Wirecard already is shaping up to be to Germany what Enron was to the United States: An accounting oversight failure so epic in its scope and scale that its aftermath is likely to forever alter the country’s auditing and accounting profession as it exists today.
Founded in 1999 by now-former CEO Markus Braun, Wirecard appeared to have a promising future as a behemoth in Germany’s financial technology sector, finding a coveted spot on Germany’s prestigious DAX 30 index. But the global payments company had its fair share of skeptical investors and analysts as well and, since 2008, has deflected suspicions about its rapid growth and inconsistencies in its financial statements.
For example, in February 2016 Zatarra Research published a report linking Wirecard to online gambling operations and companies that were laundering money into the United States. The Financial Times, too, has been doing a series of investigative reports on Wirecard. In January 2019, it published a damning exposé detailing how Wirecard allegedly falsified accounts and engaged in money laundering. A compliance officer had raised these concerns in May 2018, a whistleblower told the FT. In October 2019, the FT published internal documents that further indicated Wirecard fraudulently inflated its sales and profits.
In response to those reports, Wirecard commissioned Big Four audit firm KPMG to conduct a special audit regarding the balance-sheet manipulation allegations. But the company was quick to report KPMG didn’t produce any “substantial findings” that would lead to the correction of its 2016, 2017, and 2018 annual financial statements.
KPMG’s final report, published April 27, 2020, told a very different story. In its review, KPMG said many of the documents and banks records necessary to conduct a full review never arrived; it struggled to receive cooperation from three of Wirecard’s key partners who were at times responsible for half of the group’s sales and most of its profits; it was unable to verify €1 billion (U.S. $1.1 billion) in cash balances; and Wirecard “would neither track nor monitor” know-your-customer compliance checks carried out by its partners. Wirecard, however, responded it was “convinced that it has at all times communicated to the best of its knowledge and belief and in accordance with the statutory information requirements.”
For a while, Wirecard’s deceitful tactics worked, until they didn’t. The company finally imploded on June 25, with its announcement it was filing for insolvency just three days after acknowledging there was “a prevailing likelihood” bank trust account balances in the amount of about $2 billion—representing approximately one quarter of the company’s balance sheet—“do not exist.” The acknowledgement came after Wirecard’s long-time auditor, EY, refused to sign off on Wirecard’s 2019 financial report after discovering the glaring black hole on its balance sheet.
In addition to suspending certain members of its management board—including the resignation of Braun—Wirecard announced the creation of a new “Integrity, Legal and Compliance” department, led by its newly appointed chief compliance officer, James Freis (who is now the company’s interim CEO). But its efforts could prove too little, too late.
Now, the real fallout begins. Braun was arrested by German prosecutors on June 26 but was later freed on $8 million bail. Jan Marsalek, Wirecard’s former chief operating officer, is still at large and could be on the run. The two are now also facing criminal complaints in Austria over allegations of market manipulation. In Germany, two more unnamed Wirecard executives also have been arrested.
“As we learn more about the issues leading to Wirecard’s collapse, there is little doubt that it will mean reputational damage, both to the audit firm concerned and to the audit profession more generally. It will add fuel to the debate taking place across a number of jurisdictions about the need for reform of the audit profession and strong action to support high audit quality.”
Mike Suffield, Director of Professional Insights, Association of Chartered Certified Accountants
On June 26, the U.K.’s Financial Conduct Authority imposed several requirements on Wirecard, including that the company “must not dispose of any assets or funds, that it must not carry on any regulated activities, and that it must set out a statement on its website that it is no longer permitted to conduct any regulated activities.”
The wider questions now: What happens next, and who is really to blame for the oversight failure?
BaFin investigates Wirecard. Germany’s financial regulator, BaFin, said it’s investigating Wirecard, but also noted that it’s limited by the scope of its mandate. “As a listed company, Wirecard AG is not subject to BaFin’s ongoing supervision, which means that we do not have the powers to approve or object to appointments to the management board,” Elisabeth Roegele, BaFin’s deputy president, said on a June 29 media call.
Currently, BaFin said it’s analyzing KPMG’s special audit report, specifically examining whether the report contradicts what Wirecard declared about KPMG’s findings. BaFin said it’s also focusing on “whether the report shows whether Wirecard kept information that had to be published or provided false information.”
European Commission investigates BaFin. BaFin, itself, is facing scrutiny after the European Commission penned a June 26 letter to the European Securities and Markets Authority (ESMA) requesting it conduct “a fact-finding analysis” into the adequacy of BaFin’s supervisory response leading to Wirecard’s collapse.
ESMA is also being tasked with looking for “any evidence of administrative or legal obstacles that impeded the effective enforcement of applicable financial reporting requirements or, if relevant, the effective sanctioning of any breaches of such requirements.” It’s expected to complete its report by July 15.
