What exactly is going on in the Wirecard scandal?

Wirecard, a darling of the German fintech sector, has collapsed and its boss has been charged with fraud. Red flags have waved for years, yet the regulators went for the flag bearers. What went wrong?

What’s happened?

German payments giant Wirecard, which processes tens of billions of euros in credit and debt transactions every year, filed for insolvency last week, with around €3.5bn of debts, following the exposure of an accounting scandal. The firm, founded in 1999 in Munich, has long been the darling of the German fintech sector. It boomed as demand for online payment-processing technology surged and the firm floated in 2005. In 2018 it replaced Commerzbank in the Dax 30 index of Germany’s biggest listed companies. Things were looking good and at its peak it was valued at €24bn.

But?

But short-sellers and journalists have long been sceptical about its financial reporting, in particular questioning the vast sums apparently spent buying obscure businesses in Asia. Last week, following years of sustained investigative reporting by the Financial Times, the auditors EY confirmed that they had identified a €1.9bn hole in Wirecard’s finances, triggering a 95% crash in the share price, frantic negotiations aimed at keeping the business afloat, and the arrest of Wirecard’s founder and chief executive, Markus Braun, on suspicion of fraud. He has since been released on €5m bail, while administrators are busy carving up the business in the hope of rescuing some value for creditors.

Was the implosion a shock?

It was certainly dramatic, but questions over Wirecard’s finances have been swirling for years. As early as 2008 the head of a German shareholder association published an attack on the business, alleging balance-sheet irregularities. Wirecard engaged auditors EY to conduct a special audit. But as profits grew rapidly, so did the questions – in particular over whether the firm was overstating the size of its Asian operations in order to inflate its share price and drive its highly leveraged expansion. In 2015 the FT began raising questions over Wirecard’s accounts. In 2016 anonymous short-sellers published a dossier of allegations. And over the course of 2018 and 2019 the FT was involved in a series of legal battles with Wirecard over its reporting on alleged malpractice at its Asian HQ in Singapore, as well as Dubai, the Philippines and Dublin – focusing on claims by short-sellers and insiders that Wirecard was fraudulently inflating its cash and profits and inventing customers.  

What triggered the final collapse?

Under pressure from investors, last October Wirecard asked KPMG to conduct a special review. KPMG’s report, published in April, raised further concerns and cited “obstacles” to its work. In particular, it queried the existence of €1bn in cash balances. In June, German police raided Wirecard’s Munich offices. Then, in mid-June, two Philippines banks informed EY that documents supposedly confirming €1.9bn in cash balances with them were fakes. EY refused to sign off on the 2019 accounts and Wirecard was obliged, on 18 June, to announce that the money was “missing”. Braun resigned the next day and within a week he was under arrest and Wirecard had filed for insolvency.

This doesn’t look good for EY?

EY’s position is that it was conned along with everyone else. “We’ve established that third parties, with a deliberate aim to deceive, provided EY with false documentation in connection with its 2019 Wirecard audit,” said a spokesman. “The extent and sophistication of these suggest a large-scale international fraud at Wirecard.” EY says it identified false information during the 2019 audit and reported this to the relevant authorities at the time. But, it said, “even the most robust and extended audit procedures may not uncover a collusive fraud”.

Isn’t spotting fraud its job?

Ideally, yes. EY signed off Wirecard’s accounts for more than a decade before raising the alarm and it now faces a class-action lawsuit from more than 1,000 Wirecard investors seeking up to €1bn in damages. The big question, according to the FT, is why EY’s auditors apparently failed to confirm Wirecard’s cash balances with its banks for three years prior to the company’s collapse and instead relied on other documents and screenshots. 

What about the German regulator?

It is now facing a probe by Brussels and multi-billion-euro lawsuits from thousands of investors. Felix Hufeld, head of the regulator, calls the Wirecard scandal “a complete disaster” and “a shame”. Yet he and the agency he leads, BaFin, failed for years properly to scrutinise Wirecard – and have instead pursued the firm’s critics. As early as the first shareholder attacks on Wirecard in 2008, the German authorities ended up prosecuting two of the people who had raised red flags for not disclosing their own positions in Wirecard stock. In January last year, after the FT reported on malpractice in Singapore, BaFin started investigating the newspaper for market manipulation. The next month, after police raided Wirecard’s Singapore offices, BaFin announced an unprecedented two-month ban on short-selling the stock. That’s a level of apparent “regulatory capture” that raises concerns over the whole German financial system.

Does anyone emerge with credit?

The Financial Times, obviously. Short-sellers deserve a pat on the back, too. One silver lining is that the affair could give a lift to the UK’s burgeoning fintech sector, says banking editor Katherine Griffiths in The Times. The Wirecard scandal means that fintechs globally are likely to take a knock as investors “question their sky-high valuations compared with the hard reality of how much cash is actually coming through the door”. But “Britain’s fintech sector should be one of the relative winners, due to its reputation for robust business practices and regulatory oversight”.

Recommended

Changpeng Zhao: Binance founder undaunted by the crypto winter
Bitcoin & crypto

Changpeng Zhao: Binance founder undaunted by the crypto winter

Changpeng Zhao, the founder of controversial cryptocurrency exchange Binance, has been severely battered by carnage in the sector. But the future is b…
3 Jul 2022
Ray Dalio’s shrewd $10bn bet on the collapse of European stocks
European stockmarkets

Ray Dalio’s shrewd $10bn bet on the collapse of European stocks

Ray Dalio’s Bridgewater hedge fund is putting its money on a collapse in European stocks. It’s likely to pay off, says Matthew Lynn.
3 Jul 2022
Just how powerful is artificial intelligence becoming?
Tech stocks

Just how powerful is artificial intelligence becoming?

An uncannily human response from an artificial intelligence program sparked a minor panic last month. But just how powerful are machines getting – and…
2 Jul 2022
Persimmon yields 12.3%, but can you trust the company to deliver?
Share tips

Persimmon yields 12.3%, but can you trust the company to deliver?

With a dividend yield of 12.3%, Persimmon looks like a highly attractive prospect for income investors. But that sort of yield can also indicate compa…
1 Jul 2022

Most Popular

Five dividend stocks to beat inflation
Share tips

Five dividend stocks to beat inflation

During periods of high inflation, dividend stocks tend to do better than the wider market. Here, Rupert Hargreaves pick five dividend stocks for incom…
30 Jun 2022
Don’t try to time the bottom – start buying good companies now
Investment strategy

Don’t try to time the bottom – start buying good companies now

Markets are having a rough time, so you may be tempted to wait to try to call the bottom and pick up some bargains. But that would be a mistake, says …
1 Jul 2022
The ten highest dividend yields on Aim
Income investing

The ten highest dividend yields on Aim

Rupert Hargreaves picks the highest-paying dividend stocks on Aim, London’s junior market for small and medium-sized growth companies.
29 Jun 2022