Boris Ignachkov Markus Braun, The former CEO of Wirecard – a German payment processor – has been arrested for the second time following fraud accusations levelled against him. Braun’s €5 million bail has now been revoked. The fraud allegations refer to accounting fraud, which enabled Braun and other executives at Wirecard to inflate the company’s revenue to mislead investors. The company admitted in June 2020 that €1.9 billion of its cash was likely non-existent. It is suspected that such illegal activity could date back to 2015, at the earliest. The public scandal surrounding Wirecard, now defunct, has huge implications for the actions of the accounting industry and the future of auditing.
Fraud
In 2017, BaFin – a German financial watchdog – announced its earlier request that public prosecutors investigate suspected market manipulation by Wirecard. At the time, Bafin responded that they had concluded an investigation into the matter, launched in 2016. In February 2019, Wirecard’s Singapore office was raided by police. The raid followed an internal probe’s discovery of accounting discrepancies and forged documentation. Ten days later, BaFin prohibited investors from betting on Wirecard shares, for a two-month period. This action was unprecedented in the history of the German stock market. Though BaFin has since come under fire due to perceptions of investigation into Wirecard occurring too late, it is thought that the German regulatory system was simply ill-equipped to deal with the payment company. Additionally, it is speculated that German regulatory bodies may have been reluctant to undermine an uncommon German tech giant. Nevertheless, in June of this year, following Wirecard’s collapse, the EU announced that it would investigate whether BaFin acted unlawfully with respect to EU laws through its dealings with Wirecard. The investigation was launched on 15th July 2020.
Recent investigations into Wirecard, beginning in 2019, found accounting irregularities – the aforementioned missing €1.9 billion was alleged by Wirecard to be held in two Phillipine banks. However, these banks have stated that they never dealt with the company. Consequently, the Philippine government is investigating the missing sum. Additionally, between 2011 and 2014, Wirecard began expanding internationally by purchasing third-party payment companies in Asia using €500 million from its shareholders. Several of these businesses established escrow accounts – an arrangement where a third party receives and uses money for the primary parties of the transaction. Consequently, Wirecard could operate without a license in companies including Dubai, Malaysia, and Singapore.
Last year, it was discovered as a result of the latest set of investigations that half of Wirecard’s global revenue and the vast majority of its reported profits came from three ‘opaque’ partner businesses. In fact, in 2016, the partners’ earnings equated to 95% of the Wirecard group’s EBITDA (essentially the net income). Most of the profits from these partners were processed through CardSystems Middle East, Wirecard’s largest business. CardSystems Middle East is based in Dubai. Allegedly, accounts for CardSystems Middle East had not been audited in years. Furthermore, the large amount of business recorded for the company was unmatched by its cash flow, prompting suspicions. The largest of the partner companies is Dubai-based Al Alam Solutions. The other partners are based in Singapore and the Philippines. Two executives at the Singapore-based partner, Senjo, assisted a Wirecard employee in producing a fraudulent contract for software sales. Unsurprisingly, such actions led to the aforementioned investigation into fraud and money laundering accusations in Singapore.
Insolvency
In late June, Wirecard filed for insolvency. An insolvent company is one unable to pay its debts – Wirecard owes creditors €3.5 billion, and there is no guarantee that it will survive. Share prices fell from €100 per share to only €17, leading Braun, who still possesses approximately 7% of Wirecard’s shares, to lose €600 million in a single day due to this fall in share price. Late June saw share prices fall even further, to as low as under €2. As the fraudulent parts of the business – including its Asian and Middle Eastern partners – comprise such a large proportion of Wirecard’s revenue, it is evident that its remaining genuine parts cannot cover the business’s costs and debt. Thus, it is unlikely to recover.
Auditors’ Roles
The role of auditors involved with Wirecard and its partner businesses arguably enabled the scandal to occur in the first place – or at least allowed its continuation. This year, KPMG conducted a special audit commissioned by Wirecard, which was described by EY (Wirecard’s auditor) as lacking context. EY saw a draft of the report the day before its publication, and expressed concern over inconsistencies and vague representations of third party business, which could lead to misinterpretation. EY warned Wirecard of its concerns. KPMG was unable to verify activities that accounted for half of Wirecard’s revenue. EY admits that there was evidence of fraud by Wirecard, though argued that more thorough auditing may not have uncovered Wirecard’s intricate fraud.
Yet the biggest accounting firms in the UK (including EY) face criticism from the UK’s accounting watchdog (the Financial Reporting Council) for their declining work quality. This follows a third of audits failing to meet the watchdog’s standard, as revealed in the watchdog’s annual review. This suggests that EY’s auditing of Wirecard was sub-standard, and thus may have overlooked the absence of missing money. It is unlikely that the auditor did not notice the missing €1.9 billion and undocumented activity that supported the company. Rather, it may be inferred that such inconsistencies were willfully overlooked.
In a similar case of poor auditing standards, KPMG is being sued for £250 million by Carillion. Carilion claimed that KPMG was negligent in its audits of the company, which led its directors to believe in its profitability and sustainability, consequently paying out over £250 million in advisory fees and dividends over two years. The audits allegedly misrepresented Carillion’s financial situation, leading them to incur losses as a result of misinformation. Carillion collapsed in 2018. Similarly, PwC and EY were accused by UK MPs of being complicit in the collapse of Thomas Cook last year. PwC audited the company between 2007 and 2016; EY between 2017 and the company’s collapse. Both firms are accused of signing off Thomas Cook’s accounts as healthy – in the face of financial risks and concerning accounting. PwC have been criticised for not challenging Thomas Cook’s management over ‘exceptional item’ allocation. Accounts omitted these items, worth £1.8 billion over eight years. The company also took over a decade to acknowledge (in writing) its £1.1 billion of goodwill (intangible assets associated with a company’s acquisition from another) from its acquisition of MyTravel in 2007. Presumably, had its auditors been more stringent, these problems would not have occurred. Thomas Cook may have taken fewer financial risks and may have still existed today.
Following plans drawn up by the FRC, the Big Four accounting firms (PwC, EY, KPMG, and Deloitte) are preparing to separate the auditing parts of their business from the broader consulting, tax, and restructuring parts. This preparation began prior to the most recent vitriolic annual review. Hopefully, once this separation has occurred, fraudulent activity such as the Wirecard scandal will cease to occur.
