Who’s to Blame for Spilt Milk? An Institutional Autopsy of the Parmalat Disaster

Michael Charles Cimasi, M.A., J.D.

Institutional Disaster Manuscript

5th May 2016

An Institutional Autopsy of the Parmalat Disaster Exploring the

Mechanisms of Gatekeeper Failure in the International 

I.)            INTRODUCTION

Far from the regional pasteurization plant opened by Calisto Tanzi in 1961 outside the Italian city of Parma, Parmalat’s 2004 bankruptcy captured over fourteen billion Euros (€14 billion) of bad debt—a number equivalent to nearly one and a half percent (1.5%) of Italy’s entire gross national product for that year (Buchanan & Yang 2005; Celani 2004). Similar to the 2002 Enron debacle that shook market confidence and effectively destroyed Arthur Anderson in its wake, Parmalat’s blatant financial frauds generated disbelief at the cataclysmic failure of both public regulatory agencies and private market controls (Storelli 2005). These fantastically large, systematic failures of all financial control mechanisms cut a wide swath of destruction across the highly integrated world economy, as evidenced by lawsuits against Parmalat and its subsidiaries being levied from Rome to Los Angeles. 

Though large-scale corporate disasters are extremely complex and creatures of their particular legal and cultural environments to a certain degree, there are always harbingers or signs of impending trauma that have gone unnoticed (Choo 2005). In depth study of these collapses through the lens of organizational theory can lead to a better understanding of the mechanisms and harbingers of corporate disasters, which is a sub-field that seems to experience popularity only sporadically in the wake of news-breaking corporate traumas such as Enron and Parmalat. To extend the critical literature on disasters by drawing on both organizational and environmental disaster studies, this analysis will proffer a new heuristic—the Engineered Disaster—characterizing corporate-financial disasters as both crescive and acute in terms of an often quiet incubation period followed by nearly instant and severe market effects upon discovery (Beamish 2000; Choo 2005). Failure to uncover malfeasance and/or nonfeasance during the incubation period results from informational failures on the part of gatekeepers, whether intentional or negligent (Choo 2005). Towards this end, the analysis opens with a review of relevant literature on disaster studies. It is then followed by an in-depth case study of Parmalat’s growth, expansion, and collapse into insolvency. The case study is followed by discussion and analysis of relevant themes flowing from the literature, and concluded on general thematic observations and suggestions for future research.   

II.)         LITERATURE REVIEW—Cataloging the Disasters of Gods and Men

Seeking to maximize the analytical benefit from extant literatures on disaster analysis, a wide range of disaster studies will be reviewed, including natural disasters, man-made natural disasters, and socio-technical disasters. There is certainly a grey area between these categories. For example, Hurricane Katrina was clearly a natural disaster in the purest form, but the secondary disasters, such as oil spills and damage wrought to wide swaths of the New Orleans built below sea level, were both made-made yet integral to the understanding of Hurricane Katrina overall—hence the development of the term NaTech disaster (i.e. Natural Disaster triggering Technical Disaster) (Brunsma et al 2010). 

     Environmental disaster studies have been neatly parsed into crescive and acute categories (Beamish 2000). Crescive disasters, like the Guadelupe Dunes oil spill were slow moving and their aggregate effect was not felt for many years (Beamish 2001). Acute manmade disasters involving nature, like the Buffalo Creek Flood, were violent and immediate in their effects (Erikson 1976). The crescendo-collapse of several inadequate dams let loose millions of gallons of “black water” to rush through a valley, sweep away all signs of life, and leave a poisoned coating of slag in its wake. In studying natural disasters, this dichotomy between crescive and acute is important due to the risk-trust relationships that exist between people and the institutions that structure social life, which vary over time (Beamish 2001). During the 1970s, the mining families of the Buffalo Creek were stunned that the Buffalo Mining Company would allow such a tragedy to ensue despite the painful immediacy of its effects (Erikson 1976). By the 1990s, the residents of San Luis Opispo County were less reticent to believe that the Unocal Corporation bore responsibility for poisoning the dunes once the technical aspects of the dilutent leak were brought to light (Beamish 2001).  

