3 Handle Shower Cold Water Turns On Shower

I have a 3 Handle Shower/Tub where the left is Hot, middle is shower, and right is cold. The Hot knob works exactly as expected, the shower knob turns the shower on and off, BUT the cold knob will turn on cold water, and also turns the shower on!

What must I do to repair this issue? — Seat or Stem issue? I feel confident it's just the diverter the middle knob but am not 100% certain.

This is an image of what my set-up looks like
(note this is a stock google image not my exact set-up)

EDIT
I thought I could remove the knob but I am having issues….

I removed the screw from the knob itself like this image

But I am unable to twist off the knob itself. If I twist the ring behind it that is against the wall, that will loosen up until it is flush against the knob but then it will not move any further like this image.

EDIT 2
After a few mighty taps with a hammer this way and that way I got the knob off and used my valve stem socket set to get the valve stem out. Now, I have the replacement, but floating around in the packaging was an extra O-Ring washer and a "bolt" that was not attached to the valve stem.

Where do I attach these two parts? Here is an image

EDIT 3
Last Question and I'm all set! The "pieces" were caulked into the wall, most of the work was spent removing the caulk so that I could actually remove the valve stem. As you scan see in the image below, I removed the caulking from the diverter but it remains on the hot/cold. Is this a necessary evil? Or will it be okay if I do not re-caulk the diverter?