Accounting Fraud

One of the most notable fraudulent actions was the creation of a completely fictitious bank account in the United States that supposedly contained $5 billion. After media reports exposing the account surfaced, the financial institution at which the depositsupposedly existed (Bank of America) denied any such account. The company’s management fooled auditors by creating a fictitious confirmation letter regarding the account. In addition to misleading the auditors about this bank account, the company’s CFO, Fausto Tonna, produced fake documents and faxed them to the auditors in order to hide the fact that many of the company’s dealings were completely fictitious.

Parmalat’s management also used “nominee” entities to transfer debt and sales in order to hide them from auditors and other interested parties. A nominee entity is a company created to hold and administer the assets or securities of the actual owner as a custodian. These entities were clearly controlled by Parmalat and most existed only on paper.

Using nominee entities, the Parmalat management created a method to remove uncollectible or impaired accounts receivable. The bad accounts would be transferred to one of the nominee entities, thus keeping the bad debt expense or write-off for the valueless accounts off the Parmalat income statement. The transfers to nominee entities also avoided any scrutiny of the accounts by external or statutory auditors (in this case, Italian-designated auditors under the country’s laws).

Creating revenues was another scheme in which the nominee or subsidiary entities were used; if a non-Italian subsidiary had a loss related to currency exchange rates, management would fabricate currency exchange contracts to convert the loss to a profit. Similar activities were undertaken to hide losses due to interest expense. Documents showing interest rate swaps were created to mislead the auditors or other parties. Interest rate swaps and currency exchange contracts are both instruments usually used to hedge on the financial markets, and sometimes to diversify the risk of certain investments. Parmalat abused these tools by creating completely fictitious contracts after the fact and claiming that they were valid and accurate. The understatement of debt was another large component of the Parmalat fraud, as was hidden debt. On one occasion, management recorded the sale of receivables as “non-recourse,” when in fact Parmalat was still responsible to ensure that the money was collectible.

There were many debt-disguising schemes in relation to the nominee entities. With one loan agreement, the money borrowed was touted as being from an equity source. On another occasion, a completely fictitious debt repurchase by a nominee entity was created, resulting in the removal of a liability from the books, when the debt was still in fact outstanding. Parmalat management also incorrectly recorded many million euros’ worth of bank loans as intercompany loans. This incorrect classification allowed for the loans to be eliminated in consolidation when they actually represented money owed by the company to outsiders.

The fraud methods did not stop at creating fictitious accounts and documents, or even with establishing nonexistent foreign nominee entities and hiding liabilities. Calisto Tanzi and other management were investigated by Italian authorities for manipulating the Milan stock market. On December 20, 1999, Parmalat’s management issued a press release of an appraisal of the Brazilian unit. While this release appeared to be a straightforward action, what Tanzi and others failed to disclose were the facts relating to the appraisal itself. The appraisal came from an accountant at Deloitte Touche Tohmatsu and was dated July 23, 2008, nearly 19 months prior to the press release. This failure to disclose information in a timely and transparent manner demonstrates yet another way that Parmalat was able to exert influence and mislead investors.