PARMALAT
How the Milk Spilled

Article by - Shirisha Regani ,
Faculty Associate ,
ICMR Case Studies and Management Resources.

SNOWBALLING SCANDAL

2003 was a tough year for Parmalat. The problems which hounded the company since the early-2000s came to a head at the end of 2003, and Parmalat all but collapsed under the strain.

For over a year before the scandal erupted, analysts had been expressing doubts about the inordinately high levels of debt the company raised from the market, despite showing high reserves of cash in its financial statements. Analysts were also concerned about the pattern the company adopted in investing its surplus funds, often choosing little known overseas funds in which to invest surplus resources. In late-2002, Joanna Speed (Speed), an analyst at well known investment firm Merrill Lynch, prepared an eighteen page report on Parmalat, in which she laid out in lucid terms why she felt investors should steer clear of the company's stocks."The key issue which continues to perplex us is why the group (Parmalat) continues to tap the market for relatively small, yet often quite complex debt issues, when its cash pile continues to rise,"[1] wrote Speed.

On the basis of this report, Merrill Lynch advised its investors to sell Parmalat stocks. "We consider that management's regular tinkering with the balance sheet to little obvious benefit of the group undermines investor confidence and overhangs the share price," said the report.[2]

As the effects of the report gained in momentum, several other analysts also became skeptical about Parmalat's financial systems. Rumors began circulating in financial circles about the company's opaque financial systems and its high levels of debt. Consob, the regulatory authority in Italy also initiated an inquiry into Parmalat's annual statements, and asked the company to submit the work done by its auditors in 2002, for verification. The company's credit rating was also slashed by Standard and Poor after the auditors, Deloitte and Touche expressed doubts about its investment of €500 million in an unlisted mutual fund called Epicurum, based in the Cayman Islands, a well known tax haven.

The controversy erupted with full force in early December 2003, when Parmalat found itself unable to muster the resources to honor a €150 million bond payment that had become due. Considering the cash reserves the company claimed to have €150 million was a meager amount and it surprised analysts that it was not in a position to raise the amount. However, company officials announced that it was only a temporary liquidity problem that would blow over. Parmalat also announced that it was unable to withdraw funds from Epicurum, and hence the problem. It requested its banks to help it resolve the liquidity crisis.

Very soon after this, however, Tanzi admitted that the accounts of the Parmalat group were not accurate and that the books had been cooked. On this admission, the company's banks immediately appointed Enrico Bondi, a well known turnaround expert in Italy as a consultant. Later Tanzi resigned and Bondi took over the company in an executive capacity.

For all Bondi's skill turning around hopeless cases, Parmalat is likely to prove a monumental challenge. His biggest challenge would be to unravel the Byzantine financial systems, involving several overseas subsidiaries and accounts in banks around the world. This itself, was likely to take a number of months, considering the complications that arose as investigations proceeded. Then he would have to devise a suitable plan to help put the company back on its feet.

As the investigation deepened, it became clearer that the complicated systems of accounting were created quite deliberately by company officials and that they been operational for well over 15 years, since the late-1980s. The company used a complicated system of bond and derivative deals to transfer amounts between its different subsidiaries around the world to create a picture of financial health for the entire group. It had a regular system for creating false accounts and exercised it four times a year, when the quarterly results were announced. In fact, a subsidiary called Bonlat was created in the Cayman Islands, specifically to act as a routing agency for all overseas transactions of the company.
Most of the money went from Parmalat to other overseas subsidiaries that were operating poorly or to Tanzi family businesses and Bonlat acted as an intermediary in the transactions. It was said that Tanzi issued directions to officials at Parmalat that money be sent through bank transfers to companies owned by him or his family, or to other subsidiaries of Parmalat. The amount so transferred would be accounted for as a credit owed to Parmalat from the other companies. Most of the amounts however, were book entries and created huge assets for Parmalat, even when no money actually existed. The balance sheets of the subsidiaries were then adjusted to make sense of the group's overall financial position, and then reported as audited numbers. The company used complex derivative transactions (many of which defied the comprehension of specialist investigators after the scandal broke), to aid these transfers and cover huge group debts. The amounts thus transferred came to millions of euros over the years and were so cannily done that the company's auditors also failed to discover anything wrong with the system.

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