More recent works studying the NaTech Fukushima disaster have explored both network analysis and issue salience to understand how such an organizational planning failure could occur and how its effects ripple across the globe (Dreiling et al 2015; Hoffman & Durlak Manuscript). The network analysis approach studying organizational embeddedness revealed how Japanese industry, regulators, and environmental groups were all connected in ways that limited safety planning and efficacy building up to the hurricane and tsunami in 2011 (Dreiling et al 2015). Further, Hoffman and Durlak developed the concept of “Shelf Life” as a form of issue salience to explain how and why a disaster such as Fukushima could result in significant policy changes in some similarly situated nuclear-producing nations, but not others. In terms of nuclear power as a commodity, the “Shelf Life” of the disaster’s efficacy vis-à-vis policy change could manifest as a short-term economic lull pending a return of consumer and investor confidence. 

All of the above disaster scenarios encompass, to a greater or lesser degree, natural or environmental disasters. Though seemingly aberrant in their formation and effects, corporate-financial disasters, and major corporate frauds, can be viewed similarly as significant and multi-level organizational failures. Perrow published the Normal Accident Theory in 1984, which contends that interactively complex and tightly coupled technological systems, like a power plant or an international corporation, will inevitably experience accidents—this is essentially the “new” normal. These inevitable breakdowns usually nurse long incubation periods during which the tell-tale signs of impending disaster often manifest as: (1) institutional cultures developed around epistemic blind spots; (2) risk denial such as ignored or discredited reports; and, (3) structural impediments such as being told to follow “proper channels” (Choo 2008). 

These signals act as “mechanisms …to cope with risk and uncertainty” as well as information impairments (Choo 2005 & 2008). Information is key in all disaster planning and recuperation efforts—so much so that Intel’s Andrew Grove popularly quipped, “Only the paranoid survive” (Choo 2005). This information culture must be groomed at all levels and overlap across all gatekeepers. With respect to organizational studies and financial markets, gatekeepers are “reputational intermediaries who provide verification and certification services” to investors, managers, and regulators (Coffee 2002). In large corporate-financial disasters like the scandals at Enron in 2001 and Parmalat in 2004, long incubation periods and myriad informational failures resulted from multi-level gatekeeper malfeasance and nonfeasance (Coffee 2002; Storelli 2005). In the case of Parmalat, gatekeepers included not only the company’s own operations officers and board of directors, but also credit rating agencies and the credit committees at global banking conglomerates (Buchanan & Yang 2005). 

Specifically with corporate-financial disasters, the ethical climate set by upper-tier management is crucial in accomplishing the type of information culture necessary to prevent catastrophic organizational failure (Soltani 2013; Choo 2005). This can be directly linked in governance structure through efforts to separate shareholders (owners) from management in large corporations to defend against unchecked personal executive interest and the myriad maladies associated with concentrated interest (Soltani 2013; Buchanan & Yang 2005). Regardless of who perpetrates the fraud, literature draws on Edwin Sutherland’s concept of “white collar crime” and Donald Cressey’s embezzlement studies to construct the fraud triangle framework that maps the factors necessary to foment the commission of fraud and violation of ethical standards: (1) incentives or pressures to deviate; (2) opportunities to deviate; and, (3) justifications or rationalizations for deviation (Soltani 2013):

Enron’s Skilling, Tyco’s Kozlowski, and Parmalat’s Tanzi had to at least tacitly establish these three elements before commencing their fraudulent acts no differently than any of their secretaries would if stealing from the petty cash. 

           This broad yet selective literature review provides ample theoretical frameworks to apply to the upcoming case study for purposes of analysis and review. 

