The crisis of Parmalat: Milking lessons

Date: 03/01/04

It seems that a massive fraud was behind the collapse of Italy's Parmalat. But how did it happen and who benefited?

WHEN Enrico Bondi, a turnaround expert, arrived at Parmalat in mid-December, he thought his job was merely to help restructure the finances of Italy's biggest dairy group. Within days, however, events moved faster than even the shrewd Mr Bondi can have predicted. First, Calisto Tanzi, Parmalat's founder and boss was ousted in a brutal show of strength by the company's main banks. Then Mr Bondi began to uncover the truth behind Parmalat's strange balance sheet, and a bad story got much worse.

The immediate problem at the company had been one of short-term liquidity. As a regular heavy user of the bond markets, Parmalat had been criticised as being inefficient for its habit of carrying large debts that were supposedly offset by big cash holdings. Suddenly in December, it struggled to redeem a €150m ($180m) eurobond, despite apparently having already bought back much of the issue. Financial markets wondered why the redemption was a problem for a group with more than €4 billion of reported cash and short-term assets. Investors then panicked when Parmalat admitted that it had been unable to release almost €500m trapped in a mutual fund based in the Cayman Islands.

That was when Mr Bondi arrived. He quickly discovered that Parmalat had overseen a huge and long-running deception, perhaps dating back nearly a decade. The Tanzi family lost control of the company as forensic accountants got down to work. Mr Tanzi was arrested for questioning on December 27th. On December 29th, Parmalat's by now almost worthless shares were suspended indefinitely on the Milan stock exchange. A full-scale judicial inquiry is under way, with 20 people under investigation. And America's Securities and Exchange Commission accused Parmalat of misleading bond investors in “one of the largest and most brazen corporate financial frauds in history.”

Colleagues of Mr Tanzi, including a former finance director, have alleged, according to investigating magistrates, that he personally siphoned up to €800m from Parmalat. Mr Tanzi's lawyer denies that any money has “disappeared”. Mr Tanzi did have a penchant for buying football clubs, but his lifestyle was reportedly not especially lavish. Even if this specific allegation against him turns out to be true, it would not explain the billions more that have gone missing.

So where were Parmalat's auditors during all of this? Grant Thornton was the long-time auditor of Parmalat itself and had remained auditor of Bonlat, a Parmalat subsidiary. Deloitte & Touche, Parmalat's main auditor since 1999, insists that it abided by Italian accounting standards and is co-operating fully with investigators. For its part, Grant Thornton has claimed that a letter from Bank of America vouching for €4 billion of cash in Bonlat was a forgery good enough to fool them into approving accounts that were fake.

But there were numerous such documents. Indeed, investigating magistrates claim that four times a year Parmalat was operating a crude, but effective, system for forging documents that purported to show big cash balances within Bonlat. The balance sheets of the subsidiaries were simply adjusted to make sense of the group's overall financial position, and then reported to the centre as audited numbers.

Grant Thornton claims that it too was the “victim” of a fraud. But it seems either to have been too close to its client or to have been incompetent. For example, investigating magistrates say that, according to former finance officials with Parmalat, the auditor used Parmalat's internal mail to request financial information, rather than dealing with banks or other parties directly. If so, this would mean that vital transactions were not scrutinised outside a closed loop of communications.

Among other things, Mr Bondi wants to know where the missing money has gone-assuming it ever existed. The sooner he can separate invented assets from real ones, the sooner he can reassure investors that there will be money to recover from the mess. Shareholders seem set to lose everything and there will be painful negotiations with the holders of Parmalat's numerous bond issues. However, Mr Bondi probably has just enough breathing room in which to pare Parmalat back to a viable operating business with a manageable financial structure and to save as many of the firm's 36,000 jobs as possible.

Using new laws rushed through by the government, Mr Bondi is now acting as the sole administrator of Parmalat. He has 180 days to try to salvage what he can. The new law allows Parmalat to use its working capital to pay suppliers, and will also make it likely that its banks will give it more short-term capital within a few weeks.

It remains possible that the task will prove too much, even for the talented Mr Bondi. So far, there has been no good news to offset the steady flow of bad developments at Parmalat. Outsiders are still guessing at the size of the black hole in the firm's accounts-is it €10 billion? €12 billion? More? One likely scenario is that Mr Bondi will break Parmalat into pieces, selling what he can and trying to retain a core milk business. Whether he can close the funding gap, however, is a big question.

If he is to have a chance, Mr Bondi needs to know quickly, and in detail, how the fraud was committed. Untangling such schemes is never easy, especially when there are hundreds of interwoven subsidiaries and shell companies, not to mention tax havens and offshore banks, involved. Mr Bondi has done the sensible thing and looked first for the big sums, only to realise the scale of his challenge. Now he must go after multiple, smaller amounts. It will take time, perhaps several months.

Until there is more precise information, most people can only guess at how such a large fraud can have been constructed. But the broad outlines have begun to emerge. On the face of it, a financial-holding company seems to have been used to grab cash from the operating company, before losing that money through the silly use of derivatives and other speculative financial dealings. As the losses mounted, instead of coming clean it seems that the stakes were raised in a desperate and ultimately futile effort to keep the scam going. If such a picture is broadly accurate, then Parmalat will look much like other corporate scandals. Until then, the worry is that fresh horrors may yet emerge.

It seems that a massive fraud was behind the collapse of Italy's Parmalat. But how did it happen and who benefited.