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US stock market daily report (January 09, 2014, Thursday)
Diamond Foods, Inc. (DMND), San Francisco-based snack foods company and two former executives are under fire from the Securities and Exchange Commission for their roles in an accounting scheme to falsify walnut costs in order to boost earnings and meet estimates by stock analysts. For fiscal quarters in 2010 and 201, Diamond reported higher net income and inflated earnings to exceed analysts' estimates by manipulating walnut costs. The SEC alleged that one of Diamond’s significant lines of business involves buying walnuts from its growers and selling the walnuts to retailers.
Diamond found they had to increase pay to its growers in order to maintain longstanding relationships with them, due to the sharp increase in walnut prices during 2010. Neil was facing pressure to meet or exceed earnings estimates of Wall Street stock analysts. The walnut growers largest commodity cost was pay to walnut growers. He could not increase what Diamond paid growers without decreasing the net income that Diamond reports to the investing public. Neil instructed his finance team to consider the payments to growers, as advances on crops that had not yet been delivered, instead of correctly recording the costs on Diamond’s books. Neil orchestrated a scheme in which he devised two special payments to please Diamond’s walnut growers and bring the total yearly amounts paid to growers closer to market prices. He did however, improperly exclude portions of those payments from year-end financial statements. After adjusting the walnut cost in order to meet EPS target for Q2 of 2010, Diamond went was able to tout their record of “Twelve Consecutive Quarters of Outperformance” in its reported EPS results during investor presentations. Diamond was able to manipulate walnut costs in its accounting to hit quarterly targets for earnings per share (EPS) and exceed estimates by analysts by disguising the reality that the payments were related to prior crop deliveries.
The SEC alleges that Diamond Foods former chief financial officer Steven Neil directed the effort to fraudulently under-report money paid to walnut growers by delaying the recording of payments into later fiscal periods. Neil referred to the commodity costs as a “lever” to manage earnings in Diamond’s financial statements, based on internal emails obtained by the SEC.
In November 2012, Diamond restated its financial results to reflect the true costs of acquiring walnuts, sending shares plummeting to just $17 per share from a high of $90 per share in 2011. The SEC alleged that Diamond's former CEO Michael Mendes should have known that Diamond’s reported walnut cost was incorrect at the time he certified the company’s financial statements.
Jina L. Choi, director of the SEC’s San Francisco Regional Office said, “Diamond Foods misled investors on Main Street to believe that the company was consistently beating earnings estimates on Wall Street. Corporate officers cannot manipulate fiscal numbers to create a false impression of consistent earnings growth.”
The SEC alleges that Neil misled Diamond’s independent auditors by giving false and incomplete information to justify the unusual accounting treatment for the payments. Neil personally benefited from the fraud by receiving cash bonuses and other compensation based on Diamond’s reported EPS in fiscal years 2010 and 2011. The SEC found that Mendes he should have known that Diamond’s reported walnut cost was incorrect because of information he received at the time and he omitted facts in certain representations to Diamond’s outside auditors about the special walnut payments.
Diamond Foods will pay $5 million to settle the SEC’s charges without admitting or denying SEC allegations. Mendes will pay a $125,000 penalty to settle charges without admitting or denying the allegations. Mendes has already returned or forfeited over $4 million in bonuses plus other benefits he received during the time of the company’s fraudulent financial reporting. Penalties collected from Diamond and Mendes may be distributed to harmed investors if SEC staff determines that a distribution is feasible.
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