Why Diamond Foods' Late Director Shouldn't Have Been On The Audit Committee

| About: Diamond Foods, (DMND)

My recent article on Diamond Foods (NASDAQ:DMND) questioned the motive of its Audit Committee Director's, Joe Silveira, suicide. Since this was during an accounting probe regarding potential shady accounting practices by Diamond Foods, it's especially troubling.

The stock has dropped over 20% since November 22nd when Silveira's death was reported as a suicide (which the company didn't disclose but admitted it was true after excellent detective work by CNBC analyst Herb Greenberg). If there is no foul play, the company should figure out the reason for Silveira's suicide and tell the public ASAP to dispell any suspicions. Once it's established that his tragic death didn't have to do with the accounting irregularities, the stock should recover most of its losses since November 22nd. People don't commit suicide for no reason, and Diamond Foods management's silence on the matter is deafening.

Although I believe Silveira's suicide is at least partially because of his wanting to avoid the repercussions of engaging in accounting fraud with Diamond Foods, I can't say I know for sure. I am a believer that a company and individual are innocent until proven guilty, so until there's further proof, I can't say otherwise.

However, through my research, I believe Silveira shouldn't have been on the audit committee in the first place. This is because A. Silveira didn't have an accounting or finance background and B. his business and contacts caused a conflict of interest.

On Diamond Food's own investor relations section on its website, this is what it says is the purpose of the audit committee:

oversee the integrity of accounting and financial reporting processes of the issuer and the audits of the financial statements of the issuer;

monitor the periodic reviews of the adequacy of the accounting and financial reporting processes and systems of internal control that are conducted by the Company's independent auditors and the Company's financial and senior management;

review and evaluate the independence and performance of the Company's independent auditors; and

facilitate communication among the Company's independent auditors, the Company's financial and senior management and the Board.

Then it says:

In order to serve these functions, the Committee will have unrestricted access to Company personnel and documents, and will have authority to direct and supervise an investigation into any matters within the scope of its duties.

Here is Joe Silveira's professional profile on Forbes. For his education, it says he only "holds a B.S. from California Polytechnic State University, San Luis Obispo." Being from California, I know that Cal Poly is a respected technical/engineering college. Students don't go there to take accounting or finance classes. For work experience, it says:

since 1994, Mr. Silveira has served as President of Farmland Management Services, Inc., an agricultural services company, directing property acquisitions, operations, leases and sales on behalf of clients including large institutional investors.

Nothing on his resume suggests he had any accounting experience or education. His career skills look like he was a farm manager and deal maker.

Also in the Forbes description, it says: "Mr. Silveira brings considerable expertise in agribusiness to Diamond Foods, including ... his valuable contacts in the tree-nut industry." Wait a second here. Was he on the board to oversee the integrity of accounting reports, or to hook Diamond up with his nut grower business contacts? To do both would make it very difficult to avoid a conflict of interest.

How is a guy, who has probably never taken an accounting or finance class in his life, be qualified to review and evaluate the independence and performance of the Company's independent auditors?

Compare Silveira's resume to the audit committee (.pdf) of a Diamond Foods competitor: Flowers Foods (NYSE:FLO). Each member of the FLO audit committee worked or are working in high level finance, two of them were CFOs, and none of them currently work for a company that could possibly cause any conflict of interest with Flowers Foods.

A CONFLICT OF INTEREST

Aside from not having the education and accounting experience to be on the audit committee, perhaps even more troubling is the conflict of interest. As shown here, which was updated on 11/15/11, Joseph P. Silveira was the President, Chairman, and Director of Farmland Management Services, Inc. This is an agricultural services company that I assume mostly serviced nut growers. Silveira was a part of the walnut grower's group in California and managed walnut orchards.

The definition of conflict of interest regarding an audit committee is described best here from the Government of Alberta.

#2 says: Definition of Conflict of Interest

A conflict of interest exists in any situation in which a Member exercises or performs a duty or function for or on behalf of the Committee with the knowledge that it provides the opportunity to further a private, personal, or business interest of such Member and / or his or her Direct Associates

Silveira had full reign to see all of Diamond Foods' company secrets. The following are examples of things that could happen in the face of a conflict of interest:

1. Nut growers might be more inclined to hire the services of Farmland Management Services, Inc. because they know Silveira is on the Diamond Foods' audit committee and could possibly hook them up with deals.

2. He could share insider information about Diamond Foods' financial situation with his nut grower clients that do business with Diamond Foods, thus helping them with their negotiations with Diamond Foods, and vice versa.

3. He could charge higher prices to Diamond Foods for his own walnuts, or his clients' nuts, and advise Diamond Foods not to do business with other competitors that would in fact be a better fit for Diamond Foods.

4. He could inflate expenses for Diamond Foods in some areas and decrease expense payments to the nut companies and in reality pay the nut companies (either his own companies or his clients) more than what's reported.

5. He could have expenses pushed to another accounting period to make Diamond Foods or its clients accounts look more profitable.

Conclusion

Like I said, whether Silveira's suicide has anything to do with the accounting probe is still under investigation. However, because Silveira's position in the audit committee is questionable, it gives further evidence that Silveira's suicide did have something to do with the probe.

Disclosure: I am short DMND.

Additional disclosure: I am long DMND puts.