Required: a) Conclude the most recent rules on corporate governance for public firms that could be practiced by Parmalat to ensure the integrity of management and financial reporting will not be compromised. b) Propose changes in Parmalat's control system and corporate governance structure to mitigate the risk of accounting and business fraud in future years.
Parmalat is one of the leading firms in in the long-life milks, yogurt, and juices market. The company became the world's seventh-largest supplier of diary products. In 2002, the company reported 7.6 billion euros in annual sales. Parmalat's failure is expected to have a stimulative effect on corporate governance reform. Parmalat Finanziaria S.P.A misrepresented its financial statements by billions of dollars.
The company's founder and former CEO, Tanzi, now stands accused of market rigging, false auditing, and misleading investors. Tanzi established a series of overseas companies to transfer money among and to conceal liabilities. Parmalat defaulted on a 150 million euros (U.S. $184 million) payment to bondholders. Calisto Tanzi admitted to having falsified Parmalat's accounts for over a decade and to having stolen at least $600 million from the publicly traded company. The fraud was perpetrated by, among others, CFO Fausto Tonna, who produced fake documents to falsify the existence of subsidiaries.
In 2003, some shareholders began lobbying Tanzi for an independent member, chosen by the minority shareholders, to be put on the company's Audit Committee. The story of Parmalat reveals many weaknesses in governance at both the corporate and the professional accounting levels. One major weakness in corporate governance was a lack of oversight on the part of the Board of Directors. By placing too much faith in the integrity of the managers and the competence of its auditors, the company became susceptible to fraud. After the crucial default to bondholders, Tanzi appointed a turnaround specialist named Enrico Bondi who decided to liquidate the U.S. $5 billion Bank of America account.
The testing procedures that the auditors used while auditing Parmalat were inadequate. The company's assets were overstated and its liabilities understated, which had not been noticed by the company's auditors. One example involved Deloitte's apparent inability to locate and/or audit what is referred to as Account 999, which held a debit of 8 billion euros (U.S. $12.83 billion) representing the "trashbin" for all faked revenues, assets and profits. To cover up the fake transactions, the entries were transformed into intercompany loans and credits. In December 2003, executives "took hammer to a computer at headquarters" in attempt to destroy Account 999-but a printout survived.
Parmalat Finanziaria overstated its level of cash and marketable securities by at least 2.4 billion euros. The company recorded approximately 1 billion euros debt as equity through fictitious loan participation agreements. Parmalat S.P.A. transferred uncollectible and impaired receivables to "nominee" entities, where their value was hidden. As a result, the company carried assets at inflated values and avoided the negative impact on its income statement. Parmalat Finanziaria recorded fictional revenue through sales by its subsidiaries to controlled nominee entities at inflated or entirely fictitious amounts.
In order to avoid unwanted scrutiny, the related receivables would be transferred or sold to nominee entities. As a result, rather than have a neutral effect on the consolidated financials, the loan transaction served to inflate both assets and net income. By March 2004, eleven people from Grant Thornton had been arrested, and more arrests may follow. International banks supplied 80% of the funding, with the rest from Italian lenders. By contrast, Parmalat generated only 1 billion euros in gross cashflow. It is noteworthy that Citigroup had been instrumental in setting up the insolently named 'Buco Nero' ('black hole') as an offshore account.
Required:
a) Conclude the most recent rules on corporate governance for public firms that could be practiced by Parmalat to ensure the integrity of management and financial reporting will not be compromised.
b) Propose changes in Parmalat's
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