III.)       EXPLORING THE CASE STUDY—Parmalat and the Sequelae of Total System Failure

Parmalat’s story began in 1961 when Calisto Tanzi used his share of proceeds from a small family-owned factory to establish a pasteurization plant (Buchanan & Yang 2005). In 1966, Tanzi retooled his plant to utilize a newly developed Swedish pasteurization technique, Ultra High Temperature (“UHT”), which allowed milk to last for up to six months unrefrigerated. This new technique offered dramatic opportunities to expand a diary business into export (Storelli 2005). For the first decade of operation, Parmalat continued to expand across Italy offering a wider range of dairy products, and its earnings were growing by annual margins of fifty percent (50%) or more. By the mid 1970’s, Tanzi’s ambitious growth program had run his company up against stringent Italian anti-trust regulations. 

In 1973, Parmalat began its international expansion by breaking into the Brazilian market with a joint-venture yogurt distributorship. (Buchanan & Yang 2005).  By the end of the 1970s, Parmalat was now Italy’s eighth largest food company and the unrivaled leader in UHT milk production holding over twenty-five percent (25%) of the market. The 1980s were a period of rapid growth and expansion for Parmalat, but Tanzi’s avarice for growth and prestige caused him to enter too many competitive markets that yielded narrow profit margins, if any (Storelli 2005). By the late 1980s, Parmalat had achieved international brand recognition and rapid growth in an industry erstwhile perceived as relatively parochial and low growth. In fact, Tanzi’s various ventures had accumulated nearly US$400 million in debt up to this point, and more than half of that took the form of short term notes (Buchanan & Yang 2005). Further, all the debt was directly bank financed as no public offerings or bond financing had been pursued.

Despite this rather meteoric rise, Parmalat was still a closely held corporation with Tanzi as the principal shareholder (Storelli 2005). In 1988, another major figure in the Parmalat drama came into position—Fausto Tonna. After starting as a clerk in Tanzi’s organization, Tonna rose to become Chief Financial Officer, a position he would hold until the company’s eventual collapse. That same year, Kraft Food offered to buy Parmalat, but Tanzi refused citing his interest in keeping Parmalat “Italian,” which was in-keeping with the economic-political climate of Italy at that time due to public outcry in the face of several large international buy-outs of Italian firms in recent years (Buchanan & Yang 2005). 

The domestic solution that Tanzi sought became a large series of loans from Italian banking consortiums and a series of public offerings via reverse merger with the publicly traded entity FinanzariaCentroNord on the Milan Exchange (Storelli 2005). This alleviated Parmalat’s cash crisis, allowed Tanzi to remain majority control of the company, and prevented any significant public disclosure of Parmalat’s financial status (Buchanan & Yang 2005). During the 1990s, Parmalat expanded into the international financial markets with a series of aggressive bond offerings to buoy massive expansions into industries as diverse as bottled water, a FIFA soccer team, and an international travel syndicate (Storelli 2005). 

Between 1990 and 2003, Parmalat also acquired over one hundred food companies, thus making it Italy’s eighth largest food and industrial concern as well as one of the world’s largest independent dairy producers bosting over thirty six thousand (36,000) employees in one hundred twenty (120) factories across more than thirty (30) countries and five (5) continents (Buchanan & Yang 2005). Parmalat’s management stated their determination to “become the Coca-cola of milk” (Storelli 2005). These expansions were initially buoyed by a 427 Billion Lira[1] rights issue in 1993 alone (Buchanan & Yang 2005). Over the next decade, multiple public offerings were made by Parmalat and any number of its one hundred and thirty six (136) subsidiary companies across the globe, despite the company also reporting massive cash reserves. In the immediate aftermath of the Parmalat’s collapse, a socialist commentator observed that the speculative bond and shell company scheme (essentially a Ponzi scheme) that buoyed Parmalat’s massive debt structure was essentially “invented, built up, and managed” by “the Burke’s Peerage of the international financial system: Bank of America, Citicorp, J.P. Morgan, DeutscheBank, Banco Santander, ABN…” (Celani 2004, p. 1). 

