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Wirecard: The soft underbelly of Big Four auditsby
The collapse of Wirecard AG exposed longstanding cultural issues in Big Four audit firms that will take regulators years to overcome, reports Mark Taylor.
The German payment technology and processing firm filed for bankruptcy last month after admitting that €1.9bn (£1.7bn) was missing from its accounts, causing the resignation and arrest of CEO Markus Braun as his number two fled the country.
The company’s offices in Germany and two locations in Austria were raided by Munich prosecutors as 12 prosecutors and 33 police officers pursued the investigation.
Widespread condemnation of the auditors and regulators overseeing the firm quickly followed.
“The collapse of Wirecard is sure to have implications for regulation and oversight arrangements in Germany,” said Mike Suffield, director of professional insights at ACCA.
“BaFin [German finance regulator] has already received criticism, the previously profession-led arrangements for review of German company accounts are under threat and it is probably only a matter of time before attention is turned explicitly to the audit oversight body in Germany and its own work overseeing the quality of the auditor’s work.”
The reputational fallout will fuel the debate taking place across a number of jurisdictions about the need for reform of the audit profession and strong action to support high audit quality, Suffield added.
Trigger for reform
Wirecard’s fall from beloved fintech darling to global embarrassment shook Germany into action. BaFin took more than a year to report Wirecard for market rigging after a whistleblower came forward, and even defended the firm in the face of allegations made by the Financial Times.
Since the collapse, however, German finance minister Olaf Scholz vowed to terminate the contract of the Financial Reporting Enforcement Panel (FREP), Germany’s accounting oversight body, at the end of 2021.
Scholz wants to end the current two-stage procedure under which BaFin is only called in when red flags are raised in a primary vetting of accounts by a private monitoring association.
“We need far-reaching reforms,” Scholz said. He wants to see BaFin step in earlier, with the power to launch special audits on a large scale.
Wirecard’s auditor EY, meanwhile, is now facing three separate shareholder lawsuits that accuse the firm of harmful practices.
“Collusive frauds designed to deceive investors and the public often involve extensive efforts to create a false documentary trail,” EY said. “Professional standards recognise that even the most robust and extended audit procedures may not uncover a collusive fraud.”
Tip of the iceberg
Repeated failures at the top of the accounting profession since Enron went down 20 years ago show Wirecard is not an isolated case, according to anti-corruption campaigners Transparency International (TI).
“Financial supervisors, auditors, creditor banks, analysts, fund managers and politicians - they are all now facing a huge dilemma,” said Stephan Klaus Ohme, head of the working group on financial affairs at TI Germany.
“This case raises many questions: Is Wirecard only the tip of the iceberg? What other risks may arise from the increasing shift of public services to private sector providers? How do we ensure that powerful interest groups do not undermine the effectiveness of legislation?”
Wirecard’s downfall may ultimately force action at a European level. BaFin took more than a year to report Wirecard for market rigging after a whistleblower came forward, and even defended the firm in the face of allegations made by the Financial Times.
In the European Parliament, German MEP Sven Giegold called for an investigation into Wirecard and for the European Commission to review its rules on auditing. “We have to end the wrong incentives for statutory audits,” Giegold said. “Audit firms have to be fully separated from advisory business.”
The parade of corporate scandals such as Carillion and BHS during the past decade led to renewed promises of changes in how audits are conducted, but very little action was taken in the UK – until Wirecard’s meltdown.
In April FRC said the coronavirus outbreak had disrupted its plan to split the Big Four’s accounting and advisory units, a comforting conclusion from a lame-duck regulatory body that has been widely criticised for falling prey to the undue influence exercised by former big firm partners who sit on its ruling committees.
“The audit regulatory landscape has few neutral voices. Alumni abound,” commented Karthik Ramanna, professor of public policy at the University of Oxford.
Action at last
This week, however, the FRC changed its tune and promised to move forward with the scheme to achieve operational separation of audit practices. The Big Four will have to separate their audit and non-audit businesses by 2024 to ensure audits “do not rely on persistent cross subsidy from the rest of the firm”.
EY, PwC, KPMG and Deloitte released statements backing the regulator’s announcement, which attracted less welcoming responses from other quarters.
“My committee has been clear in previous inquiries that reform of the audit sector is overdue,” said Darren Jones MP, chair of the business, energy and industrial strategy committee. “But when reform is so sorely needed, why are the Big Four firms allowed four years to enact these changes?
“There are also questions about how far an operational split along these lines will be able to tackle conflicts of interest and whether it will go far enough to provide the tough, professional challenge and scepticism needed to deliver genuinely high-quality audits in the public interest,” he said.