Munich-based Wirecard, once a shining star of European fintech, filed for bankruptcy last Friday (26 June) following the arrest of its CEO Markus Braun, who has been accused of conspiring to inflate the company’s assets.
The insolvency filing only affects the group’s German holding company, Wirecard said. The fintech’s operating businesses are continuing following initial disruption from regulatory interventions that affected many UK users of Wirecard-based e-money services including Curve, Revolut and ANNA.
Uncertainty remains over whether Wirecard’s international subsidiaries will file for bankruptcy too.
In the wake of Friday’s announcement, the German Shareholders Association filed a criminal complaint against two current and one former partner at the Big Four auditor EY over their role in the Wirecard debacle.
The association, known as Schutzgemeinschaft der Kapitalanleger (SdK), said it was unacceptable that it took 11 years and a special investigation by KPMG for EY to accept that €1.9bn was missing from the German payment company’s balance sheet.
It has been alleged in recent weeks that the auditors did not get balance confirmations from two Philippines-based banks for the years 2016 to 2018.
“This behaviour is incomprehensible and raises numerous questions,” SdK said in a statement. “Checking the existence of bank balances is one of the easier tasks of an auditor and the procedure is clearly regulated.”
EY declined to sign off Wirecard’s delayed 2019 annual accounts following the discovery of the accounting black hole, which led to a default and triggered the group’s collapse.
The auditor said it is reviewing all the information available regarding falsified accounting and will not comment further at this time.
Private lawsuits have been launched in Germany and another major investor in the Wirecard, Japanese conglomerate SoftBank, is also planning to sue EY, according to German news magazine Der Spiegel. SoftBank Investment Advisers, the subsidiary that manages SoftBank’s $100bn Vision Fund, declined to comment.
Wirecard also declined to offer comment.
EY is now under pressure to explain how it missed the fraud, with accounting experts wondering how one of the world’s top audit firms allowed itself to be duped for so long.
Outdated audit methods
“This type of fraud is nothing new,” said Brian Fox, founder of Confirmation, which enables auditors and banks to electronically certify account balances. “Some auditors are still using 100-year-old, outdated and easily manipulated audit procedures and techniques that let fraud slip through the cracks.”
Major banks and financial institutions rely on paper trails and easily manipulated technologies to confirm billions of dollars in assets and receivables, Fox said, making them more susceptible to fraud and manipulation.
“When a company wants to inflate revenue by booking false revenue to their financial statements, the offsetting entry has to be either to ‘Cash’ or ‘Accounts Receivable’,” said Fox.
“In this case with Wirecard, they booked the offsetting phony entry to ‘Cash’ and then circumvented the auditors’ bank confirmation procedures. This was done by directing the auditors to send the bank confirmation to a person whom they knew would respond with the phony balance information to match what the company had provided to the auditors.”
If covering up fraud, the perpetrator will use phony bank accounts that don’t actually exist, Fox told AccountingWEB. “The auditor ends up confirming a cash balance that they thought was legitimate and confirmed by a bank, but it actually was the internal fraudster using a fake account.”
Regulatory changes required
That EY also missed clear red flags is a major worry, said John Hemming, CEO of Cirrostratus Exedra, which offers Open Banking and Making Tax Digital software and services.
“Wirecard should not have been a shock given the story about an office in a bus station,” Hemming said. “Even if that was not enough, the delays in producing accounts should have resulted in companies putting the foot to the floor on contingency plans.”
EY have serious questions to answer, he said.
“Both Wirecard and Patisserie Valerie were very basic accounting fraud with the balance sheet being out by a material sum of actual cash in bank accounts,” said Hemming. “In the end the lesson for everyone is to avoid single points of failure. Best to have at least two accounts with two separate institutions particularly in a developing cashless society.”
Germany is now planning to overhaul its accounting regulations in the wake of the fiasco, which has been billed as the country’s Enron.
The German government is ending its contract with the country’s accounting watchdog, the Financial Reporting Enforcement Panel, and will hand power to launch investigations into companies’ financial reporting to BaFin, Germany’s financial regulator.
Fintech concerns
Last week, the Financial Conduct Authority (FCA) said Wirecard Card Solutions must cease all regulated activities, effectively freezing customer money and sparking alarm across the UK payment sector. The FCA said Wirecard’s UK unit would also have to state this information on its website and communicate it to customers
On Tuesday, the FCA lifted the restrictions to allow Wirecard to resume payment activities, but only after thousands of people and businesses could not access money or make payments through apps as a result.
“Our primary objective all along has been to protect the interests and money of consumers,” the FCA said.
According to John Hemming, however, the regulator’s actions would have shaken confidence in the UK’s fintech sector. “A lot of fintechs were caught out when the UK subsidiary was prevented from trading. Whether the FCA should have taken that action or whether the action should have been lighter touch is something that will come out over time. However, many account holders ended up in a real mess,” he said.
“I would expect the FCA to be asked by MPs to explain their reasoning. The funds were held in client trust accounts and that should mean something.”
Some fintech firms that experienced problems as a result said they would ditch Wirecard once a suitable replacement had been found. ANNA, which offers a business account and tax app for small companies, broke the issue down for customers online: “We were aware of the situation with Wirecard AG in Germany, however we were repeatedly reassured by Wirecard Card Solutions that this would not affect operations in the UK.”
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