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Parmalat: A slow and painful death

“I wish you and your families a slow and painful death.” Fausto Tonna, the
charming, long-serving former CFO of Parmalat, had few kind words for the
assembled journalists as he entered the Italian public prosecutor’s office to
answer questions about his role in the collapse of the food and dairy business.
Tonna had resigned in March 2003, just weeks after the company failed to place
bonds worth up to EUR500m with investors, who questioned Parmalat’s ability to
repay its existing debt and were starting to become concerned about the group’s

But in December 2003 the company missed a bond payment and Bank of America
revealed that a document purporting to show a EUR3.9bn bank balance in a Cayman
Islands’ account was a forgery. A fraud investigation was launched, Parmalat
went into administration and, at the end of December, Tonna, former chairman and
chief executive Calisto Tanzi and other senior executives were arrested by
Italian police.

And so a company that had claimed to have cash balances of EUR4.2bn now
appears to be missing assets worth at least EUR8bn, and possibly as much as
EUR10bn or even EUR13bn.

Parmalat’s rapid meltdown sent the rating agencies into a flurry of activity,
with Standard & Poor’s firing off successive downgrades that in four days
sent the company’s credit worthiness plummeting from investment grade BBB- to D,
which the agency defines as “payment default on financial commitments”.

On 19 December, S&P withdrew its rating of Parmalat, saying that all key
information provided by the company had been misleading. That was when it was
disclosed that Bonlat, a Parmalat subsidiary in the Cayman Islands, did not have
accounts worth almost EUR4bn at Bank of America. Italian prosecutors confirmed
that a scanning machine had been used to forge BoA documents, which were then
sent to auditors who certified the accounts. Cayman seems to provide a key link
in the network of missing funds. Italian investigators reportedly believe
EUR250m, raised in a EUR500m bond issue in Brazil in 2001, ended up in Malta via
a Cayman Islands unit of Spain’s Santander Central Hispano.

Shortly before the axe fell, the market started to make known its own views
on Parmalat’s credit worthiness. In the 28 days up to 19 December, Parmalat’s
five-year bond spreads widened by an alarming 2,400 basis points.

For more than a week prior to the debacle, the company had been reduced to
trading on an ‘up-front’ basis, inasmuch as protection buyers had to pay 53% of
the credit default swap contract cost. The company’s shares, in effect worth
next to nothing, have been suspended.

Italian sources say that the total sum of bogus operations uncovered at the
firm as of 30 June 2003 amount to $10bn, including $1.4bn in obligations by
other companies in which Parmalat invested. La Repubblica newspaper claims that
Parmalat had not bought their obligations at all, but had merely copied their
names from the internet. It quoted a source at PricewaterhouseCoopers, which has
taken over as auditor to Parmalat, as saying that if Enrico Bondi, the
turnaround specialist called in by the government to keep the company afloat,
does not deny these allegations, “One may draw one’s own conclusions”. A PwC
spokesman in London said the accounting firm was obliged to maintain a strict
silence on the Parmalat investigation, but added that the reported comments
might have come out of the company’s Italian office.

The Italian government, which had initially promised to bail out Parmalat,
had a quick rethink and deftly put some distance between itself and the fallout
by enacting emergency bankruptcy legislation. The decree allows a company with
at least 1,000 employees and debts of more than EUR1bn to apply for immediate
but temporary protection from creditors. This allows the bankrupt firm to
continue trading without government aid, which almost certainly would have
elicited the wrath of the European Commission. Parmalat now has nine months in
which to come up with a satisfactory restructuring.

“The goal of the decree is not to save the controlling shareholder or
managers, but small savers, suppliers, the integrity and the Italian nature of
the firm,” said industry minister Antonio Marzano.

The shock waves from the Parmalat bombshell hit banks, rating agencies,
analysts and auditors from San Francisco to Vienna. It emerged that Bank of
America had told Grant Thornton, Bonlat’s auditor, as early as last November
that a document purportedly showing the alleged Cayman accounts with cash and
securities was simply a forgery. The document was used by Grant Thornton as part
of its work on Bonlat’s 2002 accounts, which were then consolidated into
Parmalat’s group financial statements for that year.

Deloitte, one of the Big Four global accounting firms, acted as Parmalat’s
group auditor from 1999, while Grant Thornton, which had been the group auditor,
carried on as auditor at many of the company’s subsidiaries. The sub-Big Four
accounting firm, which audited up to 49% of Parmalat’s assets, was quick to
disassociate itself from its Italian operations. On 8 January it expelled its
Italian business from its global network. “Grant Thornton (Italy) has been
unable to provide sufficient assurances or access to the appropriate information
and people in an acceptable timeframe,” says David McDonnell, head of Grant
Thornton International.

