12.3Fraudulent behaviour and scandals in nancial markets

We deal with nancial scandals of various sorts in several places in this book. These

include problems of: mis-selling (personal pensions, endowment mortgages; split-

capital investment funds); misuse of funds (the Maxwell pension fund collapse); and

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Chapter 12 • Financial market failure and nancial crises

falsication of records (Barings Bank). In Chapter 9, we consider the case of Long-

Term Capital Management in which the near collapse of a hedge fund led to problems

in many nancial markets in different parts of the world. In Chapter 13, we touch

upon the problems of the Lloyd’s of London insurance market in the 1990s. Many

other scandals are given a brief mention and again in Chapter 13, we consider the

difculties in regulating nancial markets to try to prevent such problems and thus

retain the condence of investors in these markets.

However, several of the major nancial scandals in recent years have involved

non-nancial rms. Given the nature of modern capitalism, these involve nancial

institutions – auditors, nancial analysts, credit-rating agencies and banks. They also

have obvious implications for nancial markets – equities markets, bonds markets,

and so on. In this section, we look at a couple of these scandals of recent years

and consider issues relating to them. Both of the scandals we deal with here were

based on deliberate accounting deceptions to misrepresent the nancial position of

companies. We look at Parmalat of Italy (see Box 12.4) and then Enron in the US.

Box 12.4

Parmalat

Parmalat was Italy’s best known food company. It had been established by Calisto Tanzi

who in 1961, having inherited his father’s delicatessen, set up a dairy plant near Parma in

northern Italy to challenge a then-existing Italian milk monopoly. Parmalat became Italy’s

rst producer of branded milk and greatly expanded its market through the production

of UHT milk. It expanded strongly and by 2002 was the fourth-largest food products group

in Europe. It had grown by gradually moving into new product lines and by making a

large series of acquisitions, particularly abroad. At the end of 2002, the Parmalat group

consisted of 213 companies in fty countries and had 37,000 employees, of whom about

4,000 were in Italy. The shares of Parmalat Finanziaria, which controlled the industrial

rm, were listed on the stock exchange in the 1990s. The company was well-known for

sport sponsorships and had bought the Italian Serie A football club, Parma.

Parmalat accompanied its strategy of expansion abroad with a large-scale interna-

tionalisation of its nancial operations. Acquisitions and investments were nanced by

entering into debt. Through various group companies Parmalat obtained very substantial

nancing on the international capital market. Despite the heavy indebtedness of the

company, nancial institutions and markets seemed happy with the acquisition strategy.

At the beginning of 2003 Parmalat’s shares were brought into the index of the thirty

largest companies listed on the Italian stock exchange. Many international nancial

analysts continued to advise investors to buy the company’s securities. However, by the

beginning of the second week in December it had become clear that Parmalat would

have difculty meeting a debt repayment to a group of investors who had bought 18 per

cent of Parmalat’s large Brazilian subsidiary but who had then exercised an option to

sell it back to Parmalat following the failure of the subsidiary to be quoted on the

Brazilian stock exchange. Parmalat claimed that it would be able to meet the payment

by recovering a A500m ($590m) investment in a mysterious hedge fund in the Cayman

Islands tax haven but the fund did not, in fact, exist. The company had been engaged

in false accounting, the concealment of liabilities, the ination of assets and the forging

of bank statements. Parmalat had been using Enron-style accounting to hide liabilities

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