The Milk Just Keeps On Spilling At Parmalat

It's a tale of globalization gone wrong: Bankers across Europe harbored doubts about company numbers for years, yet no one blew the whistle

The prisoners have begun talking. And talking. From his cell at Milan's gloomy 18th century San Vittore prison, Italian entrepreneur Calisto Tanzi has admitted to magistrates that he cooked the books for more than a decade -- and skimmed off at least $640 million from his publicly traded dairy company, Parmalat, to plug losses at family businesses. Parmalat's chief financial officer Fausto Tonna, too, has provided some fifty hours of testimony to prosecutors detailing how he and Tanzi pulled off biggest fraud in European financial history. Both were arrested in December along with seven other Parma executives, accountants, and advisers on suspicion of false accounting, fraud, and market-rigging after the globe-spanning dairy company went belly-up.

You've heard many of the details: The $13 billion in missing assets that no one can account for. The $5 billion Bank of America (BAC ) account that didn't exist -- and the forged letter on BofA stationery that allegedly fooled auditors into thinking it did. The bewildering constellation of offshore subsidiaries. The faked invoices for hundreds of millions of dollars in bogus sales. The $640 million of Parmalat funds gone missing in the Cayman Islands investment fund. The family travel business, Parmatour, run by daughter Francesca, that received a mysterious series of cash infusions. More revelations surface every day. (Neither Tanzi nor Tonna were available to comment and their lawyers did not return phone calls.)

But there's a parallel tale to this Italian family saga. It's a story of globalization gone wrong. Evidence is emerging that many investment bankers in Italy, Germany, and London harbored doubts about Parmalat's numbers for years, suspicious of its superheated growth. They also wondered why an Italian dairy company needed to raise so much debt if it had billions in cash. Other banks, meanwhile, liked what they saw: a fast-growing company in an easy-to-understand business, with books audited by one of the Big Four -- all good reasons to court Parmalat for its steady business in stock and bond offerings.

Did Parmalat's banks, then, deliberately ignore the warning signs? Or were they, too, taken in, as most of them vigorously claim? One thing is clear: The global influence of the top banks helped spread the mayhem among investors from London to Alaska. Some $1.5 billion in Parmalat bonds were sold to U.S. investors alone, mainly through private placements. Bankers, accountants, legal advisers -- even some members of Calisto Tanzi's family -- all claim that they had no idea what was going on. "What's appalling is that the mistakes were made by many banks all over the world. Parmalat was a totally international affair," says Valter Lazzari, professor of banking and finance at Bocconi University in Milan.

The next round of bombshells, therefore, is likely to concern the bankers, accountants, and other financial advisers who worked with the company over nearly two decades. A U.S.-based class-action filed Jan. 5 on behalf of Parmalat investors targets Citigroup, Deloitte Touche Tohmatsu, and Grant Thornton International, in addition to Parmalat management. The charges range from assisting in manipulative financial transactions to participating in the falsification of audit-confirmation documents. Citigroup and Deloitte firmly deny wrongdoing, insisting they were victims of the fraud. "We believe [the suit] is baseless and without merit," says a Citigroup spokesperson. Deloitte points out that it raised the alarm about Parmalat late in 2003. A Grant Thornton International spokesperson says the firm feels it is not liable, and that its former Italian partnership should bear responsibility if there was misdoing.

RUNNING FOR COVER. That's not all. Italian magistrates last week raided the Milan offices of Deutsche Bank (DB ), seizing documents. Officials at Bank of America and Citigroup in Italy are also being questioned, as are the top executives at Italy's largest banks. Prosecutors suspect some outsiders from banks, law firms, and accounting companies were involved in the fraud, making it more difficult to detect. That's why two outside accountants for auditors Grant Thornton are under arrest. Twenty-five other outsiders are under investigation, including two Deloitte managers and a former Bank of America corporate banker in Italy, Luca Sala. A BofA spokesperson says the company won't comment on Sala because he left the firm last June. She adds that BofA has to date "found no evidence of wrongdoing by any current or former employee of the bank." Deutsche Bank says it is cooperating with investigators.

