Preventing the Next Parmalat

The Italian cabinet has approved a draft law aimed at reforming Italy's regulatory system. The law, which is still subject to parliamentary approval, is the first step towards changing a system which, in the eyes of many, failed to prevent the multi-billion dollar Parmalat scandal.

But after months of political wrangling, the tough original version of the bill was watered down -- and may be further diluted before it gets final parliamentary approval sometime in the next three months -- raising doubts about the current Italian government's ability to impose better corporate governance and soothe investor anxieties. Elsewhere in Europe, including Germany, steps have been taken to prevent a Parmalat or Enron-style meltdown. But are the safeguards sufficient?

Italian Economy Minister hopes for radical reform

The law approved by the Italian government last week was very different from the one proposed by Italy's Economy Minister Giulio Tremonti. Shortly after Parmalat first made the news in December, Tremonti called for shifting oversight authority away from the Bank of Italy and giving more power to the anti-trust authority and Consab, the Italian equivalent of the United States' Federal Exchange Commission (FEC). Those found guilty of financial fraud would also face longer prison terms.

In short, Tremonti hoped to consolidate Italy's complicated regulatory system, which is comprised of five parts, each devoted to different types of business, into a three-pronged system.

Italian politicians reluctant to make big changes

But Tremonti faced tough opposition from the country's business-mogul prime minister Silvio Berlusconi and his allies, who feared that a harsh response would be bad for business. "We don't need to turn an exceptional event into a witch hunt, which would make the running of an insurance or financial company difficult," said Berlusconi.

As it turned out the draft law did not, as some had hoped, consolidate the various authorities. Instead it strengthened Consob with greater sanctioning powers and the authority to oversee corporate bond issues. Not everyone, including Tremonti, was convinced. "We would have liked a radical reform, and now we risk introducing a reform that isn't very incisive," he said.

The German path to reform

In an interview with Deutsche Welle, Marco Becht, the Executive Director of the European Corporate Governance Institute and a professor of finance and economics at the University of Brussels, points to the complexity of the issue. "Sometimes it is a case of management without enough shareholder oversight, as was the case with Enron, and sometimes it is a case of a very powerful shareholder getting up to something, as was the case with Parmalat," he said. "The tools you need in each of these situations is slightly different," he added.

Given the complexity of the task at hand, and the increasing complexity of multi-national corporations engaged in different types of business, what's a government -- say the one in Berlin -- to do? Tremonti's approach, consolidating various oversight authorities into a more cooperative powerful single entity, is an approach that has proven popular elsewhere in Europe, according to Ernst Maug, a professor of business administration at Humboldt University in Berlin.

Germany did so in 2002, consolidating various regulatory agencies into BaFin, the federal agency responsible for overseeing the entire financial sector. "This seems to be the trend and makes a lot of sense to me," Maug told Deutsche Welle. "It doesn't make sense to have different regulatory agencies overseeing different sectors just because one security is called a stock and another a bond; when you have one authority you have a better chance of catching things."

What's more, also in 2002, the German Corporate Governance Code, also known as the "Kodex," was implemented. This code of "best practices" is not legally binding, but companies are now required to disclose in their annual reports the extent to which they comply with the code and explain opt-outs.

A German Parmalat?

These measures by no means guarantee that a corporate scandal like Parmalat or Enron won't happen in Germany. "Could it happen here -- yes," says Maug. You will never have a system where everyone complies with the law all the time, he points out, and reducing these scandals to zero is not an option, since the resulting regulation could prove too costly for business.

Brecht concurs. "There is always a trade-off in trying to prevent the next Parmalat from happening and restricting executives from being able to do business," he says. "With regulation, you have to do a cost-benefit analysis."

In the meantime, governments in Europe and the world over continue to debate how to strike the best balance.