Still crying over spilt milk

Oct 4th 2005
From The Economist Global Agenda

The trial of Calisto Tanzi, former boss of Parmalat, has opened in Milan. This and other legal action relating to the accounting scandal that bankrupted the Italian dairy giant will remind investors that Italy is in need of better financial regulation. But the chances of reform look slim

THE bankruptcy of Parmalat in December 2003, after the discovery of a giant accounting hole, inevitably invited comparison between the Italian dairy group and Enron, an American energy-trading company that collapsed in 2001. There are indeed numerous similarities. Both firms misled markets and investors over the health of their accounts and both spectacularly imploded when the extent of the deceptions became known. And in the aftermath, exhortations that this sort of thing must never be allowed to happen again were accompanied by a welter of arrests and lawsuits against those thought to have perpetrated or borne some responsibility for the frauds.

However, one obvious difference between the two collapses is the pace at which the alleged perpetrators have been dragged into court. On Wednesday September 28th, less than two years after Parmalat went bust, a trial began in Milan of Calisto Tanzi, former head of the family-controlled firm. Along with 15 others, including former executives and two financial institutions, he is accused of market-rigging, false accounting and misleading regulators. Meanwhile, Enron’s former chairman, Kenneth Lay, and former chief executive, Jeffrey Skilling, still await trial for their part in the company’s demise.

Another difference is that “Europe’s Enron” is still in business—and even reported a modest first-half profit for 2005. Much of the credit for keeping Parmalat alive goes to Enrico Bondi. He has enhanced his reputation as a corporate-turnaround expert by resurrecting the firm in his role as special administrator.

Despite some earlier concerns that a firm with a healthy cash balance seemed to be taking on rather a lot of debt, the first obvious signs that all was not well at Parmalat came in December 2003 when the firm failed to repay a €150m ($180m) bond. It quickly became clear that the investments which Parmalat had intended to use to repay the debt did not exist. By mid-December Mr Tanzi, the chairman, founder and main shareholder, quit and was replaced by Mr Bondi. Shortly afterwards he was arrested along with several other executives.

In due course the scale of the fraud became apparent. Over a decade the apparently thriving company had reported profits while masking losses that added up to a €14 billion hole in its accounts. But the fraud was nowhere near as sophisticated as the financial shenanigans at Enron. A key element, for instance, was a crudely forged letter from Bank of America confirming the existence of an account containing €4 billion at a Parmalat subsidiary in the Cayman Islands.

The trial of Mr Tanzi, some ex-employees, three Bank of America executives and former auditors is the first Parmalat-related case to reach court. However, in June a judge in Milan sentenced 11 people, mainly former company employees, to jail terms of up to two-and-a-half years after plea bargaining on charges similar to those Mr Tanzi faces. Among them was Fausto Tonna, Parmalat’s former chief financial officer, and Gian Paolo Zini, a lawyer who set up offshore vehicles to hide losses. Along with Mr Tanzi, these two made up the triumvirate that ran Parmalat. Also sentenced were Mr Tanzi’s brother and son.

Mr Tanzi had also hoped to bargain for a reduced sentence for charges that could carry jail terms of up to five years, but his request was refused. And even if he is found guilty in Milan and goes to jail, there is potentially far worse in prospect. Another investigation by prosecutors in Parma could result in further charges against Mr Tanzi and others on more serious charges that carry sentences of up to 20 years in prison.

Mr Tanzi’s defence, like that of Bernie Ebbers, is likely to be that he knew nothing of the frauds perpetrated at Parmalat. Mr Ebbers had little luck: he got 25 years inside for his role in the demise of WorldCom, his telecoms company.

Mr Bondi may have little time for such a defence, but he certainly believes parties other than Mr Tanzi played key roles in Parmalat’s travails. He is pursuing a host of the firm’s former bankers and auditors for damages and to recover cash lost in deals made by Parmalat shortly before it went bust. He is seeking $10 billion through American courts from the group’s auditors—Grant Thornton and Deloitte & Touche—and Bank of America and Citigroup. He is also seeking over €10 billion through Italian courts from a group of banks that includes J.P.
Morgan, UniCredito Italiano, Deutsche Bank and UBS. And on October 4th, Mr Bondi launched another lawsuit against Credit Suisse First Boston claiming €7.1 billion in damages and said that there would be further claims for some €8.2 billion against financial institutions that were not named. In addition, the banks face a class-action suit in America from Parmalat’s shareholders and bondholders.

Despite the unusually sprightly response of Italy’s courts so far, the various cases connected with Parmalat could drag on for many years. (The next session of the current trial is not due until December 2nd). And Italy’s attempts at legislation along the same lines as the Sarbanes-Oxley Act, America’s response to Enron’s collapse, have faltered. A new insolvency law was rushed onto the statute books but efforts to introduce a bill to tighten the country’s financial regulation have been held up in parliament for the past year and a half.

Opponents of Sarbanes-Oxley may say this is a good thing. They claim that the new law has imposed hefty compliance costs on all businesses for the sake of deterring the few bad apples and that companies had cleaned up their acts anyway for fear of scaring away investors. Italian businesses, too, have taken some voluntary measures in the wake of the Parmalat affair, such as appointing more independent directors to their boards.

But Italy remains in a regulatory mess: it has four separate financial watchdogs as well as a supervisory role for the central bank. The current political crisis there, caused in part by a banking scandal, has done little to reassure investors, and the crumbling coalition government led by Silvio Berlusconi is unlikely to make regulatory reform a centrepiece of its campaign for the general election due next spring. Furthermore, the continued legal wrangling over Parmalat will only serve to remind investors that there are safer places in which to stick their money than Italy.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.