Sala and the auditors from Grant Thornton and Deloitte deny responsibility for the fraud. But those close to the investigation say the Parmalat dragnet could ensnare members of Italy's financial establishment. "The whole thing is rotten. Everyone is running for cover," says one senior Italian banker.

Several bankers told BusinessWeek that they suspected trouble at Parmalat years before its fall. "Things have been strange at Parmalat since the mid-1980s," says one senior investment banker, who avoided all business with the company. "It smelled bad." As the fast-growing dairy group returned time and again to the corporate-debt market -- issuing some $8 billion in bonds between 1993 and 2003 -- analysts, investment bankers, and fund managers all began raising questions about Parmalat's strange hunger for debt despite its seeming mountain of cash. The Parmalat board, consisting overwhelmingly of family members and Parmalat insiders, wasn't prone to raising questions. According to a person close to the situation, several worried fund managers started to lobby Tanzi in 2003 for an independent member to be chosen by minority shareholders on the audit committee, as was their legal right. Tanzi refused, and they didn't take the matter further.

Governance specialists in Europe flagged Parmalat as a company ripe for trouble due to a combination of its poor stock performance, strange asset allocation, and lack of independent board members. "The audit committee met twice in 2002. That's pitiful. For us, Parmalat was a disaster waiting to happen," says Stilpon Nestor, member of the European Corporate Governance Council and founder and principal of Nestor Advisors Ltd. In London.

When confronted -- in phone calls, meetings with underwriters, or on road shows -- about the company's opaque finances, Parmalat's former chief financial officer, Fausto Tonna, bluffed. To answer the question of why Parmalat was boosting debt further when it had such huge cash reserves, Tonna had a standard reply: The company was on an acquisition spree and needed cash -- and the liquid funds were earning good returns, 3.5% after taxes in 2003. Tonna's lawyer did not return calls for comment.

Yet by early 2003, equity analysts were becoming increasingly skeptical. "The actual size of Parmalat's net financial debt is, in our view, much higher than the $2.3 billion reported by the company," said an analyst at Auerbach Grayson & Co. on Jan. 24, 2003, putting the figure at $4.5 billion. A research report sent to investors by Merrill Lynch & Co., as well as internal reports by Lehman Brothers Inc. (LEH ) and Goldman, Sachs & Co. (GS ), also cast doubt on Parmalat's stated performance. "If a company like Parma is very, very well managed, it earns about 6% to 7% operating margins. Parmalat was reporting 12%," says one Milan banker.

REASSURING REPORTS. The mounting criticism spurred Tanzi to counterattack. On Mar. 20, he sent a 34-page complaint to Italian stock market regulator Consob, charging Lehman and others with seeking to slander the company in order to make speculative gains on Parmalat's shares. Nonetheless, the critical reports raised enough fears to force Tanzi and Tonna to pull a planned $384 million bond issue in February.

Some banks, however, issued reassuring research reports until a month before the collapse. An October equity report by Deutsche Bank rated Parmalat's shares a buy and noted the strong cash flow, which warranted a higher premium. Citibank also issued an optimistic bulletin on the company in November. That was shortly before Parmalat failed to meet a $184 million payment to bondholders and admitted, under prodding from Deloitte, that it could not liquidate some $640 million it had said it held in a murky Cayman Islands mutual fund named Epicurum, the activities of which the company could not describe.

Financial markets panicked, and CEO Tanzi appointed respected turnaround specialist Enrico Bondi as adviser. But when Bondi suggested liquidating a $5 billion Bank of America account to pay debts, "the rabbit popped out of the hat," in the words of one banker, since the account was fictitious.

