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After Wirecard: The lessons for Britain’s audit shake-up | accountingweb
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After Wirecard: Lessons for Britain’s audit reform

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Audit failures, including the high-profile Wirecard case, highlight the shortcomings of the institutions investors rely on. To sustain the UK’s reputation in the audit profession changes must be made to focus on integrity and efficiency.

10th Jan 2023
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In a scandal dubbed as Germany’s largest instance of fraud since the conclusion of World War II, former Wirecard chief executive Markus Braun and two other former managers went on trial last December. Wirecard and several recent corporate failures in various countries, including the UK, suggest that the audit’s function needs to be strengthened in order to regain the public’s trust.

Founded in 1999, Wirecard went from a payment-processing company for porn and online gambling to a tech company that was, at one point, worth $28bn. However, thanks to the Financial Times’ courageous reporting, the truth was finally revealed and Wirecard crashed into insolvency in June 2020. 

In his book Money Men, now adapted as the Netflix documentary Skandal, Dan McCrum, who led the Financial Times investigation, wrote that nobody, not its investors or regulators, “really understood what was happening inside” Wirecard. Its billionaire CEO, Braun, was feted as a technological visionary until the collapse of the payments company sent shockwaves through Europe.

Four lines of defence

The downfall of Wirecard indicates the failures of at least four lines of defence against corporate fraud: the company’s internal control system, its supervisory board, the financial regulatory authority (BaFin) in Germany, and the external audit. 

EY produced a clean audit for Wirecard’s financials from 2009 to 2018. Carmine Di Sibio, the company’s worldwide chairman, expressed regret that fraud at Wirecard had gone undetected and promised clients that the company would “raise the bar” to improve its standards.

We must keep in mind that following numerous audit failures globally, the world’s top four accounting firms – EY, Deloitte, PwC and KPMG – continue to be under pressure from regulators and shareholders. Following the fall of Enron, the largest energy trader in the world, in a $40bn fraud in 2001, Arthur Andersen was the first international accounting firm to close, and the Big Five was reduced to the Big Four. 

However, numerous scandals have prompted inquiries as to why auditors failed to detect discrepancies in the accounting. Following failures like those at Carillion, BHS and Thomas Cook, there has been pressure on the UK government to change the auditing requirements.

Restoring trust

In the UK, the Department for Business, Energy & Industrial Strategy (BEIS) published its consultation, Restoring Trust in Audit and Corporate Governance in March 2021. It proposed the creation of the Audit, Reporting and Governance Authority (ARGA), to take over from the Financial Reporting Council (FRC). ARGA’s overarching objective is to protect and promote the interests of investors, other users of corporate reporting and the wider public interest. The government promises to improve the quality of audit and making it more informative, driven by the regulator’s responsibilities for standards and inspection. Companies listed on the FTSE 100 and FTSE 250 will be compelled to delegate at least a portion of their audits to smaller firms in an effort to end the dominance of the Big Four auditors.

The proposed changes to the audit regime are necessary to promote quality and competition. Unfortunately, the idea is being challenged in the UK. While KPMG has stated that the approach is unlikely to function in practice, Deloitte, EY and PwC have publicly expressed their disapproval. Additionally, some experts contend that there is little convincing proof that shared audits will enhance conditions for any party. 

To boost competition without jeopardising audit quality, a gradual approach might be the best course of action. The involvement of challenger firms in the audit of public-interest entities should step up from shared to joint audits. In the short term, a managed shared audit regime would allow smaller firms to gain experience and develop their reputation. The four-eyes principle and collaborative responsibility would result in enhanced value in the medium term if joint audits were made mandatory. 

The second question is how to handle conflicts of interest. EY is looking to circumvent any conflict-of-interest accusations from its audit and advisory services by segregating audit from the rest of the business. However, an operational split of the Big Four is not enough if they can still offer audit and non-audit services. A more practical approach, as advocated by Sebastian Mack, policy fellow, Jacques Delors Centre, is to forbid the simultaneous provision of audit and any non-audit services to the same client. In addition, auditors should be required to present their findings at annual general meetings and answer shareholders’ queries.

Failures revealed

Finally, the Wirecard scandal reveals the failures of the German financial regulatory authority (BaFin), the Financial Reporting Enforcement Panel (FREP) and the audit regulator (APAS). In this regard, the UK seems to be in a better position by promising a stronger audit regulator, in ARGA. 

