilings set for each Sightholder on how much it can apply for during the next six month supply period.
If someone came in too low, it is virtually impossible to meaningfully improve one’s Sights allocation. This gets us to two questions which will be addressed in this article: Did, in fact, the “nightmare scenario” take place? And, if so, what are the repercussions of such findings?
The latter worries me more than anything else does because the Sightholders are not in a very “forgiving mood.” ITO’s have been reduced by some 15 to 30 percent. The timing of this article could, for the DTC, not come at a more inopportune moment – but it is an important story that has to come out, as the main trial is scheduled for late January.
The Role of the Ombudsman
The parties to the court case, formally listed as Jayam NV versus The Diamond Trading Company, are tightlipped. We have published in the past that the dispute between Jayam and the DTC involves a DTC refusal to abide by decisions by the SoC Ombudsman. The DTC, through its Managing Director,
It needs to be stressed that the only decision power bestowed on the Ombudsman is to make a recommendation. One might argue whether a ’recommendation’ actually means a ‘binding recommendation’ – and the EC’s SoC approval document doesn’t make this distinction. The role of the Ombudsman is to enable dispute resolution. Clearly, if that role is interpreted as leading only to a non-binding recommendation, the EC’s objective is not achieved. On the other hand, the term clearly is more of an “advisory” nature.
The EC said: “The introduction of a third party, an Ombudsman, was considered the best way to introduce a check into the system of selection of Sightholders and allocation of diamonds to them. The terms of reference of the Ombudsman are quite detailed, providing for a comprehensive system of dispute resolution. The scope of authority of the Ombudsman will comprise the ability to determine whether improper procedures have been followed by the DTC under the Supplier of Choice documentation (by ignoring relevant matters or taking irrelevant matters into account or applying provisions incorrectly):
(1) In making selection or de-selection decisions;
(2) In relation to DTC’s supply decisions that it proposes to make to Sightholders over a six month period.”
In both cases, if the DTC has not followed proper procedures, the Ombudsman will recommend that the DTC reconsider the relevant decision.
For Jayam to have a case – any case – it must have a decision by the Ombudsman that the DTC failed to follow proper procedures under the SoC documentation. Jayam has such a decision. It is not really relevant whether the DTC accepted the recommendation of the Ombudsman or not. What is relevant is that, according to its own SoC Ombudsman, the DTC did not act properly. Jayam reportedly has filed various claims. But in this specific instance, Jayam has identified – and the Ombudsman confirmed – an apparent fundamental problem in the DTC’s implementation of the allocation agreements.
The Ombudsman has access to the most intimate DTC records; he has the right (and used that right) to demand papers, notes, records – anything needed to arrive at a decision. If the Ombudsman, former Irish Attorney General Dermot Gleeson, found that the DTC has fundamentally broken its agreement with Sightholders, the case takes on a different character: it becomes, de facto, Ombudsman versus De Beers – and the Ombudsman’s arguments would be applicable to all sightholders. The DTC doesn’t see it that way; it has only an issue with Jayam.
The Essence of the Court Case
If this was a movie, the main character would be Ombudsman Dermot Gleeson and his team. Though most people in the trade have been suspicious of that position and see it as an extension of the DTC, the truth is different. This gentleman has proven to be utterly honest, he focuses solely on the issues at hand within the spheres of his (very limited) responsibility, he is precise about timetables, he only deals with the essence of a complaint and doesn’t expand issues or allow amending complaints after they have been filed. But most importantly – he doesn’t allow himself to be side-tracked or railroaded by any party. He gets to the bottom of it with a tenacity which surprised all of those who have become aware of him. The Ombudsman – or, rather, this specific Ombudsman – is an asset to the allocation system and Sightholders ought to feel less inhibited to ask for his intervention.
Now to the case at hand. Jayam, historically was one of the largest, if not the largest, Sightholder of the DTC. Over the last 30 years, the company’s average annual Sight was skirting the $140 million level. In the few years before the commencement of SoC, the principal of Jayam suffered some health problems (he totally recovered) and he also faced some commercial difficulties as a result of the Far Eastern economic meltdown. After a few years with smaller Sights, Jayam, according to market estimates, was back at an $80 million level in 2000 and that kept rising.
The years immediately preceding the formal launch of SoC, in mid-2003, the company had rather low Sight levels. Presumably, that wasn’t relevant when SoC started, as the company believed that its profile showed, by any standard, a solid business with unambiguous plans and programs justifying a Sight that would come closer to historical levels.
Prior to its first ITO (Intention to Offer) under the SoC agreements, Jayam, just like any other Sightholder, was presented with a “capping mechanism.” Thresholds were set and each Sightholder was told how much it was allowed to apply for.
This “capping mechanism” is the focus of the Ombudsman’s contested findings. Neither the SoC documentation nor the SoC Policy Statement makes any reference to the “capping mechanism.” [De Beers, internally, refers to an initial application limit, referring to the fact that when SoC formally started, each applicant was given a ceiling on the amounts he could apply for.] De Beers says it has discussed this with the EC, but it has failed to substantiate that or to convince the Ombudsman that this was the case.