Long before the final day of reckoning, Parmalat had several brushes with disaster. In 1988, after an acquisition spree, Tanzi was facing a debt crisis. Bankers suggested he sell the $717 million company to U.S. giant Kraft Foods Inc. (KFT ). Tax police launched an investigation into one of Parmalat's Swiss subsidiaries for false accounting. The inquiry lasted six years but never resulted in charges.

Many believe Tanzi was already out of his depth by then as a manager. He had made acquisitions in Brazil and Europe in the 1970s that were largely unprofitable, but he seemed to pay little attention to performance, focusing instead on growth. Italian sources say Tanzi was probably driven to falsifying accounts as losses mounted in the 1980s -- out of fear of losing face.

But Tanzi was lucky in 1988. Political allies helped him arrange an $80 million financial bailout from a seven-bank consortium led by Monte dei Paschi di Siena. At the same time, Tanzi began creating a web of finance companies in the Dutch Antilles, which magistrates believe were used to hide liabilities from investors prior to listing Parmalat's shares on the Milan stock exchange. Once Parmalat was public, Tanzi quickly began tapping into the vast global capital markets. Between 1990 and 2003, Parmalat raised a total of about $8 billion in debt globally. Bank of America arranged $743 million in debt sales between 1997 and 2002. Chase Manhattan, Bank of Boston, Deutsche Bank, Barclays, and Merrill Lynch (MER ) sold billions of dollars of debt. The cash injections fueled frenetic growth -- 17 acquisitions in 1993 alone -- boosting revenues from $800 million in 1990 to $9.7 billion.

OFFSHORE LEGERDEMAIN. Tanzi also went to great lengths to limit the number of outside eyes prying into his books. When Italian regulations required Parmalat to change its accountants in 1999 after nine years, Tanzi shut down all its offshore companies in the Dutch Antilles and set up a new batch in the Cayman Islands, making sure the oversight of the new accounts remained in the hands of its former auditors, Grant Thornton. By then, Grant Thornton Italian managers Lorenzo Penca and Maurizio Bianchi had already been working for Tanzi for a total of 15 years, part of the time under the auspices of another accounting firm. Penca and Bianchi have been arrested by Italian authorities on suspicion of fraud but not officially charged. Their lawyers say the two deny any wrongdoing.

But even if business was tough, Tanzi always found banks willing to do business. In addition to underwriting Parmalat's last bond issue in September, which paid interest of 6.125% at the time of offer, Deutsche Bank purchased 5% of Parmalat's shares on the same date, selling down the position to 1.6% on Dec. 19. The sell-off came two days after Bank of America, when asked by Grant Thornton to verify the $5 billion that Parmalat claimed it held at the bank, told the auditors, and then the Securities & Exchange Commission, that no such account existed. Deutsche Bank officials insist the purchase was made on behalf of another client. One Deutsche bank executive says the capital-markets team in London assumed Parmalat was a reasonably sound business, even if hard to deal with, based on the company's statements. On Jan. 13, Standard & Poor's said it relied on documents from Deutsche Bank when it retained Parmalat's rating at BBB-, one notch above junk, prior to the bond issue in September.

Private-equity firms, for their part, did sense impending disaster. In a last-minute maneuver, Tanzi and his son Stefano met in Italy with executives of New York private-equity specialist Blackstone Group LP on Dec. 9 about a possible buyout. The meeting came a day after Parmalat admitted that it had not recovered a payment of $640 million from the Epicurum investment fund in the Cayman Islands.

During the course of discussions, they confirmed that $12.8 billion was missing from the company's balance sheet, according to a lawsuit filed by the SEC. Blackstone's managers refused to work with Parmalat on a buyout plan unless Parmalat publicly restated its books. And Blackstone was not the first buyout group to back away. In 2002, several private-equity companies considered taking over Parmalat as its share price plunged, but all steered clear. Thousands of investors wish they had done the same.

By Gail Edmondson in Parma, with David Fairlamb in Frankfurt, Nanette Byrnes in New York, and bureau reports

    Before it's here, it's on the Bloomberg Terminal.