To be an effective deterrent, however, tougher enforcement by a regulator must be swift, strong, visible and frequent, according to the Chartered Financial Analysts (CFA) Institute. ARGA must also have the authority to conduct investigations – including obtaining information from third parties – and the ability to enforce its rules, standards and regulations with meaningful measures.

Wirecard is only one example of how the number of audit failures has risen recently, seemingly without any warning signs. The scandals surrounding Wirecard and other companies highlight the shortcomings of several of the pillars on which investors rely, including management, the audit committee and board, auditors, audit regulators and corporate reporting regulators. 

To sustain the UK’s reputation for excellent standards of corporate governance, adjustments are required to re-establish faith in audit and corporate reporting. Changes made in the UK could influence changes in audit policy across the globe because of the UK’s crucial position in the audit profession.

Focusing on the integrity and efficiency of auditors won’t prevent irregularities from happening. However, it is an important step in ensuring that the government and investors are well prepared for future corporate failures.

Replies (4)

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By Hugo Fair
10th Jan 2023 17:23

Unfortunate opening sentence:
"In a scandal dubbed as Germany’s largest instance of fraud since the conclusion of World War II" suggests that the conclusion of WWII was a fraud!

Otherwise a reasonable potted history, but without any newsworthy revelations.

It can hardly be a surprise that a system of controls which is tantamount to self-regulation makes going to sea in a colander an attractive alternative.
And the oft repeated refrain of promising to “raise the bar” is only proof at how low it is currently set ... otherwise by now all this raising would have that bar touching the moon!

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By JustAnotherUser
11th Jan 2023 08:37

On first read this feels like a generic stab at audit failures, peel back a few layers and it seems like a simple case of fraud across the board.

You claim "EY produced a clean audit for Wirecard’s financials from 2009 to 2018"

"...Ernst & Young, may have failed, for three years running, to confirm money Wirecard said was in a Singapore bank account actually existed."

Failure: "lack of success"

Fraud: "wrongful or criminal deception"

"EY did not check with Singapore’s OCC Bank to confirm it held large amounts of cash on Wirecard’s behalf. EY relied instead on documents and screenshots provided by Wirecard and a third-party trustee."

I'm sure verifying bank balances is pretty basic stuff for an auditor?

"A whistleblower warned Wirecard’s long-standing auditor of potential fraud and bribery attempts at the payments business four years before its eventual collapse"

"a probe by fellow auditor KPMG has found that an internal whistleblower at EY flagged potentially fraudulent practices at the business back in 2016, as well as an alleged attempt to bribe an auditor in India"

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By paul.benny
11th Jan 2023 10:04

Hugo Fair wrote:
... a reasonable potted history

Apart from the omissions and non-sequiteurs:

Wirecard: Whilst it appears to be true that the incumbent auditors did not identify the frauds, Wirecard was a German company subject to a different regulatory and supervisory regime. Any reforms proposed or implemented by the UK government won’t directly impact auditing elsewhere.

The collapse of Thomas Cook was due to high levels of debt and failure to adapt to holidaymakers’ changing tastes. There has been no widespread suggestion of audit failure.

The Carillion failure appears to be much more about management decisions than auditing, although it is true that the Insolvency Service are, somewhat unusually, suing KPMG.

And on conflicts of interest, providing non-audit services to audit clients of public interest entities (PIEs – principally all listed companies) has been prohibited for years.

This article looks like recycling content that could have appeared any time in the last few years with nothing newer than proposals issued in 2021.

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By DianaParsons
11th Jan 2023 19:38

You must see Skandal! Bringing Down Wirecard if you are a real crime and espionage illuminati. If you enjoyed reading the epic fact based spy thriller "Beyond Enkription" in The Burlington Files series you should love watching James Erskine’s Skandal! Bringing Down Wirecard on Netflix and vice versa. The Burlington Files was about a British Chartered Accountant (MI6 codename JJ, aka Edward Burlington) who was employed by Coopers & Lybrand (now PwC) in the seventies.

He was one of Pemberton’s People in MI6 and unwittingly started working for them and infiltrating international organised crime gangs and then got good at it. His bio makes most investigative journalists jealous! If you are an espionage aficionado or an aspiring investigative journalist the raw and noir thriller Beyond Enkription is a must read. For starters, see the brief News Article dated 31 October 2022 in TheBurlingtonFiles website.

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