Common sense has it, argues Jayam, that if its “capping threshold” was based on its profile, its sight allocation should have been considerably higher. This is the point the Ombudsman explored – Dermot Gleeson wanted to understand on what basis the capping ceilings for applications were set. What he discovered might have been quite normal for the clients, but it must have stunned him, namely that the initial application thresholds were based on the average of the ten sights preceding SoC.
It was clear to Jayam and to the Ombudsman that in establishing the allocations to the Sightholders external factors, unrelated to the profile, had been used.
The issue to be decided by the court centers on paragraph 2.4 of the SoC Policy Statement which states: “Subject to market conditions, DTC will use reasonable endeavors to meet applications for those boxes placed by Sightholders at each Sight taking into account
(a) the requirements of DTC’s other Sightholders,
(b) the Sightholder’s level of satisfaction of the Sightholder Criteria as compared with that achieved by other Sightholders,
(c) the Sightholder Considerations, and
(d) the aggregate value and nature of goods requested by the Sightholder and indicated by the DTC as those it intends to make available for inspection.”
When the DTC used the average of ten Sights immediately prior to the start of SoC in mid-2003, and based its capping mechanism and thus its allocations on these figures, says the complaint, the DTC clearly introduced a factor which was not included in paragraph 2.4. This is what Jayam has claimed; this is what the Ombudsman found; this is what the DTC contests. The only mandate the Ombudsman has is to determine whether the DTC had applied an “improper procedure.” As the use of averages of previous Sights to set the application ceilings for each client were not covered in 2.4, the Ombudsman ruled in favor of
The DTC, however, believes that Paragraph 2.4(a) does give it the right to impose a capping mechanism, an application ceiling. How can the DTC know the “requirements” of other sightholders if it doesn’t refer back to a client’s allocation history? If a client, who always had a $5 million sight, applies for a $25 million allocation, how can the DTC determine whether the $25 is consistent with the client’s requirements? The DTC strenuously denies that capping is an “improper procedure”. The opposite is almost suggested: not applying a capping mechanism would have been irresponsible and unfair to all sightholders. The DTC also believes that Paragraph 2.4(d) also allows them to use a capping mechanism for the initial SoC allocation levels.
The facts are not in dispute. The DTC has conceded that it already used (for internal purposes) a capping mechanism in 2001. But it strongly takes exception to a linkage to ranking that is suggested in the complaint (and noted by the Ombudsman) and the DTC denies it had a ranking order of Sightholders well before the profiles for SoC’s first formal contracts were received.
DTC: “Ranking” and “Capping” Are Two Different Issues
It is a core argument in Jayam’s complaint in which it alleges that already a few years before the EC approval of SOC the management of De Beers/DTC had already made a ranking. This is a contention the DTC will challenge in court, if it is raised. The DTC is adamant that “ranking” and “capping” are two entirely different issues and it makes it unequivocally clear that the ranking of the new sightholder list announced in mid 2003 was solely derived from the profiles of the sightholders. This ranking was produced by the DTC’s computerized Evaluation and Allocation Model, says the DTC, and this process was fully in accordance to the contractual arrangements. By introducing the notion that ranking was decided well in advance, it almost sounds like there was some kind of “conspiracy” well before SOC was introduced. This is ridiculous, as it is false, the DTC will argue in court.
The complaint by Jayam squarely links the “ranking” with the size of the sights and thus the resultant “capping ceilings”, which are based on historic averages of the size of the sights. The DTC, however, will argue that Sightholder Assessment (ranking) and applications management (capping) are entirely separate processes. Neither process influences the other – but both processes are critical influences on the eventual outcome in terms of Sightholder Selection and ITO volumes.
The “Capping Process”
The DTC will explain to the court that, historically, a capping process had to be used internally as soon as the DTC started collecting 6-monthly ‘Proforma Applications’ (the precursor of ITO applications) -- simply because the applications Sightholders made were in many cases so inflated as to be unusable. The capping mechanism eventually used in the SoC process was explained publicly in a presentation made by
The DTC will further argue that the level of purchases a Sightholder made from the DTC in the pre-SoC period was utterly irrelevant to the SoC assessment score the Sightholder achieved, and their consequent ranking. The score was ENTIRELY a product of the Sightholders’ satisfaction of the Sightholder criteria, and the ONLY data taken into account in the scoring and ranking process was the data collected in the 2003 Sightholder Profiles. It is expected to explain to the judge that sight size had absolutely no influence on the scores Sightholders achieved in the 2003 scoring and ranking process.
