Case in Point

Investors Through Financial Statement Fraud


Parmalat – a milk-and-cookies conglomerate – seemed at first glance to be above suspicion. But the firm began to implode when the Italian regulatory commission began its investigation, a Parmalat bank account supposedly holding 3.9 billion Euros was found to be fictitious, and Parmalat fired its two chief auditing companies. This one will last for years.

If you've ever traveled or lived in Western Europe, it becomes apparent that any expectations of fresh milk – delivered from local farmers, served in glass containers – are badly dated, naïve dreams. Fresh milk is a rarity in Europe , with sterilized milk in drink box-like cartons or shrink-wrapped plastic bottles being the norm. Dominating this norm is Parmalat Finanziaria, Europe 's largest milk producer, generating 2.7 billion Euros in European sales.

Along with milk, Parmalat produces ready-to-eat milk-based sauces, yogurts, tomato products, as well as a selection of food stuffs. Americans may know Parmalat through its holdings of Archway, Mother's, and Salerno brands, with Parmalat coming in as America 's third-largest producer of cookies. If classified along the lines of American publicly traded companies, Parmalat would find its place in the rather vanilla Foods category, where, according to its 2003 financial report, it generated approximately 7 billion Euros in worldwide revenue. While an impressive presence in Europe , Parmalat obtains 60 percent of its revenue from its worldwide subsidiaries in the Americas , Asia , Africa , and Australia , employing 36,000 throughout the world.

Signs of Trouble

To begin with, Parmalat was never a particularly lucid example of financial reporting. The conglomerate produced long, complex, and convoluted financial statements, along with bizarre, baroque, and confusing “guidance” from management. Two examples might serve to illustrate the confusing nature of information produced by Parmalat. Pages 51 through 77 of Parmalat's 2003 half-year report provide, in small-fonted, densely presented spreadsheets, a breakdown of related party holdings and transactions. Here one encounters a complex array of intercompany loans, transactions, and holdings. Portuguese food processing companies, for example, provide loans to Ecuadorian finance companies, which in turn provide capital to Brazilian engineering companies – all owned, in part or in whole, directly or indirectly, by Parmalat. Although I haven't performed an exact count of all the holding companies, one can gain a broad perspective from the following consideration: there are 42 countries in which Parmalat has holdings. Smaller countries, where there are, for example, three to four main holdings, are themselves held by on average three to four entities owned directly or indirectly by Parmalat. In the United States and Australia , the number of holdings and entities constructed for the holding of these concerns is considerably larger. Such a list goes on in similar complexity for more than 28 pages. In the end, an astute analyst can do nothing but ask: Why does a food company — a relatively small food company in comparison with U.S. behemoths such as Kraft or Sara Lee — have more complexity than a General Electric (which has an extensive finance arm which might legitimate various intercompany transactions)? Why would a relatively small company have more complexity than a $100 billion affair? How and why on earth would a food company weave such a convoluted web? How bad can taxes possibly be?

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