Overnight, the mild-mannered American was thrust into the center of the most important financial scandal in modern German history: Wirecard’s decline from a successful fintech company to the “Enron of Germany.”
What happened next?
In doing so, he taught investors and regulators vital lessons in regards to the importance of assessing corporate governance and culture. The most significant lesson is: do not be seduced by the “myth” of an organization and speak up whenever you encounter wrongdoing.
To make clear the context, here’s a transient overview of Wirecard Timeline:
- Wirecard was founded in Munich in 1999.
- In 2005, Wirecard was listed on the German Stock Exchange in Frankfurt.
- A decade later, the corporate publishes its “House of Wirecard” series, which raises questions on the corporate’s balance sheet.
- On May 8, 2020, Wirecard announced the appointment of Freis as Chief Compliance Officer.
- On 18 June 2020, Wirecard announced that 1.9 billion euros missing; Freis joins the management team with immediate effect.
- On 19 June 2020, long-standing CEO Markus Braun resigns and Freisis appointed interim CEO on his second day of labor.
- Wirecard File for bankruptcy on June twenty fifth.
The “Enron of Germany”?
Enron was a world-famous name within the early 2000s. The energy giant collapsed, together with its auditor, under the load of enormous accounting fraud. It was one in all the most important economic scandals in US history.
According to Freis, the comparison between Enron and Wirecard is apt: in each cases, the auditor missed the financial fraud and, consequently, quite a few questions were raised about regulatory oversight.
“The reason why [Wirecard] The reason for the collapse was an accounting scandal that, like that of Enron two decades ago, involved a situation in which a company with real business had effectively “faked the books,” misrepresenting its earnings and the ultimate impact on the balance sheets – things that went undetected by the accounting firms,” Freis said.
In the Enron case, the auditing firm Arthur Andersen failed in its audit supervision. Wirecard’s long-standing auditor EY said it had been deceived like everyone else“There is clear evidence that this was an elaborate and sophisticated fraud involving multiple parties across multiple institutions around the world and with a deliberate intent to deceive,” the corporate said.
“Enron was heavily involved in Sarbanes-Oxley,” Freis said. The Wirecard scandal could provoke an analogous response from regulators.
“Many of these issues that have not yet been implemented are being examined in terms of corporate governance reforms and government oversight, and also in terms of the way the digital economy is challenging some of our traditional notions in this regard,” he said.
Where were the financial analysts?
Freis was not the primary to specific doubts about Wirecard: conducted a five-year investigation into the corporate and short sellers had actively bet against the corporate.
As the corporate’s share price rose, Short sellers have repeatedly expressed concerns about Wirecard’s financial figuresHowever, these warnings didn’t result in a comprehensive investigative response by the German authorities.
Freis was aware that some investors were skeptical and that many doubted the credibility of the corporate’s reporting. But it was only on his first day, when he took a primary take a look at Wirecard’s internal documents, that he realized the corporate’s true situation. The situation was worse than even Wirecard’s harshest critic had suspected.
Why then did it fall to Freis holed up in his hotel room outside Munichto finally confirm the fraud?
Andrews asked two critical questions: What should the analysts have been listening to? And where did they fail to ask senior management questions?
“I came to Wirecard from Deutsche Bank, which operates Deutsche Börse among other things, and had focused on the area of governance, particularly the importance of ESG, less on the E side, which is the focus in defining standards, but on the G side,” Freis said. “All of us as charterholders … can process numbers, we can make comparisons. But when we look at the quality of that revenue and the long-term growth potential, that leadership is so important.”
And that’s a crucial lesson from the Wirecard debacle: financial analysts must look far beyond the financial data and take a detailed take a look at the executives on the manager floor.
And within the case of Wirecard, the management team was not the correct one for the corporate.
“Wirecard had a management team that had basically grown up with a company that was little more than a start-up two decades ago,” Freis said. The company grew rapidly to grow to be one in all Germany’s blue chips and the country’s second-largest bank – the biggest by valuation – with a market capitalization of 24 billion euros.
“But there were still many unresolved issues with this management team,” Freis said.