The Issue is “Capping”
If the court accepts that there was no “conspiracy”, no improper procedure, and no breach of contract on ranking, than, in the view of the DTC, the only remaining issue is “capping”. Apparently, the DTC argues that every single Sightholder knows – and has known – that there is a ceiling on Sight applications. The DTC is convinced that each Sightholder knows very well that this ceiling is based on past performance. The use of a capping mechanism ensures stability, it makes it more difficult for Sightholders to manipulate their applications, and it is in everyone’s best interest. Moreover, say my sources, this “capping mechanism” was extensively discussed with the European Commission which not only approved it, but even demanded it.
Source familiar with the DTC’s defense strategy say that the use of “capping” protected the sightholders – and, especially, those sightholders who make realistic applications. Who don’t exaggerate. “In the periods when we didn’t use a capping mechanism, there were sights for which we received $1.5-$2.0 billion worth of applications, while we could only supply some 25% of such amounts. So what must the DTC do when there are two sightholders, who in the past had equivalent sights, and one asks for $10 million and the other asked for $50 million? Because of the capping mechanism, both sightholders in the example received similar amounts. The capping mechanism protected the sightholders and preserved the integrity of the system”, explains the DTC.
In fact, it is my understanding that the Ombudsman accepted the rationale that the DTC needs a mechanism to ascertain the genuine requirements of a sightholder and having an anti-manipulation provision in some form or shape is not incompatible with the provisions of Paragraph 2.4 of the SOC Policy Statement. At the same time, the Ombudsman argues that introducing “capping” to ensure fairness (and prevents manipulations) represents the introduction of an external factor, and thus it is an “improper procedure.” The court will have to decide whether the Ombudsman conclusion is indeed consistent with his very own findings. That gets us to a philosophical question: could the DTC have found a different way to avoid manipulations (playing games) without resorting to historical sight levels?
A source familiar with the DTC position remarked, “There were so many in-depth discussions with the European Commission, so many details were brought up, that not every smallest detail could be included in the SoC sightholder documentation.” That may well be the case, but as the SoC documentation represents a binding contract between the DTC and Sightholders, that omission is something it may have to pay for – or, at least, that is what the court must decide.
The complaint raises question. Why was the initial application threshold based on one historical year, why not three years or ten year averages?
Findings Impact All Clients
On the one hand, it is remarkable that only Jayam filed a complaint on this issue – and it took that company more than a year to “discover” the use of “external factors” in setting the Sight allocations. This “improper procedure” may have caused damaged to Jayam, it may have put it at a disadvantage vis-?-vis other Sightholders, but this basically applies to each and every Sightholder and applicant Sightholder. On the one hand, maybe, the reasons that others didn’t complain was because they felt that the capping mechanism was rightly an inherent part of the SoC structure.
Neither the DTC nor the sightholders had experience in operating under a contractual agreement – and the absence of a specific mention isn’t so relevant. As one sightholder said to me: “If we talk about a Frigidaire, is it necessary to note that there is also an ice-box inside? It wouldn’t be a Frigidaire without one.”
What are the Repercussions of This?
If the positions of Jayam and the Ombudsman are upheld by court documents and in its final judgment, some believe that the integrity of SoC may have been compromised so much that it is hard to believe it can be sustained - it may need to get a “fresh start.” Others will see it merely as a contract interpretation dispute and warn against giving it too much importance. It is easy to lose one’s perspective. Justice Evans-Lombe has already remarked that he believes that each side will find it difficult to prove its case – and he prefers that the sides settle out of court. In that, all judges are the same.
Jayam needs a victory not less than the DTC. The standing of the company in the market has suffered. Management is preoccupied with the legal proceedings. Some clients may already have been reluctant to deal with a company that is perceived as “fighting De Beers.” If I am not mistaken, once upon a time, Jayam may have been the largest Sightholder, purchasing between 8 to 9 percent of annual DTC sales. Just as in the De Beers anti-trust cases now being resolved in the
Whatever formula the court decides to adopt may set a precedent for similar cases – if these are filed. It is not an easy decision for a Sightholder to sue the DTC – it certainly isn’t the preferred way to improve one’s allocation and to grow one’s Sight. What has driven the company to this point, apparently, was the absence of loyalty to one of its longest clients. The Ombudsman, however, would be the first to point out that this is also an external factor, not included in SoC documentation.
The court has already asked for expert advice on damage assessment. Presently they are following the logic of “how much would Jayam have received if there was no capping” – which seems, to me, like an exercise in futility. Jayam would have applied for more – but so would everybody else. I wish the court “good luck” in getting through this material, if it ever has to address the damage issue.
It is too late now for other Sightholders to complain to the SoC Ombudsman about this specific “improper procedure” adopted when SoC started, as there are strict (very short) time limits to file a complaint. However, breach of contract is something that can be charged at any time, in almost any court. This might create an enormous headache for the DTC, if they don’t win.
If I were in the shoes of DTC Managing Director,
This also explains the DTC management is convinced they did not do anything wrong; they scrupulously implemented their model. Jayam claims that there was also no advance consultation on this subject with either brokers or clients, unlike some other elements of SoC. The aforementioned
Have a nice weekend.