Europe's Enron?

Parmalat (latte is milk in Italian, and Parma the name of the place) is a giant milk and cookies producer and distributor with operations in many countries and a turnover of $10 billion.

It is obvious, however, that Parmalat's financial operations are not quite as wholesome as milk and honey  --  there is a Euro 13 billion ($17 billion!) hole in the balance sheet. Income and earnings have been overstated. Actual debt, at Euro 14.5 billion, is eight times the disclosed figure.

The Italian authorities have arrested the company's promoter and senior management, partners of the auditing firm and so on, but are nowhere near locating the money. Calisto Tanzi, the promoter, has acknowledged diversion of only Euro 500 million.

In the US, where the company had sold bonds, the Securities Exchange Commission has alleged "one of the largest and most brazen financial frauds in history", and has charged the company with material misstatement of facts in its offer document.

US investors have alleged that investment banks connived at transactions used "to artificially inflate Parmalat's financial statements", and are suing.

Parmalat was an old-style family-managed company with the promoter's relatives and long-serving friends on the board and working as senior executives. It had a network of family-owned companies, and a number of offshore subsidiaries in various tax havens.

The company was "over-fond of elaborate (complex) bonds and derivatives deals" and published accounts that investors and, indeed, the company's own bankers struggled to understand.

To get a flavour of the opaque accounting, consider one large transaction listed in the group balance sheet under "financial contributions deriving from a participation agreement drawn up by a consolidated company, in partnership with a third-party financier". Anyone who understands this deserves a medal.

The affair started unravelling last December when Parmalat defaulted on a relatively-small bond obligation of Euro 150 million.

The bubble burst a few days later with a communication from Bank of America to the auditors of Parmalat's Cayman Islands subsidiary, about the existence of an account said to hold $3.95 billion, which turned out to be fraudulent.

For organising the complex financial structures and derivatives transactions, the clutch of "usual suspects" are of course there in the Parmalat case  --  Citigroup, JP Morgan, Morgan Stanley and Merill Lynch.

Deutsche Bank had also advised Parmalat in answering queries raised by the rating agency, and could well land into trouble for its involvement in that area  --  based on the answers, Parmalat enjoyed an investment grade rating right up to the day the bubble burst.

Deutsche Bank and Citigroup analysts' reports continued positive up to October/November 2003!

As investigations continue, some transactions, perhaps only the tip of the iceberg, have come to light:

• Tetra Pak, a Swedish supplier, paid Euro 90 million out of the discounts due from it to Parmalat, to an account controlled by the promoter's family, as instructed by Parmalat;
• Carital, a family associated company, fraudulently billed Parmalat for millions of euros, to remove funds;
• Over 2002-03, Parmalat and its subsidiaries raised a total of $7 billion equivalent in bond issues in Cayman Islands and the Netherlands even when the accounts were showing huge cash balances. Some transactions involved private trusts buying unsubscribed bonds. One subsidiary raised $300 million last year, despite its accounts having been qualified for three successive years;
• In Brazil, acquisitions were made at inflated prices to pay bribes;
• Bonds worth $2.9 billion, reportedly bought back by Parmalat as per its accounts, were in fact still outstanding;
• A Cayman Islands mutual fund supposedly holding Euro 500 million of Parmalat's money, does not seem to be traceable now.

Apparently, books have been fudged for 15 years!

But coming back to the banks specialising in structuring complex transactions, one question needs to be considered: Do such complex transactions satisfy any basic economic purpose beyond feeding the pockets of the investment banks who package them?

Nobel Laureate James Tobin gave the answer back in 1984: "I confess to an uneasy...suspicion, perhaps unbecoming in an academic, that we are throwing more and more of our resources, including the cream of our youth, into financial activities remote from the production of goods and services..... I suspect that the immense power of the computer is being harnessed to this 'paper economy', not to do the same transactions more economically but to balloon the quantity and variety of financial exchanges".

One recent article on the subject of risk management also noted that "complex structures...(have) moved further and further away from financial reality  --  and were being bred simply to avoid accounting rules. . . by abiding to the letter, not the spirit, of the law."

Corporate users of complex structures would do well to remember the old adage: "caveat emptor", or buyer beware!

But, overall, what I find astounding is that, after Credit Lyonnais, Vivendi, Ahold, Kirch, Parmalat and others in Europe, and Enron, Tyco, WorldCom in the US, western commentators still manage to sneer at the business practices and corporate governance in emerging markets, that too with a straight face.

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