It has been said many times: the multi-billion-euro scandal at Italian food company Parmalat is “Europe’s Enron.” And as with Enron, one of the most important and closely watched aspects of the saga is whether, and to what extent, Parmalat’s banks will be held accountable for the fraudulent “Ponzi scheme” that the company became. As part of their investigation, Italian and US authorities are examining the role played by 20 European and US banks in selling 8 billion of Parmalat bonds over a six-year period, and in setting up the web of special-purpose entities that siphoned off Parmalat money and concealed the true financial state of the company.
However, Parmalat’s bondholders and shareholders—the main victims in the scandal—are not looking to regulators to recoup the money they’ve lost. They are suing through the courts, the main battleground being New York, where a handful of class action suits have already been filed in the district court in Manhattan.
The class action suits—which are not possible in European courts—are effectively the only route open to many investors, says William Lerach, a partner at New York-based Milberg Weiss, the law firm that brought the first class action suit against Parmalat and its advisers, including Citibank, Bank of America, Deutsche Bank and Morgan Stanley. Its clients in the case include the Southern Alaska Carpenters Pension Fund, in addition to Italian and other European investors. So far, says Lerach, the courts have lent a sympathetic ear to investors in such cases, ruling twice that banks can be sued as part of the class actions against the companies. While other European companies—Vivendi, for example—have been subject to investor class action suits in US courts, Parmalat is the first European case in which banks have been named, following the example set by the cases of Enron and WorldCom, whose banks are also being sued.
Why have the class action suits naming banks come about now? “Regulatory failure,” Lerach asserts. “There has clearly been, on a world-wide basis, a massive regulatory failure. The frenzy of deregulation in the 1990s clawed-back legal protection against conflict of interest. Parmalat, Enron and WorldCom, all three scandals bear that common imprimatur. The coal in the engine of those scandals was that you have billions in commercial loans being made by the corporate banking guys, and then a few floors below, you have the investment guys selling billions in securities to investors.”
This line of reasoning seems to be gaining favour among European policymakers. In a February speech to the European Parliament about Parmalat, Frits Bolkestein, European commissioner of internal market (which under the Financial Services Action Plan now has unprecedented powers in setting European company law warned: “The financial services industry had better get its act together, and do so fast. We need some real industry leadership to stand up and take charge: to clear out the crooks, expose their unscrupulous practices and curb excessive greed. If industry leaders are not prepared to do this, then regulators will have to do much more than perhaps they or we would like.”
Tough words. So far, the commission has sought to put the main burden of responsibility on the boards of public companies and the external auditors. Bolkestein is pushing for stronger European-wide “corporate governance/company law” (it is not yet clear what form it will take), which will place a more specific liability on board directors for the accuracy of their accounts—Sarbanes- Oxley “lite”, you could say. He is also pushing for strengthened laws that will tighten the supervision of outside auditors, with more severe penalties for infringements that will extend to the parent firm, not just the local branch.
But what of the banks? Or more specifically, the “financial conglomerates,” the giant financial institutions, like those named in the Parmalat lawsuits, which constantly face the temptation for their right hand to conspire with their left? A tough regulatory line could have the effect of radically altering the relationship between banks and their corporate clients, just as the auditor-client relationship has changed forever.
Bolkestein remains vague on this point. In his speech, the commissioner said the Investment Services Directive, which is expected to come into force in August, “will help deal with some of the major conflicts of interest in the investment services business.”
However that is more of a hope than anything else at this point. As one high-level official at the internal market division of the commission explains, “Banks and investment firms will be required by the new Investment Services Directive to provide buyers of securities with all relevant information about the issuer. The precise definition of the ‘relevant information’ to be given will be defined by the commission in implementing measures to be adopted subsequently.” And those “implementing measures” will, of course, be the subject of intense lobbying.
Banks, needless to say, are for the lightest of touches. “The industry is for self-regulation,” says Panos Papapaschanis, legal adviser at the Brussels-based European Banking Federation, a lobbying group. “We have always supported [the Committee of European Securities Regulators, advising the commission on capital-markets reform] and we definitely support the [regulatory] process in banking. Why? Because it is a flexible approach; it allows the industry to be heard. The framework we support, but we have to see what comes out of it. But policing our customers? No.”
