James H. Freis, Jr., CFA: The Rise and Fall of Wirecard

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Thursday, 18 June 2020, is a day James H. Freis, Jr., CFA, the founding father of Market Integrity Options, will always remember.

In a single day, the mild-mannered American was thrust into the middle of what would grow to be the biggest monetary scandal within the historical past of contemporary Germany: Wirecard’s fall from high-flying fintech to the “Enron of Germany.”

Earlier than its collapse, Wirecard was a number one world digital funds agency with operations throughout 5 continents. Freis, a CFA charterholder with in depth expertise in authorized and compliance capabilities, was readying to affix the administration board as chief compliance officer when he was unexpectedly known as in early to evaluate a grave state of affairs: $2 billion had vanished from Wirecard’s steadiness sheet and the auditors have been refusing to sign-off on the corporate’s 2019 financials.

What Occurred Subsequent?

On the Alpha Summit by CFA Institute, Freis took viewers and moderator Paul Andrews alongside on his unusual Wirecard odyssey, from its starting in a lodge room exterior Munich, to his appointment as interim Wirecard CEO, to his work winding down the corporate.

Alongside the best way, he shared essential classes for buyers and regulators on the significance of assessing company governance and tradition. Paramount amongst them: Don’t be seduced by an organization’s “mystique” and converse up within the face of wrongdoing.

First, to set some context, right here’s a brief Wirecard timeline:

  • Wirecard is based in Munich in 1999.
  • In 2005, Wirecard is listed on the Deutsche Börse Frankfurt.
  • A decade later, the Monetary Occasions begins publishing its Home of Wirecard sequence, which raises questions concerning the firm’s accounts, on FT Alphaville.
  • On 8 Might 2020, Wirecard pronounces Freis’s appointment as chief compliance officer.
  • On 18 June 2020, Wirecard declares that €1.9 billion is lacking; Freis joins the administration board with quick impact.
  • On 19 June 2020, long-time CEO Markus Braun resigns and Freis, in his second day on the job, is called interim CEO.
  • Wirecard information for insolvency on 25 June.
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The “Enron of Germany”?

Enron was a family title within the early 2000s. The vitality large collapsed together with its auditor below the burden of an infinite accounting fraud in one of many largest enterprise scandals in US historical past.

Freis says the Enron-Wirecard comparability is becoming: In each instances, the auditor missed the monetary fraud and, within the aftermath, numerous questions have been raised about regulatory oversight.

“The explanation why [Wirecard] collapsed was an accounting scandal that, like Enron twenty years in the past, concerned a state of affairs the place an organization with actual enterprise had been successfully ‘cooking the books,’ misrepresenting its revenues and supreme affect on the steadiness sheets, issues that weren’t discovered by the accounting companies,” Freis mentioned.

In Enron’s case, accounting agency Arthur Andersen failed in its auditing oversight. Wirecard’s longtime auditor, EY, mentioned it had been fooled together with everybody else: “There are clear indications that this was an elaborate and complicated fraud, involving a number of events all over the world in numerous establishments, with a deliberate goal of deception,” the corporate mentioned.

“Enron led to a big a part of Sarbanes-Oxley,” Freis mentioned. The Wirecard scandal might evoke the same regulatory response.

“A lot of these points that weren’t already applied are being checked out when it comes to company governance reforms, when it comes to authorities oversight, and the best way that the digital economic system is difficult a few of our conventional notions in that regard,” he mentioned.

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The place Have been the Monetary Analysts?

Freis was not the primary individual to lift doubts about Wirecard: The Monetary Occasions had performed a five-year investigation of the corporate and short-sellers had been actively betting towards the agency.

As the corporate’s inventory worth rose, short-sellers repeatedly expressed considerations about Wirecard’s financials, however such warnings did not inspire a broad investigative response from German authorities.

Freis knew that some buyers have been skeptical and that many had doubts concerning the veracity of the corporate’s reporting. However solely on his first day, when he took his first have a look at Wirecard’s inside paperwork, did he come to grasp the agency’s true predicament. The state of affairs was worse than even probably the most fervent Wirecard critic had suspected.

Why then did it fall to Freis, holed up in his lodge room exterior Munich, to finally affirm the fraud?

Andrews posed two essential questions on this regard: What ought to the analysts have been in search of? And the place did they fail when it comes to questioning the C-suite?

“I got here to Wirecard from the Deutsche Börse group, which runs the German inventory change amongst different issues, and had centered on the realm of governance, particularly the significance of ESG, much less the E that’s the space of major focus in defining requirements, however on the G aspect,” Freis mentioned. “All of us as charterholders . . . we are able to crunch numbers, we are able to do comparisons. However after we have a look at the standard of these revenues and the long-term development potential, that energy of management is so necessary.”

And that’s a essential lesson from the Wirecard debacle: Monetary analysts should go effectively past the financials and take have a look at these occupying the C-suite.

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And, within the case of Wirecard, the management workforce was not the best one for the corporate.

“Wirecard had a administration workforce that basically had grown up with an organization that was a bit of bit greater than a start-up twenty years in the past,” Freis mentioned. The agency ascended a speedy development path to grow to be certainly one of Germany’s blue chips and the nation’s second largest financial institution — the biggest by valuation — with a market capitalization of €24 billion.

