Parmalat founder arrested as dairy-fresh success story turns really sour

The collapse of Italy's milk giant threatens to be Europe's biggest financial scandal, writes Jason Nissé

As the scandal at Parmalat started unravelling, it emerged that the Italian milk multinational had struck a series of unusual financial deals with the US bank Citigroup. One of the offshore vehicles used was named Bucerono ­ which is the Italian for "black hole". Whether this was a bad joke or a prescient piece of nomenclature has yet to be revealed. But given that the fraud that has brought the collapse of one of the country's most famous companies has been going on for more than a dozen years and may run to more than ¤11bn (£7.8bn), everyone is fearing the worst.

Yesterday, Parmalat was granted the Italian form of bankruptcy protection, under which it will be run by three appointed commissioners, including the restructuring expert Enrico Bondi, who replaced Parmalat's founder, Calisto Tanzi, as chief executive two weeks ago. The move, which followed an emergency decree from Silvio Berlusconi's government, ended a period of rapid decline since the group admitted at the beginning of this month that it could not pay the interest on some of its bonds. Meanwhile, investigations into what has happened at the milk, cheese and yoghurt giant, whose operations stretch from Brazil to the United States to the Loseley dairy in Surrey, have unearthed a scandal that may have been going on since 1989 and could leave a bucerono of millions of euros. In the latest twist, it emerged yesterday that Tanzi had been detained in Milan on the order of magistrates investigating suspected fraud at the global food group.

The Parmalat affair seems to have almost everything you could want in a full-scale financial scandal. There is money missing from offshore bank accounts; curious transactions with US banks, which appear to have had the effect of boosting profits and hiding losses; investments in mysterious hedge funds; falsified documents given to auditors; and questions about whether these auditors were rigorous enough in checking the group's financial statements. Throw in a charismatic founder, who inherited his father's small food business when he was 21 and turned it into one of Italy's few true multinationals, as well as the ownership of two top-flight football clubs ­ Parma in Italy and Palmeiras in Brazil ­ plus some of the best-known food brands in the world, and you get a scandal of epic proportions.

The final collapse of Parmalat was precipitated by the revelation by the Cayman Islands subsidiary of Bank of America that an account held by a financial subsidiary of Parmalat, called Bonlat, did not have any money in it. According to Parmalat's books, there was supposed to be ¤3.9bn in the Bonlat account. Grant Thornton, the auditors that verified Bonlat had the ¤3.9bn, said on Tuesday: "It does appear that Grant Thornton SpA and others may have been the victim of a fraud committed by others." The documents produced by Bonlat saying it had the money appeared to have been forgeries. One key letter, purportedly from Bank of America in New York, was signed by an official called Agnes Belgrave. While Ms Belgrave does work for Bank of America, she has nothing to do with Parmalat and when contacted said she knew nothing of the letter.

The old joke that Italian companies have three sets of books ­ one for the taxman, one for the auditors and a third showing the real accounts ­ has a hollow ring at Parmalat. According to investigators appointed by Italian magistrates, it appears that the fraud at Parmalat goes back to 1989, before the company even floated on Milan's stock market.

But the Parmalat story really begins in 1961, when, after the death of his father, Mr Tanzi took over what was a small dairy and ham producer in the northern Italian town of Parma. The entrepreneurial 21-year-old saw possibilities in supplying richer areas such as Milan, Genoa and Florence with milk, and was able to expand despite apparent regulations preventing the transport of dairy products across Italy. He opened his first business overseas, in Brazil, in 1974, and soon expanded into Germany and France. In 1990, he floated Parmalat in Milan, though he and his family retained a 51 per cent holding, and embarked on a rapid expansion plan, buying businesses as diverse as a dried milk maker in Brazil, cookie bakers in the US and the Loseley ice cream and yoghurt producer, in Guildford, Surrey. The company now operates in 30 countries, employing 36,000 people.

It was around the time of the float that the seeds of the scandal that would engulf Parmalat were first sown. The group started creating companies in the Caribbean islands of the Netherlands Antilles, which acted to get rid of liabilities it offset with assets elsewhere. However, it now appears many of those assets were simply invented.

The structure using offshore entities, not only in the Antilles but also in the Cayman Islands, Singapore and other offshore centres, was approved by the then auditors, Grant Thornton, which never spotted the fraud. Under Italian law, companies have to rotate their auditors every nine years, so in 1999 Grant Thornton was replaced by Deloitte & Touche, though it continued to audit 17 of Parmalat's subsidiaries, including Bonlat.

In the past three or four years, the extent of Parmalat's use of these financial structures to boost its profitability has accelerated. It set up a number of deals with the Wall Street banks Citigroup and Merrill Lynch, including the aforementioned Bucerono, that allowed it to make bets on the financial markets. In one deal, Parmalat essentially gambled on its own credit rating. In another, it invested about ¤500m in a Cayman Islands hedge fund called Epicurum. Parmalat said that Epicurum would pay it money back, but three weeks ago it emerged that Epicurum would be doing no such thing.

All sorts of things are now coming out of the woodwork. It appears that, in a conference call with investors in mid-November, Parmalat's chief financial officer, Fausto Tonna, referred to a currency swap deal that delivered a profit of ¤121m. As Parmalat's pre-tax earnings for the first half of this year were only ¤125m, this raised a few eyebrows, especially as dealers speculate that Parmalat would have had to put more than ¤1bn at risk to generate such a profit.

Mr Tonna is one of 20 Parmalat employees and advisers who have been called in for questioning by the Italian criminal investigators. He spent most of Tuesday with magistrates, led by top examiner Francesco Greco, and is understood to be "singing like a canary".

Meanwhile, shareholders and bondholders are desperate to ask him questions. Not least about the ¤2.9bn of bonds that Parmalat said in a financial statement it had bought back. It appears the bonds were not repurchased and instead stand as a very large liability looming over the group.

Mr Berlusconi, no stranger to financial scandals, is keen to bail out Parmalat. The Italian PM said he was concerned about the potential for milk supplies to be disrupted in Italy and for the 4,000 employees in the country to lose their jobs. Suppliers to Parmalat, owed tens of millions of euros, are said to be lobbying for a bail-out.

However, the European Commission, in the shape of the Italian-born competition supremo Mario Monti, has warned Mr Berlusconi that it will be watching closely to ensure any help given to Parmalat does not breach EU state-aid rules.

Bondholders, who have hired their own lawyers, want Parmalat to be broken up and sold off to pay its debts. But this is unlikely to happen. First, new chief executive, Mr Bondi, is opposed to the move and second, the finances are in such a mess that it may be a while before it is clear what can be sold. The Parmalat crisis is rapidly turning into Europe's biggest financial scandal, eclipsing Royal Ahold and the collapse of the notorious Maxwell empire. For the credibility of Italian business, it must ultimately be hoped that the bucerono stops with Parmalat.