The Price We Pay for Cosy Ties with Banks and Auditors!
Tuesday, November 30, 2004 at 4:01AM Rarely could corporations defraud investors without the assistance of others like the bankers, auditors and attorneys. An article written by Andrew Davis and James Pressley in the Business Reporter entitled Millions pay the price for Parmalat's cosy ties with banks and auditors, shows how Bank of America assisted Parmalat in defrauding millions of investors out of billions:
Four years before milk producer Parmalat Finanziaria collapsed in Italy's biggest bankruptcy, Bank of America's head of corporate finance in Milan, Luca Sala, encouraged the company to publicly describe $300 million (R1.8 billion) in loans as investments, not debt.
"Please use a text like the following," Sala wrote in a fax on December 17 1999. "Bank of America has led a group of US investors to invest $150 million in the Brazilian operating subsidiary of the Parmalat Group. The transaction may be increased by a further $150 million."
A day later, the dairy issued a news release under the headline "New shareholders for Parmalat in Brazil". It drove Parmalat shares up 17 percent the next trading day - the shares' largest one-day gain ever.
For almost a decade, bankers like Sala structured financing that helped Parmalat build a house of cards that kept debt off the books, confounded credit analysts and misled investors, according to thousands of pages of court documents, internal e-mails and regulatory filings.
"There is a great deal of concern about the role of investment banks and commercial banks in very complicated transactions ultimately intended to disguise true financial results," says David Ruder, who served as US Securities and Exchange Commission chairman from 1987 to 1989.
"It is the kind of action motivated by greed and a lack of integrity that ought not to be accepted," says Ruder.
Milan prosecutor Francesco Greco asked Judge Cesare Tacconi in May to indict Sala, Fausto Tonna (who was Parmalat's chief financial officer in 1999), Parmalat founder Calisto Tanzi and 26 other former officials, bankers and auditors on criminal charges that they had manipulated the market. The judge hasn't yet ruled on the request.
The Parmalat executives are also under investigation for fraud in a court in Parma.
Parmalat paid banks well for their help, says Enrico Bondi, the company's government-appointed bankruptcy administrator and chairman. About 40 percent of the e13.2 billion (R102.5 billion) in financing the company burned through from 1990 to 2003 went towards interest payments and commissions for the banks, he wrote in a June report.
Foreign banks raised about 80 percent of all bank financing for the company after 1990, providing the means for Tanzi and Tonna to hide more than a decade of losses and accounting fraud, prosecutors have said.
The weight of that debt dragged Parmalat into one of Europe's biggest bankruptcies when it defaulted in December 2003.
The banks say they were victims, not agents, of the fraud. Citigroup says it was owed about e540 million when Parmalat collapsed, making it the company's biggest creditor. Bank of America has already written off a similar amount of its debt.
Both banks say they didn't know the true state of Parmalat's finances before the fraud was exposed, and they plan to contest any allegations in court. Bank of America chief executive Kenneth Lewis says: "It defies logic to think that [we] knew of a company that was not solvent and were lending $600 million to it."
The case raises questions about how far banks, analysts and other gatekeepers of the financial system should go in determining the wellbeing of companies and in sharing that information with investors.
"The more desperate you become, the more creative you become," says Louis Gargour, a senior money manager at hedge fund firm RAB Capital in London. "If the banks were helping them with these novel financing structures, they should have sensed that something was amiss."
Gargour says he began shorting Parmalat bonds - betting they would decline in value - almost a year before the bankruptcy.
Greco also asked the judge for indictments against Parmalat's former auditors at the Italian arms of Grant Thornton International and Deloitte Touche Tohmatsu: Grant Thornton SpA and Deloitte & Touche SpA.
"There is a lot of freewheeling going on," says James Cox, a professor of corporate and securities law at Duke University in Durham, North Carolina.
He says bankers are often motivated more by winning fees than following rules. "Sometimes there is a breakdown of the protections in the organisation that aim to keep them in line."
Grant Thornton International has responded that Parmalat's accounts were audited mostly by Grant Thornton SpA, which the global accounting firm expelled from its network in January.
Evidence in the Milan court filings suggests that analysts, as well as bankers and auditors, could have done more to warn investors about Parmalat.
Internal e-mails show that Standard & Poor's (S&P) affirmed an investment-grade rating on the company in mid-September 2003 - three months before the collapse - even after its analysts said they doubted Parmalat's managers and its accounting.
"The problem is that we do not trust them," S&P analyst Vincent Allilaire wrote of Parmalat management in an internal message on September 12 2003.
"Cash flows are opaque, gross debt is ever increasing, despite their good words, and this reduces confidence further."
S&P didn't lower its credit rating on Parmalat until December 2003, just two weeks before the company publicly admitted that it had reported phony assets.
A written statement from S&P spokesperson Martin Winn says the company did nothing wrong.
