How did it come to that?
As I say in an Associated Press article appearing in the New York Times and Washington Post, it’s too early to say what happened at Wirecard – and why nobody prevented it, or at least discovered it sooner. And it is certainly too early for pointing fingers.
The parties playing a role in any case of accounting fraud and other corporate misconduct typically include the firm’s top management and supervisory board, the auditor, and external monitors. In the big scandals in recent history, none of them looked good. Still, we know stunningly little about what goes on within these players, and how they interact with each other. So, one thing seems clear to me: The Wirecard case highlights – again – a dire need for transparency along several dimensions.
First, what’s goes on within firms’ C suites? According to the fraud triangle, the likelihood of fraud rises in the joint presence of three conditions: (Perceived) financial need, (perceived) opportunity, and rationalization. Are we paying our executives too little, or are they too greedy? Don’t we have sufficient checks in place to shield them from temptation? And, fascinating to me, what are the stories they tell themselves so they can keep falling asleep at night, facing their kids, and looking at themselves in the mirror?
What about supervisory boards, who act on behalf of important stakeholders like investors and employees? We don’t know much about how they’re selected, their relevant skill sets, and what they do in and outside of their meetings. What could and should they have known, and what could and should they have done to prevent bad things from happening?
There seems to be a recurring pattern: It is firms where people don’t understand how they make money – where the reporting is not making the business model transparent – that are vulnerable to accounting scandals. I recently spoke to a sophisticated financial journalist who told me he had been looking into doing a background story on Wirecard – but after some initial research dropped the idea because he couldn’t for the life of him figure what Wirecard actually does. Similar statements have been made about Enron. Still, it has been the financial press that has helped uncover accounting scandals more than once in recent years: In 2001, Bethany McLean’s Fortune article ‘Is Enron Overpriced?’ was a major milestone in the undoing of Enron. With Wirecard, it was the Financial Times’ coverage that got the ball rolling. How much easier must it have been for insiders, like supervisory board members and auditors, to see that something fishy was going on?
The second line of defense against corporate misconduct is the external auditor. External auditors are also intransparent. We don’t know on what grounds they are selected by their clients, or – apart from self-reported statements – what exactly they do in their audits. Who did the auditor talk to? What kinds of questions did they ask, or fail to ask? How forthcoming were those they asked? What types of analyses did they run on whatever information they did obtain? How much support did they receive from the supervisory board – especially from the audit committee and its chairperson? About much of this, outsiders don’t have a clue. To this day, auditors do not take the podium at the annual shareholders’ meeting to speak to, or be questioned by, shareholders.
Third, what about the external monitors? In Germany, the setting I am most familiar with, IFRS reporting by public firms is subject to oversight by the private-sector Financial Reporting Enforcement Panel (FREP), often labeled the German “accounting watchdog”. Where the FREP finds errors that the firm disputes, it will involve the (German) Federal Financial Supervisory Authority, or BaFin. This enforcement structure is also largely intransparent. While the FREP does report on its aggregate error findings and enforcement priorities, it does not publicly disclose the firms it audited in a given year. So, the important signal that a firm was audited by the FREP and found to be clean is lacking from the markets. The BaFin’s role is intransparent, too. We don’t know what kind of own investigations they launch in addition to the DPRs’, and what that they find.
Repeated accounting scandals, with Wirecard being the latest, suggest that this opacity contributes to a breeding ground for corporate wrongdoing. True, each case is different. But they all illustrate the need for more transparency about firms, auditors and oversight bodies. Voluntary disclosure incentives – e.g., the market interpreting non-disclosure as bad news – do not seem sufficient. Why not publish the minutes of supervisory board meetings, or at least of audit committee meetings? Why not disclose the full-blown auditor’s report instead of its watered-down version that we call ‘key audit matters’? Why not allow shareholders to call the external auditor to the podium during the annual shareholders’ meeting? I've never heard convincing arguments that would justify withholding this kind of information from the firm’s owners – and society at large.
