Paul Betts in Milan, Tony Barber in Rome and Fred Kapner in New York

Milking, in the various senses of the word, was what lay at the heart of Parmalat.

The company that Calisto Tanzi founded in 1961, using the proceeds of a small family prosciutto and tomato paste business in northern Italy, was built on milk.

His big idea was to exploit a new Swedish technology for packaging long-life milk in cardboard cartons and, thereby, turn a humble local food company into a giant international business - "the Coca-Cola of milk" as he is reputed to have described it.

Parmalat did indeed become a corporate icon. As Italy's eighth-largest company, it has operations stretching across five continents and 30 countries, employing more than 35,000 people in 200 units.

But it is now at the centre of what increasingly looks like Europe's biggest corporate scandal: a fraud, in the view of Italian prosecutors, that involved sophisticated financial mechanisms designed to siphon money from the company to Mr Tanzi, to benefit other family owned operations, to prop up Parmalat's share price, to disguise the parlous financial state of the group, to invent paper assets purporting to be worth billions of euros and to hide what in retrospect has proved to be an ill-considered spree of expansion and acquisitions in the 1990s.

Mr Tanzi spent New Year's Eve in Milan's San Vittore prison, and two of Parmalat's former chief financial officers were among seven executives and company advisers detained on Wednesday as Italian authorities broadened their investigation. No one, however, has faced formal charges.

"I still cannot believe this," Pietro Lunardi, Italy's Minister for Transport and Infrastructure, who went to school with Mr Tanzi as a child, said yesterday. "When I read the news, I feel as if I've woken up from a bad dream."

The fraud came to light on December 19th when Bank of America declared that a document purporting to show €3.95 billion in an account held by Bonlat, a Parmalat subsidiary registered in the Cayman Islands, was false.

Subsequently, investigators searching Parmalat's offices discovered "a whole set-up for falsifying papers, transactions, accounts", said one person involved in the inquiry.

"They had clearly started to do this many years ago, and it must have become like a drug. They became more and more dependent, to the point that they were inventing transactions from Singapore to Cuba, and viewed it all as a routine way of doing business," the person said.

For example, Parmalat forged a purchase order from Empresa Cubana, a Cuban import business, for $620 million (€495 million) of powdered milk, "enough white powder to make Cuba look like Switzerland in winter", said one person familiar with the transaction.

But the seeds of Parmalat's disaster were sown many years earlier. Even before Parmalat was listed on the Milan stock exchange in 1990, Mr Tanzi relied on debt to grow the company.

The stock market listing was a complex operation in which Mr Tanzi took control of an already quoted company called Finanziaria Centro Nord (FCN), which turned into Parmalat Finanziaria. This step was crafted to help restructure Parmalat's accounts after an earlier buying spree.

Before the listing, Mr Tanzi had been close to selling his company to Kraft of the US. Kraft made an offer but Mr Tanzi rejected it on the grounds that he wanted to retain management control of his company.

The deal with FCN brought Mr Tanzi into a close partnership with Giuseppe Gennari, an eccentric Sardinian financier who controlled the financial company and had made headlines with his involvement in an abortive takeover bid for Banca Nazionale dell'Agricultura, an Italian bank.

The even more controversial figure of Florio Fiorini, a former financial director of the Eni oil group, had also set his sights on FCN. But Mr Tanzi won the day and Mr Gennari took a stake in La Coloniale, Mr Tanzi's family holding company.

Mr Tanzi had also long-established business dealings with Sergio Cragnotti, the former head of Cirio, the Rome-based food group that collapsed last year.

Both men expanded operations in Brazil. Mr Cragnotti sold a business to Mr Tanzi in a deal that was approved by Italy's antitrust authorities on condition that Mr Tanzi disposed of certain assets.

These assets have been found to be controlled by a Delaware company Boston Holding, whose legal representative is Gian Paolo Zini, a lawyer acting for Parmalat. Mr Zini was among those detained on Wednesday.

Although Mr Tanzi portrayed himself as a parsimonious entrepreneur who would call his production managers each morning to check on deliveries, he appeared to have a weakness for spending money on himself and his family.

"For his deals, Tanzi would fly over with his entire family on his jet to have a look. It was crazy. There were no controls," said one person involved in the investigation.

Much of what is known about Parmalat's dubious self-financing comes from prosecutors' interrogations of Mr Tanzi and Fausto Tonna and Luciano del Soldato, the two company finance directors also in detention.

The central feature of the fraud, prosecutors say, was an offshore system of companies set up first in the Netherlands Antilles and then, in 1999, at Bonlat in the Cayman Islands.

These companies allowed Mr Tanzi and his closest associates to manipulate funds raised on the capital markets by Parmalat Finanziaria, by Parmalat SpA (the core industrial part of the group), and by Parmalat Finance Corporation, their Dutch affiliate.

They were the conduits for intra-group financing manoeuvres involving back-to-back credit and loan transactions and fraudulent propping up of Parmalat's balance sheet through non-existent cash and securities accounts - most notably, the faked Bank of America account.

Mr Del Soldato told prosecutors that he had ordered Gianfranco Bocchi, another Parmalat executive in detention, to use a Parmalat computer to forge the Bonlat account. In Mr Bocchi's version of events, Mr Del Soldato demanded that this computer be destroyed with a hammer.

Apart from shifting money out of Parmalat, the Caribbean vehicles and their fictitious assets were used to protect the company's ability to raise funds through an investment-grade status that was only removed last month by Standard & Poor's, the credit rating agency.

The offshore entities were partly the brainwave of Mr Tonna and Mr Zini. But, according to Guido Salvini, a judge investigating the affair, the inspiration behind Bonlat's creation also came from Lorenzo Penca and Maurizio Bianchi, chairman and partner respectively at Grant Thornton SpA, the Italian unit of auditing firm Grant Thornton International.

Grant Thornton SpA was Parmalat's principal auditor until 1999 and continued thereafter to act as Bonlat's auditor. Mr Penca and Mr Bianchi were detained on Wednesday.

Mr Zini was also linked with the creation of Epicurum, a Cayman Islands investment fund in which Parmalat said it had placed €496.5 million.

Parmalat's failure to recoup that money last month contributed to the declaration of insolvency, which means the group is now administered by Enrico Bondi, a government-appointed commissioner.

According to Italian investigators and people close to Parmalat, the group's money was invested in Epicurum in the hope that it would provide a high return for Parmalat's liquid assets.

After a sudden trip to Ecuador over Christmas, the purpose of which is unclear, Mr Tanzi returned to Milan and was seized by police on December 27th.

Before his detention, he had a meeting with Mr Bondi and told him that he estimated the hole in Parmalat's accounts at about €8 billion.

He told prosecutors that he had diverted about €500 million from Parmalat over a period of seven to eight years, largely to the Tanzi family's unlisted travel company, run by his daughter Francesca. Prosecutors say they suspect the real figuremay be as high as €800 million.

"We realise that there are savers and shareholders who have seen their money, work and everything go up in smoke," said Mr Tanzi's lawyer, Fabio Belloni.

Whether these investors will see any of their money again depends on the outcome of what the US Securities and Exchange Commission calls "one of the largest and most brazen corporate financial frauds in history". - (Financial Times Service)