PARMALAT SCANDAL

SHORT HISTORY OF PARMALAT

• Parmalat Finanziaria SpA, an Italian food giant started out as a family business specializing in dairy products. It was founded in 1961 by Calisto Tanzi, a 22 year-old college dropout and Italian food industry heir. The company was named for Parma (“the food valley” in Italian) and lat (an abbreviation of latte, Italian for milk). The eighties was a period of further expansion: Parmalat consolidated its position as a world leader in the dairy market and extended into other food markets, such as bakery products, tomato sauces, fruit juices.

• Parmalat's major innovation allowed it to produce the first shelf-stable milk through an Ultra Heat Treatment (UHT) process developed in Sweden, enabling processors to produce milk that could be stored for long periods without refrigeration. The product was a hit, benefiting from its associations with and advertising through sports, including Formula One Racing and Alpine Ski Championships. Parmalat was a European pioneer in brand advertising.

• Sales rapidly expanded throughout Europe, Latin America and, in total, in over 30 countries. The firm rapidly grew into a family empire, the largest food company in Italy, the fourth largest food company in Europe, with over 36,000 employees in 139 plants and branching into a variety of industries including beverages, television, tourism, cookies and football.

• In 1997, Parmalat initiated an aggressive campaign to acquire other firms, particularly in the Americas. One of its large purchases in 1997 was Beatrice Foods, a large U.S. producer. Many of these acquisitions were huge money losers. Most of the acquisitions were financed with debt and the firm's debt ratings gradually deteriorated. Nonetheless, Parmalat appeared to be a good citizen to many Italians, donating to Catholic causes and rebuilding a cathedral in Parma. By 2002, the firm had grown to realize €13 billion in sales.

FINANCIAL FRAUD (2002–2005)

• In 1997, Parmalat jumped into the world of financial markets in a big way, financing several international acquisitions with debt. But by 2001, many of the new divisions were producing losses, and the company financing shifted largely to the use of derivatives, apparently at least in part with the intention of hiding the extent of its losses and debt.

• In February 2003, chief financial officer Fausto Tonna unexpectedly announced a new €500 million bond issue. This came as a surprise both to the markets and to the CEO, Calisto Tanzi. Tanzi forced Tonna to resign and replaced him with Alberto Ferraris. Ferraris was surprised to discover that, though now CFO, he still did not have access to some of the corporate books, which were being handled by chief accounting officer Luciano Del Soldato. He began making some inquiries and began to suspect that the company's total debt was more than double that on the balance sheet.

• .

• Epicurum The plan for a €300M fundraising effort was dropped in September 2003 and the

company's shares depreciated significantly.

Ferraris resigned less than a week after the public fall-out and was replaced by Del Soldato. Del Soldato resigned the next month, unable to get cash from Epicurum fund, needed to pay debts and make bond payments totalling at least €150M, a seemingly small sum given Parmalat’s size and prominence.

Tanzi initially attributed the default to a temporary liquidity problem, blaming it on a customer, a speculative fund named Epicurum. Parmalat claimed that Epicurum did not pay its bills.

It was later revealed that Epicurum was one of Parmalat's own offshore subsidiaries. The rating agencies quickly downgraded Parmalat's bonds to junk status.

• Bank of America’s Fake account

Enrico Bondi was called in to help the company as it went into administration, while Tanzi himself resigned as chairman and CEO.

Bonlat was a subsidiary of Parmalat set up in the Cayman Islands. Bonlat's bank, Bank of America, then released a document showing €3.95 billion in Parmalat's bank account as a forgery. Parmalat confirmed that it simply did not exist.

Prime Minister Silvio Berlusconi initiated a fraud investigation and appointed Bondi to administer the company's rescue. Hundreds of thousands of investors lost their money and would never recover it.

About a week later, Tanzi, who admitted to taking over €500 million for himself and his other businesses, was jailed . Two Italian-based executives of Parmalat's former auditing firm, Grant Thornton S.p.A., were also held and questioned in Italian jails.

