Main Facts
In February 2010, Diamond Foods Inc.’s then-Chief Financial Officer Steven Neil asked his team of accounts an unusual question. How much could the snack-food company pay for walnuts that year and still top Wall Street estimates? According to the complaint released by the Securities and Exchange Commission, the answer was 10 cents less than the expected 82 cents that the company was expected to pay. To cover the difference, Mr. Neil devised a plan to put the extra cost into the following year which all the company the report better-than-expected results.
The alleged fraud gave the company a string of earning beats and a strong rise in its stock. It also allowed Diamond Foods Inc the necessary currency needed to clinch a deal to buy the Pringles snack brand from Proctor and Gamble for $2.35 billion. Everything unraveled after the Wall Street Journal and some skeptical investors questioned the company’s accounting.
According the Diamond Foods Inc, they conducted an internal investigation and ultimately restated its finances for the 2010 and 2011 fiscal years. The restated numbers showed the stock price per shared dropped from $90 a share to $13 a share. The fraud also had a negative impact on acquiring the Pringles snack brand. Diamond fired Mendes and Neil in early 2012 and restated its earnings after an internal probe concluded that the accounting was improper. (Hamilton, 2014)
On January 9th 2014, the Securities and Exchange Commission charged Diamond Foods and its former SFO in an accounting scheme to falsify walnut costs in order to boost earnings and meet estimates by stock analysts. The SEC also charged Diamond’s former CEO for his role in the company falsifying financial statements that were filed with the SEC.
Diamond Foods agreed to pay $5 million to settle the SEC’s charges. Former CEO Michael Mendes also agreed to settle charges against him. The SEC’s litigations continue against Neil.
Diamond Foods Fraud and the Fraud Triangle According to the SEC complaint, Neil was facing pressure to meet or exceed the earnings estimates of Wall Street stock analysts. With sharp increases of walnut prices in 2010, Diamond now had a situation where it needed to maintain longstanding relationships with walnut growers by paying them more. Yet Diamond could not increase the amounts paid to growers for walnuts, which was its largest commodity cost, without also decreasing the net income that Diamond reports to the investing public. (SEC, 2014) Faced with this pressure, Neil had the opportunity to orchestrate a plan to have it both ways. He created two special payments to please Diamond’s walnut growers and bring the total yearly amounts paid to growers closer to market prices. He excluded portion of those payments from year-end financial statements. To cover up the plan, Neil instructed his finance team to consider the payments as advances on crops that had not yet been delivered. By disguising the reality that the payments were related to prior crop deliveries, Diamond was able to manipulate walnut costs in its accounting to hit quarterly targets for earnings per share (EPS) and exceed estimates by analysts. (SEC, 2014) Neil also misled Diamond’s independent auditors by giving incomplete and false information to justify the unusual accounting treatment for the payments. Neil personally benefited from the fraud by receiving bonuses in the amount of $875,00 and incentive compensation in the amount of $1.1 million because of the EPS that was stated in fiscal years 2010 and 2011. Mendes also personally benefited from the fraud by receiving approximately $1.4 million in bonuses and $2.6 million in incentive compensation. The company benefited from the fraud by being able to have the funds to bid for the purchase Pringles. According to Neil, he followed Diamond Foods long-standing practice and accounting treatment approved by the company’s outside auditors.
My Thoughts Regarding Diamond Foods Fraud I think the main reason Neil committed this crime was because he was under pressure to achieve what stock analyst had predicted the company’s EPS would be. Knowing that the new cost of walnuts had risen, he knew that he could not achieve that goal. He came up with a scheme to achieve that goal but he went overboard. His accounting team should have blown the whistle on him in the very beginning. The fact that he made up two special payments without the approval from the audit team should have been a cause for concern. The omitting half of the payments from the financial should have been a red flag for his team and someone should have reported him immediately. Not only the CFO and the CEO be punished for this crime, but so should his accounting team. I think it speaks volumes on the accounting team’s work ethic and integrity. In regards to very close acquisition of Pringles, I do not think it was part of the reason to commit the fraud. I think the acquisition was just a ripple effect of the fraud. The company thought that it had enough money to purchase Pringles and the company went for it. If it was not for Neil and the fraud he committed, I do not think the company would have thought twice about purchasing Pringles. Neil increased compensation and bonuses were also a ripple effect of the fraud. I do not think that receiving extra money was his main concern. Neil seemed more worried about the company’s well being than his own well being.
Fraud Prevention
The fraud could have been prevented if more controls were put in place. For example, in changes in how accounting is done, should be first be approved by an outside auditor. According to an article, certain checks could have also been performed to help prevent Diamond Foods from cooking the books. The examples listed in the article are a balance sheet check, accrual ratios and the manipulation score.
Does the Punishment Fit the Crime? In my opinion, since Diamond Foods settled, I do not think the punishment was enough. The fact that both the CEO and the CFO only had to pay back a portion of the earnings received due to the fraud is outrageous. I think they should return all funds they received during the period of the fraud plus interest. I also think that Diamond Foods should be accountable for pay all of the losses that investors accrued during the time of the audit. Lastly, I also think that company and its audit team should be on probation with the SEC. This “slap on the wrist” is not letting the company know this is a very serious crime and that it will not be tolerated. I think it leaves the door open for future fraud cases because they have seen that you will get off easy for the first offense. References
Hamilton, W. (2014, January 9). Diamond Foods agrees to pay $5 million to settle SEC case. Retrieved October 20, 2014, from LA Times: http://articles.latimes.com/2014/jan/09/business/la-fi-diamond-foods-fraud-20140110
Henning, P. (2012, February 13). Next Steps in Diamond Foods Accounting Inquiry. Retrieved October 20, 2014, from NY Times: http://dealbook.nytimes.com/2012/02/13/next-steps-in-diamond-foods-accounting-inquiry/?_php=true&_type=blogs&_r=0
Jun, J. (2012, January 20). Could You Have Predicted Diamond Foods Accounting Fraud? Retrieved October 20, 2014, from Old School Value: http://www.oldschoolvalue.com/blog/valuation-methods/could-you-have-predicted-diamond-foods-accounting-fraud/
SEC. (2014, January 9). SEC Charges Diamond Foods and Two Former Executives Following Accounting Scheme to Boost Earnings Growth. Retrieved October 20, 2014, from SEC: http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540598296#.VE1cu5RdXgs