Two Deloitte partners in Italy are under investigation, while in Luxembourg a
magistrate said investigations had been opened into possible money laundering by

Deloitte, which denies acting negligently or being complicit in what is
unravelling as a massive fraud, allegedly found its relationship with Grant
Thorton coming under strain in the second-half of last year when the cracks
started to show. In October, Deloitte declined to authenticate the value of
Bonlat’s mutual fund in Cayman and also refused to approve a gain on a
derivatives contract held by the fund. The auditor had cause to be sceptical.

In each year of the three-year periods to 2001 it had qualified the accounts
of Parmalat Soparfi SA, a Luxembourg subsidiary, on the book value of a
participation in Parmalat Paraguay. There was also a qualification on the book
value in Parmalat Food Industries South Africa Ltd. Deloitte had good reason to
treat Parmalat with suspicion, bearing in mind how the Enron domino collapsed
right on top of its auditor, Andersen, the firm that soon broke apart as its
reputation imploded. Deloitte excluded these assets from its valuation of the

The firm declines to comment but, according to auditor sources, Deloitte
failed to do checks on those big bank accounts supposedly held by Bonlat at BoA.
Remarkably, in spite of the qualified accounts, it was business as usual at
Parmalat Soparfi SA. The group was able to raise EUR246.4m in an equity-linked
bond issue just over a year ago, with Morgan Stanley acting as manager.

The international banks, following their usual lemming instinct, were loathe
to turn their backs on apparently good business that was being picked up by
rivals. Data from Thomson Financial lists the banks that had a role in helping
Parmalat to raise money and includes such heavyweights as JP Morgan Chase,
UniCredito Italiano, Merrill Lynch, Morgan Stanley, Barclays Capital, Deutsche
Bank, Citigroup, Santander Central Hispano, Bank of America and UBS. Bankers
involved in the Parmalat negotiations say that Citigroup and Bank of America
each hold exposures of up to $1bn in Parmalat, without taking into account any
laying-off of risk through the derivatives market. Together, the banks sold
about EUR8bn in Parmalat bonds between 1997 and 2002. Other banks had smaller
exposures, given as EUR393m for Capitalia and EUR360m for Banca Intesa, for
instance. The international banks have set up a steering committee chaired by
Citigroup, which is attempting to recover their losses. The Italian financial
police, the Manhattan District Attorney and the US Securities and Exchange
Commission (SEC) have launched a probe of a different nature, looking into how
the dairy group perpetrated one of the biggest financial scams ever, and whether
any of the banks involved knowingly played a role in it.

However, as far as the SEC is considered there is no need to uncover
deliberate fraud. The banks could find themselves in trouble simply for having
acted negligently by selling Parmalat bonds. The SEC has labelled the Parmalat
scandal “one of the most brazen corporate financial frauds in history”. Brazen
almost falls within the realm of understatement in the light of a statement by
one Parmalat executive who said that orders had been given to take a hammer to a
computer used to falsify documents.

The computer contained a bogus Bank of America logo. With regard to the
banks, Lawrence West, the SEC’s associate director of enforcement said, “We need
to understand if they acted in a way that was negligent or reckless or

Investors are already pointing an accusing finger at the banks, while the
Southern Alaska Carpenters’ Retirement Trust, of all people, has already filed a
civil suit against Parmalat seeking $1bn that the company allegedly paid to
executives, financial advisers, lawyers and auditors. The Alaskan carpenters
have retained the services of the same law firm that was involved in the
shareholder litigation against Enron. This was followed by another US class
action suit from Parmalat shareholders.

US investors hold more than $1.5bn of Parmalat bonds. As the probe widens,
the Parmalat scandal promises to provide a jamboree for litigation. So far,
Italian prosecutors have stated that the black hole at Parmalat could be
bottomless, taking into account the Tanzi family’s other financial interests,
such as football club Parma, tourism business Parmatour and others.

The ultimate guilt for what happened at Parmalat lies with the direct
perpetrators of the financial scandal; that is, whoever is found to be
responsible for a corporate shortfall that prosecutors have estimated at up to
EUR10bn – EUR2bn more than the figure cited by Tanzi, who is under interrogation
in a Milan jail. Tanzi has also admitted to diverting some EUR500m from the
publicly quoted company into family owned firms. The rating agencies, auditors
and banks involved all claim they were misled or the victims of lies or fraud.