“However you continue to had quite a lot of lingering points from this administration workforce,” Freis mentioned.

One other downside from a company governance perspective: a board that did not query the management. Whereas Wirecard’s board was a various one and much from a homogeneous boys’ membership, range alone didn’t assure efficient oversight.

“So 50% girls, 50% males, girls of coloration, folks with IT backgrounds — quite a lot of the issues we’re striving to,” Freis mentioned. “But when we checked out that as simply check-the-box, we miss the purpose, as a result of what they weren’t doing is difficult administration, being a shareholder consultant in the best way we discuss non-executive administrators.”

Rumors concerning the firm’s accounting and different public suspicions did not encourage diligence amongst board members.

“There was not an audit committee up till just lately regardless of very public audit allegations,” Freis mentioned. “Whenever you have a look at a world company and also you take into account issues like interlocking administration, directorships of subsidiary, together with regulated monetary providers firm, these are the forms of issues that any analyst wanting on the governance construction would have seen as pink flags.”

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Beware the Attract of Mystique

So what concerning the analysts and buyers? What saved them from catching the fraud?

In spite of everything, Wirecard was not “a microcap with skinny analyst protection,” Freis mentioned, however probably the most closely traded fairness in Germany at its peak.

He believes Wirecard demonstrates the risks of following the herd and being lulled into complacency by “massive names” within the enterprise.

Wirecard had the fintech firm mystique and that protected it, Freis mentioned.

“Overwhelmingly, analysts have been bullish on this firm,” he mentioned. “The corporate . . . had surrounded itself — and that is the mystique — with a few of the finest names.”

It had engaged the very best accounting companies, all 4 of them. This lent the corporate an air of not simply legitimacy, however status.

“Not solely did it have a Huge 4 auditor, which might be anticipated,” Freis mentioned, “however every of the Huge 4 have been concerned in a few of the essential points, so auditing its financial institution subsidiary, offering recommendation on some conflicts that had come up in a regulatory surroundings, and the non-executive administrators known as within the final of the Huge 4 to take a look at the identical subject up to now yr.”

The mystique didn’t finish there.

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Wirecard additionally had “a few of next-tier-down monetary advisers” advising on acquisitions and mergers. It had entry to the large strategic consulting companies, authorities lobbyists, and all the opposite accoutrements related to an assumingly well-capitalized multinational fintech company.

Nevertheless it was all an phantasm.

Nonetheless, certainly somebody should have seen one thing that didn’t add up? Why weren’t folks talking up en masse?

“This was probably the most surprising factor for me, as a result of all these folks have been working to this firm,” Freis mentioned. But only a few raised any considerations or reduce ties with Wirecard, even after getting a more in-depth look.

“They have been blinded by numbers, which, on reflection, have been fictitious,” he mentioned. “So this veil of legitimacy, this mystique — finally when critics got here in, the corporate’s reply was, ‘You simply don’t perceive what it’s to be a disruptive fintech. Get out of the best way.’”

Was it a case of greed over governance? Maybe.

“I believe lots of people simply didn’t have the braveness to disassociate themselves from a reputation that a lot of the business, a lot of the press . . . that the overwhelming majority was cheering on and lauding,” Freis mentioned.

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Classes from Wirecard?

A key query to think about, Andrews mentioned, is whether or not a know-how firm or fintech firm, which is basically what Wirecard was, ought to have been allowed to run what, in impact, was a monetary providers enterprise.

Freis agreed. Wirecard was principally regulated as a publicly listed firm, as a know-how supplier, however had an entirely owned subsidiary that was a financial institution.

“The talk in Germany going forwards and backwards was whether or not it ought to have been labeled as a monetary holding firm, which might have given the banking regulator extra oversight,” Freis mentioned.

From a governance perspective, what is going to it take to make sure one thing like Wirecard doesn’t occur once more?

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“The imbalance in the present day is the best way a world firm in a digital work operates versus the best way the company governance framework is about up,” Freis defined.

“For a digital firm or a tech firm, you don’t have the fee inputs that we do in a manufacturing unit, and even your labor now’s digital and dispersed, and you’ll ebook your IP wherever on the earth, so that you don’t have a jurisdictional part. And also you’re promoting wherever on the earth via the web. So we’d like to consider that versus the truth that you will have individually integrated entities with native boards and native contracts and we even have auditors that aren’t actually a world agency with a world branding and may they assist us in that regard.”

If there’s a single lesson to move on to buyers and analysts it’s this: In the event you see one thing, say one thing.

“Individuals, once they see issues, they should converse up and they should observe via,” Freis mentioned. “If it’s worthwhile to ask troublesome a query and be a ache, I encourage you to try this.”

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All posts are the opinion of the creator. As such, they shouldn’t be construed as funding recommendation, nor do the opinions expressed essentially replicate the views of CFA Institute or the creator’s employer.


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Lauren Foster

Lauren Foster is a content material director on the skilled studying workforce at CFA Institute and host of the Take 15 Podcast. She is the previous managing editor of Enterprising Investor and co-lead of CFA Institute’s Ladies in Funding Administration initiative. Lauren spent almost a decade on workers on the Monetary Occasions as a reporter and editor primarily based within the New York bureau, adopted by freelance writing for Barron’s and the FT. Lauren holds a BA in political science from the College of Cape City, and an MS in journalism from Columbia College.

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