Corporate Scandal at Diamond Foods Incorporation

Corporate Scandal at Diamond Foods Incorporation

CorporateScandal at Diamond Foods Incorporation

CorporateScandal at Diamond Foods Incorporation

Accountingscandals arise from the disclosure of misdeeds associated withintelligent accounting by financial officers or trusted corporateexecutives. Organizations are expected to put in place adequateinternal controls that will help them detect, prevent, and addressfraudulent activities before they threaten the going concern oforganizations. However, detecting some frauds is difficult given thefact that most of them are organized by experienced executives, whoknow how to bypass the available internal controls (Free, Macintosh &ampStein, 2007). This paper will analyze an accounting scandal thatoccurred in Diamond Foods Incorporation in 2014. Diamond Foods is afood packaging company based in Stockton, California (Diamond FoodsIncorporation, 2015). Diamond Foods was founded in 1912 by walnutgrowers in the state of California. The scandal in question involvedunderstatement of the price of walnuts, which resulted in highincomes reported in the financial statements. This paper will focuson the summary of the ethical issue, issues that the company did nothandle properly, and compare how Diamond Foods handled its scandalwith how other companies handled or prevented scandals in the past.

Ethicalissues

DiamondFoods is one of the recent companies engage in intelligent accountingwith the objective of benefiting the chief executives andshareholders. Diamond Foods committed the fraud by under reportingthe price of walnuts, which is one of the key ingredients that thecompany used to manufacture its final products (Lynch, 2014). Thisscheme was spearheaded by the Chief Finance Officer named StevenNeil. Neil managed to under report the walnut prices by pushing therecording of those prices to the subsequent fiscal periods. It isestimated that the scandal started in the financial year 2010 and wasdiscovered in the year 2014. The scheme allowed Diamond Foods toreport a higher net income in the affected financial periods, whichbeat the expectations of the financial analysts, especially for thefinancial years 2010 and 2011 (Lynch, 2014).

Thecompany’s chief executive officer named Michael Mendes was heldaccountable in spite of the fact that he was not directly involved inthe scandals. This is because, as a chief executive officer, heshould have noticed that the financial reported were inflated bycomparing the misleading reports with the company expectations andthe previous financial reports (Lynch, 2014). Consequently, Mendeswas fined $ 125,000 penalty the company was given a $ 5 millionpenalty. Diamond Foods was also required to restate its 2012financial reports, which resulted in a sudden decrease in the priceof the company’s share from $ 90 to $ 17 (Lynch, 2014).

Issuesthat the company failed to handle properly

Neilstated that he had followed a long-standing accounting treatment andother company processes that had been approved by the externalauditor (Lynch, 2014). From this statement, it is clear that thechief financial officer, failed to use financial reporting proceduresthat are recommended by the Securities Exchange Commission. Moreover,the fact that the department of finance managed to under-report theprice of walnuts for more than one financial period without beingdetected by the chief executive officer implies that the company didnot have sufficient internal controls to prevent detect and preventfraudulent accounting.

Howthe issue should have been handled more ethically

Companieshave an option to handle cases of fraud in-house or allow externalagencies (including the law enforcement and business regulatoryagencies, such as the SEC) to take over the matter. In most cases,external agencies intervene when the company fails to detect fraud intime or persistently denies the fraud, which force the authorities toconduct an in-depth investigation (Boyd, 2013). A company that takesthe initiative to detect and prevent fraud in-house protects itsimage and its stock price. Studies have shown that an in-houseinitiative prevents bad publicity by 38 % (Boyd, 2013). This meansthat Diamond Foods should have utilized its internal controls todetect and punish the responsible officers, and then report thematter to the regulatory agencies, including the Securities ExchangeCommission.

Anin-house mechanism should have taken three major steps. First, theCEO should have avoided denying the allegations, but conduct anin-depth investigation into the matter (Busby, 2011). For example,the CEO would have wanted to know by how much the walnuts wereunder-reported and the implication of the fraud on the financialstatements. The implications of the fraud together with the measuresthat the company intends taking to correct the errors should havethen been reported to the relevant authorities, including the SEC.

Thesecond step should have involved the implementation of correctivemeasures as a way of assuming responsibilities for the company’sfailure to prevent the occurrence of fraud. For example, the CEOshould have ordered a restatement of the financial reports for theaffected financial periods, instead of waiting to be forced by theSEC (Lynch, 2014). Corrective measure should have included voluntarypayment of fines and the demotion of the officers involved in thefraud. In addition, the Diamond Foods should have considered hiringanother auditor, since the accounting procedures that subjected thecompany to the risk of fraud had been approved by the currentexternal auditor (Lynch, 2014). In most cases, regulatory agencies donot make public statements unless the matter gets to the mediainvoluntarily or the company waits to be forced these agencies.

