How It Went Sour

By Peter Gumbel

For a hard-charging executive like Alberto Ferraris, being named chief financial officer of an $8.7 billion company was a career-making moment--and he wasn't going to let a few nagging doubts stand in his way. Since the company was Parmalat, the Italian dairy-and-food conglomerate that the U.S. Securities and Exchange Commission has charged with perpetrating "one of the largest and most brazen corporate frauds in history," and since Ferraris, 46, now faces charges of market rigging and issuing false information, he may wish he had heeded those doubts. But back in March 2003, he says, he knew the company had some financial problems but had no idea how bad things were about to get.

Ferraris was brought aboard in the spring of 2003 to calm investors, who had been rattled when the outgoing CFO, Fausto Tonna, announced an unexpected new bond issue, sending Parmalat stock into a nose dive. The issue was quickly canceled. Within a few days of taking over, Ferraris made a presentation to financial analysts in Milan, stressing the company's rosy outlook: sales and earnings were up, debt was under control, and the company was awash in cash. "It was my job to patch up relations with the market," Ferraris told TIME in his lawyer's Milan office.

But as time passed, Ferraris had second thoughts. He couldn't understand why the company's interest payments on its debt were so high. Nor could he grasp why his boss wouldn't give him free access to the accounts. So over the summer, Ferraris asked two members of his staff to investigate discreetly. They came back several weeks later with a total debt estimate of EUR14 billion, or $18.2 billion--more than double the amount shown on the balance sheet. Ferraris went to see Calisto Tanzi, the Parmalat founder and chief executive, whom he viewed as "an excellent person, a real entrepreneur," a charismatic but steady leader who was so proficient at mathematics that he spotted calculation errors in presentations. "I expected him to say, 'Your numbers are wrong,'" Ferraris recalls. "Instead, he said, 'Eight billion, 11 billion, 14 billion--it's all the same.'" Stunned, Ferraris urged Tanzi to call a meeting with the company's banks to explain the debt problem. Tanzi refused, Ferraris quit, and a few weeks later, on Dec. 19, Europe's biggest corporate scam was exposed. Parmalat confirmed that an account it had claimed to have at Bank of America with $4.9 billion in cash did not, in fact, exist.

This was the first revelation in the scandal that turned Parmalat into Europe's Enron, a morass of fraud and financial failure made all the more dramatic by the fact that the company had established itself as a recognized global brand. In the past year three teams of forensic accountants have combed through the company's books, and dozens of executives have made detailed confessions to magistrates in Parma and Milan. Using documents obtained by TIME, it's possible to piece together the inside story of how the company that wanted to be the Coca-Cola of milk went sour.

The company's tactics were so brazen they were "almost banal," says Francesco Greco, the senior magistrate on the case in Milan. For well over a decade, it seems, Parmalat borrowed money on the basis of fictitious or double invoices to retailers and then made the debt vanish through transfers to shell companies based in offshore tax havens. When the hole grew too large to hide, the company came up with its most audacious invention, but one that ultimately proved to be its undoing: a fictitious milk producer in Singapore that supposedly supplied 300,000 tons of milk powder to a Cuban importer via a Cayman Islands subsidiary. By the time the whole house of cards came tumbling down, the company had lost $15.6 billion. So far, 29 people have been indicted in Milan, and others will be charged in coming weeks.

But if the fraud at Parmalat was so blatant, the question now is how did it go undetected for so long? After all, some of the world's largest banks and respected auditors were up to their milk mustaches in Parmalat business. Were they victims of Parmalat's deceptions? Or, as the company's bankruptcy administrator, Enrico Bondi, alleges, were they more like well-paid enablers, looking the other way while helping Parmalat hobble toward ruin?

They certainly helped the company take its warped finances global. Bank of America alone arranged $1.7 billion in financing through bonds and private placements for U.S. investors. Citibank packaged and resold the firm's receivables, even installing its own software at Parmalat headquarters to help track them. The Italian affiliates of international accounting firms Grant Thornton and Deloitte Touche Tohmatsu signed off on Parmalat's increasingly surreal accounts. Deutsche Bank helped it work with Standard & Poor's, which kept its "investment grade" rating on the firm until 10 days before the collapse.

At the very least, it seems clear that the international institutions working with Parmalat missed some key clues that all was not well. The question of why is at the center of a legal--and increasingly political--storm. The Milan magistrate last month added Deloitte Touche and Grant Thornton to his investigation, as well as a slew of banks, including Bank of America, Citigroup, Switzerland's UBS and Credit Suisse First Boston, and Deutsche Bank. Bankruptcy administrator Bondi has filed civil suits in Italy and the U.S. against many of the same firms, alleging that they knew about Parmalat's shaky financial situation and contributed to its collapse by helping to camouflage it. Using the same argument, Bondi has rejected many of the foreign banks' creditor claims in his proposed bankruptcy settlement. A judge in Parma overseeing the case is expected to rule shortly.

