If you were supervising someone with questionable money management skills – perhaps a child, or maybe one of Europe’s highest-profile tech startups – you would notice if they lied about having a couple of billion dollars, wouldn’t you?
Most of us would like to think so. Kids will do the darndest things sometimes, like make up an imaginary friend. But they seldom fib about an imaginary $2 billion, stashed away in a couple of banks in the Philippines. A tech startup, on the other hand, may feel it’s worth a try.
Wirecard AG, a former darling of Germany’s corporate community, apparently lied to this effect before its accounting house of cards collapsed in June. Prosecutors in Munich arrested the fintech company’s former CEO and largest shareholder, Markus Braun, alleging that he systematically inflated the company’s revenues. Braun reportedly turned himself in days after being forced to resign. Wirecard’s principal auditor, Ernst & Young GmbH – the country’s affiliate of the global EY accounting giant – refused to issue its report on Wirecard’s 2019 financial statements. The refusal followed a decade of signing off on the startup’s audits, despite repeated allegations of fraud and manipulation from investors and journalists. Germany’s financial regulator, BaFin, took a big hit to an already shaky reputation, too. And Wirecard itself conceded that the $2 billion it had claimed to have in those Southeast Asian banks was never really there.
It’s a financial scandal on the scale of Enron, which precipitated a major overhaul of American corporate reporting two decades ago and led to the demise of what was then the world’s largest accounting firm, Arthur Andersen & Co. (I launched my own financial career at Andersen, but I left the firm in 1992, a decade before it imploded.) Scale aside, I actually find the Wirecard debacle more reminiscent of the Bernard Madoff Ponzi scheme that unraveled in 2008. In that case, too, the messy end arrived after skeptics had raised questions for years about financial results that seemed too good to be real. That’s because, for Madoff and Wirecard alike, they weren’t.
Fabricated or not, Wirecard’s results got the company into Germany’s DAX 30 stock index, a major benchmark. Its collapse is a huge embarrassment to the country’s financial oversight system. BaFin’s initial reaction to the allegations against Wirecard was to investigate those who were casting aspersions on the company, rather than the company itself. It remains to be seen whether and to what extent the debacle will change either the country’s regulatory regime or the mindset behind it.
One mindset that the scandal may have changed is that of the auditors. EY’s global chief, Carmine Di Sibio, wrote to the firm’s clients that auditors “should play more of a role in the future to detect material frauds,” The Wall Street Journal reported.
The average person could be forgiven for thinking that auditors already should play a pretty big role in detecting “material fraud.” Yet the accounting industry has always been at pains to explain that a company’s financial statements are prepared by the company’s management, which is ultimately responsible for them. Auditors can detect errors in the numbers they receive. They can also help interpret and apply rules that make a company’s financial reports comparable with reports from other companies, or with reports from the same company covering other periods. This stance toward auditor responsibility works when the company’s management is operating in good faith. It fails when management is inherently dishonest.
Auditors have a point when they say there is no practical way for them to penetrate an elaborate, extensive, well-concealed fraud – or theft, or other form of dishonesty – especially if it involves a company’s top managers. But in this case, we are talking about $2 billion that the company was supposedly keeping in two Philippine banks. Normally auditors confirm such balances via correspondence, which a dishonest company can fake.
But $2 billion? In only two banks? In an out-of-the-way corner of the world, where it would be odd on its face for a major company to park so much cash? A simple phone call to the head of each institution asking if they had $1 billion or more of Wirecard’s money could easily have elicited the response “Wirecard? Never heard of them.”
Apparently nobody at EY made such a call until after suspicions got so big that Wirecard was forced to hire a rival auditor, KPMG, to do a special investigation. KPMG reported earlier this year that it could not get straight answers about the company’s finances. Only then did EY back away from its endorsement of Wirecard’s reports.
If EY did not think part of its existing mandate included tracking down $2 billion supposedly stashed in the tropical Pacific by a European company already under suspicion of cooking the books, it is hard to see how increasing auditors’ responsibilities would change anything. The firm would merely have fallen that much further short of the reasonable expectations people already have for the global Big Four accounting giants.
When these things happen – and they happen too often for anyone’s comfort – bystanders raise questions about the system in which public companies are audited. The public relies on financial reports issued by companies and endorsed with a “clean opinion” from the accounting firms that those companies hire. Should we have battalions of government workers do the auditing instead? To answer that question, ask whether you would like to see annual financial statements issued within months of year-end, or within in a decade or so (maybe). If you have ever been through a tax audit, you know that timeliness and efficiency are not government workers’ hallmark.
This incident and others like it also raise the question of whether an accounting firm is willing to part with a dishonest client. Some outsiders cannot conceive of this. In fact, I believe Andersen’s unwillingness to stand up to Enron’s aggressive practices is what led to the firm’s undoing. But that was a specific failure, not a systemic one. At least in my long-ago public accounting experience, we asked all the time whether prospective and existing clients were honest and reputable. I continue to operate that way in running my own firm. Dishonest clients are never worth the trouble they bring, and by now everyone in the industry ought to recognize this.
So I don’t see very much changing in the auditing world, despite the platitudes coming from a chastened EY. We’ll tighten the seams and turn up the lights, which may make a difference at the margins. But people have been lying for as long as people have been talking. Human frailty means we won’t always catch the lies before they catch us. Wirecard isn’t the first deceptive company to unravel, and it won’t be the last.