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Greenberg: Diamond's Intent to Mislead

By: Herb Greenberg | 01/10/14 - 08:48 AM EST

Stocks in this article: DMND

SAN DIEGO (TheStreet) -- If nothing else, the government's case against Diamond Foods (DMND) should be a reminder that some companies and execs -- even today, with laws supposedly in place to deter malfeasance -- will pull out all stops to blatantly manipulate earnings in an effort to beat the street.

The Securities and Exchange Commission announced Thursday it had sued the company, its former CEO Michael Mendes and CFO Steven Neil.

The company and Mendes have settled. Neil hasn't. His attorney told the Wall Street Journal he didn't settle because he did nothing wrong.

That'll be something for the courts to decide, but the lawsuit should be required reading because the charges read straight out of a "how to fool investors" handbook.

The Diamond story, with questionable accounting first unearthed by the research firm Off Wall Street, and written about several times in Barron's -- back when nobody cared -- suggested the company was manipulating the timing of walnut payments to farmers.

It was a classic case of the company and bullish analysts trying to discredit the critics.

The SEC's lawsuit, however, shows just how crafty a company can be. These three paragraphs sum it up:

"In February 2010, Diamond CFO Neil instructed members of the Finance Team to adjust the walnut cost to hit an EPS target for the second quarter. Members of the Finance Team provided Neil with a walnut cost estimate that would result in reported EPS that would be higher than the consensus analyst estimates of $0.47 per share for the quarter. Based on these calculations, Neil reduced the existing walnut cost estimate of 82 cents per pound by 10 cents per pound, to 72 cents per pound. Diamond's quarterly financial statements for the second quarter of 2010, as well as its books and records, accounted for the walnut cost at the adjusted estimate of 72 cents per pound. 

"On or about February 25, 2010, Diamond filed an SEC Form 10-Q with the Commission that included the second quarter 2010 financial statements. The same day, Diamond filed an SEC Form 8-K reporting EPS of $0.48, beating consensus analyst estimates. A week later, on March 1, 2010, Diamond filed an SEC Form 424B5 prospectus related to a proposed stock sale to pay a portion of the acquisition costs associated with Diamond's recent acquisition of a snack food company, and the prospectus incorporated the Form 10-Q for second quarter of 2010. This offering closed on March 8, 2010, and Diamond raised approximately $181 million. 

"On March 10, 2010, Diamond filed an SEC Form 8-K, which attached an investor presentation touting Diamond's EPS record of 'Twelve Consecutive Quarters of Outperformance' from Q3 2007 through Q2 2010."

And you wonder why I abhor the "beat the street" game? The only thing worse is when management's bonus is tied exclusively to earnings and especially meeting a certain earnings per share number.

As it turns out (drumroll!) from Diamond's 2010 proxy: "For the 2010 fiscal year, the financial metric target for the objective portion of our Annual Bonus Program was $1.80 earnings per share." And wouldn't you know it? According to the proxy, "Diamond Foods achieved $2.00 earnings per share for bonus purposes, resulting in maximum performance under the bonus program."

And the rest, as they say, is history.

-- Written by Herb Greenberg in San Diego

Herb Greenberg, editor of Herb Greenberg's Reality Check, is a contributor to CNBC. He does not own shares, short or trade shares in an individual corporate security.

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