By using international markets and speculation, Parmalat was able to divest massive amounts of debt into offshore holding companies, particularly ones located in the Cayman Islands. After years of financial chicanery on a global scale, Standard and Poor’s (“S&P”) finally became suspicious of the large amount of liquid assets Parmalat had invested in a holding company named the Epicurum Fund in December 2003; as S&P began to pull the strings on Parmalat’s financial boondoggle, Tanzi resigned as President on December 14th, then Parmalat defaulted on a one hundred and fifty (150) million Euro bond payment on December 15th (Storelli 2005). This finally caused S&P to lower Parmalat’s long-term investment rating from stable to junk status. Only now did the immense breadth and scope of Parmalat’s fraudulent activities begin to emerge. 

The Epicurum Fund was a shell wholly owned by Parmalat’s overseas subsidiaries that simply served as a holding company for billions of Euros in fictitious funds. Further, Tanzi and Tonna created further shell companies and wholly fabricated sales, assets, trademarks, bank accounts, discounts, and promissory notes (Storelli 2005). These forged assets were then used as collateral and security for each consecutive round of financing and bond issuance. Some of these frauds were as blatant as fabricating a Bank of America account for BonLat with over 3.9 Billion Euro in fictitious deposits, when no such numbered account even existed at the bank. Others were as seemingly ludicrous as fabricating the sale of 300,000 tons of powdered milk from Singapore to Cuba in the course of one year (2009), which would have yielded sixty liquid gallons of milk for every man, woman, and child on the island. The sheer arrogance of these transactions is evident even in the names chosen for various debt shells in coordination with major international investment banks—for example, Citigroup set up a Delaware subsidiary on behalf of Parmalat as a “special financing vehicle” named Buconero LLC, which translates to “Black Hole LLC” (Storelli 2005, p. 787).  

By the last days of 2003, Parmalat’s stock prices plummeted, PricewaterhouseCoopers estimated Parmalat’s standing debt at fourteen billion Euro, Tanzi and Tonna were about to be indicted along with their lawyers and accountants, and the Italian Parliament issued Decree Law 347/2003 to save the Parmalat Group from major default in the interest of the Italian economy, a law which became popularly known as the “Parmalat Decree” (Celani 2004; Storelli 2005; Bava & Devalle 2012). 

IV.)       DISCUSSION & ANALYSIS

The narrative above is fraught with success, failure, greed, fraud, complicity, politics, and above all arrogance. But this was not Tanzi’s arrogance existing in a vacuum; it was fostered and perhaps even manipulated by various gatekeepers who were either actively complicit in this fraud turned disaster, or were willfully ignorant to the bizarrely contrived financing scheme before them. To better understand the mechanisms at play in this type of corporate disaster, it will first be situated amongst other disaster narratives discussed in the literature review, then distilled to its distinct characteristics.

Whereas natural disasters have been discussed in terms of crescivity or acuteness, corporate-financial disasters and major frauds tend to have elements of both (Beamish 2000). Since a scheme like Parmalat takes years to finance and develop, the incubation period is crescive in nature as it accumulates bad debt and sells worthless assets to investors, but the impact of the fraud is almost always acute at the point of discovery. Thus, neither heuristic is sufficient by itself. A better conceptualization would be the “Engineered Disaster,” meaning a wholly man made, distinctly non-natural event that required significant planning and social structuring. The mens rea required to produce such an event could be specific intent, like Tanzi’s intent to defraud, or merely reckless disregard, closer to Enron’s energy-based derivative scheme (Storelli 2005). This provides a malleable heuristic tool to identify, classify, and discuss major corporate frauds that take on disaster status. 

