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Parmalat: Europe`s rotten cheese

In late 2003 the Parmalat scandal broke aIter it become known that nearly 2.7
billion pounds didn`t actually exists in an account at the Bank oI America. In today`s
terms, not including inIlation, that`s roughly the equivalent oI a little over $4.3 billion in
nonexistent money. As a result, prosecutors in Europe as well as the United States levied
charges against the dairy giant, alleging that, among other things, it had overstated cash
and marketable securities, understated its reported debt, and embezzled nearly $500
million to businesses owned by executive`s Iamily members.
One oI the Iirst case questions that I would like to touch on is the one covering
why the United States Securities and Exchange Commission Iiled charges against
Parmalat in US courts instead oI in the Ioreign courts. In 1976, Congress passed the
Foreign Sovereign Immunities Act (FSIA), a law that reaIIirms sovereign immunity oI
separate nations and protects Ioreign governments Irom being sued in US courts unless:
1) the lawsuit is in connection with a commercial activity carried on in the US or that has
a direct eIIect on the US, or 2) iI the nation sponsored terrorism (courtesy oI Larry
Spurgeon`s summer BLAW 636 class).
This act eIIectively gave the SEC the ability to Iile charges against a Ioreign
business entity within the United States court systems. In the amended complaint Iiled on
July 28, 2004, the SEC alleges that Parmalat engaged in 'one oI the largest Iinancial
Irauds in history and deIrauded U.S. institutional investors when it sold them more than
$1 billion in debt securities (Mintz 267). Due to the damages occurring in the US and to
US citizens, legally speaking the SEC has every right to press charges within the United
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States in an attempt to mitigate damages caused Irom the Iall out at Parmalat. In Iact, I
believe that the SEC has the ethical responsibilities to mitigate damages caused to
investors by regulating certain Iinancial markets and levying Iines when situations
warrant.
It becomes highly obvious aIter reading through some oI the allegations made in
the SEC complain (understating debt, transIerring money Ior services not rendered, and
using Iake entities to make up transactions), that there had to be absolutely no internal
controls whatsoever! In addition, it hints at a very low quality oI Iinancial reportingiI
there was even actual Iinancial reporting at all. Given the Iact that they were using
Iictitious entities to Iabricate Iinancial data, it makes me question the validity oI all oI
their Iinancial data, not just the parts that were obviously made up.
As Iar as transparent Iinancial reporting goes, I can`t see how a company oI this
size could get away with what they did Ior as long as they did. Transparency obviously
wasn`t taking place, period. In Iact, in the case it even mentions that Parmalat Iailed to
disclose inIormation regarding to the transIer oI large amounts oI cash to the Tanzi
Iamily. It Iurther goes on to say that during investigations, it was noted that the auditor
Irom 1990 to 1999 did not have copies oI documents relating to the companies Ioreign
subsidiary, Bonlat, located in the Cayman Islands. It was later Iound out that these
subsidiary companies were used to generate Iictitious revenues. Probably explains why
the paperwork was missing or nonexistent.
When it comes to Iraudulent acts, by paying out money to the Tanzi Iamily, the
Iirm was directly parting in embezzlement oI company Iunds. Aside Irom being illegal in
nature, this also violated the Iiduciary duty owed to shareholders by the executives oI the
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company. By not acting in the best interests oI the company and not attempting to
maximize shareholder returns, any shareholder may bring about a lawsuit against
directors or oIIicers oI the corporation Ior violating said Iiduciary duties (Spurgeon).
Another Iraudulent act that occurred is something known as a 'conIidence trick.
It`s basically where people or a Iirm misrepresents material Iact to take advantage oI
another person (basically, think oI a con artist). By misrepresenting Iinancial inIormation,
investors bought into the company expecting a reasonable rate oI return at a reasonable
risk to them personally. Instead, basically they bought into a lie, which is where the con
artist or 'conIidence trick aspect comes into play. They thought they were getting
something oI value, when it Iact, it`s highly possible at the time oI purchase oI the stock
or debt security oI the company, that it actually had no market value whatsoever iI the
actual Iinancial inIormation was reported.
Another criminally punishable act is the Iailure to perIorm the Iiduciary 'duty oI
care. Although not necessarily Iraudulent, a companies executives and directors have the
duty to act as a ordinarily prudent person, making reasonable investigation and acting in
good Iaith Ior the best interests oI the corporation (Spurgeon). It`s blatantly obvious that
none oI the executives within Parmalat were doing any oI this! FalsiIying Iinancial data
and embezzling money by giving it to Iamily members is a Iar cry Irom being a
reasonably prudent person.
For lack oI a better idea oI how to structure this paper, I`m going to move on to
discuss what the 'Iinancial shenanigans are as outlined by Schilit in the Mintz textbook.
