Ethical Leadership Challenges at Diamond Foods
Diamond Foods, a nut and snack company, was founded in 1912 by a group
of cooperative walnut growers, known as "Diamond of California."
Over the years, Diamond Foods grew mostly by acquiring other
ands, including Pop
Secret, Kettle Foods, and Harmony Foods. It also introduced another line of
snack nut products under its Emerald Brand. Today the company is owned by
Snyder' s-Lance. Inc. and is headquartered in Charlotte, North Carolina.
Snyder' s-Lance, Inc. purchased the company for $1.91 billion in a cash-
and-stock deal after an SEC investigation. In addition to Diamond, the
Snyder s-Lance, Inc. product line includes the
ands Cape Cod, Lance,
numerous notable competitors such as Kellogg, U.SA., Frito-Lay,
USA Inc., and Mondeleze International, Inc. Brian Driscoll was named President and CEO of Snyder' s-Lance, Inc. in June 2017. He had previously been President and CEO of Diamond Foods, a
position he assumed after its former President and CFO were let go due to the
scandal at Diamond in which financial reports were falsified. The scandal
originated in 2005 under the management of the preceding President and CEO,
Michael Mende. His business philosophy was "Bigger is Better, which
ultimately led to a corporate culture of poor judgment and fraud. As part of his
growth strategy, he secured millions in loans to finance the acquisition of Pop
Secret. He later attempted to purchase Pringles from Proctor and Gamble. Had
the merger been successful, Diamond Foods would have been the second largest
distributor of snack foods in the United States following PepsiCo.
In 2011. Mark Roberts an analyst with the Off-Wall Street Consulting
Group, raised questions about Diamond's accounting practices. He accused
Diamond of inco
ectly reporting its payment to suppliers. Diamond would pay
growers in September for walnuts that were delivered in Diamond's fiscal yea
2011 which had already ended in July. This significantly impacted Diamond'
financial statements which if done intentionally, would be illegal. Initially Diamond denied any wrongdoing, arguing that the payments were an advance on the future 2012 crop and had nothing to do with the previous year's crops. Growers refuted this claim, arguing that they were told that the payments were, in fact, for the previous year. Investigations revealed that these payments
were made to inflate the fiscal 2011 results by shifting costs into the upcoming
year. An internal investigation found that CEO Michael Mendes and CRO Steven
Neil had systematically improperly accounted for growers' payments in 2010,
2011, and 2012. They skewed Diamond s financial results and reported an EPS
of $2.61 when the co
ect number was $1.14. As a result, they took home
millions of dollars in additional compensation.
The "improved* EPS resulting from the accounting fraud was, in part, an
attempt to follow Menes' aggressive philosophy and acquire Pringles from P&G. Diamond needed to improve financial performance at any cost in order to meet conditions laid down in the loan convenants and seal the deal. One of those conditions required higher performance standards for factors that affected
management compensation. Higher reported earnings would allow for greate
compensation. The improper accounting of earnings was an attempt by
management to deceive the lenders about Diamond's true earnings. Anothe
ethical concern raised at this time was the fact that Diamond's CFO had a seat
on the company
s Poard of Directors, which created an overlooked conflict of
interest that could have easily lead to a lack of oversight by the Board
Subsequently, the company was investigated for criminal fraud, and a new
audit was undertaken. This also disrupted the Pringle acquisition process. In
addition, Diamond had difficulty meeting the financial report filing deadlines,
Their fraud resulted from lack of quality controls and from the inability o
unwillingness of top management to set proper ethical standards, thus
encouraging more unethical behavior by employees. For example, after payment
i
egularities were discovered, Diamond's management denied the claims, and
insisted that the system worked to "optimize cash flow for the growers."
Stock prices dropped to a six-year low of $12.50. The lower stock price
was the result of restated historical financial results as well as of the cu
ent
year's performance. The restated financial results removed a previously
eported $56.5 million in profits due to the accounting fraud. The price decline
was also impacted on rumors that billionaire investor and activist, David Einhorn,
was shorting the stock. The combination increased investor uncertainty about Diamond's future profitability, and the Pringle deal with Procter & Gamble was
lost.
