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Due Diligence Failure: The Wirecard Scandal


In June 2020, the FinTech company Wirecard, listed on the DAX, made headlines with a bang. The company had to announce that it was missing 1.9 billion euros. Previously, Wirecard was known mainly to yield-hungry investors who hoped for miraculous wealth multiplication with the payment service provider. But then everything collapsed. Fraud, corruption, and embellished financial statements came into focus, and the beautiful façade crumbled. The share price plummeted by an incredible 98 percent in those days, and countless investors lost a lot of money. Naturally, leading figures like CEO Markus Braun and COO Jan Marsalek also came under the scrutiny of the public and justice system. The Wirecard case became one of Germany’s biggest financial scandals, not least due to the complete failure of due diligence checks.

The Wirecard Collapse was one of the most spectacular corporate collapses in German economic history. What makes the case so exceptional is that following the collapse, not only did renowned auditors such as Ernst & Young (EY) find themselves in trouble, but also politicians who had directly or indirectly associated themselves with the financial industry’s shooting star in the previous years. Before discussing the failures of the financial market supervision and the auditors, let’s take a quick look at the former high-flyer.

Who is Wirecard?

Founded in 1999, the German FinTech Wirecard, based in Aschheim near Munich, was the shining star of the German FinTech industry until just before its bankruptcy. As a payment processor and financial service provider, the company was an absolute rarity. Both in Germany and Europe, there were hardly any comparable players in this industry that could keep up with the large American payment service providers, such as PayPal. Wirecard expanded globally to 26 locations with 5,800 employees. According to its own statements, the company processed payments for more than 280,000 companies. When Wirecard was valued at 27 billion US dollars in 2018, the FinTech company was worth more than Deutsche Bank. In September 2018, the Munich financial service provider finally joined the DAX-30 index, replacing Commerzbank, which was now listed in the M-Dax.

The Beginnings of the Wirecard Scandal

Wirecard’s descent began at the end of January 2019, triggered by a report by Financial Times journalist Dan McCrum about a senior manager of the company in the Asia-Pacific region. He was accused of having falsified accounts and engaged in money laundering. The basis was an internal presentation from May 2018, which was passed on to the Financial Times by a concerned whistleblower.

Neglecting internal controls proved fatal for Wirecard. Despite concerns expressed by critical investors in previous years, the company repeatedly managed to dispel doubts. The leaked presentation provided detailed information about dubious transactions in the mid-double-digit million range, including, for example, invoices from companies like Flexi Flex in Singapore, which had no business relationship with Wirecard. Round-trip transactions were also used, a fraudulent accounting technique.

The list of questionable transactions in the Asia-Pacific region grew longer and longer. Wirecard pulled out all the stops to make its business activities appear larger. The company referred to supposed due diligence checks and the certification by Ernst & Young (EY) to nip concerns in the bud. Rapid revenue and profit growth between 2015 and 2018 led to a quadrupling of the stock price, which was celebrated by investors. But behind the impressive revenue figures was mostly hot air.

The Collapse of Wirecard

As a result of the article in the Financial Times, Wirecard’s share price fell by more than 13% in 2019. This was just the first warning shot. The major explosion occurred on June 18, 2020, when an ad-hoc announcement was distributed over the stock exchange tickers in the morning. It stated that the publication of the 2019 annual report would be postponed due to indications of incorrect balance confirmations. On that day, Wirecard’s share price plummeted by up to 70% as investors sold off their shares in a panic.

EY refused to certify the 2019 financial statements. This put bank loans of approximately 2 billion euros at risk, which were now threatened with cancellation. The ad-hoc announcement referred to cash balances of 1.9 billion euros, of which it was not certain whether they even existed. Supposedly, these were deposited in Asian trust accounts, which shortly afterwards turned out to be false information. On this single day, 7.6 billion euros of Wirecard’s market value were wiped out.

When Wirecard announced in another ad-hoc statement on June 22, 2020, that balances of 1.9 billion euros most likely did not exist, the share price further collapsed. On the same day, CEO Markus Braun resigned and was subsequently arrested. An arrest warrant was also issued against COO Jan Marsalek, who was dismissed without notice and then went into hiding, after three days. On June 25, 2020, Wirecard finally filed for bankruptcy.