The Iirst issue to classiIy using this system is the transIer oI money Irom the
corporation to the Tanzi Iamilythis most likely Ialls under Shenanigan #7, 'shiIting
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Iuture expenses to current period as a special charge. The reason Ior this stems Irom the
Iact that the argument could be made that the Tanzi Iamily was going to provide Iuture
services to Parmalat, thereby generating a Iuture expense in the Iorm oI consultations or
services. However, when the expense/transIer oI money occurred, no service had been
rendered on behalI oI the Tanzi Iamily to the Parmalat Corporation.
In regards to one oI the SEC allegations oI Parmalat overstating its levels oI cash,
that most likely Ialls into shenanigan #2, 'recording bogus revenue. One oI the Iew, and
probably simplest ways oI boosting revenue, would just be to record Iake cash sales in
order to temporarily boost proIits and make Iinancials look peachy. The downside oI
course is whenever there`s actually no cash-money coming into the organization. This is
especially troublesome when it comes to paying those pesky expensesthe ones that
actually happen, not the made up ones.
The next SEC allegation is understating reported debt by almost $10 billion
dollars by using various tactics. One oI which was eliminating debt held by a nominee
entity. This Ialls under Shilit`s 5th shenanigan oI 'Iailing to record or improperly
reducing liabilities. Fairly straight Iorward, Parmalat wrote oII the debt illegally which
resulted in improperly reducing liabilities, even though technically those liabilities still
exist externally most likely. Another that Ialls under the same classiIication would the
Parmalat recording $1.6 billion in debt as equity through a loan agreement. Personally I
thought this was a rather creative to write down liabilities and seemed to be a really
interesting concept.
One oI the next SEC allegations in their lawsuit accused Parmalat oI removing
$500 million in liabilities by lying about selling certain receivables, when in Iact no such
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sale took place and the company maintained the actual liability. This Ialls under
shenanigan #1, 'recording revenue too soon. At the time oI writing down these
receivable accounts, actual collection oI the revenues had not occurred yet. Even though
the sale had taken place, cash had not been collected, leaving the company with the
remaining liability.
Item d in the book under the SEC allegations was pretty interesting. Parmalat
basically took external debt and classiIied it was being an internal debt. The reason why
this struck me as kind oI interesting is the Iact that our class has just recently discusses
transIerring costs within an organization between branches or departments. We learned
the proper way to do it and here is a perIect example oI how those methods could be
misused.
One oI the last things in the allegations is probably the most priceless. This is
where Parmalat used subsidiary or nominee entities to basically shuIIle numbers around.
One would create nonexistent revenue, thereby negating the eIIects oI losses in another
nominee entity or transIerring that revenue to cover up losses in other area oI the
company. It just goes to show you what an accountant can do when it comes to getting
creative and covering up an absolute mess.
One oI the things that really was interesting to me while reading through this case
is that Europe didn`t seem to have many explicit or 'hard rules regarding this kind oI
Iraudulent accounting. They use what is known as a 'principals-based approach whereas
the United States uses a 'rule-based approach. I think the main diIIerence being is that
the United States had already dealt with a Iair share oI accounting problems and scandals
beIore Europe dealt with their Iirst large magnitude one. Americans are creative,
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ingenious, determined, and some oI us are very good at being greedy capitalistsit
makes sense that we would have oI 'been there, done that in a sense. It also makes sense
that policy makers would have been appalled and worked to correct the problems as soon
as possiblehence the rule-based approach to accounting standards.
One oI the reasons why I picked this case was because oI the sheer magnitude and
super materiality oI some oI the amounts involved. This Iraud occurred over the course oI
multiple years and it both shocks and Irightens me that nobody caught it or had the
decency or the nerve to stand up and say 'HEY! She`s going down! Bail out! The worst
part in most oI these scandals, at least in my opinion, is the negative impact is has on the
market, the stockholders, and the accounting proIession. You can`t easily do creative
accounting without someone Iamiliar with accounting behind the wheel making the
changes and Iudging things up.
In recent news regarding this scandal though, back in April oI this year, Iour
banks were acquitted in the Parmalat scandal. Those banks included Citigroup Inc., Bank
oI America Corp., Deutsche Bank AG and Morgan Stanley. They had been Iormerly
accused oI stock-market manipulation and Iailing to have necessary procedures in place
that could have prevented the crimes that lead to the Italian based Parmalat sink.
In even more recent news, in a June 28th Wall Street Journal Article, Lactalis, a
competing dairy company, managed to gain control oI 9 oI the 11 Parmalat Board oI
Direct seats. This Iurthers their control in the company. In addition to their 29 share
hold in the company, they`re now poised to be able to execute high level decisions within
the organization.