Another problem from a management perspective: a board that didn’t query leadership. Although Wirecard’s board was diverse and anything but a homogenous men’s club, diversity alone didn’t guarantee effective control.
“So 50% women, 50% men, women of color, people with IT backgrounds – those are a lot of the things we’re aiming for,” Freis said. “But if we look at that as just checking boxes, we’re missing the point, because what they’re not doing is challenging management and being a shareholder representative, the way we talk about non-executive directors.”
Rumors in regards to the company’s financial statements and other suspicions that arose in the general public eye didn’t help to extend the diligence of the board members.
“Until recently, despite public allegations, there was no audit committee,” said Freis. “If you look at a global corporation and take into account things like the interlinking of management, the directorships at subsidiaries, including regulated financial services providers, then these are things that any analyst looking at the governance structure would have seen as warning signals.”
Beware the fascination of mystery
And what in regards to the analysts and investors? What stopped them from exposing the fraud?
After all, Wirecard was not a “microcap with little analyst coverage,” says Freis, but at its peak it was probably the most heavily traded share in Germany.
He believes that Wirecard is an example of how dangerous it’s to follow the herd and be lulled right into a false sense of security by the “big names” within the industry.
Wirecard maintained the parable of the fintech company and this protected the corporate, said Freis.
“The analysts were overwhelmingly bullish on this company,” he said. “The company … had surrounded itself – and this is the mystery – with some of the best names.”
The company had hired all 4 of one of the best accounting firms. This gave the corporate not only legitimacy but in addition prestige.
“There was not just one auditor from the Big Four, which was to be expected,” Freis said, “but each of the Big Four was involved in the audit of some critical issues, such as the audit of its subsidiary bank, advising on some conflicts that had arisen in a regulatory environment, and the non-executive directors engaged the last of the Big Four last year to look at the same issue.”
The mysticism didn’t end here.
Wirecard also had “next-level financial advisors” advising the corporate on acquisitions and mergers. The company had access to the foremost strategic consulting firms, government lobbyists and all other entities related to a presumably well-capitalized multinational fintech corporation.
But it was all an illusion.
Still, someone will need to have seen something that did not add up? Why didn’t people protest together?
“That was the most shocking thing for me, because all these people were flocking to this company,” Freis said. But even after closer inspection, only a few expressed concerns or broke off their relationships with Wirecard.
“They were blinded by numbers that, in hindsight, were completely fabricated,” he said. “So this veil of legitimacy, this mysticism – when critics came forward, the company’s response was, ‘You just don’t understand what it means to be a disruptive fintech. Get out of their way.'”
Was it a case of greed towards the federal government? Maybe.
“I think a lot of people just didn’t have the courage to distance themselves from a name that was celebrated and praised by much of the industry and the press,” Freis said.
Lessons from Wirecard?
A key query to contemplate, Andrews said, was whether a technology or fintech company – and that was essentially what Wirecard was – must be allowed to operate what was essentially a financial services company.
Freis agreed. Wirecard was fundamentally subject to the regulations of a listed company, a technology provider, but had a completely owned subsidiary that was a bank.
“In Germany, the debate revolved around whether the bank should have been classified as a financial holding company, which would have given banking regulators more control,” Freis said.
What must be done from a governance perspective to be sure that something like Wirecard doesn’t occur again?
“The imbalance today is in the way a global company operates in a digital world and the way the framework for corporate governance is constructed,” Freis explained.
“For a digital company or a technology company, there aren’t the costs that we have in a factory, and even your work is now virtual and distributed, and you can book your intellectual property anywhere in the world, so you don’t have a jurisdictional component. And you sell anywhere in the world over the internet. So we have to think about whether we can compare that with the fact that you have separately incorporated companies with local boards and local contracts, and that we also have auditors who are not a truly global company with a global branding. Can they help us in that regard?”
The lesson we can provide to investors and analysts is: If you see something, say something.
“When people see something, they need to speak up and follow through,” Freis said. “If you need to ask a difficult question and be annoying, I encourage you to do so.”
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