Thursday, March 15, 2012

Diamond Foods Announces Audit Committee Findings in Response to SEC and Federal Investigations

Diamond Foods is facing a formal investigation by the SEC and federal prosecutors as to whether certain financial practices involved criminal fraud.  The investigation revolves around how the company made crop payments to walnut growers.  In response, Diamond engaged an audit committee to conduct an internal inquiry into the allegations.    

Diamond made sizable payments to its walnut growers in September that they claimed were an advance on their 2011 crop.  However, three walnut growers allege that they told Diamond that they did not intend to deliver their 2011 crops to Diamond but were assured by company representatives that they could cash the checks anyway.  Some critics believe the payments were used to inflate last year’s earnings by shifting costs into the current year.  Diamond’s fiscal year ends in July so the September payment shifted the costs into the 2012 accounting year.  Diamond contended that these “momentum payments” were made in an effort to optimize cash flow for growers and initially denied that these payments were compensation for last year’s crop.   

Because of the investigation, Diamond has announced that its plans to acquire Pringles from Proctor & Gamble are on hold.  Diamond planed to pay most of the purchase price by issuing its stock to Proctor and Gamble shareholders.  The deal, which was initially valued at $2.35 billion, is now valued at $2 billion based on Diamond’s current stock price.  The company’s stock price was trading around $96 in September are now trading around $33. 

Thus far, Diamond has cooperated fully with the investigation.  The investigation has also opened Diamond up to several securities class-action lawsuits.     

More recently, the audit committee for the company conducted the internal probe on the accounting treatment of the walnut payments.  It concluded that approximately $20 million “continuity” payments made to growers in August, 2010 and approximately $60 million “momentum” payments made in September 2011 were not properly accounted for in the correct periods.  Furthermore, the audit committee identified material weaknesses in Diamond’s internal control over financial reporting. 

In response to these findings, Diamond’s Board of Directions has taken several corrective actions such as appointing a new Chief Executive Officer and Chief Financial Officer.  Diamonds will restate its 2010 and 2011 financial statements. 

Investigators are now likely to review Diamond’s accounts very carefully because accounting violations are rarely an isolated incident.  Diamond is also likely to face a civil enforcement action by the SEC for failure to maintain accurate books and records and failure to maintain adequate internal controls. 

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