Ivar Kreuger Reborn: Classic Accounting Fraud Resurfaces in Italy and India

In part 1 of this two-parter, we compare the Ivar Kreuger frauds with the Parmalat crimes. In the next issue, we discover the similarities between Kreuger's con games and the Unit Trust of India devastation. 

 

Much has been written in recent years about the Italian Parmalat fraud and the role of company founder, Calisto Tanzi, but has anyone checked out Tanzi's genealogy? We could almost imagine that he's the illegitimate grandson of Ivar Kreuger, the former world-record fraudster. Yes, Ivar Kreuger, the man whose 1932 suicide led to the largest bankruptcy case to that date and resulted in many changes in financial reporting. After all, Kreuger did live in Italy much of the time in the 1920s and early 1930s. Although there's no evidence of any relationship, Tanzi has surely emulated his illustrious predecessor. 

 

India also might lay claim to a Kreuger disciple. The mutual fund industry in India has come a long way since 1963 when there was a single player, the Unit Trust of India (UTI), in the industry. At present, there are more than 30 major players, offering more than 460 mutual funds. In addition, this industry has grown enormously in size as reflected in the assets under management, which stands at more than Rs. 3 trillion (approximately US$75 billion), as of Oct. 16, 2004, up from Rs. 1 trillion in early 2000 [Adajania, 2006 (b)]. But in 1998, and again in 2001, there were crises typical of Kreuger's type in India. In this article, and in a second one in the Sept./Oct. issue, we compare these frauds to Kreuger's and speculate on the impact the frauds might have on accounting practice. 

 

PARMALAT AND KREUGER 

The Parmalat fraud in Italy in 2003 through 2004 is probably the more obvious of the Kreuger-type frauds. When people think of a company selling a basic everyday type of product in many nations throughout the world, which used off-shore entities to avoid financial scrutiny and simultaneously refused to provide analysts with full information on its activities, thoughts naturally turn to the cases of Parmalat and Ivar Kreuger. The comparisons between the Kreuger empire and that of Parmalat are staggering. 

 

Throughout the late 1920s and early 1930s, the securities of Kreuger & Toll, Inc., a Swedish match conglomerate, were the most widely held securities in the world. The company was founded and headed by Ivar Kreuger, who was known throughout the world as the "Match King." Kreuger's rise and fall, in a way, synthesized the years of boom and depression between 1918 and 1932. Matches were a basic commodity in those days. Everybody used them. You couldn't cook your food, heat your home, or light a cigar without a match. Kreuger emphasized that everyone in the world, rich or poor, needed his product daily. 

 

Similarly, Parmalat (literally, the milk of Parma), as the world's largest dairy company, sold dairy products in 100 countries; almost everybody uses dairy products [Singh, 2004]. North Americans will recognize such Parmalat brand names as Archway Cookies, Black Diamond Cheese, and Sunnydale Farms dairy products. Both matches and milk are low-margin industries, but Kreuger and Tanzi made them appear to be extremely profitable. 

 

Surprisingly, Kreuger & Toll kept few accounting records despite that it was a multibillion-dollar international conglomerate with more than 400 subsidiaries. Like Parmalat, not only large investors owned Kreuger's companies but many ordinary citizens. So after Kreuger's fall, many vigorously called for laws that would stop future fraudsters like him. The result was the passage of the Securities Act of 1933 [Flesher and Flesher, 1986]. Similar cries are now haunting the Italian government. 

 

Kreuger, born in Sweden in 1880, came to America in 1900 and worked at various engineering-type jobs. He returned to Sweden in 1913 and took over his father's small match factory. Through mergers, Kreuger eventually controlled the entire Swedish match industry. He then made inroads into the match business throughout the rest of Europe. 

 

Kreuger realized that the poverty of many governments after World War I provided an opportunity for capitalists with cash. He set out to make large loans (up to $125 million per country) to governments in return for official match monopolies. The scheme worked so well that, by 1930, he had 90 percent of the world's match production. Kreuger emphasized to investors that the foreign loans were risk-free because they were secured by an excise tax on match sales -- the proceeds of which went into a trust account at a Kreuger-owned bank until the loan and interest were paid. Kreuger's company was the pride of Sweden, just as Tanzi's company was the pride of Italy. In both cases, a small provincial company had become a huge international conglomerate. 