However, at least some policing of customers is already written into the new European legislation. Michael McKee, executive director of wholesale markets and regulation at the British Bankers Association, which represents many of the major financial groups with European headquarters in London, says, “There are a couple of drivers out there for greater pressure on banks to supervise their customers. The Market Abuse Directive, for example, which is in the process of being implemented, has a requirement that if a financial institution is suspicious about a customer’s transaction, it has an obligation to notify its regulator—which regulator that is is less clear. Most of these pieces of legislation are fresh and the paint hasn’t even dried.”
The big challenge, in any case, will be in the implementation and supervision of that law is the key. McKee says that it is too early to tell what role will be played by the Committee of European Banking Supervisors (CEBS), the main institution for implementing (or at least co-ordinating the implementation of) bank regulation.
There’s one area where regulators and the regulated see eye to eye—much work still needs to be done. The commission has yet to decide whether it will create a separate “level 3” committee to co-ordinate supervision of “financial conglomerates,” as opposed to banks in general. As it stands, these issues are thrashed out at regular meetings run by committee chairmen Arthur Docters van Leeuwen of CESR, José-María Roldán of CEBS and Henrik Bjerre-Nielsen of CEIOPS (the Committee of European Insurance and Occupational Pensions Supervisors). Their first meeting was in Amsterdam in February.
Roldán says that the division of responsibility, between the European committees themselves, and between the committees and the national regulators, is the top order of business for the new regime. “The key for success will be to go for convergence of supervisory practice where it is needed, while at the same time giving some room for manoeuvre at the national level,” he says, adding however that it is important to avoid any opportunities for “regulatory arbitrage” between the countries.
The European Commission already is thinking about firming up the loose “co-ordinating” role that CEBS is fulfilling. At a seminar organised by the Centre for European Policy Studies (CEPS) last November, Patrick Pearson, unit head for banking under Jean-Claude Thébault at the commission, said a lead supervisor for all cross-border banking should be a goal for regulators. “The cost savings (alone) … would justify the loss of power of national regulators,” Pearson said.
Taking the Lead
In most previous EU-wide efforts, it has been virtually impossible to get a consensus to devolve power of an important policy area to the centre, says Karel Lannoo, a director at the CEPS. But it is different with the single market in financial services because it would be unworkable to have 15 (or 25, as of May) different sets of interpretation and bureaucracies. “There is much more power with Brussels (on financial services) than there has ever been in the past” on other areas, he contends. “There is much more [financial services] regulation set in Brussels than in the capitals.”
Of course, the powerful players—the UK, Germany, France—will continue to exert their influence at all levels. The ministries of finance have senior civil servants on “level 2” committees where policy is decided officially. While those committees are chaired by top commission officials, the more powerful members are far from passive. And they also have high-level, government-appointed representation on the level 3 committees, which are made up of regulators, such as the heads of the FSA in Britain, BaFin in German and the ATM in France.
But even back in the capitals, where the banking lobby traditionally has been strong, the political fall-out from Parmalat and other scandals may be turning the tide against self-regulation.
“One reason why Parmalat happened is a lack of supervision over companies and their financial transactions,” says Erik Bomans, a partner at Deminor, a Brussels-based investor rights advocacy firm. Deminor has joined Altroconsumo, an Italian consumer association, to represent a number of Parmalat’s investors, including Belgian, French and Italian companies that make up the biggest block of bondholders among the five class action suits filed so far. “If only the regulatory authorities in Europe would do their job, then this kind of situation would certainly have been detected much earlier. Once you have this kind of situation, the only thing for investors is to sue for damages. People are now speaking about regulatory reform. But it is only when you have these kind of shocks that people start thinking about a system and when it should be applied.”
The banks’ case for loose supervision is also weakened by the information coming out in the courts about their exact role in the corporate scandals. In March, it emerged through documents filed in the WorldCom class action in New York that officials at JP Morgan, Deutsche Bank and Bank of America expressed doubts in internal memos about the company’s financial health months before they sold $12 billion (10 billion) of its bonds to investors. In the Italian press, both the former CEO and CFO of Parmalat alleged that some of its bank advisers not only were aware of the company’s troubles but proposed transactions to cover them up.
Says Bomans of Deminor, “I think you cannot expect financial institutions to act as policemen. But there is a difference between requiring a financial institution to monitor a client to make sure they don’t do anything illegal and requiring a bank, when proposing certain transactions, to ensure that transaction serves a legitimate purpose. When a financial institution starts to set up, at the request of their clients, certain structures aimed at hiding risks and liabilities, or when it is advising companies to issue securities on the basis of information it knows is wrong, then you can ask about its behaviour. And the rules are there, if only they are implemented.”
And that job now falls to the new bodies of Europe’s regulatory regime.