Crying over spilt milk
The Italian Enron is shaking the US world of institutional investors and investment banks. A large proportion of the bonds issued by Parmalat, the giant diary company filing for bankruptcy, is in fact owned by American insurers and pension funds: at least $1.5bn (E1.2bn) according to estimates by the Securities and Exchange Commission(SEC), the US financial authority.
The SEC has filed a suit in New York against Parmalat alleging that the Italian company engaged in “one of the largest and most brazen corporate financial frauds in history”. Also the SEC is looking at the role played by banks that helped Parmalat raise billions of dollars over many years and conceal its real situation.
Some of the institutional investors that own the defaulted bonds have decided to sue former Parmalat chairman Calisto Tanzi and his financial, accounting and legal assistants, trying to recover some money by legal action. They may be trying to also involve the banks that acted as underwriters of Parmalat offerings, as some US pension funds are doing in the WorldCom case.
But the question is whether pension funds and the other institutional investors can blame third parties for the holes in the due diligence process relating to the issuing of Parmalat bonds.
In the US, Parmalat bonds were sold to institutional investors in the private placement market under Rule 144a. According to this, issuers must sell bonds only to sophisticated buyers and can do so without registering the deals with the SEC. A private placement bond offering takes less time and allows more flexibility in how these are finalised.
“You may say that responsibility for due diligence falls more on the sophisticated 144a investor than on the underwriter in this case,” points out Gianmaria Delzanno, a financial consultant based in New York. “The SEC vetting process is there to protect the unsuspecting individual investor, while Rule 144a was put in place because big institutions need less protection. In a private placement they are supposed to ask questions directly to the issuing company, for example during meetings with its managers.”
There were many questions that ‘sophisticated’ investors could have asked Tanzi. The company had a higher relative debt level than most of its peers, yet kept a seemingly enormous amount of cash in bank accounts and it repeatedly raised more funds despite its purported cash pile. Parmalat and its units did about three dozen separate bond issues in 10 years, raising at least E7bn. Few analysts noticed this anomaly during the last 12 months.
In more than one report, the investment banks Lehman Brothers and Merrill Lynch recommended selling Parmalat securities: they observed that selling milk was not the primary business anymore and the company looked more like a high-risk financial investment fund; they underlined the opacity of the company’s balance sheet and its managers’ unwillingness to give the market better disclosure.
Only few global bond investors took these matters seriously. One of them is the UK asset management company M&G. “We did look at Parmalat but we decided not to buy its bonds or private placements because we couldn’t get good answers to our questions,” says Stephen Wilson-Smith, head of credit research at M&G, said to the Wall Street Journal. “We couldn’t have predicted Parmalat would be one of the biggest alleged frauds of all time, but we were concerned enough to not be willing to lend to them.” Other people familiar with the matter say that even at presentations for Parmalat public issues, investors had scant opportunity to sit down with Parmalat executives and get answers about its financial policies.
But a lot of bond investors were more interested in the yields offered by Parmalat, a little higher than those guaranteed by bonds with the same investment-grade rating. Besides, they claim they trusted Parmalat’s rating by Standard & Poor’s and its auditing by one of the Big Four accounting firms, Deloitte & Touche. That is why they now allege they have been defrauded.
The first US institutional investor that has decided to legally act is the Southern Alaska Carpenters Pension Fund: it filed a suit in US District Court in the Southern District of New York, seeking class-action status on behalf of investors who purchased Parmalat securities between January 5, 1999 and December 29, 2003. The plaintiff’s attorneys are William Lerach and Darren Robbins at Milberg Weiss Bershad Hynes & Lerach LLP, a leading legal firm in shareholder class-action litigation. Milberg Weiss is assisting the University of California and other US institutional investors in the shareholders’ class action against senior Enron executives.