Winn says S&P warned the public of increasing risk at Parmalat in September 2003 by lowering its outlook to stable from positive. The statement says S&P repeatedly pressed Parmalat for more information in 2003, only to receive detailed answers that later proved false.
Nine out of 14 stock analysts who followed the company rated its shares a buy in August 2003. There were still seven buy recommendations in November, even after Parmalat had named its third chief financial officer in less than a year and S&P had threatened to cut its rating to less than investment grade.
The Brazilian deal with Bank of America helps explain how Tonna, as Parmalat chief financial officer, succeeded in keeping almost $10 billion of debt off the balance sheet.
Acting at the behest of Tanzi, Tonna inflated sales, fabricated assets and created an interlocking network of international units that funnelled debt through the Netherlands Antilles and the Cayman Islands until it vanished from the group's books, Italian court documents show.
Another way Parmalat disguised debt was by using a company called Buconero, Bondi said in a lawsuit he has brought against Citigroup.
According to Bondi, Citigroup set up Buconero, which is Italian for "black hole", in 1999 in Delaware, allowing Parmalat to account for $137 million in loans as equity.
The loans were made to a unit called Gestione Centrale Latte, known as Geslat.
Citigroup knew Parmalat would record the loans as equity, investors allege in the class action lawsuit filed in US district court in New York on October 18.
"Buconero was created and designed by Citigroup for the express purpose of hiding Parmalat debt by improperly treating loans to Parmalat as equity investments,'' the suit says.
Citigroup said in a statement to bankruptcy court on November 1: "The Buconero/Geslat transaction was not, as is maintained, a disguised loan. The transaction was disclosed in Geslat's accounts, and the structure was fully compliant with the requirements of Italian law."
Citigroup has sued Italy itself, saying the government's handling of the group's restructuring violated the bank's rights as a lender. Bondi used his powers as bankruptcy administrator in July to recommend rejecting more than 99 percent of Citigroup's credit claims against Parmalat.
Sala referred questions to his lawyer, who didn't respond to phone calls and faxed questions. Tanzi and Tonna declined requests for an interview.
Bank of America spokesperson Liz Wood said the bank did nothing wrong in the Brazilian transaction and it was appropriately disclosed at the time. "Bank of America denies that it engaged in any form of market manipulation with respect to Parmalat".
Parmalat and its lenders grew so cozy over the years that the dairy became a revolving door for bankers. Sala left Bank of America in July 2003, when Parmalat hired him as a consultant. Alberto Ferraris joined Parmalat in 1997, after serving as a Citigroup vice-president who helped it expand into Canada in the 1990s.
Massimo Armanini walked through the door in both directions: as head of international corporate finance at UBS in 1996, he organised a e100 million loan to Tanzi. Armanini left UBS to run Parmalat's North American division from 1998 to 2000.
In March 2003, Armanini became Deutsche Bank's managing director for corporate finance in Milan, where he handled a Parmalat bond sale in September.
Parmalat's borrowing binge began in the 1990s, after Tanzi latched on to a new technology that allowed milk to be stored for months without refrigeration.
So Tanzi sought lenders willing to bankroll what became a e4.8 billion acquisition spree that transformed the dairy into one of the world's largest food companies, with operations in 30 countries from Mexico to China.
The acquisitions contributed to Parmalat losing money every year but one from 1990 to 2002, even though it reported earnings each year over that time. Tonna managed to hide e1.78 billion in losses, court records show.
Auditors from Grant Thornton SpA helped out, Tonna testified to prosecutors. Instead of questioning the company's accounts, Grant Thornton auditors assisted in the fraud by shifting some of the debt into two units in the Netherlands Antilles, called Curcastle and Zilpa.
That system faced a threat in late 1999, when Deloitte & Touche SpA replaced Grant Thornton as Parmalat's lead auditor under an Italian law requiring rotation every nine years.
So Grant Thornton auditors advised Tonna to transfer the hidden debt to a new unit they would audit, Tonna testified. In November 1998, the Cayman Islands arm of Grant Thornton International incorporated the unit as Bonlat Financing. Parmalat shifted more than e1 billion of Curcastle and Zilpa debt to Bonlat, which Tonna described in testimony as a garbage can clogged with fake assets and real debt.
Grant Thornton auditors also helped Tonna invent dummy transactions to help bury the bad numbers, Italian court documents show. In 2002, he consulted the auditors about creating a Cayman company called Epicurum, which Parmalat later presented to the world as an independent hedge fund in which it had invested about $500 million.
The collapse of Parmalat unleashed a barrage of criminal investigations, civil lawsuits, creditor claims and soul-searching among investors. It's unlikely anyone will come out a winner.
But one thing is clear: Bondi and the prosecutors have forced open a window on the darker corners of global debt markets.
Published on the web by Business Report on November 28, 2004.
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