The white-collar fraud pandemic is as serious as Covid

Wirecard is the latest corporate scandal. The German company declared, last week, that it was unable to locate €1.9 billion of its bank deposits! Its stock price declined 99 per cent, dropping from €104 on June 7, to €2 on July 8, wiping out shareholders. The Wirecard fraud is eerily similar to Satyam. Set up in 1999, Wirecard became a payments processor to process credit card payments for online credit card transactions. It acquired a listed company, thereby obviating scrutiny to get its own listing and also acquired a bank in 2006 in Germany.

Wirecard also used overseas subsidiaries to process the payments and apparently faked transactions, generating business volume (fake) as well as the resultant cash flow (also, naturally, fake). The fake business growth generated an EBIDTA margin of 30-35 per cent, significantly higher than payment processors.

These fake bank balances were ostensibly deposited in a bank in Singapore, even though Wirecard had its own bank in Germany. There were no deposits in the bank; the audit, signed by E&Y, was based on a forged certificate by an employee. A simple phone check, as required, would have revealed this much earlier but was done only after the company stated in June that €1.9 billion was missing!

Unlike the Satyam case, were the fraud was revealed only when its founder, Ramalinga Raju, admitted to it in a public confession, the risks in Wirecard were revealed through a series of investigative articles in the Financial Times since 2015 (5 years before the scandal was exposed).

This is what Bill Black, author of ‘The Best Way to Steal a Bank is to Own One’, and co-founder of Bank Whistleblowers Ltd., , in an interview titled ‘The Finance Curse’ calls an accounting control fraud. Similar to what Enron and a host of other fraudsters did.

So, basically, fake transactions create fictitious profits which drives up the stock price, which allows the top management to get hefty bonuses based on puffed up results. Wirecard’s market cap overtook that of Deutsche Bank and Commerzbank and it replaced the latter in the index!! That meant that pension funds, whose investment of money mimics the index, were compelled to buy its shares!

Which agency prevents such fraud? Not the auditors. The June 30 Lex column in Financial Times mentions three built in protections afforded to audit firms. The first is time; these frauds are committed over long periods and, ultimately, result on only fines (which is paid out by insurance) and no consequences for the management of the firms. The second is the organisational structure; the global firms form partnerships in countries. As a result, in the Parmalat scandal, Grant Thornton pointed a finger at its Italian subsidiary. The third are country laws. In the case of Luckin Coffee (the Chinese competitor to Starbucks, listed on NYSE), which recently went bankrupt, in which E&Y was also an auditor, the Chinese Government prohibits entry to investigate it to Public Companies Accounting Oversees Board.

Not the management. It is often complicit in the fraud, to benefit from the increase in market cap providing a boost to the value of their option, and to their variable pay package linked to performance (measured by market cap).

Not the regulator. Germany is a country known for its strict discipline. Surprisingly, though, its regulator, BaFin, not only failed to order an investigation after the investigative journalism by FT, but, incredulously, acted on a complaint by Wirecard management alleging bias by FT to facilitate short selling of its stock, placed a ban on short selling! That allowed the stock price to go higher, and to the ultimate crash from Euro 104 to 2 in 3 weeks.

Bill Black, in his must see interview The Finance Curse,(see Youtube) explains also the fraud that led to the sub prime crisis in the global financial crisis of 2008. These were ‘Liars Loans’ deliberately given, ostensibly to help the poor, but actually was an accounting control fraud meant to inflate the business and book profits of lenders such as Wells Fargo and Contrywide, the originators of these loans. The Originators then sliced these loans and packaged them for sale to retail and other investors, thus taking the risk of default out of their own books. The particularly vulnerable of these retail investors were Latinos and American African senior citizens, who lost 60 per cent of their life savings.

In India, we have had several such scandals and no one is really jailed for them. The scamsters are often protected by powerful politicians to whom they have made ‘donations’.

The stock markets will react to the economic impact of the pandemic, to the uncertainty over US elections and to the aggressiveness of China. It is going up due to quantitative easing, which is artificial. Caution is advocated.