Reference no: EM131046954

Parmalat - Milk Spills After Sour Confirmation

Story Parmalat Finanziaria SpA is a Parma, Italy-based company, whose main operating subsidiary, Parmalat SpA sells dairy products around the world, employs 36,000 people, and has world-wide operations in 30 countries, including the USA. It was Italy's biggest food maker and Italy's eighth largest industrial group with market capitalization of ∈1.8 billion. On December 24, 2003, Parmalat SpA filed for bankruptcy protection with a court in Parma, Italy, and on December 27, 2003, the court declared Parmalat SpA insolvent. (SEC 2003) The problems at Parmalat first became apparent in mid-December 2003 when Parmalat failed to meet a ∈150 million ($184 million) payment to bondholders. This seemed odd because the company showed ∈4.2 billion in cash on their September 30 balance sheet. Parmalat had raised $8 billion in bonds between 1993 and 2003. Why did they need to keep raising money with their mountain of cash? Their standard reply was that the company was on an acquisition spree and needed cash - and the liquid funds were earning good returns. (Edmonson and Cohen 2004) Now the reckoning had come. The following week in December, Parmalat executives admitted to their auditor Deloitte that they could not liquidate the e515 million Parmalat claimed it held in Epicurum, a Cayman Islands fund. When Enrico Bondi, an advisor, suggested liquidating the e3.95 billion held by a Cayman Islands subsidiary called Bonlat, the rabbit popped out of the hat. Italian prosecutors say that they discovered that managers simply invented assets to offset as much as e13 billion in liabilities and falsified accounts over a 15-year period. (Edmonson and Cohen 2004)

Bonlat

Parmalat purportedly held the ∈3.95 billion worth of cash and marketable securities in an account at Bank of America in New York City in the name of Bonlat Financing Corporation ("Bonlat"), a wholly-owned subsidiary incorporated in the Cayman Islands. Bonlat's auditors certified its 2002 financial statements based upon a confirmation that Bonlat held these assets at Bank of America. (SEC 2003)

Confirmation Letter

Grant Thornton, auditor for the Bonlat subsidiary, sent a letter to confirm the balance in the Bonlat account to Bank of America in December 2002. On March 6, 2003, three months later, the auditors received a letter on Bank of America stationary and signed by a senior officer confirming the existence of the account with a balance of ∈3.95 billion. The letter was mailed, not faxed, to Grant Thornton's offices in Milan. (Rigby and Michaels 2003)
Bank of America Says Letter is a Forgery

On December 19, 2003 the letter certifying that Bank of America held ∈3.95 billion for Parmalat's offshore unit Bonlat was declared false by the bank in a statement to the US SEC and in a press release. The bank account and the assets did not exist and the purported confirmation had been forged. Agnes Belgrave, the signatory of the letter who worked in Bank of America's Manhattan offices, denied any involvement in Parmalat's affairs. (Betts and Barber 2004) Although documents concerning the Cayman Island subsidiary had been destroyed, Italian prosecutors found documents and a scanning machine used to forge the bank documents on Bank of America letterhead at DPA, a shell company near Parma.
Parmalat CEO Calisto Tanzi flew out of Italy the day Bank of America announced that the letter showing ∈3.95 billion was false. He went to Switzerland then Portugal, then an undisclosed country in central or south America, and finally back to Milan where he was detained by police. (Barber 2003)

The Auditors

In 1999, Parmalat was forced to change its auditor under Italian law, and it replaced Grant Thornton with the Italian unit of Deloitte Touche Tohmatsu. However, Grant Thornton's Italian arm continued to audit at least 20 of Parmalat's units, including Bonlat. Deloitte became increasingly reliant on Grant Thornton for scrutiny of Parmalat's accounts. During its work on the 1999 accounts, other auditors had examined subsidiaries representing 22 percent of Parmalat's consolidated assets. On the 2002 accounts, Deloitte said other auditors examined subsidiaries representing 49 percent of consolidated assets. (Parker and Betts 2004) A suit filed by US shareholders contends that both Deloitte and Grant Thornton issued materially false reports on Parmalat's 1998-2002 year-end financial statements. Deloitte, which took over as Parmalat's primary auditor, deliberately failed to verify reports from Grant Thornton on assets held by a Parmalat subsidiary. The suit also asserts that on at least eight occasions, Grant Thornton failed to send third-party confirmation request letters in connection with its audits of Parmalat's subsidiaries. Further, it asserts, the firm failed to conduct independent audits on the 17 Parmalat subsidiaries that it was engaged to audit from 1999 to 2003, but rather participated in the falsification of audit confirmation documents. (International Herald Tribune 2004) Italian authorities arrested Lorenzo Penca, chairman of Grant Thornton SpA and Maurizio Bianchi, a partner in the firm's Milan office, on charges that their actions contributed to Parmalat's bankruptcy. They claimed that two men suggested ways that Parmalat executives could "falsify the balance sheet" of a subsidiary and then "falsely certified" the financial statements. (Galloni et al. 2004) Prosecutors in Italy have said Penca and Bianchi were behind the plan to create Bonlat and they failed to disclose details of two other offshore Parmalat vehicles in the Netherlands Antilles, according to court documents. (US District Court, Southern New York, 2003)

Discussion Questions

¦ What audit procedures should auditors use in confirming a very material cash balance?

¦ If a primary auditor is significantly dependent on the work of another auditor, what reviews and substantive tests should they conduct?