The international auditors and banks that were working for Parmalat vehemently reject the allegations, saying they were tricked by Parmalat's management. (U.S. ambassador to Rome Mel Sembler has been lobbying on behalf of the U.S. banks, alleging that they are being discriminated against in the bankruptcy proceedings and warning of damage to bilateral relations.) Bank of America notes that it has been a victim in the case, already writing off $425 million. Citibank puts its total Parmalat exposure at $540 million. Where did the rest of the lost billions go? According to Bondi, $8.5 billion went to pay interest, dividends and fees--with $3.6 billion of that going to the banks. Magistrates allege that about $1.7 billion was siphoned out of the company by Tanzi and his family, and much of the rest was used to cover operating losses that management was desperate to hide.

To understand how the foreign financial institutions got so deeply involved with Parmalat, it's important to appreciate the hype surrounding the company a decade ago. During the 1990s, it was one of the hottest firms in Italy. Tanzi, 66, was a legendary figure, revered for building a world-class company from scratch through hard work and innovation. Soon after founding Parmalat as a dairy company in 1961, he embraced a new pasteurization technology that allowed milk to stay fresh for months without refrigeration. He discovered the power of sports marketing and plastered the Parmalat name on events ranging from World Cup skiing to Formula One racing.

For years Tanzi hid his company's difficulties by expanding. Following a disastrous foray into television in the 1980s, he staved off bankruptcy by engineering a reverse merger with a dormant holding company listed on the Milan stock exchange and followed up with a big capital increase. That enabled Parmalat to go public in 1990 and plug some of the gaps in its accounts. As early as 1993, according to evidence given to magistrates in Parma, Parmalat allegedly began to play fast and loose with its balance sheet. Starting in 1992, the group began buying up dairy and other companies in Italy, Brazil, Argentina, Hungary and the U.S. "It was a reversal of logic," says Vito Zincani, the chief investigating magistrate in Parma. Usually, companies take on debt in order to grow. But in Parmalat's case, "they had to grow to hide the debt," Zincani says.

The company seemed so attractive that foreign banks, with Citibank at the head of the line, were clamoring to get a piece of the business. Ferraris, who worked at Citibank in Milan for seven years before joining Parmalat in 1997 as an executive in Canada and Australia, remembers making regular sales calls on CFO Tonna. "There was big competition for Parmalat business," Ferraris recalls. "You needed to come up with a product that really interested them." On Ferraris' watch, Citibank scored two coups, first setting up a securitization program, then advising Parmalat on its acquisition of Beatrice Foods in Canada.

Though he claims to have been shocked when he learned of Parmalat's shaky finances soon after he joined the company, Ferraris in 1995-96 had laid the groundwork for a complex financing scheme through a Delaware company audaciously named Buco Nero, Italian for black hole. Citigroup later set it up for Parmalat in 1999. Bondi, who has filed a lawsuit against Citigroup seeking $10 billion in damages, says the firm must have known about Parmalat's true financial situation and alleges that Buco Nero was used to dress up debt as an equity infusion. Citibank denies such a setup and says the deal was not a disguised loan but fully disclosed and perfectly legal. "Similar structures have been used by other leading Italian companies to obtain low-cost financing," Citigroup said in a Nov. 1 court filing.

At around the same time, red flags were popping up elsewhere in the Parmalat empire. At the end of 1999, Esteban Pedro Villar, an accountant in Buenos Aires with Deloitte Touche, filed an internal "early warning report" highlighting serious concerns about Parmalat's Latin American operations. He peppered Parmalat executives with so many questions that Tonna lost his temper. The requests for information were "offensive and ridiculous," Tonna wrote in a June 9, 2000, fax to Adolf Mamoli, the Deloitte partner in Milan who was the company's lead contact. "I am revoking with immediate effect the mandate conferred on Deloitte Touche in Argentina." Instead of investigating further, Deloitte, which had taken over as Parmalat's worldwide auditor the previous year, quickly backed off. The accounts were certified, and Mamoli sent a terse email to his colleague Villar. "For the future," he wrote, before contacting Parmalat on any issue, "you should contact me in advance to discuss possible solutions." Deloitte insists that it behaved properly and in accordance with Italian standards in force at the time. It points out that the investigation of Parmalat began only after Deloitte Italy, in its October 2003 midyear review, drew attention to irregularities in Parmalat's financial dealings. Mamoli has denied any wrongdoing, and Deloitte is defending him.