 

KEY TO SUCCESS: SILENCE 

The source of Kreuger's capital was the American public. Since securities were often issued in small denominations, many of Kreuger's stocks and bonds ended up in the hands of small investors. For instance, Kreuger issued $5 bonds, whereas the minimum at other corporations was $1,000. Kreuger's securities, both bonds and the stocks of his many subsidiaries, paid high returns to investors, yielding as high as 20 percent annually on both stocks and (participating) bonds. Unfortunately, those dividends were mostly paid out of capital, not profits. Price Waterhouse later estimated that actual profits were 1.5 percent of capital, and that was before deduction of interest. Kreuger was essentially operating a giant pyramid scheme. Essentially, Parmalat was doing the same thing, as initial findings indicate that the Italian conglomerate might have had only one profitable year between 1990 and 2002 [Sylvers, 2004]. 

 

Neither the investing public nor financial analysts were aware of Kreuger's manipulations because corporate secrecy was an acknowledged practice. Kreuger frequently stated that all an investor needed to know was a company's dividend policy; nothing else mattered. Kreuger often told accountants, bankers, and other investors that the key to success was "silence, more silence, and even more silence." (This philosophy, according to some analysts, was also espoused by Parmalat and the Indian company UTI.) If an investment banker were to ask for an audited balance sheet, Kreuger would simply refuse to deal with that individual. No investment banker wanted to risk losing Kreuger & Toll securities because the securities paid such high dividends. Hence, billions of dollars of securities changed hands without any reference to financial statements. The resulting Senate investigation determined that even the corporate directors never saw financial statements. And the directors never attended directors' meetings. Kreuger said he had to keep secret the delicate negotiations with foreign kings and dictators about government monopolies and taxes on matches. He used this supposed need to create stories to fit situations as they arose [Flesher and Flesher, 1986]. He was able to justify high-dividend payments by pointing to the huge profits earned by many of his subsidiaries (read "off-shore entities"). These special-purpose entities were basically shell corporations formed in small European countries supposedly for the purpose of avoiding taxes. Kreuger was able to show the necessary profits to make high-dividend payments only through these shell corporations. Although Parmalat appeared to be more open with investors and analysts than Kreuger, the result was the same. The large international banks were so anxious to deal in Parmalat securities, they failed to exercise due diligence before getting involved. One report noted that the Parmalat case "reveals an alarming lack of transparency at one of Europe's largest and most global companies" [Edmondson and Cohn, 2004]. 

 

Both frauds involved not only fraudulent financial statements but also false documents and financial instruments. With Kreuger, the biggest non-existent asset was $142 million in forged Italian bonds; at Parmalat, it was a $4.9 billion bank account with Bank of America. (The nonexistent account represented 38 percent of Parmalat's assets.) These fraudulent assets ultimately led to the uncovering of the frauds [Edmondson and Cohn, 2004]. 

 

Kreuger was considered a financial genius. He appeared on the cover of Time magazine during the week of the 1929 stock market crash. Major articles about Kreuger appeared in national magazines, such as the Saturday Evening Post and Literary Digest. He was a frequent visitor to the Hoover White House and received the French equivalent of knighthood. Kreuger was referred to as the "Savior of Europe," and "Savior of the World" because the money he loaned to foreign governments often was used for humanitarian purposes. In 1930, Syracuse University awarded Franklin D. Roosevelt and Kreuger honorary doctorates. Similarly, Tanzi was a highly respected Italian business man; he supported the arts, owned the Parma football club, and was known as a loving husband and father. 

 

The Depression accelerated the collapse of the Kreuger pyramid. Investors had little money to invest, and when there were no new investors there could be no dividend payments. Seeing the end of his empire and hounded by an Ernst & Ernst auditor working for a legitimate subsidiary, Kreuger took his life in Paris on March 12, 1932. Initially, the world mourned his loss, but Price Waterhouse auditors, who were hired to unravel his affairs, discovered the truth. Nearly a quarter of a billion dollars in assets apparently never existed. On the Monday following Kreuger's death, his securities accounted for one-third of the New York Stock Exchange volume, and lost two-thirds of their value. Within weeks, the securities were worthless. Parmalat shares almost immediately lost 95 percent of their value. Unlike Kreuger, Tanzi has not yet committed suicide, although he has been rumored to be "depressed." 

