Sleek writers

Case 8-3 Parmalat: Europe’s Enron
After the news broke about the frauds at Enron and WorldCom in the United States, there were those in Europe who used the occasion to beat the drum: “Our principles-based approach to accounting standard-setting is better than your rules-based approach.” Many in the United States started to take a closer look at the principles-based approach in the European Community and that is used in International Financial Reporting Standards (IFRS), which relies less on bright-line rules to establish standards, as is the case in the United States, but may have loopholes making it relatively easy to avoid the rules. In the end, it was not the approach to setting rules that brought down Parmalat. It was a case of greed, failed corporate leadership, and sloppy auditing.

Background
Parmalat began as a family-owned entity founded by Calisto Tanzi in 1961. During 2003, Parmalat was the eighth-largest company in Italy and had operations in 30 countries. It was a huge player in the world dairy market and was even more influential within Italian business circles. It had a network of 5,000 dairy farmers who supplied milk products and 39,000 people who were directly employed by the company. The company eventually sold shares to the public on the Milan stock exchange. The Tanzi family always held a majority, controlling stake in the company, which in 2003 was 50.02 percent. Tanzi family members also occupied the seats of CEO and chair of the board of directors. The structure of Parmalat was primarily characterized by the Tanzi family and the large amount of control that it wielded over company operations. It was not unusual for family members to override whatever internal controls existed to perpetrate the accounting fraud.

The Parmalat scandal broke in late 2003, when it became known that company funds totaling almost €4 billion (approximately $5.64 billion) that were meant to be held in an account at the Bank of America did not exist. On March 19, 2004, Milan prosecutors brought charges against Parmalat founder Calisto Tanzi, other members of his family, and an inner circle of company executives for their part in the Parmalat scandal. After three months of investigation, the prosecutors charged 29 individuals, the Italian branches of the Bank of America, and the accountants Deloitte & Touche and Grant Thornton. The charges included market rigging, false auditing, and regulatory obstruction following the disclosure that €15 billion (approximately $21.15 billion) was found to be missing from the bank accounts of the multinational dairy group in December 2003. Former internal auditors and three former Bank of America employees have been jailed for their roles in the fraud. The judge also gave the go-ahead for Parmalat to proceed with lawsuits against the auditors. Parmalat’s administrator, Enrico Bondi, is also pursuing another lawsuit against Citigroup in New Jersey state courts. Despite all its troubles, Parmalat has recovered and today is a thriving multinational food group with operations in five continents through either a direct presence or through license agreements.

U.S. Banks Caught in the Spotlight
Parmalat had induced U.S. investors to purchase bonds and notes totaling approximately $1.5 billion. In addition, in August 1996 Parmalat sponsored an offering of American Depositary Receipts (ADRs) in the United States, with Citibank, N.A., headquartered in New York City, as depositary. Parmalat actively participated in the establishment of the ADR program. This activity made Parmalat subject to SEC rules. The SEC’s inquiries focused on up to approximately €1.05 billion ($1.5 billion) of notes and bonds issued in private placements with U.S. investors. The banks investigated included Bank of America, JP Morgan Chase, Merrill Lynch, and Morgan Stanley Dean Witter. Parmalat’s administrator, Enrico Bondi, helped the authorities identify all the financing transactions undertaken by Parmalat from 1994 through 2003. During the investigation, it was noted that Parmalat’s auditor from 1990 to 1999, Grant Thornton, did not have copies of crucial audit documents relating to the company’s Cayman Islands subsidiary, Bonlat. The emergence of a €5.16 billion (approximately $7.28 billion) hole at Bonlat triggered the Parmalat collapse. The accounting firm has since handed over important audit documents to investigators.

Accounting Fraud
One of the most notable fraudulent actions was the creation of a completely fictitious bank account in the United States that supposedly contained $5 billion. After media reports exposing the account surfaced, the financial institution at which the depositsupposedly existed (Bank of America) denied any such account. The company’s management fooled auditors by creating a fictitious confirmation letter regarding the account. In addition to misleading the auditors about this bank account, the company’s CFO, Fausto Tonna, produced fake documents and faxed them to the auditors in order to hide the fact that many of the company’s dealings were completely fictitious.

Parmalat’s management also used “nominee” entities to transfer debt and sales in order to hide them from auditors and other interested parties. A nominee entity is a company created to hold and administer the assets or securities of the actual owner as a custodian. These entities were clearly controlled by Parmalat and most existed only on paper.

Using nominee entities, the Parmalat management created a method to remove uncollectible or impaired accounts receivable. The bad accounts would be transferred to one of the nominee entities, thus keeping the bad debt expense or write-off for the valueless accounts off the Parmalat income statement. The transfers to nominee entities also avoided any scrutiny of the accounts by external or statutory auditors (in this case, Italian-designated auditors under the country’s laws).

Creating revenues was another scheme in which the nominee or subsidiary entities were used; if a non-Italian subsidiary had a loss related to currency exchange rates, management would fabricate currency exchange contracts to convert the loss to a profit. Similar activities were undertaken to hide losses due to interest expense. Documents showing interest rate swaps were created to mislead the auditors or other parties. Interest rate swaps and currency exchange contracts are both instruments usually used to hedge on the financial markets, and sometimes to diversify the risk of certain investments. Parmalat abused these tools by creating completely fictitious contracts after the fact and claiming that they were valid and accurate. The understatement of debt was another large component of the Parmalat fraud, as was hidden debt. On one occasion, management recorded the sale of receivables as “non-recourse,” when in fact Parmalat was still responsible to ensure that the money was collectible.