EURO HOLE IN ACCOUNTS

On December 24, 2003, Parmalat S.p.A. filed for bankruptcy protection with a court in Parma Italy, the largest bankruptcy in European history. Since December 2003, Parmalat has been enmeshed in, and apparently emerging from the aftermath of the largest financial fraud in European history, with approximately €14 billion having apparently simply vanished. Much of this loss seems to be related to Parmalat's debt level being over €14 billion, almost eight times what had been reported before the firm’s unraveling.

For years, Parmalat hid its losses, overstated its assets, recorded non-existent assets, understated its debt and diverted cash to Tanzi family members. The firm created over 260 foreign entities such as Bonlat, its Cayman Islands subsidiary to dump its non-performing and fictitious assets and to hide its debts. Interestingly, much of the fraud went undetected for as long as 13 years.

Parmalat's business interests were far-flung, extending into travel and sports businesses and well beyond the areas of competence of its founder and his family

HOW?

Parmalat hid losses, overstated assets or recorded non-existent assets, understated its debt, and diverted company cash to Tanzi family members.

• In order to hide losses, Parmalat had used various wholly-owned entities, amongst which the most significant was Bonlat, the Cayman island waste basket of the Group in its final 5 years, and the holder of the Bank of America’s false account.

• Uncollectible receivables were transferred from the operating companies to these nominee entities, where their real value was hidden.

• Fictitious trades and financial transactions were organized to offset losses of operating subsidiaries and to inflate assets and incomes.

• Securitization schemes based on false trade receivables and duplicate invoices were recurrently used to finance the group.

Parmalat understated its debt through

• different fraudulent schemes. It recorded non-existent repurchases of bonds.

• It sold receivables falsely described as non recourse, in order to remove the liabilities from the records.

• It mischaracterized debt or, simply, did not record it.

Funds were diverted to Tanzi family members and their private companies.

• A recurrent scheme was to record the payments as receivables and then move the false receivables through the

• web of the offshore entities in order to blur their true nature.

REMERGING FROM BANKRUPTCY• After Parmalat filed for bankruptcy protection, court administrators hired turn-around specialist

Enrico Bondi to reorganize the firm. Bondi immediately began to trim down Parmalat to focus on its core dairy business.

• A number of its non-core subsidiaries such as its football teams were spun off as well as operations in Latin America, Thailand and Ireland and several poorly-performing brands were eliminated.

• Bondi set out to streamline the corporation's operations to 16 milk and juice-based businesses around the world and 30 of its stronger global and regional brands, including Bonlat milk, Santal juices and Kyr yogurt, a substantial reduction from its 120 brands under Tanzi.

• Prior to its re-emergence from bankruptcy, Parmalat creditors agreed to swap about €20 billion of the firm's debt for equity, earnings began to resurface and the firm soon relisted its shares on the Italian Stock Exchange in Milan.

• Parmalat remerged from bankruptcy and Bondi's appointment to remain as CEO afterwards was approved by the firm's new shareholders.

• Bondi also began to seek billions of euro in compensation from a number of banks that may have participated in Parmalat's meltdown, alleging they colluded to hide Parmalat's problems.

• Bondi charged that several banks provided assistance in creating false financial statements and profited from floating bond issues that delayed disclosures of Parmalat's financial problems.

• Among the banks defending themselves against these charges were Deutsche Bank for (at least €17million), UBS (€290 million) and Citigroup (over €8 billion).

• In addition, Parmalat sued its auditors Deloitte & Touche and Grant Thornton for approximately €20 billion, though they claimed to be victims of Parmalat's fraud.

BANKS NEGLIGENCE

• This episode also reveals the shoddy role of some well-known international banks such as Citigroup and UBS. The laxity of big banks and financial institutions to lend unsecured loans to Parmalat had negative repercussions

• Banks and financial institutions were so busy in making money through their dealings with Parmalat without considering long term consequences.