 

Interestingly, some Swedish biographers of Kreuger argued that he wasn't really a crook; he just followed different accounting principles from other companies. For example, his balance sheets showed intangible monopoly rights and bribes at a time when few other companies had intangibles. This quote is attributed to Kreuger: "Some day people will realize that every balance sheet is wrong because it doesn't contain anything but figures. The real strengths and weaknesses of an enterprise lie in the plans" (as quoted in Shaplen, 1960, p. 98). Again, there were arguments from Parmalat (and many e-business companies) that traditional accounting didn't show the true value of the company. Based on history, it seems more likely that the problem lies not with historical cost-based accounting, but with the company itself. Similarly, some Italians view Tanzi not as a crook, but as a person at the helm of a public company that had social and economic responsibilities to its thousands of employees, creditors, and stockholders. If the company wasn't showing a profit, thousands of workers would be unemployed, and farmers would have no place to sell their milk [Singh, 2004]. Thus, some would argue that the fraud was perpetrated for a good cause. 

 

Kreuger & Toll didn't have either external or internal auditors. In the Parmalat case, an affiliate of Grant Thornton, and later Deloitte Italy, served as external auditors, but there was no internal auditor. (Some might argue that there was little auditing done by the external auditors either because overlooking a $10 billion hole in the cash account is indicative of a "drive-by" audit.) This lack of an internal auditor simply meant that there was one less internal control in place. Arthur Levitt recognized this inadequacy in 2001, and spoke openly about it, but was silenced by the Big 5 who saw the outsourcing of the internal audit function as an area of practice development. As far back as 1987, the Treadway Commission report recognized that the major frauds of the 1980s were at companies without internal auditors, and that the internal auditors were the first line of defense against fraud. 

 

COMPARING PARMALAT TO KREUGER & TOLL 

Here are some comparisons between the Kreuger debacle and the Parmalat fraud: 1. Both were the largest bankruptcies on record for their country at the time of filing, and the frauds were perpetrated over more than a decade. 2. Both were defrauded by a trusted founder and chairman. 3. Both used special-purpose entities to create otherwise nonexistent profits. 4. Both advocated secrecy in explaining financial dealings. 5. Both led to tremendous losses among thousands of smaller investors, and there was no cache of assets hidden away since the frauds were perpetrated to create profits where none existed. (At least this seems to be true for Parmalat.) 6. Both led to wide publicity in the popular media. 7. Both led to widespread government investigations. 8. Both engaged PricewaterhouseCoopers (Price Waterhouse) to uncover the true state of affairs after the fraud was uncovered. 9. Neither had independent internal auditors. 10.The directors and investment banks had little knowledge of what was going on at either company. 

 

The Kreuger case led to new federal laws, mandatory audits for listed companies, and other changes at the New York Stock Exchange, but it is still too early to know the legacy of the Parmalat case. Some have argued that a person of Kreuger's ilk was needed to bring about improved financial reporting [Flesher and Flesher, 1986]. Will we say the same for Parmalat and Calisto Tanzi in a few years? Already, the Italian Parliament is expected to propose a new financial-market watchdog, modeled on Britain's Financial Services Authority, to assume powers now held by stock market regulator CONSOB and the Bank of Italy. The effectiveness of any such institution will depend on its insulation from the political interfering that undercuts many of Italy's regulatory bodies. 

 

Part 2 in the Sept./Oct. issue: the Unit Trust of India fraud 

 

Gaurav Kumar, Ph.D., CPA, is an assistant professor of accounting at the University of Arkansas -- Little Rock.   

 

Dale L. Flesher, Ph.D., CFE, CPA, CIA, is an Arthur Andersen Alumni Professor of Accountancy at the University of Mississippi.   

 

 

References (for part 1)  

 

Adajania, K.E. June 1, 2004 (a). "Payback Time." Outlook Money.  

 

Edmondson, Gail, and Laura Cohn. Jan. 12, 2004. "How Parmalat Went Sour." Business Week Online.  

 

Flesher, D.L., Flesher, T.K. 1986. "Ivar Kreuger's Contribution to U.S. Financial Reporting." The Accounting Review, 61 (3).  

 

Shaplen, Robert. 1960. Kreuger: Genius and Swindler. New York: Knopf.  

 

Singh, Kavaljit. Feb. 9, 2004. "Parmalat's Fall: Europe's Enron." ZNet Economy.  

 

Sylvers, Eric. April 17, 2004. "New Audit Details Fall of Parmalat." The New York Times.  

 

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