Failure of Supervision and Management

Not only did Wirecard’s supervisory board fail, but so did Germany’s banking supervisory authority, BaFin. They adopted the viewpoint of Wirecard’s management and saw the company as a victim of speculators trying to depress the share price. This explains why BaFin imposed a short-selling ban on shares of the DAX-listed company from February to April 2019. The step was justified with the argument that (among other things, due to the critical reporting of the Financial Times) the stability of the financial market and the confidence in the German market were seriously threatened.

It is evident that there was too close a relationship between BaFin employees and Wirecard. There was a lot of insider knowledge at BaFin. Many employees used this to trade in Wirecard shares. Thus, they were actively involved in things they were supposed to supervise. Many also criticize that BaFin is not properly set up to combat financial crime, and therefore fails repeatedly.

Political Support and Blindness

Politics was dazzled by the meteoric rise of Wirecard. Germany could finally showcase a major FinTech company that could compete globally at the top level. For many, it was unimaginable that a German DAX-listed company could be so brazen as to falsify account receipts and simply invent billions in revenues. Ultimately, German political celebrities also actively advocated for Wirecard. For example, former German Defense Minister Karl-Theodor zu Guttenberg, in his role as a lobbyist, asked Chancellor Angela Merkel to support the company in its market entry into China. A topic in her talks with the Chinese leadership was the opening of the Chinese financial market to German companies. Not coincidentally, Wirecard ended up on the list of recommendations.

wirecard

Consequences of the Wirecard Scandal

The Wirecard scandal was a wake-up call for politics and authorities. Many questions regarding responsibilities remain unanswered, and the legal processing continues to be protracted. While former CEO Markus Braun is in custody, there is still no trace of his once associate, the former COO Jan Marsalek. He is internationally wanted, but so far without success. It is suspected that he fled to Belarus or Russia to avoid arrest.

German Bundestag Investigative Committee

On the request of three opposition factions of the 19th German Bundestag, an investigative committee was established in September 2020, which began its work in October 2020. By March 2021, a total of 67 people were questioned. Among those questioned were supervisory board members of Wirecard AG, as well as members of auditing firms, supervisory institutions, and federal authorities. Additionally, FT journalist Dan McCrum, who kick-started the saga in early 2019, was questioned. The final report was presented on June 22, 2021.

Legislative Initiatives in Response

As a consequence of the Wirecard case, the German federal government initiated numerous measures to prevent incidents like Wirecard in the future. This includes an improved system for balance sheet control to prevent future manipulations of financial statements. An action plan was presented to initiate extensive legislative reforms. As a result, the Act to Strengthen Financial Market Integrity was passed by the German Bundestag in May 2021. The law includes a tightening of balance sheet controls, stricter rules for final audits, and a tightening of balance sheet criminal law. It also envisages a reform of corporate governance and gives the Central Office for Financial Transaction Investigations expanded powers. Moreover, the law restricts private trading by BaFin employees in financial instruments to avoid potential conflicts of interest.

Lessons from the Wirecard Scandal

Not only lawmakers but also NGOs and analysts have drawn their conclusions from the Wirecard case. Transparency Germany demands strict liability rules for auditors in case of breach of due diligence duties. The NGO attributes the Wirecard scandal primarily to a systematic lack of comprehensive due diligence management and highlights its importance in the financial services sector. Therefore, according to Transparency, further lessons to be drawn from the Wirecard scandal include, in addition to a reform of financial market supervision, the introduction of extended due diligence procedures.

This point is also addressed by well-known analyst Adrian Klee. In his blog post, he even calls for the establishment of a “compliance culture” to prevent cases like Wirecard from repeating. New banks and financial service providers should be able to follow established rules early and thoroughly. Company management must be aware of the risks and committed to compliance. Last but not least, Klee recommends the introduction of a risk management system tailored to the specific risks of the company.

Failures in Due Diligence

An undeniable fact is that compliance rules in due diligence were largely neglected and Wirecard’s supervisory board did not optimally oversee the operational business. In addition to deficiencies in auditing and the failure of German financial market supervision, the lack of due diligence was the main reason why Wirecard’s fraudulent business practices were not discovered earlier. Many former managers of the financial service provider now have to answer before the Munich Regional Court. The inadequate risk management of their former employer becomes a significant burden for them, as it complicates the proof of innocence. In the end, many of the former leading employees must bear the full responsibility because compliance in due diligence within the company failed.”

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