The finance industry already grappling with the effects of COVID-19, faced yet another shock with one of the biggest financial scandals in the world coming to the limelight - the Wirecard scandal. Wirecard, a Munich-based payment processing company, once seen as a darling of investors with a market capitalisation of over $28 billion at its peak, filed for bankruptcy on June 25, 2020, after disclosing a $2.1 billion hole in its balance sheet. But what went wrong with the company?
The fintech company incorporated in 1999, joined the Frankfurt stock exchange in 2005 and ascended to the ranking of Germany’s 30 leading companies, also known as the DAX Index. It claimed to have subsidiaries across the globe, with payments being processed for more than 200,000 merchants and clients including major European supermarket chains and airlines. It attracted notable investors such as SoftBank. Wirecard was like any other payment processing company that facilitated transactions between consumers and merchants, and earned a certain percentage per transaction. However what set the company apart from its competitors was its rapid expansion in Asia for the reason that it marketed itself as the leader in this system, claiming to have superior technology and highly capitalising on the shift to a cashless society.
In 2008, the first allegations of accounting irregularities against the firm came to light and in the wake of the attack, the company appointed Ernst & Young (EY), one of the largest accounting enterprises in the world, to conduct a special audit on these claims. EY soon then became the Chief Auditor of the organisation for the next 10 years, signing off the firm’s balance sheet. As allegations against the firm of inflating its operational numbers in Asia continued to surface over the years, a pattern emerged with how the company dealt with these criticisms. They would aggressively deny any wrongdoings and announce that it was an attempt to manipulate their stock prices. However, the stock prices kept rising, undeterred by any negative news coverage.
As claims of malpractice mounted, BaFin- the German financial regulator, during its probe focussed more on the accusers rather than the claims against the enterprise. Various analysts believe that authorities’ protection stemmed as it was a huge moment to see a European home-grown company competing against tech titans of Silicon Valley.
In 2019, the regulator announced an unprecedented 2-month ban on short-selling of the company’s shares due to its stock price plummeting below €100, citing its importance to the economy and serious threats to market confidence. Some also point to Germany’s corporate culture being wary of foreign speculators, since many allegations were brought forward by the British newspaper Financial Times (FT). However, the regulators denied all allegations against the organisation and even filed a criminal investigation against FT for colluding with short-sellers.
Wirecard mainly functioned by buying shell companies that acted as third party payment processors for the organisation. In return, these companies paid them a commission. However, instead of funds flowing into their Munich bank, it was all transferred to escrow accounts. These are special accounts where multiple parties can use them, hence convincing the public that large sums of money existed in them and were used by its subsidiaries. These accounts held more than $2 billion, all of Wirecard’s profit of more than a decade.
In 2018, FT published an article after being alerted by a whistle-blower, that the organisation was cooking accounting books, hiking up its sales and profit numbers of Asia and Pacific operations. Hence, to put an end to these allegations, the company, in 2019, hired Klynveld Peat Marwick Goerdeler (KPMG) to conduct a special audit. The audit report stated that it could not verify the authenticity of these escrow accounts. As more events unfolded, the company stated that all of the money was stored in the Philippines, and not in these escrow accounts. When EY went to examine these claims from the Philippines bank, the former was notified that the documents submitted by the company were all spurious and money never really entered their financial system, thus the $2.1 billion never existed.
This announcement led to the arrest of Markus Braun, CEO and CTO of Wirecard since 2002, on June 23, 2020, on suspicion of inflating the value of the company through feigning business with third parties. Two days later, the company filed for insolvency, making it the biggest accounting scandal in post-war German history.
The disclosure of malpractice of such a magnitude has eroded the trust in the country’s authorities, giving a heavy blow to Germany’s reputation as a financial centre - impacting its businesses and the confidence of market participants. This revelation has increased the scrutiny of not only accounting firms, especially EY, for failing to inspect the legitimacy of such an account, but also on regulators for their inadequacy. Various critics argued that Germany’s regulatory system is neither equipped to handle large scale processing enterprises like Wirecard nor does it have the power to oversee the investigation of potential malpractices. This highlights the need for transparency in financial systems and various regulatory reforms such as incentives for whistleblowers, a better framework for fintech companies, etc. With the expansion of inquiry, more details are yet to come, nonetheless, investigators worldwide are trying to comprehend how the company used the loopholes to present itself as a profitable business for more than a decade.
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