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Wirecard implosion to accelerate regulatory change beyond 2021

Heads are still rolling following the demise of German payment processor Wirecard earlier this year, and with auditing figures now being pulled into the mire, experts believe change in accounting regulation is ever more certain.

16th Dec 2020
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Germany’s audit regulator has sacked its chief executive after he admitted trading in Wirecard shares whilst investigating the company weeks before its collapse.

A criminal complaint has also been lodged against Apas head auditor Ralf Bose, who was suspended then “released from work with immediate effect” to protect the agency’s integrity, the federal office of economics and export control (Bafa) said on Monday.

Bose, head of Apas since 2016 and a former senior partner at KPMG, told a German parliamentary inquiry into the accounting scandal that he purchased Wirecard shares in April and sold them at a loss the following month.

Separately, Germany’s financial regulator BaFin, which is probing Bose’s share trading, has fired an employee for breaching disclosure rules on the trading of Wirecard-related securities.

Three other BaFin employees are being probed over similar allegations, according to the Financial Times, whose lengthy investigation led to the demise of the Munch-based payment processor.

In June, after years of denials over its suspect accounting, Wirecard disclosed a €1.9bn black hole in its accounts and promptly collapsed. CEO Markus Braun was arrested, and his second-in-command Jan Marsalek is currently a fugitive wanted by international law enforcement.

German law firm Schirp & Partner has filed a class action lawsuit against EY, and has also this week filed a criminal complaint with Berlin’s public prosecutor accusing Bose of insider trading.

“With regard to the sale, it can be assumed that Mr Bose made the sale of the Wirecard shares on the basis of his insider information about the BaFin investigation proceedings as well as about the professional supervision proceedings against EY, as he expected a decline in the price of the shares due to the now manifest suspicions of false accounting,” said attorney Dr Marc Liebscher.

Bose has not responded with comment regarding his suspension or the lawsuit.

Last week, Deutsche Bank’s head of accounting Andreas Loetscher stepped down after he and the firm became embroiled in the widening scope of the investigations.

Prior to his switch to Deutsche Bank in 2018, Loetscher was in charge of auditing Wirecard at EY, where he worked for over 20 years. He is one of at least two Wirecard auditors under investigation by Apas for potentially violating professional duties.

EY, which audited Wirecard for a decade, was soon dragged into the debacle. According to a report by the Financial Times, EY’s anti-fraud unit warned in 2018 of “red-flag indicators” at Wirecard that indicated potential accounting manipulation and required further investigation, which EY didn’t act on.

Several clients have dropped EY as an auditor following its links to Wirecard and allegations it had ignored a whistleblower who came forward in 2016.

EY has defended its actions and said it was also duped by a sophisticated fraud carried out by senior management at Wirecard.

Long-term consequences

The fall of the once high-flying payment company stunned the business world and has triggered ramifications far beyond Munich. The fallout will continue long beyond 2021, experts said, and may accelerate regulatory change across Europe.

In the UK, EY, KPMG, Deloitte and PwC are required by law to separate their audit and consultancy arms by 2024 to reduce conflicts of interest and strengthen the quality of their accounting. Wirecard’s implosion was held up as an example of why such change needs to happen faster.

Much soul-searching is occurring in Germany’s accountancy sector, but the industry is also lobbying to water down government plans to tighten up supervision.

“In the future, BaFin is to receive a broadened mandate, which would allow it to launch its own forensic audits without having to await confirmation by the so-called Financial Reporting Enforcement Panel (FREP), another independent but hopelessly underfunded accounting investigator,” said London School of Economics author Dustin Voss.

He said the move was an important first step for Germany to take to free itself of the supervision paralysis that has affected previous attempts to stop scandals such as Wirecard escalating, but said it must be followed by other more robust changes.

“It remains highly questionable if this measure alone will empower BaFin to effectively restore the public utility function of German high finance,” Voss said. “Since carrots don’t work, it would certainly need to be armed with many more sticks in order to live up to the harsh financial realities of the 21st century.”

Giorgio Barba Navaretti, professor of economics at the University of Milan, said the default of Wirecard highlighted several problems in the regulation and supervision of both fintech firms and auditors, with regulatory holes in investor protection, customer protection, and financial stability.

“With respect to investor protection, Wirecard’s case calls for stronger national authorities, increased international harmonisation, coordination and cooperation, and direct and sound supervision of auditing firms,” he said.

Change in mentality

Rather than waiting for governments to act, the audit profession must up its game and accept that catching fraud is part of the job, said Brian Fox, president and founder of Confirmation, which is part of Thomson Reuters.

“Nobody is upset at an auditor for missing that someone stole $100 from petty cash or a couple of screwdrivers from the inventory,” said Fox. “What they are upset about are material misstatements, like Wirecard with its $2bn missing, or Luckin Coffee. Material misstatements, whether accidental or fraudulent, are our responsibility, so we have to design the audit to detect them regardless if it was an error or deliberate fraud.”

Failure to adapt in such a manner may result in heavy-handed regulation unless the industry becomes better at identifying and calling out fraud, Fox said.

He said the UK decision to split the Big Four was down to repeated instances of missing material fraud, and the wider industry must heed the lesson.

“EY dropped several clients they thought would be too risky to audit,” he said. “You can see why the UK has taken such a stance. We have to embrace the mentality that finding fraud is our job. We must start looking for fraud. I am optimistic we have the technology, but fearful we aren't moving fast enough.”

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