• In the same vein, credit ratings gave higher ratings to Parmalat without adequately examining its financial data.

BANKS’ EXPOSURE TO PARMALAT• Bank of America $274 million

• Citigroup $242 million

• Capitalia 614 million Euro

• UBS 420 million Euro

• Banca Intesa 360 million Euro

• Banca Monte dei Paschi di Siena 183 million Euro

• Unicredito 150 million Euro

• Banca Nazionale del Lavoro 110 million Euro

• Banca Popolare di Lodi 100 million Euro

• Banca Popolari Unite 100 million Euro

• ABN Amro 70 million Euro

• Credem 50 million Euro

• Banca Lombarda 35 million Euro

• Banco Popolare di Verona e Novara 35 million Euro

• Barclays £45 million

CORE ISSUES THAT ARE VIOLATED

• Parmalat lacked board independence.

• Parmalat is family owned company of Tanzi and Sons, Tanzi is the founder and chaiman and CEO of the company.

• Parmalat was also weak on the composition of key board committees.

• Parmalat does not sufficient no. of independent director as per the SOX.

• Both audit committee and remuneration committee is completely dependent on Tanzi family.

VIOLATION OF LAWS

• The responsibility of both chairman and CEO is not different.

• The holding company controls majority of voting rights which ultimately belongs to the Tanzi family.

• Wrong disclosure of financial report. The company was facing debt which is more than double what was disclosed in financial report.

• As per SOX, board should have more 50% independent director. But in Parmalat, the board was composed of 3 independent director remaining are executive director out of which only one is independent director.

• Lack of monitoring company operation by the board of directors.

• Parmalat had 3 internal auditors which were appointed by company and neither of them appointed by minority shareholder in order to protect their rights.

• Lack of rotation of external auditor, as per Italy corporate governance external auditor should be rotated after 3 years

ROLES OF BOD,ID, SENIOR MANAGEMENT

Founder, Chairman and CEO: Calisto Tanzi

• No role distinction between CEO and Chairman.

• Without understanding the company financial condition acquired

many companies in the food industry which resulted in financial

losses.

• Manipulate financial report by hiding losses

• Diverted 500 million euro from company reserve to

Parmatour(which belongs to his daughter) without taking

approval from shareholder and stakeholder.

CFO: Fausto Tonna

• Completely dependent on the company internal auditor, not even access company books which was handled by internal auditor

• Announced a bond issue of 500 million euro, without communicating shareholder, stakeholder and other personals.

Independent directors:

• Being independent director of the company. They did not question the company malpractices.

Internal Auditor

• Manipulation of balance sheet by reducing debt to half, in order to give company better financial picture.

• In order to cover losses, post profit by representing that company involved in aggressive acquisition.

External Auditor:

• Lorenz Penca of Grant Thornton auditor firm, remained chief auditor for 9 years, even Italian government have role of rotation after 3 years.

• Not an independent director as related to one the company subsidiary.

• Also involved in company fraud and laundering activities.

• Company has nonexistent account in Bank of America. Grant Thornton claimed that this account is existent in order to show third party confirmation.

Senior management:

• Not perform efficiently to minimize the risk of company and did not question activities of Executive Director.

Executive Directors:

• company had 7 executive directors, all of them equally involved in company malpractice. They also received compensation for their involvement.

Institutional investors:

• Not find the company actual financial condition and invest 150 million euro.

• Help the company to go public, raised fund from the market.

Bank of America, Citigroup and J.P. Morgan:

• Largest bond placers helping Parmalat to fake balance sheet and hide their actual financial condition.

• Bank of America give higher rating to Parmalat bonds based on the fake account which never existent.

• Citigroup and J.P.Morgan help Parmalat to build a fraudulent accounting practice

Deloitte and Toushe: Auditing firms

• Even after rotation of external auditor in 3 years, agreed to continue Lorenz Prenca to be chief auditor of the company.

