Twenty years ago, it was Enron, a huge energy company, that took Arthur Andersen, one of the venerable accounting and auditing firms, down in the dumps with it. Enron had been cooking the books for years until a shareholder lawsuit, and the subsequent fall in share prices, forced an SEC investigation. Andersen had quietly complied all along, destroying sensitive documents to tamper with the evidence and obstruct justice. Soon, Enron had declared bankruptcy, America’s largest at the time ($63.4 billion). And Andersen had to close shop. It’s difficult for an auditor to come under government investigation and still survive.
The year after, in 2002, it was WorldCom, the owner of MCI and the second-largest telecommunications operator in the world, that brought the accounting world to its knees. WorldCom was forced to admit that it had overstated its assets by over $11 billion using a series of accounting manoeuvres. To date, this remains the largest accounting fraud in American history.
Since then, there have been numerous other corporate frauds resulting from unethical practices in corner offices of the executive floor. Volkswagen admitted to doctoring emissions tests on 11 million diesel cars. Mitsubishi revealed that it, too, was routinely cheating on its fuel economy tests. In India, the Vijay Mallya and Nirav Modi corporate escapades are well known. Thousands of crores of bad loans from banks are still outstanding even as banking entities struggle to recapitalise. Satyam’s $1.5-billion fraud, when the company falsely boosted revenue in 2009, is India’s largest accounting scandal to date.
Coolly living the lie
Wells Fargo got caught in one of America’s biggest banking scandals. From 2002 to 2016, employees opened millions of accounts in customers’ names without their knowledge, signed unwitting account holders up for credit cards and bill payment programmes, created fake personal identification numbers, forged signatures, and even secretly transferred customers’ money – as The New York Times reported. Earlier this year, the company agreed to pay $3 billion in fines to settle criminal charges.
The latest fraud from German fintech company Wirecard is a shocking example of how a few people carefully lived the lie that they aggressively promoted to the outside world, made millions of dollars for years, and then, when pushed to the corner, revealed all and surrendered.
For anyone who has travelled in Europe or South-East Asia, the popular Wirecard logo is ubiquitous. Listed on the DAX, Wirecard is in the back-office business of operating a cashless payments infrastructure – like PayPal or PayTm. In addition, Wirecard distributes devices to retail merchants that accept a wide variety of credit, debit, and other electronic cards. Wirecard handles the complicated transactions of taking money from the buyer’s bank, paying the merchant, and keeping a commission for its services.
The Financial Times exposé
Due in part to excellent reporting by Dan McCrum of the Financial Times , Wirecard first came under the scrutiny of the German regulator, BaFin (Bundesanstalt für Finanzdienstleistungsaufsicht), the Federal Financial Supervisory Authority. Curiously the investigations centered on FT reporters because Wirecard had always sought to discredit negative stories of the company as hit pieces to help short-sellers – professionals who make risky bets that stock prices would fall, and reap large profits when prices do fall.
BaFin’s interests were triggered by Matthew Earl, a London-based short seller, who wrote a blog in 2016 accusing Wirecard of malpractice and said the company probably had links to money laundering because it had profited from online gambling, which is illegal in the United States.
British authorities began their own independent investigation. And, true enough, after years of denial, Wirecard recently admitted that a whopping $2 billion of cash that it purportedly saved in escrow accounts in a bank in the Philippines had gone missing. An investigation by its auditors showed that there never was a bank account. Nor was there any money in it. Its charismatic CEO and founder, Markus Braun, immediately resigned. A criminal investigation began on June 22 and Braun was arrested the same day. On June 25, Wirecard filed for bankruptcy, but its board has said that it plans to continue business operations.
Restructuring accounting systems
Each time a massive scandal is unearthed, the world shakes its head and tries to bury it all, hoping optimistically that there will never be another fraud again. There's a reason for this optimism. The financial accounting infrastructure for the world’s public companies is rock solid but flexible enough to adopt changes and improve every time there’s large-scale fraud.
The American Institute of Certified Public Accountants first created accounting standards in 1939, ten years after the Great Depression. After decades of regular redesign, the Generally Accepted Accounting Principles (GAAP or US GAAP) became the accounting standard for US companies in 1973. Together with the global International Financial Reporting Standards (IFRS), corporate entities are governed by extremely tough rules of financial reporting. In most countries, enforcement of these standards is well-governed and funded, through civil penalties brought about by regulatory agencies such as the SEC and SEBI.
The result is that periodic auditor statements about the accuracy of financial reporting provide investors the confidence that the three main accounting reports — a company’s balance sheet, its income statement, and the cash flow statement — are true and verified. It is this confidence that helps drive equity markets — the confidence that everyone has the same information so that millions of stock trades can happen at warp speed, in a second, without a second thought.
But as long as there are greedy people at the top who are willing to collude with lazy enablers, such as auditors and regulators – some of whom may even be corrupt – corporate fraud is, unfortunately, a fixture in modern business. And it is one more reason why the financial press is such a crucial player in the proper functioning of world markets.