Wirecard Scandal: Lessons for Investors | Shanice Phee

Introduction: Wirecard

Wirecard was founded in 1999, in a Munich suburb, backed by a venture capital. The FinTech startup is a payment processor that enables websites to collect credit card payments from customers.

In 2005, Wirecard became public through a reverse merger with a defunct call centre company, InfoGenie.

Wirecard’s growth was substantial, with a market value of €24bn and 5,000 employees by August 2018.

In September 2018, it became a member of DAX, a market index comprising 30 major German companies on the Frankfurt Stock Exchange. As Europe’s largest fintech, it is seen as a rare German tech company able to challenge the giants of Silicon Valley.

How the Scandal Unfolded

On 18 June 2020, Wirecard was scheduled to publish its annual report for FY2019. However, this report was delayed after Wirecard’s auditors, Ernst & Young (EY), were informed by Philippine banks BPI and BDO that documents supposedly detailing €1.9bn ($2 billion) in balances are “spurious”. As such, EY refused to sign off its books as $2 billion in cash was unaccounted for on Wirecard’s balance sheet.

The next day (i.e. 19 June 2020), Wirecard CEO Markus Braun resigned from his position “with immediate effect” amidst the accounting scandal.

On 22 June 2020, Wirecard admitted that the $2 billion likely doesn’t exist. Following the news, Wirecard’s shares plunged more than 40% on that day. To-date, the stock is down 98% since the start of 2020.

Aftermath

1. Wirecard’s Former CEO Arrested

On 23 June 2020, Wirecard’s former CEO was arrested on suspicion of false accounting and market manipulation. Markus Braun is accused of inflating Wirecard’s balance sheet through “feigned income” from third party transactions to attract more investors.

2. Wirecard Files for Insolvency

On 25 June 2020, Wirecard filed for insolvency with the District Court of Munich, becoming the first member on the DAX to fail. The company said that management had decided to seek court protection “due to impending insolvency and over-indebtedness.”

3. EY Sued Over Wirecard’s Accounting Fraud

EY is now facing a class-action lawsuit in Germany brought by Wirecard investors.

It was reported by the Financial Times that for more than 3 years, EY failed to request crucial information from OCBC, a Singapore bank, to confirm that OCBC had held large amounts of cash on behalf of Wirecard. Instead, EY relied on documents and screenshots provided by a third-party trustee and Wirecard itself.

However, EY claims that it was also a victim of the Wirecard scandal. “There are clear indications that this was an elaborate and complex fraud, involving a number of events around the globe in several establishments, with a deliberate purpose of deception,” it mentioned. EY further argued that “even the most robust audit procedures may not uncover this kind of fraud”.

Moving Forward: Lessons for Investors

The meteoric rise of Wirecard, and their dramatic fall from grace carries important lessons for every retail investor. Below are a few key takeaways our team has gathered from this incident.

1. Auditors do not Eliminate the Fraud Risk of a Company

Every investor should recognise that balance sheets that are audited do not necessarily mean they are void of fraud risk, and auditors are only there to ensure that effective accounting standards are used. As Carson Block, the Chief Investment Officer of Muddy Waters Capital LLC succinctly puts it: “Investors mistakenly assume that auditors are there to perform anti-fraud functions.”

2. Consider the Adoption of Technical Analysis in Stock Picking

Consider adopting technical analysis in your decision making. As technical analysis relies solely on price and volume, it enables investors to detect fraud by, for example, looking at key support levels. Furthermore, using technical analysis in your security analysis reduces reliance on financial statements (which can be fraudulent and misrepresented), as only price and volume data are required.

A good example of when technical analysis proved to be superior to fundamental analysis is during the fall of Enron Corporation. Enron had hid their financial losses using mark-to-market accounting, but many fundamental analysts continued to hold favourable views of the company, and even issued “BUY” ratings even as the share prices declined. Those investors who used technical analysis would have sold the stock after observing negative chart patterns and numerous sell signals.

3. Do not put all your eggs into one basket

Since it is hard for the retail investor to detect if the audited financial statements of a company conceals the presence of fraud within the company, it may be prudent to include a healthy level of diversification within your investments. If you are investing in stocks, pick a few companies with healthy financials or businesses in which you believe in.

After all, the chances of 10 companies committing fraud at the same time will be much lower than the chances of 1 in 10 of the companies you invest in committing fraud. With a healthy level of diversification, you are less likely to lose all your capital to one incident of fraud.

Sources: CNBC, The Wall Street Journal, The Financial Times, Bloomberg

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