(I have to state that this is all based on what I have read in the press in the last few days, hence it might be inaccurate or the effect of misleading reporting. At this point in time I assume no liability with regards of the accuracy of the facts)
It is with a mix of curiosity and dismay that I am reading reports on the accounting fraud that seems to have occurred at Wirecard, a fintech German company and so far a darling of the European Fintech scene.
To put things in perspective, this is not a scrappy start-up, rather a multi-billion company business.
The event so far have panned out with a depressingly predictable schedule.
First the company delays its filings multiple times.
Then rumors of accounting fraud start to emerge.
Then the CEO stepped down and the auditors(EY) start to put out carefully worded press statements.
Then predictable news of alleged accounting and other fraudsters’ tricks start to leak to the press:
- 1,9 Euro billions of Cash unaccounted for
- Revenue inflation in one of the company subsidiaries obtained by backdating sales contracts.
If it sounds familiar (at least to auditors) it is because it is. I have myself seen similar tricks multiple times (at Parmalat, back in 2003 or at OW bunkering a bit more recently, to name a few instances that I have witnessed directly).
What I find amazing is the recurring topics with accounting fraud schemes. They do not seem to change much overtime. Always the same kind of shenanigans, both at high tech and low tech companies. New economy or not, fraudsters seem to be fairly unimaginative when it comes to documents forgery.
Another thoughts that comes to my head is the intrinsic limitations that financial audit has in undercovering fraud. To the credit of EY, it has been its findings, it seems, that undercovered the fact that cash balances were non-existing. Another special audit by KPMG has reinforced said findings.
As a former auditor, I have to say this means EY has done a fairly good job. It had received forged documents on which was basing its judgments, and yet through additional procedures has uncovered the issue. So you could actually chalk one up to them in this case: they are not the bad guy in this case. This however has not stopped a Dutch company, VEB, to seek damages from EY. It is difficult for me to say whether this claims are founded:I have some doubts, but I also do not know all the details of the fact, and VEB states on its website:” Besides being the main source of independent information for the Dutch investor, the VEB is widely known for its collective redress (VEB actions) – lawsuits typically brought to obtain compensation for groups of aggrieved shareholders” so it is essentially their job to go after whoever they can in the hope of winning compensation. It is essentially a business strategy.
The limits however that auditors face when dealing with dishonest management are however glaring, and this for a very misunderstood fact that the general public has towards the role of the auditors: Auditors have to rely, to a certain extent, on management representation, and their ability to investigate is limited by the fact that they are a private company, not a public authority.
Are they useless then? No. They provide a disproportionate amount of Assurance, and it is difficult to explain to people outside the profession how many errors and frauds are uncovered BEFORE the public knows about it.
There is unfortunately no waterproof safeguard against fraudulent management, who also benefits from being insiders.
Could auditors do more? They are already doing more and more by the year, a bit because of changes in regulation, a bit because of the escalating costs of litigation, a bit before contrary to popular belief, auditors are for the most part upstanding professionals who take a lot of pride, and put a lot of diligence, in the work they do.
A very underreported fact is how much audit firms are investing in technology to deliver higher quality audit and to provide to stakeholder more assurance on financial reporting.
So what should we learn from this story?
Well, first that in order to ensure accurate financial reporting, no amount of audit or procedures can insure against malevolent managerial practices.
Second, a sound internal control system will not take away the risk of fraud, but it will help and it will be vital in the aftermath: going in front of a criminal prosecutor without the demonstration that the internal control system was at least designed to reduce the risk of fraud, is a sure-fire way to add further troubles, and further costs, to an already difficult situation.
Third: investors need to come back to planet earth in their expectations of growth.
I am talking to you Softbank… it seems like whenever there is an appalling accounting issue (see:wework) and unreasonable growth expectations, Softbank is there. It might be confirmation bias, as of course botched investments tend to get in the news more than successful ones.
However if there is a common leitmotiv in all these scandals is that there are always unusually high company valuations, all-to-powerful executives (Braun the CEO and Chief Technology Officer at Wirecard).
So there is another issue probably at play: governance. Putting too much power at the hand of one or few executives is never a good idea. It can work when a company is small: when is a behemoth that at its peak was worth 25 billions of euro, a sound corporate governance is paramount. (which also means that the board, rather than the auditors, has a few tough questions to answer).
Another point I want to drive home is: basic procedures, when it comes to audit, are all but. It might seem archeological to ask for bank balance confirmations and to do detail work, however, as this case seems to point out, fraud, even in the high tech world, can be a very simple affair, at least logically speaking.
In this case the suspects seem to be always the same:
- Related party transactions
- “Complex” cross-border transactions that were difficult to explain and track, in order to inflate revenues$
- Backdating of contracts (Really…in 2020.)
On top of which there were ballooning debt (the main involvement of Softbank this time was through the issuance of convertible note, bonds essentially).
The news keep on rolling out, so it is difficult to keep track on the accuracy of what is reported.
However my last word of advice is that, in finance as in everything, if it looks too good to be true it probably is. So if a company is very high-flying, with dubious governance and unrealistic targets, and an increasing debt load, you might want to take your money somewhere else.
Also I would like to extend my sympathy to the EY teams involved in this audit. The amount of pressure and of hours they must be put up with is far from small. You did a good job guys it seems.
Chainergy 
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