Parmalat accounting scandal

Background of the company

Parmalat Finanziaria SpA, an Italian food giant started out as a family business specializing in dairy products. It was founded in 1961 by 22 year old Calisto Tanzi, who discontinued his studies to expand his father's sausage and cheese shop. It began as a small pasteurization plant in Parma and further expanded into cheese, yoghurt, cookies, fruit juice and ready-made sauce production that are under different names in each country. They were the ones to produce the world's first shelf stable milk (tetra pack) which became an instant success.

This company, headquartered at Parma, Italy has expanded from 6 into 31 countries across six continents in 1990 and so was listed on Milan Stock Exchange. It was the eighth largest industrial group and contributed to 0.8% of the country's GDP. Around 36000 workers and 6000 dairy farms depended on Parmalat.

The company had to change its external auditor from Grant Thornton to DeLoitte and Touche in 1999 as Italian law states that changes in audit firms has to occur every nine years though the previous auditor can be consulted for concerns related to the firm. This was the main reason the scandal came to light.

In 2003, the firm tried to raise 300 Million in the form of bonds and was severely penalized. Hence it was under increased scrutiny of the investors as it was heavily indebted and capitalized. This was one of the very first indications of the crisis situation that was prevalent. Also doubts were raised by the Deloitte & Touche accountant regarding the 478 Million investment made in a Cayman Islands-based mutual fund, Epicurum (represented by a law firm, Zini & Associates).

The departure of two Chief Financial Officers in a span of six months and the increasing debt level created major concern amongst the investors and analysts. Analysts were puzzled that Parmalat was sinking in its core business inspite of having liquid assets of 4.2 billion.

Downfall of the company

On 14 December 2003, the company's inability to recur its stated cash of roughly $3.95 billion in assets (under Bonlat subsidiary, Cayman Islands) from a Bank of America (BOA) document (in a New York account) for the payment of a bond led to the discovery of a hole of $14 billion in its accounts. This document was scanned, added to another document having a $4 billion with the same bank and further passed through a fax machine to maintain the authenticity. The bank reported it as a falsified document.

This alleged accounting fraud forced the founder and chairman of Parmalat, Calisto Tanzi to resign under pressure. Further the responsibility of the management was handed by the Italian banks to Enrico Bondi (who had an earlier experience in rescuing Montedison Food and Chemicals Groups from its bankruptcy) who proposed for the debts of international lenders to be converted into stock so they could have a voice in the firm's directions.

The Italian government's initial promise to bail out Parmalat was deftly withdrawn. Instead some emergency bankruptcy legislations were enacted to shield the company from its creditors, thus aiding the firm to restructure and continue its business swiftly. Three days later the company was named insolvent and eligible for bankruptcy. Hours later the Parmalat founder and chairman, Tanzi was detained on criminal association suspicion. Two investigation teams probed into the firm's books to see how the firm was able to run its business based on the fake financial statements and the bank's role was probed by the Italian financial police, the Manhattan District Attorney and the US Securities and Exchange Commission (SEC).

Parmalat had made many acquisitions mainly in North and South America which led to large bank debts primarily through BOA, Citicorp, and JP Morgan Chase. Initially these debts were covered by high interest swap derivatives and later on from the off shore shell companies like Citibank subsidiary through falsely created bonds to create liquidity in its books. These illegal activities started when Parmalat's stocks went public.

Grant Thornton suggested Parmalat to use spun-off concerns (false accounts) so that illicit payments owed to the firm by the subsidiaries could be recorded unknowingly by DeLoitte and Touche firm. This loophole in the law enabled it to generate fake profits for the firm.

Key Players in the scandal

  • Calisto Tanzi - 10 year sentence for market rigging, accounting fraud(2009)
  • Fausto Tonna, CFO - 2 year sentence for forgery, creating many offshore companies
  • Grant Thornton firm - lawsuits filed dismissed in 2009
  • Deloitte and Touche firm
  • BOA - helped Parmalat acquire $170 million; lawsuit filed dismissed in 2009
  • Citicorp - Parmalat was ordered to pay $364.2 million
  • Swiss bank UBS - 357.5 million in settlements

Some lawsuits were charged by Enrico Bondi to recover several hundred million dollars.

Repercussions and reforms

One of the impacts this scandal created was a slump in the firm's stock market (1.8 billion before the scandal) - shares became almost worthless and a face value of just 20% was allotted for its bonds. This sharp drop and the failure of the company in repayments led to a lower rating by S&P (Standard & Poor). Various parties were affected -the employees across various countries who lost their jobs, Brazilian and Australian dairy farmers not paid for the delivered milk and investors. In 2005, Parmalat was restructured and relisted under Milan Stock Exchange after its various businesses was valued at 2.95 billion and market capitalization at 5 billion.

To determine the flourishing companies, the foremost change was restructuring the governmental oversights of corporations to promote corporate transparency. Further a bureau was created to monitor the Italian financial markets. Italy formed watchdog groups which were earlier formed by the US Public Company Accounting Oversight Board after scandals like Enron, WorldCom etc. Some other practices introduced is the pronouncements made by auditors on the internal accounting practises of their respective firms named Basle II and a capital adequacy rule that determines capital adequacy that shifts to credit risk keeping in mind the numerous financial disasters in the last 15 years.

The fact that Parmalat is a global consumer brand is one of the reasons for the scandal being dramatic and labelled Europe's Enron. This scandal has also been labelled as one of the most corporate financial frauds in history. Further it wiped out 135,000 people's savings making it one of the largest financial frauds in history. For a period of time the firm's financial systems totally eluded the analysts' understanding as the company's results weren't very transparent and the true extent of its liabilities were difficult to calculate.


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