How to get away with stealing $2 Billion: Wirecard fraud explained!

This post explains how a multi-billion dollar fintech stock seemingly evaporated overnight without a trace

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Wirecard AG, a German payment processor and a fintech company was once everyone’s favourite stock with strong bullish signs. The company had a prestigious spot on German index DAX 30. Think of it as India’s Sensex. When Ernst & Young, the statutory auditors of Wirecard AG refused to sign off on 2019 financial report, it set off a number of subsequent events over a period of 10 days, which made the company lose almost 97% of its market value which is around $13.5 Billion of investor money evaporated and file for insolvency after revealing that the company had a $2 Billion accounting hole in its balance sheet.

Let's look at the groundbreaking fall in its share price to understand the magnitude of impact this accounting scandal had.

Wirecard AG share price for June 2020

So, how did the one of the worst financial disasters in Europe since the financial crisis happen?

The missing $2 Billion Wirecard money was supposed to be held in two trust accounts and the auditors investigating the company said that they could not find it. This $2 Billion is equivalent to all the profits that Wirecard has made in more than a decade and nobody knows if the money really exists or if the money ever existed or not.

Let’s rewind and start with the things that we do know. Wirecard is a global fintech company with over 20 years of fintech experience. The German software company provides solutions which connects the Financial Institutions with retailers and the customers. They collect payment details from the people making the purchases and perform the role of confirming, settling and processing these payments. A lot of it was related to online gambling and adult entertainment. The growth of digital payment systems and decline of physical cash usage meant that Wirecard’s business bloomed over the past decade.

Wirecard’s stock price grew 600% between 2016 and 2018. Several people had their doubts over Wirecard’s business model and wondered if it was overvalued but these concerns were never taken seriously. Starting early 2019, a wave of Financial Times articles concerning Wirecard’s global operations lead to the company calling in KPMG for a special audit. Unofficially, this audit was supposed to provide credibility over the concerns of some its businesses that people had doubted and prove that these operations were indeed legitimate.

However, KPMG said that it was not able to determine answers to some of the questions which the investors had and one of the biggest questions was “Why is there a bunch of money in trustee accounts and whether that money was really there?” When KPMG went looking for $2 Billion in cash that Wirecard had said was in two trust accounts in Philippines, what they found was thin air. The Philippine banks stated that they had never dealt with Wirecard. Some of the statements from the KPMG report from April 2020 submitted to the company read as follows:

KPMG was therefore not able to fully understand Wirecard’s “gross balancing” of sales revenues.

It was not sufficiently possible for KPMG to forensically trace the existence of transaction volumes during 2016 to 2018

KPMG will not draw any conclusions about the total revenue for 2019 due to limited investigation period

This proved to be impossible as we were not given access to the relevant data or database

All of these should have raised red flags, not just among investors but the German Financial Regulatory Authority, BaFin should have stepped in as well but none of that happened. Instead, the company’s official statement read, “No incriminating evidence was found for the publicly raised accusations of balance sheet manipulation.”

Wirecard’s long time statutory auditors Ernst & Yound GmBH had relied on electronic scans of documents confirming the account balances. EY finally admitted that these documents weren’t reliable and they thought they had been deceived. EY accused their client of engaging in an “elaborate and spohisticated fraud”. After that, the stack of cards on which the company had been built came down pretty quickly.

June 5: Prosecutors raid Wirecard HQ and start proceedings against the management for attempting to manipulate company’s share price

June 17: EY states that it cannot release its long-delayed audit report over the failure to locate missing funds

June 19: Wirecard CEO resigns

June 22: Wirecard finally admits that the missing $2 Billion probably doesn’t exist

June 23: German prosecutors arrest the company’s former CEO and CTO Dr. Markus Braun.

June 26: Wirecard files for insolvency

Dr. Braun is alleged to have inflated the value of the company by showing bogus transactions and recognising non-existent revenues. He has denied all wrongdoings.

Wirecard AG had escrow accounts with partner companies in Dubai, Singapore etc since it did not have a license to operate in these countries. However, it could not be substantiated whether these partner companies generated any revenue for Wirecard AG at all.

Thus, there are two theories that emerge:

Theory 1: The sales revenues were completely made up and Wirecard was simply trying to inflate the value of the company in order to get more investors invest in the company and to access a larger borrowing pool from the commercial banks.

Theory 2: Some of the business from the supposed partner banks did exist and for some reason, it wasn’t going through the official bank accounts of Wirecard and the money was never put where it was supposed to be put. It maybe siphoned off by some top level executives at some period during these last few years.

No one really knows what happened and unless there is an intrusive forensic investigation going back a couple of years or more, it will remain a mystery forever. This debacle adds to several instances of failure of Big 4 firms to flag discrepancies in financial reports of major companies prior to their bankruptcies.

The questions do remain: Were Ernst & Young, Wirecard’s auditors since 2007 complicit in fraudulent activity? Why wasn’t there an involvement from the market regulators when calls about Balance sheet tampering were made? Who is liable to pay for the damages done to the investors?