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


Thursday, 18 June 2020, is a day James H. Freese, Junior, CFAThe founder of Market Integrity Solutions, will never be forgotten.

Overnight, the mild-mannered American was pushed into the center of what has become the biggest financial scandal in the history of modern Germany: Wirecard’s collapse from high-flying fintech to “Germany’s Enron”.

Before its collapse, Wirecard was a leading global digital payments firm with operations in five continents. Freese, a CFA charterholder with extensive experience in legal and compliance functions, was due to join Wirecard. Management board to help professionalize the company. But he was unexpectedly called early to assess a dire situation: $2 billion had disappeared From Wirecard’s balance sheet and auditors were refusing to sign off on the company’s 2019 financial position.

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what happened next?

Feather Alpha Summit by CFA Institute, Frees took the audience and moderators Paul Andrews With his strange Wirecard odyssey, from its beginnings in a hotel room outside Munich, to his appointment as interim Wirecard CEO, to his task of shutting down the company.

Also, he shared important lessons for investors and regulators on the importance of assessing corporate governance and culture. Paramount among them: Don’t be tempted by a company’s “secret” and face wrongdoing.

First, to set some context, here’s a small wirecard Time:

  • Wirecard was founded in Munich in 1999.
  • In 2005, Wirecard was listed on Deutsche. bores Frankfurt.
  • a decade later, financial Times Begins publication of its House of Wirecard series, which raises questions about the company’s accounts FT Alphaville.
  • On 8 May 2020, Wirecard announced the appointment of Freese as Chief Compliance Officer.
  • On June 18, 2020, Wirecard announces that €1.9 billion missing; Freese joined the Board of Management with immediate effect.
  • On June 19, 2020, longtime CEO Marcus Braun resigns and fresco, in his second day on the job, has been named interim CEO.
  • wirecard files for bankruptcy on June 25.
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“Germany’s Enron”?

Enron was a household name in the early 2000s. The energy giant collapsed with its auditors under the weight of massive accounting fraud in one of the biggest business scandals in US history.

Freese says the Enron-Wirecard comparison is fair: In both cases, auditors missed out on financial fraud and, in the aftermath, raised a lot of questions about regulatory oversight.

“reason why [Wirecard] The collapse was an accounting scandal that, like Enron two decades earlier, involved a situation where a company with real business was effectively ‘cooking the books,’ misrepresenting the eventual impact on its revenue and balance sheet. which was not noticed by accounting. firm,” Freis said.

In the case of Enron, accounting firm Arthur Andersen failed its audit oversight. Wirecard’s Longtime Auditor, EY, Said it was fooled all along: “There are clear indications that this was an elaborate and sophisticated fraud, involving multiple parties around the world in various institutions, with an intentional object of deception,” the company said.

“Enron led a large part of Sarbanes-Oxley,” Freis said. The Wirecard scam could spark a similar regulatory backlash.

“Many of those issues that were not already implemented are being looked at in the context of corporate governance reforms, in the context of government oversight, and the way the digital economy is challenging some of our traditional assumptions in that regard. is,” he said.

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Where were the financial analysts?

Freese wasn’t the first to raise doubts about Wirecard: NS financial Times Was The company was investigated for five years And short-sellers were actively betting against the firm.

As the company’s share price rises, Short-sellers repeatedly expressed concern about Wirecard’s financials, but such warnings failed to prompt a broad investigative response from German authorities.

Freese knew that some investors were skeptical and that many were skeptical about the veracity of the company’s reporting. But on his very first day, when he took a first look at Wirecard’s internal documents, did he discover the real state of the firm. The situation was worse than even Wirecard’s most ardent critic suspected.

Then why did it fall on the freeze? Hide in your hotel room outside Munich, to finally confirm the fraud?

Andrews raised two important questions in this regard: What should analysts be looking for? And where did he fail in questioning the C-suite?

“I came to Wirecard from Deutsche bores The group, which runs the German Stock Exchange, among other things, and had focused on the area of ​​governance, particularly on the importance of the ESG, the low E which is the area of ​​primary focus in defining standards, but on the G side, Said Freis. “We all as charterholders. . . We can crunch numbers, we can compare. But when we look at the quality of those revenues and the long-term growth potential, the strength of leadership is so important.”

And that’s an important lesson from the Wirecard debacle: Financial analysts should go beyond financials and take a good look at those occupying the C-suite.

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And, in Wirecard’s case, the leadership team was not right for the company.

“Wirecard had a management team that essentially grew into a company that was little more than a start-up two decades ago,” Freis said. The firm quickly climbed a growth path to become one of Germany’s blue chips and the country’s second largest bank – the largest by valuation – with a market capitalization of €24 billion.