Working within this framework, an Engineered Disaster is necessarily an interactive and collaborative effort—no single person or entity could perpetrate such far reaching fraud. Thus, a network-style analysis of the gatekeepers’ embeddedness in the financial control system is useful to understand how those charged with maintaining information culture in the financial markets could fail so spectacularly for such a long period of time in the face of such blatant fraud (Dreiling et al 2011; Choo 2005). Even in late 2003 when S&P was beginning to question some of Parmalat’s investment strategies, Tonna was replaced as CFO by Alberto Ferraris who came directly from Citigroup’s European investment team, and Luca Scala joined Parmalat’s Board of Directors while still sitting as a top business lending officer at Bank of America in Europe (Celani 2004). Without investigating the likelihood of collusion further, now two of the world’s largest financial institutions responsible for billions of Euros in bond offerings on behalf of Parmalat had senior managers (or recent senior managers) on both Parmalat’s Board and management team. 

           Since Tanzi owned over fifty percent (50%) of the company and CFO Tonna was a long-time friend and confidant, the gatekeepers within the company had significant personal ties that likely obfuscated their adherence to any information culture or fiduciary obligation to other minority shareholders. Further, the outside financial market gatekeepers (e.g. Citigroup, Bank of America, FinanzariaCentroNord, etc.) were so enmeshed with Parmalat’s management, and so incentivized to structure its debt in competition with other global lenders, that they failed to verify and certify it financial health, but rather allowed the reputations of their respective institutions act as reputational intermediaries for Parmalat to continue its investment schemes and frauds (Coffee 2002; Storelli 2005).

           The Fraud Triangle can be easily constructed around Parmalat’s managers and the financial gatekeepers. The pressure, opportunity, and rationalization to commit brazen fraud and the gatekeepers willingness to remain, at best, willfully ignorant sit right on the surface—Tanzi became excessively wealthy and famous through these efforts, even realizing the European dream of owning a FIFA soccer team (Storelli 2005). The gatekeepers from outside financial institutions were presented with paperwork and financial statements that were “in order” on their face (despite some being wholly contrived), and taking them at face value meant millions of dollars in fees for debt and bond service. 

           Though the complicated nature of modern, tightly coupled institutions may lend itself to routine discrepancies and accidents, long-term and purposive corporate fraud fall outside of this framework and must be conceptualized differently (Perrow 1984). All told, the network embeddedness of the financial gatekeepers with management of this closely held corporation provided perverse incentives for using the gatekeeper’s institutional reputations to shield the ongoing blatant fraud, thus yielding an Engineered Disaster affecting the global financial markets by instantly vanishing nearly one and a half percent of Italy’s gross national product and exposing billions of dollars in uncollateralized debt.

V.)          CONCLUSION & PARTING THOUGHTS

Capitalism is driven by investment, and investment is driven by information. The modern informational economy (Castells 2011) has created a large demand for both producers and assessors of investment information such as market research firms (e.g. J.D. Power & Associates) and investment rating agencies (e.g. S&P). However, the increasingly complicated nature of investment and finance in the globalized economy further exacerbates Giddens’ proverbial two-headed Janus, or modernity’s inherently contradictory perception of expert systems as simultaneously trustworthy and suspicious (Giddens 2013). Even though the market demands more information, and more information is available both publicly and privately, corporate frauds that reach the level of disaster give credence to a certain level of Marxist skepticism regarding both the credibility of world financial institutions and their commitment to the kind of information culture necessary for stable markets and investor confidence.

Further study of large-scale corporate-financial disasters conceptualized as Engineered Disasters may allow for a better understanding of the mechanisms by which information cultures fail in an increasingly globalized, yet at the same time tightly coupled, world financial market. It is also clear that gatekeepers act as reputational power brokers with access to the revolving door between industry management and financial sector leadership. Thus, more social science research into the power dynamics and social space of gatekeepers could complement the corpus of scholarship building in the fields of finance, accounting, and law. 

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[1] Italy did not adopt the Euro until 1999.