Of course, the auditors’ prestige is not enhanced by the fact that Italy’s
market regulator, Consob, has asked a Parma court to annul Parmalat’s 2002
accounts, which showed net profits of EUR252m, due to the company’s failure to
comply with accounting standards. According to latest estimates, Parmalat lost
EUR1.4bn between 2000 and 2003.

Another constituency that has come in for severe criticism is the equity
analyst community. Many were talking up Parmalat even as the company’s prow was
beginning to slip under the waves. One Citigroup analyst put out a “buy” note on
Parmalat as late as mid-November, when it emerged that the company was unable to
quantify its Q3 cash flow.

“Parmalat gives cause to reconsider the weight that should be given to a
number of analysts who are looking red-faced and struggling to justify their
existence, as well as to the ratings agencies,” says Philip Middleton, head of
UK retail banking at Ernst & Young. “Here is a firm allegedly with EUR3.9bn
in deposits, earning EUR75m a year in interest. The company is paying EUR400m in
interest on its debt. Why didn’t it use that cash pile to reduce its debt? This
calls into question the whole rationale of Basle II, which is predicated around
the rating agencies’ ability to evaluate risk. How can one have confidence in
these agencies that downgraded Parmalat almost within a few minutes?”

Basle II is the name given to the international capital adequacy rules that
come into effect in 2007. Under the new rules the focus for determining capital
adequacy will shift squarely to credit risk, taking into account the numerous
and often spectacular financial disasters that have taken place since the
original proposals were drawn up nearly 15 years ago.

Under the current rules, for every £100 of loans granted to a corporate
borrower a bank has to hold £8 of capital, regardless of the customer’s rating.
That is, all corporate loans are 100% risk-weighted. But in future, corporates
rated B- or lower by the three major rating agencies will see their capital
weighting go up to 150%. Currently, this affects a large number of companies in
the UK and Europe. For instance, if a BB-rated company is downgraded, its bank
needs to put up 50% more capital, and this will raise the price on lending.
Given the agencies’ performance in situations like the Parmalat affair, many
people are wondering if they are best suited to determine a company’s credit

Indeed, probing the Parmalat debacle is so akin to lifting the proverbial
rock in a field that one wonders if the ratings agencies, or any investigative
body for that matter, is equipped to uncover all the false accounts and trickery
that brought down the company. The growing number of criminal and regulatory
investigations will take much longer than the shelf-life of the UHT milk that
used to be the one thing for which Parmalat was famous.


Key dates
1961: Parmalat created by Calisto Tanzi
1990: Lists on Milan stock exchange
28 March 2003: CFO Fausto Tonna resigns, succeeded by Alberto Ferraris
14 November: Ferraris resigns, replaced by Luciano Del Soldato
9 December: Parmalat misses EUR150m bond payment
15 December: Tanzi resigns as chairman and CEO
19 December: Bank of America claims a document showing EUR3.9bn on deposit in
Cayman Islands is a forgery 20 December Fraud investigation launched
24 December: Parmalat goes into administration
27 December: Tanzi arrested
30 December: Tanzi admits EUR8bn hole in accounts. Claims managers acted of own
31 December: Tonna, Del Soldato and others arrested
8 January: Grant Thornton International expels Italian partner firm; Italian
officials investigate Deloitte

Key people

Calisto Tanzi, 65, was chief executive of Parmalat from the age of 22,
building up the business into the eighth-largest company in Italy. His son,
Stefano Tanzi, is a former Parmalat executive and now chairman of football team
AC Milan, 98% owned by Parmalat. Fausto Tonna, 52, was Parmalat CFO for 16
years. Admitted to falsification of accounts but claimed fraud was ordered by
Tanzi to disguise group’s predicament. Luciano Del Soldato, Tonna’s deputy,
succeeded as CFO in March. Reportedly told a subordinate to destroy his laptop
“with a hammer” to get rid of incriminating evidence.

Key auditors

Under new Italian company laws requiring rotation of the group auditors,
Parmalat switched from Grant Thornton to Deloitte in 1999. However, Grant
Thornton was retained on the audit of subsidiary companies, including Bonlat, a
newly formed Cayman Islands company, which was said to have EUR3.9bn on deposit
with Bank of America, though documentary evidence was forged.

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