• Allow Parmalat to follow wrong accounting practice and help them to cover fraud.

• Regulators were also responsible as they not able to detect pattern of negligence and fraud.

CIVIL ACTION

• Separately, Italian prosecutors sought trials for 27 people. Eleven of those, including three of Parmalat's former chief financial officers, were sentenced to up to two and a half years in prison under plea bargains, while a separate trial began in January for two accountants who worked at Grant Thornton.

• Many of the defendants were spared prison terms by Italian sentencing guidelines protecting first-time offenders. Prosecutors in Parma, near the company's headquarters, sought to try Tanzi and dozens of others on trial for more serious charges, including fraudulent bankruptcy and criminal association. Alessandro Bassi, a 32-year-old accountant who worked under CFO Tonna, committed suicide by throwing himself off a bridge near the company's headquarters in northern Italy.

DOWNFALL• The Parmalat scandal has been described by the SEC as “one of largest and most

brazen corporate financial frauds in history. The Parmalat case epitomizes the most important problem , a controlling shareholder that exploits the company rather than monitoring its managers. Parmalat’s governance structure was openly deficient.

• In spite of this deficiency, Parmalat enjoyed an investment grade credit rating and was able to borrow increasing amounts of capital from investors.

• Two large networks of auditors (Grant Thornton International and Deloitte Touche Tohmatsu) failed to detect the frauds. Grant Thornton’s Italian partners are also suspected of having orchestrated them.

• Some first-ranking international banks allegedly assisted Parmalat senior managers in structuring and executing complex financial transactions aimed at concealing Parmalat’s true situation.

MARKET EFFECTS OF THE PARMALAT SCANDAL

• In the wake of the Parmalat scandal, Consob (government authority of Italy responsible for regulating the Italian securities market) launched a wide-ranging investigation concerning bond issues.

• Listed companies were required to provide additional information, auditors adopted a stricter approach and some cases of insolvency were probably accelerated.

• The effect of the Parmalat scam on the bond market has been quite significant. According to a report from Fitch Ratings, the number of Italian companies accessing the bond market collapsed.

• Other companies turned their attention back to the loan market.

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.

PARMALAT NOW• Today, Parmalat has a global presence, having operations in Europe, Latin America,

North America, Australia, China and South Africa. Since 2011, it is a subsidiary of French group Lactalis.

• Still specializing in UHT milk and milk derivatives (varieties of yogurt, cheese, butter, ice cream, etc.), the group also has an interest in fruit juices. These products are distributed under brand names such as Lactis, Santal, Malù, and Kyr. Its worldwide operations include almost 140 production centres and more than 36,000 employees, while 5,000 Italian dairy farms are dependent on the company for the bulk of their business. Its shares are listed on the Borsa Italiana.

PARMALAT IN THE WORLD

in blue directed presence, in green presence under license

CONCLUSION

• The Parmalat situation started out as a fairly standard - if stunningly large - accounting fraud. Managers allegedly used various accounting tricks to avoid disclosing sizeable losses, possibly with the collusion of some auditors and lawyers.

• The presence of a strong controlling shareholder(CEO Tanzi) introduces a new divergence of interest. In fact, it is very easy for the controlling shareholder to extract non-pro rata benefits for itself at the expense of the minority shareholders and futhermore stakeholders.

• The Parmalat scandal raises the well known gatekeepers’ problem with respect to auditors, lawyers and financial intermediaries. It also confirmed the low level of law enforcement in Italy. The problem is that there was no serious effort to reshape the enforcement system.

• The key of the discussion is on transparent accounting rules. Once this is achieved it will be much easier to solve the problem of enforcement.

• Accounting Frauds will be with us al long as there are unscrupulous businessmen and dishonest or incompetent lawyers and auditors.

• Cost-effective system of better accounting rules and responsible enforcement that strives only to reduce the problem to manageable proportions.

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