“But you still had a lot of issues with this management team,” Freis said.

Another problem from a corporate governance perspective: a board that failed to question leadership. While Wirecard’s board was diverse and far from homogeneous boys’ club, diversity alone did not guarantee effective oversight.

“So 50% women, 50% men, women of color, people with IT backgrounds — a lot of things we’re striving for,” Freis said. “But if we just look at it as check-the-box, we miss the point, because what they weren’t doing is challenging management, the way we talk about non-executive directors.” Let’s do this, being a shareholder representative.”

Rumors about the company’s accounting and other public doubts failed to inspire diligence among board members.

“There was no audit committee until recently, despite allegations of very public audits,” Freis said. “When you look at a global corporation and you consider things including interlocking management, directors of subsidiaries, regulated financial services company, these are the kinds of things that would be red flags for any analyst looking at governance structure. as seen.”

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Beware of Mystique’s Charm

So what about analysts and investors? What stopped them from catching the fraud?

After all, Wirecard was not “a microcap with thin analyst coverage,” Freis said, but the most-traded equities in Germany were at their peak.

He believes Wirecard demonstrates the dangers of following the herd and being content with the “big names” in business.

Wirecard was owned by the fintech company Mystic and which protected it, Freis said.

“Overwhelmingly, analysts were bullish on this company,” he said. “The company . . . had surrounded itself – and this is the secret – with some of the best names.”

It hired all the four best accounting firms. This gave the company an air of not only legitimacy, but prestige.

“Not only did it have a Big Four auditor, which would be expected,” Freis said, “but each of the Big Four was involved in looking into some of the most important issues, so auditing its bank subsidiary, advice on some of the conflicts.” A regulatory environment ensued, and non-executive directors convened at the last of the Big Four to look into the same issue last year.

The mysticism did not end here.

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Wirecard also had “some next-level financial advisors” advising on acquisitions and mergers. It had access to large strategic consulting firms, government lobbyists, and all the other stuff associated with a well-capitalized multinational fintech corporation.

But it was all an illusion.

Still, surely someone must have seen something that didn’t add up? Why weren’t people speaking collectively?

“It was the most shocking thing to me, because all these people were running for this company,” Freis said. Yet very few people expressed any concern or disconnected from Wirecard even after taking a closer look at Wirecard.

“They were blinded by numbers which, in retrospect, were imaginary,” he said. “So this veil of legitimacy, this mystery – when the critics finally came, the company’s answer was, ‘You don’t understand what disruptive fintech is. Get out of the way.'”

Was it a matter of greed of the government? Perhaps.

“I think not many people had the courage to separate themselves from a name that most of the industry, most of the press . . . that the overwhelming majority were cheering and praising,” Freis said.

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Lessons from Wirecard?

An important question to consider, Andrews said, is whether a technology company or a fintech company that should have been allowed to run what was essentially Wirecard was, in fact, a financial services business.

Freese agreed. Wirecard was originally regulated as a publicly listed company, as a technology provider, but had a wholly owned subsidiary that was a bank.

“There was back and forth debate in Germany whether it should have been classified as a financial holding company, which would have given the banking regulator more oversight,” Freis said.

From a governance standpoint, what needs to be done to make sure something like Wirecard doesn’t happen again?

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“The imbalance today is due to the way a global company operates in a digital world, due to the way corporate governance frameworks are set up,” Freis explained.

“For a digital company or a tech company, you don’t have the cost inputs that we do in a factory, and even your labor is now virtual and scattered, and you can do your business anywhere in the world. You can book IPs, so you don’t have a jurisdictional component. And you’re selling via the Internet anywhere in the world. So we need to think about whether you’ve signed up for local boards and local contracts. And we also have auditors who are not really a global firm with a global branding and can they help us in this regard.”

If there’s one lesson to be learned from investors and analysts, it’s this: If you see something, say something.

“People, when they see things, they need to speak up and they need to obey,” Freis said. “If you need to ask tough questions and torment me, I encourage you to do so.”

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All posts are the views of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of the CFA Institute or the author’s employer.

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lauren foster

Lauren Foster is Content Director on the Professional Learning team at the CFA Institute and host of the Take 15 podcast. He . is the former managing editor of enterprising investor and co-led the CFA Institute’s Women in Investment Management initiative. Lauren spent nearly a decade on staff financial Times as a reporter and editor at the New York Bureau, then for freelance writing baron’s And this foot. Lauren holds a BA in Political Science from the University of Cape Town and an MS in Journalism from Columbia University.

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