Deloitte partners in Malta and Brazil also had concerns. In an audit report dated March 28, 2003, Deloitte's Maltese office questioned a $7 billion intercompany transfer that is now known to have been fictitious. The Deloitte partner in Brazil, Wanderley Olivetti, raised such a stink about Parmalat's accounts there that the matter went all the way up to Jim Copeland, Deloitte's then chief executive in New York City. Olivetti's objections didn't prevent Deloitte from certifying the world accounts. Olivetti and Copeland aren't talking; Deloitte says only that "we behaved properly."

Others were suspicious too. In December 2002, a year before the company collapsed, Joanna Speed, Merrill Lynch's food-industry analyst in London, issued a "sell" recommendation on Parmalat stock. She found the accounts incomprehensible. Yet as late as 2003, Bank of America was still trying to woo Parmalat. In June, Kenneth Lewis, the bank's then chief executive, flew to Parma to see Tanzi. Ferraris recalls that the meeting with Lewis was cordial; he encouraged Parmalat to use the bank's services. "It was a marketing call," Ferraris recalls. "Lewis was saying, we'd love to do more business with you guys." The bank describes the visit as "a courtesy call" and says there were no substantive discussions about transactions or the company's finances.

Traveling in the Gulfstream corporate jet with Lewis was Luca Sala, then a managing director of Bank of America in Milan who worked on some of the bank's transactions for Parmalat. Less than a month later, the bank fired him for allegedly fiddling his expenses. He immediately began work for Parmalat. Ferraris says he needed Sala's help to understand a $400 million private-placement setup for Parmalat.

Sala, 40, has since confessed to magistrates that he received more than $20 million in kickbacks from Parmalat while at Bank of America. Most of it came directly from a refinancing of a 1999 Brazilian transaction that is now a central element of bankruptcy administrator Bondi's case against the bank. In that transaction Bank of America raised $300 million in funding from U.S. investors via two entities it set up in the Cayman Islands. The bank used the money to acquire an 18% stake in Parmalat's Brazilian group. News of the transaction sent Parmalat stock soaring 17% in a single day. Bondi alleges that this transaction fraudulently made a loan look like an equity infusion, a charge the bank denies. The refinancing was even more controversial because Sala, it turns out, had an ownership interest in the company formed to handle it. Bank of America says it didn't know that at the time. Sala has been indicted along with two other Milan-based Bank of America bankers. One of them, Antonio Luzi, told magistrates how Sala had given him a total of $900,000 on three separate occasions. Bank of America says that, as Parmalat's second biggest creditor, it is one of the parties most damaged by the fraud--and that it had "absolutely no role in disguising Parmalat's true financial condition." Sala and Luzi were not reachable for comment.

Ferraris is in trouble too--primarily because of the rosy presentation he made to investors on April 10, 2003. Milan magistrates have indicted him for disseminating false information. In his last few months at Parmalat, Ferraris also worked on several financing deals that are part of the ongoing criminal investigation, including ones with UBS, Morgan Stanley and Nextra Investment Management. In October, Nextra's parent, Italy's Banca Intesa, agreed to pay $208 million to Parmalat to avoid being taken to civil court for misstating the interest rate on a $390 million bond issue.

With hindsight, it's hard to understand why the scandal didn't come to light sooner. Parmalat never publicly explained why it needed to continue borrowing money when its accounts claimed it was sitting on billions of dollars in cash. Nobody appears to have asked whether Cubans really needed $1.3 billion worth of milk powder--enough to supply everyone on the island with 60 gallons a year--and why the powder was being shipped from Singapore, of all places. And nobody challenged a key discrepancy: the amount of debt disclosed on the firm's balance sheet was at odds, by as much as $2.6 billion, with the corporate data on file at the Italian central bank. In a submission to the Parma bankruptcy court on Nov. 1, Citigroup said it "did not know of Parmalat's real financial condition from the Bank of Italy Risk Register, Bloomberg, or at all. It was lied to repeatedly by Parmalat."

Just how aggressively the Italian investigations will pursue the international financial institutions for their role in the Parmalat collapse--or, conversely, whether the foreign firms will get back any of the money they say they lost--is unclear. As for Ferraris, who is awaiting trial for market manipulation, he is "flabbergasted" by the whole affair. "I believed so much in Tanzi as an entrepreneur that I have a hard time seeing him as anything else," he says. "For 13 years I think he's a genius, and then I find out he's a crook." If Ferraris wishes he had never been seduced by Tanzi, the international banks and auditors no doubt do too.