PARMALAT
How the Milk Spilled

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

continued : SNOWBALLING SCANDAL

In the course of the investigations, it was revealed that about 38 percent of Parmalat's assets were held in a Bank of America account by Bonlat. When asked to endorse this, Bank of America issued a statement to the effect that no such account existed with it and that it never did. However, Bonlat's auditors Grant Thornton said that the subsidiary had shown them a letter from the Bank proving the existence of the account earlier in the year. Bank of America said that it had not issued any such letter and that if a letter like that existed, then it was a fake. This resulted in a €4 billion hole in the company's accounts. This also dug out the fact that Parmalat regularly forged documents to help in the creation of false accounts.

The Bank of America case was just one instance of this. Prosecutors in the case discovered that in addition to the Bank of America letter, there were several other letters like that which were faked. Several statements of accounts and business transactions were also cooked up, and the majority of the third parties, including a Cuban company that supposedly bought tons of powdered milk from Parmalat, never actually had any business dealings with the company. The forging of documents and creation of fake accounts was a regular feature at the company. "Four times a year, the system of putting together false documents was activated on the occasion of the four balance sheet operations that the company had," Fausto Tonna, the company's long standing CFO who resigned in March 2003, was reported to have revealed to prosecutors.[1]

Following the announcement of Bank of America, Parmalat's shares fell by over 65 percent and trading in the company's shares was suspended indefinitely on the Milan Stock Exchange. Standard and Poor slashed the company's rating to default and questioned the reliability of any financial information released by the company. Further investigation also revealed that the hole in the company's accounts was much bigger than what was estimated and that it could be even to the tune of €10 billion.

Parmalat applied for bankruptcy in late December 2003, and was declared bankrupt by a court near Parma. Soon after this, the Italian government passed an emergency decree under which, Parmalat was assigned to special administration under a board headed by Bondi. The decree allowed the company to conduct business from working capital while being protected from creditors for 120 days.

What further aggravated matters was that, not only was Parmalat guilty of deception, but also tried to obstruct justice and hamper the work of the investigators. As the news of Bonlat's accounts broke, it was reported that a 'top official' within Parmalat ordered that all the documents relating to Bonlat be destroyed so that investigators did not find evidence. It was said that one of the company's employees smashed a computer with a hammer to destroy its hard disk. It was said to be the same computer that was used to create the fake letter from Bank of America. Analysts speculated that the 'top official' was probably Tanzi, but it yet has to be proved.

THE ISSUES

The case of Parmalat's blatant deception raised a number of important issues that held a lot of relevance to those interested in corporate ethics.

First, it dealt a strong blow to those analysts who smugly claimed for sometime after Enron and WorldCom that corporate governance and ethics at European companies, were better than those at their American counterparts. Coming close on the heels of French media giant Vivendi and Dutch retailer Ahold, Parmalat effectively proved them wrong.

Secondly, it brought the role of auditors sharply into focus. While Parmalat's auditors, Grant Thornton and Deloitte & Touche continued to claim that they were innocent and that they too were 'victims' of the fraud, there were very few takers for their assertions. Observers found it rather incredible that a company would find it so easy to hoodwink its auditors for over 15 years. Consequently, they believed that the auditors were hand-in-glove with the company's management. It was either that, or they did not perform their role sincerely. It is the responsibility of auditors to ensure that a company conforms to the principles of good governance. They have to spot financial irregularities in the company and conduct inquiries to determine their origin. However at Parmalat, the deception went unnoticed for years.

Thirdly, it exposed the peculiarities of the Italian business environment. Most of the companies in Italy were owned by families and things were kept within the trusted circle of a few insiders. This gave more scope to manipulate information and resources, and consequently allowed companies to behave unethically. The very fact that the Parmalat controversy was given nothing more than a few column inches in the local newspaper at Parma, while it was making headlines in reputed dailies around the world, led analysts to believe that most of the local people had known what was going on, but had not acknowledged it openly. "It was scandalous-a classic case of omerta ,"[2] said one Parma businessman, reacting to the newspaper's attitude.[3]

Some people also feared that the scandal would reflect badly on the country as a whole and that people would fear investing in Italy in the future. "There is a danger that Italy will be labeled as a country with no rules. Or where the laws are just there to be changed," said Tito Boeri, a professor of economics at the Bocconi University at Milan.[4]

The collapse of one of the major companies in Italy was also expected to have adverse consequences on the country's economy. Parmalat purchased about 8 percent of the entire milk production in the country and provided livelihood to about 30,000 people in Italy. So it is only to be expected that the country would be hit hard. The Italian economy minister, Giulio Tremonti was also reported to have said that the financial scandal would cost Italy about €11 billion in the fiscal 2003-04. That figure amounted to one percent of the country's gross domestic product (GDP) and was almost exactly equal to the amount that the government was hoping to save in order to cut its budget deficit from 2.5 percent of GDP to 2.2 percent in fiscal 2003-04. Therefore, the Italian government's eagerness to put the company back on its feet is also not surprising. In addition to passing an emergency decree, the government was also providing aid to Parmalat and was said to have requested the regulatory authorities in the European Union to waive the Union's rules on state aid to failing companies.

Not withstanding the specific issues of the case, Parmalat revealed the very disturbing trend that many global companies have of masking their true financial position in annual statements covering several bank accounts and global subsidiaries. It showed the apparent ease with which companies can deceive investors and regulatory authorities, all the while maintaining an image of goodness.

However, despite the seriousness of the issue and the bankruptcy of the company, many people were still confident that, unlike Enron (to which it was most often compared), Parmalat would live and recover. The company's basic business of milk processing was a healthy operation and still enjoyed the trust of people. This confidence was justified by the fact that, close on the heels of the scandal, Parmalat's figures showed that the sales of its long life milk in Italy were up 13.8 percent at the beginning of 2004. Parmalat's death would also cost Italy dear and this was another reason why people believed that the country's government would spare no effort in turning around the company. However, recovered or otherwise, it was unlikely that Parmalat would recapture its old glory in world markets.

[1] Tom Rachman, Parmalat scandal widens in Italy, Star Telegram, January 1, 2004.

[2] Omerta means 'silence'. It was normally associated with the Sicilian Mafia.

[3] Peter Gumbel, "Land of Bilk and Money", Fortune, January 26, 2004.

[4]Sophie Arie, "Time For a Break in the Family Circle", Guardian, January 15, 2004.