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Diamond Foods (DMND) Accounting Scandal: Let the Lawsuits Begin

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Last week the stock of San Francisco walnut company Diamond Foods (DMND) dropped nearly 40% after the company's CEO and CFO were dismissed after an internal review discovered accounting irregularities.

In a statement released after the close of trading on Wednesday the company said it had exposed some $80 million in unusual payments to walnut farmers; payments not accounted for correctly in prior financial statements. The revelation will require a restatement of the company's 2010 and 2011 earnings results.

In the attached clip Trademonster.com co-founder Jon Najarian and I discuss what happened and why last week's news may be only mark the beginning of Diamond's troubles. The company fired it's top two executives on Tuesday evening yet allowed Diamond's stock to trade all day Wednesday. Bad idea.

"The board seems to have had really bad legal advice," understates Najarian. "Anything you know that's material and non-public you're supposed to disperse that information in as wide an area as possible." Such a practice is called Fair Disclosure one of the few securities laws with a straight forward definition.

Last Wednesday as DMND's board crafted a statement for after the bell, the stock traded 6.9 million shares, more than all the other days of February combined and the highest volume the stock had seen since last December 12th.

Najarian says his service, which triggers alerts when unusually high levels of puts or calls are traded on a security, also flagged curiously aggressive put buying in Diamond during Wednesday's trading session. The following day Diamond's stock fell nearly 40%. There are those who may think the high volume of trading in puts and stocks ahead of DMND's announcement was coincidental.

"This is the definition of insider information," says Najarian. Such trading is illegal, even for members of Congress.

It's within the realm of the possible that the trading on Wednesday was organic. Perhaps there was a downgrade, a walnut weather problem, or one lucky fund dumping shares in one day immediately prior to disastrous news.

Regardless the trading in Diamond last week is exactly what illegal trading looks like.

If you held Diamond last week you were at a disadvantage. If you actually bought last Wednesday it's extremely likely you were flat-out robbed.

Diamond Foods is yet another opportunity for the regulatory agencies to help restore American's confidence in markets by enforcing the rules we have rather than harrumphing about the need for new securities laws. It's a lot to ask in an election year but maybe, just maybe, this can be one time when protecting shareholders is the government's top priority.

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