Following the SEC investigation, Mendes and Neil were placed on
administrative leave. Mendes subsequently resigned, and Neil was let
go. Mende did not receive promised insurance benefits as his resignation was
considered a violation of his duty as CEO. He was required to pay back the 6,665
shares of Diamond common stock that he received from fiscal vear 2010 and
also reimburse the company for his 2010 and 2011 bonuses, which totaled
$ XXXXXXXXXXThis amount was taken from his Retirement Restoration Plan, but
he still received a payment of $2,696,000.
After restating its profits, the company still faced risks of litigation,
egulatory proceedings, government enforcement and insurance claims. The
SEC levied a $5 million fine as settlement of the fraud allegations. The SEC
charged Neil for falsifying walnut costs and Mendes for his role in the misleading
financial statements. Mendes forfeited $4 million in bonuses and benefits and
also paid a penalty of $ XXXXXXXXXXThough it was not proven Mendes participated
in the scheme, regulatory authorities believed he should have known about
Diamond's inco
ect financial statements. Neil initially fought the SEC charges
ut settled by paying $125,000 civil penalty. Investors filed lawsuits against
Diamond because of the misrepresentation of its financial standing, a $100
million settlement was made by Diamond Foods.
When Brian Driscoll took over Diamond, he outlined his strategic plan to
advance the company past its ethical mistakes. It began with improved internal
controls of financial statements. Six new directors were appointed to strengthen
the board. A forward-looking statement of risks was issued, which identified
problems that may arise in the future. It included the Company' s Code of
Conduct and Ethics Policy, and a statement about top management
esponsibility in setting the proper tone for the organization.
He replaced the CFO and installed new company financial reporting
processes in which managerial approval was needed for material and non-
outine transactions. Ethics training, led by the CFO, reinforced prope
accounting procedures and training for employees. It led to a bette
understanding of financial reporting integrity and ethical expectations. He
modified the walnut cost estimation policy and added inputs each quarter which
had to be reviewed and signed off by cross-functional management. His efforts • Referen X
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fostered better documentation and oversight of accounting procedures and bette
supplier communication. A Grower Advisory Board was introduced to receive
input from the growers and enhance communication between growers and the
company. Diamond followed the Sa
anes-Oxley internal control policies
involved with grower accounting procedures
The controls on accounts payable and invoice processing were revised. A
third-party report known as
"Internal Control-Integrated Framework*
evaluated the effectiveness of its internal controls. The reporting controls were
implemented and improved communication, which allowed better transparency.
These new controls enabled the company to escape bankruptcy and restore
shareholder confidence which ultimately led to the Snyde
s-Lance, Inc.
merger. Under Brian Driscoll' s leadership Snyder s-Lance, Inc. has an Ethical
Code of Conduct with questions and answers on the webpage.
QUESTION
What were the organizational A culture factors that caused misconduct and accounting fraud? Pease explains in detail. 650 words
CASE 2
Sseko Designs Engages in Social Entrepreneurship
Liz Forkin Bohannon, Founder and CEO of Sseko Designs, a socially minded
fashion and design company from Portland, Oregon, uses the company as a platform to
empower women in Uganda and Bast Africa. In 2008, after travelling to Kampala, the
capital city of Uganda, she was appalled to see the extreme poverty of the people,
especially that of its women. She discovered that the top 2 percent of high school
girls who were eligible to go to a university were required to return to their villages and
work for 9 months while saving their money for tuition. Most of these girls did not
continue their education because the families needed the money for their subsistence.
She also learned these women prefe
ed to work rather than receive a handout.
