Financial fraud poses a serious threat to economies, businesses, and individuals. Among its various forms, accounting fraud is particularly widespread. This blog delves into financial fraud, focusing on accounting fraud, its motivations, and a case study of the Wirecard scandal.

What is Financial Fraud?

Financial fraud involves deceitful practices like embezzlement, insider trading, and money laundering to gain an unfair financial advantage. 

The Prevalence of Accounting Fraud

Accounting fraud manipulates financial statements to falsely enhance a company’s image. Common tactics include:

• Fake Revenues: Recording nonexistent sales or inflating sales figures.
• Hiding Expenses: Concealing or minimising expenses to show higher profits.
• Misstating Finances: Overstating assets or understating liabilities to manipulate financial ratios.

This fraud erodes trust in financial markets, leading to losses, legal trouble, and damaged reputations.

Motivations Behind Financial Fraud

Motivations for financial fraud include:

• Performance Pressure: Meeting targets, satisfying shareholders, or maintaining stock prices.
• Personal Gain: Earning bonuses, promotions, or incentives.
• Weak Controls: Poor governance and oversight.
• Financial Distress: Using fraud as a last resort to survive tough economic conditions.

The Wirecard Scandal: A Case Study

Wirecard is a prime example of accounting fraud. The German payment processor and financial services provider’s rise and fall shows how fraud works and why it happens.

Background

Backed by venture capital, Wirecard was founded in 1999, and it quickly became one of Germany’s top fintech companies. During its tenure as one of the world’s leading fintech companies, Wirecard’s shares peaked at €191, valuing the company at over €24 billion. Wirecard was listed on the Frankfurt Stock Exchange and the DAX 30 index, which includes the 30 largest publicly traded companies in germany.

Initial suspicions

Over the years, there were several allegations and reports questioning Wirecard’s accounting practices and business operations. The first of which was in 2006, when Wirecard moved into banking. It did this through the acquisition of XCOM. Wirecard Bank was then licensed by Visa and Mastercard, allowing them to issue credit and manage funds for merchants. This combination of banking and non-banking functions meant it was harder to compare its accounts to its competitors, meaning investors had to blindly trust the company’s adjusted financial statements. 

In 2008, Wirecard was accused of Balance sheet irregularities by the head of a German shareholders association. This triggered the appointment of EY to conduct a special audit – EY replaced the previous small Munich firm as Wirecard’s group auditor for the following year. In the end, two men, who held Wirecard stock, were eventually arrested.

In 2015, the Financial Times released a series of investigative articles titled ‘House of Wirecard’. These articles highlighted inconsistencies and an alleged €250 million hole in the firm’s balance sheet.

In October of the same year, Wirecard announced its largest ever acquisition, purchasing indian payment businesses for €340 million. Despite this, J Capital released research claiming Wirecard’s Asian operations to be much smaller than reported. Of course, Wirecard shrugged this off as a report paid for by short sellers. (See my last blog post for information on short selling)

In 2019, a series of Financial Times investigative articles reporting inflated figures in Wirecard’s operations led to the appointment of KPMG for a special audit.

The Collapse

KPMG’s audit report, which was eventually released in April 2020, was unable to verify the existence of significant portions of Wirecard’s reported revenues and profits.

Later that year, Wirecard disclosed that auditors from Ernst & Young (EY) could not confirm the existence of €1.9 billion supposedly held in trustee accounts in the Philippines. This amount represented about a quarter of Wirecard’s balance sheet.

The company admitted that the €1.9 billion likely did not exist.

By the 25th of June 2020, Wirecard filed for insolvency, reporting debts of nearly €4 billion. This was one of the largest insolvencies in Germany’s post-war history.

Key Figures

Markus Braun, Wirecard’s CEO, was arrested and charged with fraud, embezzlement, and market manipulation. He maintained that he was unaware of any wrongdoing.

Jan Marsalek, Wirecard’s COO, was believed to be the mastermind behind the fraudulent activities. Marsalek fled and became one of the most-wanted fugitives in the world. As of the last reports, his whereabouts were unknown, and there were speculations about his connections with intelligence agencies and criminal networks.

Lessons Learned

The scandal prompted calls for stricter regulations and oversight mechanisms for financial institutions. The German regulatory authorities, including BaFin, faced criticism for their oversight failures. Investigations were launched in multiple jurisdictions to uncover the full extent of the fraud and hold those responsible accountable.

Wirecard’s fraud also highlighted the importance of strong corporate governance, transparency, and accountability in preventing similar incidents in the future. As well as this, Wirecard also raised questions about the competency of auditors and their ability to handle large global businesses. 

Accounting fraud is a serious threat to financial markets, eroding trust and causing significant financial losses. By understanding the motivations behind financial fraud and learning from past scandals, we can work towards a more transparent and trustworthy financial system.