Re:Balance -- Jim Peterson

Wirecard Crashes – And Everything Old Is New Again

German payments processor and DAX market darling Wirecard AG has been revealed to have a € 1.9 billion hole in its balance sheet. Erstwhile superstar CEO Markus Braun found himself both out of a job and into police custody.

The company’s catastrophic implosion would have been no surprise to those alert to the depth of its problems as publicized over the last 18 months – not among them the credulous at German regulator BaFin, deeply interested DeutschBank, or a group of groupies among the executive team at SoftBank.

As for the missing cash? It appears never to have been there in the first place, suggesting that the inevitable up-coming forensic exercise may not be all that complex, to unpack an extended course of malfeasance.

Professors of literature teach that there are but a handful of great plot lines. So too, there are just a few basic financial fraud schemes, repeated with minor updating variations from one decade to the next. Among them, falsified operations and fictitious assets are persistent and recurring themes – tweaked in their sordid details by each new generation of white-collar criminals.

Two examples go back a half century – the first accounting scandals on which I cut my teeth as a rookie lawyer: the Salad Oil case, in the tank farm near Newark airport where Tino De Angelis used light-weight soybean oil to top off huge tanks filled with heavier water, fooling the auditors who climbed the ladders to open the lids but neglected to tap the valves at the bottom; and the Ponzi scheme at Equity Funding, where Stanley Goldblum’s minions falsified customer ledgers to create fictitious life-insurance policy holders who went undiscovered because not directly confirmed.

Back in those old days, fraudsters did real work to cover their tracks. Barry Minkow of ZZZBest tricked up dummy customer locations to pass as real work sites. Sam Antar at Crazy Eddie dissuaded the auditors from descending into the creepy basement vaults under his boutique-sized New York shops – never large enough to hold the bulky cartons of projection televisions shown on the fanciful inventories. Head counts of phantom cattle herds were inflated by multiple cycling of the same calves through corral gates, under the noses of naïve city-bred staffers, perched on fence rails and eager to escape the dust and noise.

The evolution over five decades means that such fabrications are of less need to the malefactors. Even the revelation in 2009 that one-third of the revenue of Indian software company Satyam Computer Services was bogus involved only non-existent customer contracts, although the inexplicable absence of physical evidence for 13,000 ghost employees – such as canteen turn-over and transport allowance cards and desks and telephones – remains a puzzlement.

In the case of Wirecard, the concentration of its business in a mere three shadowy “acquiring partners” and the ostensible location of its cash in two banks in the Philippines will figure. With their mission in hand, fraud examiners should not take long, peering at Wirecard’s business model through the guiding lens of hindsight, to reverse-engineer the plot line. Any treasure hunt is eased by having in hand a map with a large “X”.

William of Occam’s reductive principle applies no little to inform the design of a large-scale financial scam. In Wirecard, “the simpler, the better” is likely to have found a new application.

 

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Evil Accounting Spirits on the Loose -- A Scary Halloween in Germany

With the mist beginning to clear after the American elections, it’s time to observe how countries differently observe the holiday known to some as Halloween.

In the US, children canvas their neighbors for candy – a ritual seemingly designed to benefit pediatric dentists, aerobic instructors and obesity consultants.

In France, Toussaint mainly presents an excuse for a ten-day school holiday. While in Germany, the souls of the dead supposedly walk the earth on Allerheiligentag until released when the church bells chime.

This season in Germany was particularly uneasy for the departed spirits of dependable financial reporting, transparent governance and stable market regulation, with ominous implications for the elusive goal of global convergence toward good-quality reporting and compliance standards.

All Hallows Eve saw Deutsche Bank report quarterly net income of € 414 million – thanks only to the bank’s avoidance of € 845 million in asset write-downs made possible by the reclassification of € 25 billion of loans originally intended for onward sale. The change was enabled by the success of the European banks in lobbying the accounting regulators for relief from the “mark-to-market” rules for impaired loans, if permissibly treated instead as “held to maturity.” 

Doubtless a precursor to similar ghoulish accounting by equally motivated banks across Europe, the D Bank move will only be credibly testable over the collection life of the underlying loans – assuming of course that the bank itself is around that long. Investors are essentially being asked to take on considerable faith the ability of bank management to wave the wand of reclassification and stir up ultimate value out of a witches’ cauldron incapable of valuation by more rigorous standards.

Among others, Tom Selling at The Accounting Onion has inveighed against the readiness of the International Accounting Standards Board to rationalize such witchcraft. Deutsche Bank’s eager adoption in practice is a signal that the IASB's accommodationism will unloose malign spirits across the accounting landscape.

The same week saw Porsche’s trick-or-treat on the hedge funds, who were caught by the extent of its option-based creeping take-over of Volkswagen. Plunging short the ordinary shares of VW and long its preference shares, a herd of funds are said to be squeezed as much as € 20 billion by their self-inflicted need to cover with a free float of less than 6%.

Meanwhile the financial sorcery of Porsche chief Wendelin Wiedeking, by which the company made three times more last year in options trading than it did building cars, has him the highest-paid warlock in the German corporate coven.

Shed no tears for the hedge funds who walked into Porsche’s strategy. But do be concerned for the wrong-footed German regulators, who will be scrambling to plug the loopholes that permitted the stealth accumulation of control over VW by way of cash-settled options not disclosable under BaFin’s presently porous rules.

And it cannot be reputation-building for Deutsche Börse, that it reacted to the run-up in VW’s stock price, reaching fully 27% of the Dax-30 index, by making a one-time adjustment to put a 10% cap on the company’s weighting.

The very essence of a credible index – stability of constituent components and adjustments that are infrequent, predictable and transparent – is traduced by such ad hoc fiddling.

These recent events in Germany remind investors and other financial information users of an inevitability: creative and agile corporate chieftains will run ahead of their slower-witted over-seers. When regulation comes too late and standard-setting yields to pressure, it’s no surprise that the nightmares are real: creepy things lurk in dark corners, never to be reached by the disinfectant of sunshine.

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