Her first attempt at a socially conscious for profit business was a short lived
chicken farm. It was then that she recalled an incident from her college days whensshe
made a sandal that used ri
ons to avoid he noise made by flip-flops, so she redesigned
them by purchasing ru
er flip-flop bottoms tied with ri
on. Liz believed she could
improve upon her original design using materials obtained locally. For two weeks she
traveled through Kampala looking for suppliers while gaining skills in sandal making
through tutorial videos on YouTube. She developed a business idea for a work-study
model for Ugandan women who showed college potential. Liz would offer women
employment during the nine-month period they had to earn enough revenues fo
college. The women would make sandals and other products that could be sold to
consumers in the United States. In the process the Ugandan women would not only learn
skills but also have the chance to earn their wages to go to college.
Of course, making the sandals was only half the battle. The Bohannons also had
to find buyers. Together the couple traveled the nation for six months in their Honda
Odvssey minivan often sleeping in the van and showering at truck stops to save
money 3 to try and convince stores to purchase sandals from Sseko Designs. In 2009,
this became the first product offered by Sseko Designs. The sandals became an
immediate success when Martha Stewart recommended them in her gift ideas and thei
inventory was soon depleted.
To continue the company s growth, Liz and her husband, Rob, sought funding
via the popular ABC reality show Shark Tank, on Fe
uary 13, 2015. Entrepreneurs
Mark Cuban, Ba
ara Corcoran, Kevin O' Leary, Lori Grainer and Robert Herjavec were offered 10% stake in Sseko for a $300,000 investment. At that price, the company would
e presumed to be worth $3 million. On the other hand, Sseko had suffered a $90,000
loss in 2014 and anticipated it would lose money in 2015 as well. The Bohannons
explained that the reason for the loss is that they are putting more money-into
development and are hiring more salespeople. They expressed their belief that as more
Americans learn about Sseko, its unique products, and its social mission, sales would
increase, and the firm would recoup its profits. It is not unusual for an organization to
incur debt or suffer losses as it expands. Debt, managed co
ectly, could actually help
a firm because it allows it to take on opportunities it would not normally have with
limited funds. However, a negative cash flow often turns off investors, and the sharks
were no exception. Of greatest concern to the sharks was the belief that the Bohannons
overvalued their business. However, the Bohannons explained that they could not lowe
their valuation due to the deals they had already struck with the four private investors.
Mark Coban made an offer for 50% ownership which they declined. The sharks
maintained that was too high a value, especially for a company that, in their judgment,
was too focused on its social mission and philanthropy and not enough on profitability,
The Bohannon' s countered that many of today' s retailers and their customers value
companies with a social mission. This, they maintain, is especially the case with the
millennial generation, their target customers. They noted that younger consumers are
less concerned about
and names and more interested in the story behind the
and.
They believe that many customers prefer buying from firms that share their values.
They maintain that if a company supports a cause the consumer cares about. then the
company's
and will be viewed more favorably. They told the sharks that this will be
the key to increasing Sseko' s sales and profits.
While the Sharks deelined the opportunity to invest in Sseko, their expäSure on
the show resulted in a 500-fold increase in traffic on their website and a 1000%
increase in sales for the month of Fe
uary. In addition, other investors came forward.
They received the entire investment that they initially wanted from the sharks without
having to decrease their estimation of the value of their company. Sseko Designs has
already had a major impact on Uganda. Not only is it the largest foot wear manufacturer-
esulting in more jobs for Uganda as well as for the Ethiopian and Kenyan artisans who
create crafted products for Sseko to sell- it also serves to empower women. Cu
ently,
Sseko employs 65 women im Uganda and is the country s largest footwea
manufacturer. Their product offerings have expanded to include apparel, footwear,
jewelry, accessories and leather bags Today, the company supports the education of women by providing scholarships fo
their employees. Kach employee Is encouraged to save b0% of their salary which goes
into their personal Sseko savings accounts for 9 months, after which the account
eceives a 200% match from the company. Additional funding for these scholarships
comes from the Sseko Fellows program. This program began two years ago and has
300 Fellows. Sseko fellows are US social entrepreneurs who sell the company
products direct.