Shareholders investigate EY. Wirecard’s long-time auditor, EY, faces mounting legal action as well. One class-action lawsuit, filed by the law firm of Wolfgang Schirp, took issue with EY auditing Wirecard’s alleged equity capital of €1.9 billion (U.S. $2.1 billion) “without objection, although no sufficient evidence was available. This procedure is very peculiar and, according to our analysis, does not correspond to the dutiful procedure of an auditor,” Wolfgang Schirp stated.
In a second action, Dutch shareholders association VEB has filed an action against EY for not properly fulfilling its role; playing a “significant role” in the scandal; and for “intentionally” neglecting its legal duties. VEB said it’s seeking compensation on behalf of Wirecard shareholders for “significant damages” caused by EY. In a third lawsuit, German shareholders association SdK filed a complaint against three EY auditors—two current and one former—for their roles in the accounting scandal.
For its part, EY has said it was duped into “an elaborate and sophisticated fraud” carried out by Wirecard and that “even the most robust and extended audit procedures” would not have been able to derail it.
Kevin Dancey, chief executive officer at the International Federation of Accountants (IFAC), tells Compliance Week, “the Wirecard situation underscores the importance of a well-functioning ecosystem as the pre-condition to achieving high-quality audits that serve the public interest.” All participants in the audit and assurance profession “must act to continually improve the audit process, the skillset, and mindset of accounting professionals; the internal governance activities within both companies and audit firms; the regulations and standards that support and oversee entity reporting and auditor behavior; and how audit quality is assessed,” he says. “And of course, a factual assessment of any given situation is always needed to inform discussions of potential improvements to be made.”
Accounting oversight reforms
“The collapse of Wirecard is sure to have implications for regulation and oversight arrangements in Germany,” says Mike Suffield, director of professional insights at the Association of Chartered Certified Accountants (ACCA). “BaFin has already received criticism, the previously profession-led arrangements for review of German company accounts are under threat, and it is probably only a matter of time before attention is turned explicitly to the audit oversight body in Germany and its own work overseeing the quality of the auditor’s work.”
“As we learn more about the issues leading to Wirecard’s collapse, there is little doubt that it will mean reputational damage, both to the audit firm concerned and to the audit profession more generally,” Suffield says. “It will add fuel to the debate taking place across a number of jurisdictions about the need for reform of the audit profession and strong action to support high audit quality.”
Even before Wirecard’s accounting scandal came to light, many in Europe—following other high-profile accounting scandals—have long called for separating audit from the accounting profession. “We can expect more interest now in this option,” Suffield adds.
In fact, the U.K. Financial Reporting Council on July 6 announced its principles for operational separation of the audit practices of the Big Four accounting firms: Deloitte, PwC, EY, and KPMG. The Big Four must submit their implementation plans by Oct. 23 and “provide a transition timetable” for completing implementation by June 30, 2024. The FRC said it will then agree to a transition timetable with each firm and, thereafter, will publish annually an assessment of whether firms are delivering the objectives and outcomes of operational separation.
Big changes for the accounting profession are now also afoot in Germany in direct response to the Wirecard scandal. The Federal Ministry of Justice and Consumer Protection, in consultation with the Federal Ministry of Finance, announced plans to terminate its contract with the Financial Reporting Enforcement Panel (FREP), the country’s accounting oversight body, at the end of 2021. The decision was “to our astonishment,” FREP responded, adding that it had “first learned of it through the media.”
FREP also defended accusations that it didn’t act quickly enough in responding to the Wirecard case, stating that “exactly the opposite is the case.” According to FREP, necessary steps were taken, such as obtaining Wirecard’s cooperation and staffing its examination team, “immediately” upon receiving BaFin’s request to perform an examination in February 2019. FREP added “the same holds for EY’s long-form audit report on these financial statements.”
FREP said its mandate is to examine whether financial statements are prepared in accordance with financial reporting principles and that “detecting and investigating financial statement fraud is not part of its mandate.” A forensic examination or fraud investigation requires “a significantly different approach—for example, challenging testimonies, inspecting the quality of evidence, and much more. Such an investigation requires considerably more personnel and the power to request information from third parties,” FREP said.
As a private organization, as opposed to a government body, FREP said it “does not have the same enforcement powers as, for instance, a public prosecutor. Rather, it must always rely on the company’s cooperation.” Any considerations for accounting reform should begin, FREP said, with transferring cases to BaFin or another sovereign organization whenever fraud is suspected.
Wheels are already in motion to hand authority over to BaFin to launch investigations into financial reporting, authorities told the FT. Moving forward, FREP said it “plans to hold constructive discussions with the Federal Ministries regarding the future structure of the enforcement system in Germany to enable it to react more swiftly and more specifically to cases of financial statement fraud in the future.”