Third,Diamond Foods should have reviewed its accounting policies andprocedures in order to fill all gaps that increase the risk of fraud.The review of policies should be accompanied by the adoption of thenecessary internal controls, such as segregation of duties, properauthorization of transactions, and establishment of a competentinternal audit unit (Baker Tilly Virchow Krause LLP, 2015). Internalcontrols will help the executive team of Diamond Foods in detectingcases of fraud early and preventing them from occurring in thefuture.

Thepossible outcomes of an in-house initiative include the protection ofa company’s reputation, building trust with the regulatoryagencies, and set a precedent that the company will not cover upfraudulent employees. An in-house initiative to deal with the fraudwould have created a perception that Diamond Foods is an honestcompany that observes integrity in its operations. Instead of doingthis, the chief finance officer and the chief executive officer paidthe penalties, but still denied that they had done any wrong. Lynch(2014) stated, “Neil denies any wrongdoing and plans to fight theSEC`s charges at trial” (1). This created a perception that thecompany was going to cover fraudulent activities by all means, whichresulted in a drastic drop in its share price since investors lostconfidence in the company.

Comparingand contrasting how other companies have handled similar issues

Moderncompanies have learned numerous reasons from the case of Enron, whichhas an award winning internal control system, but ended up beingfaced with one of the world’s largest fraud. Enron’ssophisticated internal control system comprised of a risk assessment,performance review system, and code of ethics (Free, Macintosh &ampStein, 2007). To this end, companies are adopting other measures Iadditional to the conventional internal control system to preventfraud. For example, Apple Incorporation uses data extractionsoftware, which is a technology-based control that helps themanagement in detecting cases of fraud in time (Shank, 2015). Thesoftware allows the management in extracting large volumes of dataand detects all anomalies in the financial records, which has helpedthe multinational company from ethical dilemmas. Therefore,integrating technology-based controls is the way forward in the fightagainst fraud in companies.

Somecases of intelligent accounting (including improper recording oftransactions in the financial reports) bypass company’s internalcontrols. Different companies respond to cases of fraud in differentways in order prevent a repeat of such fraud while minimizing damageto the company’s image. Some companies hold that changing themanagement is the most viable solution, since they already haveadequate internal controls, but the incumbent management has failedto utilize those controls. For example, Mobily Company, a SaudiArabia mobile phone operator violated disclosure rules and droppedits market value to $ 43.2 billion (Martin, 2015). The companyreacted to this fraudulent activity by suspending the chief executiveofficer, Khalid Omar, and promoted deputy CEO, Serkan Okandan. Thisis the opposite of the response by Diamond Foods, where the CEO andCFO paid the fines and retain their respective positions.

Conclusion

TheDiamond Food’s scandal was organized by experienced top officers,who managed to bypass internal controls for more than one financialperiod. The manner in which the company handled the scandal raisedsuspicion, leading the loss of investors` trust and a subsequentdecline in the price of its shares. By paying the fines and refusingto take up the responsibility, the CEO and CFO damaged the image ofthe company because investors may not be sure whether the topexecutives will commit another scandal in the future. It is evidentthat nearly all companies operating in the contemporary businessenvironment have adequate internal controls. This means that thechallenge stems from the failure by the management to utilize theavailable internal controls, and not the weaknesses of internalcontrols. Consequently, some companies have opted to use technologybased controls and the change of management as viable measures forpreventing and handling fraud.

References

BakerTilly Virchow Krause LLP (2015). Insight: Prevention of fraud througheffective internal controls. BakerTilly Virchow Krause LLP.Retrieved September 26, 2015, fromhttp://www.bakertilly.com/insights/prevention-of-fraud-through-effective-internal-controls/

Boyd,B. (2013). Companies trying to handle fraud in-house likely to besorry. GatehouseMedia.Retrieved September 26, 2015, fromhttp://www.telegram.com/article/20130623/NEWS/306239988

Busby,D. (2011, September 13). Six steps for handling fraud. ChristianToday.Retrieved September 26, 2015, fromhttp://www.churchlawandtax.com/blog/2011/september/six-steps-for-handling-fraud.html

DiamondFoods Incorporation (2015). Great taste naturally. DiamondFoods.Retrieved September 26, 2015, fromhttps://www.diamondfoods.com/index2.php

Free,C., Macintosh, N., &amp Stein, M. (2007). Managementcontrols: the organizational fraud triangle of leadership culture andcontrol in Enron.London, ON: Western University.

Lynch,S. (2014, January 9). Diamond Foods to pay $ 5 million to settle SECfraud case. Reuters.Retrieved September 26, 2016, fromhttp://www.reuters.com/article/2014/01/09/us-diamond-sec-accountingfraud-idUSBREA0813020140109

Martin,M. (2015). Saudi Arabia’s Mobily Company suspends CEO afteraccounting error. Bloomberg.Retrieved September 26, 2015, fromhttp://www.bloomberg.com/news/articles/2014-11-23/saudi-arabia-s-mobily-suspends-ceo-after-accounting-error

Shank,L. (2015). Fraud:Is it happening in your organization?Ohio: Apple Growth Partner.