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Wirecard Red Flags Should Have Prompted Earlier Response, Former Executive Says

Wirecard Red Flags Should Have Prompted Earlier Response, Former Executive Says

When James Freis agreed to oversee Wirecard AG’s legal and compliance functions, he saw it as an opportunity to help bring managerial order to a fast-

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When James Freis agreed to oversee Wirecard AG’s legal and compliance functions, he saw it as an opportunity to help bring managerial order to a fast-growing fintech startup. Instead, he found himself thrust into a much different predicament.

Mr. Freis was due to join the German payments company’s management board on July 1, but he was called in early, on June 18, when Wirecard said it couldn’t verify $2 billion in assets. With Wirecard’s auditors refusing to sign off on the company’s financials, Mr. Freis was asked to assess the situation.

He reached a conclusion that he says others should have made much earlier: The highflying fintech company was ensnared in a massive fraud. “So many people could have and should have stepped up and said something,” Mr. Freis said in a recent interview with The Wall Street Journal—one of the few he has given since relinquishing his last remaining responsibilities with the company in December

Wirecard, once a darling of the German tech sector, had been haunted for years by media reports detailing allegations of accounting irregularities. Going into the job, Mr. Freis had been aware of the reports and of skepticism about the company by a small group of investors. But it wasn’t until his first day, when he was given access to internal documents, that he realized the problems facing the company were larger than its biggest skeptics might have imagined.

James Freis

Photo: Courtesy of James Freis

Reviewing Wirecard’s financials from a hotel room outside Munich, Mr. Freis discovered something wasn’t right with the company’s claims that more than $2 billion was held in trust accounts in the Philippines. “I rapidly came to the conclusion that there was fraud here, but that it involved internal fraud,” he said. It didn’t take special expertise to reach that determination, he added.

The next day, Mr. Freis placed an early-morning call to Thomas Eichelmann, the chairman of Wirecard’s supervisory board, to report his findings. During an emergency meeting later that day, the board ousted Wirecard’s longtime CEO, Markus Braun, and asked Mr. Freis to take over.

It was the beginning of a whirlwind sequence of events for Wirecard and Mr. Freis, an American who previously served as managing director of Germany’s Deutsche Börse Group and as head of the U.S. Treasury Department’s anti-money-laundering watchdog. Within days, the company—once valued at almost €24 billion, equivalent to about $29 billion, on Germany’s leading stock index—was filing for insolvency.

Prosecutors in Munich are investigating whether several former Wirecard executives engaged in wrongdoing ranging from accounting manipulation to money laundering. Prosecutors have said they suspect that Mr. Braun, former Chief Operating Officer Jan Marsalek and others colluded to inflate the company’s results by booking fake income for years before the collapse.

Former Wirecard head accountant Stephan von Erffa and Oliver Bellenhaus, the former head of one of Wirecard’s Dubai-based businesses, also have come under investigation.

Messrs. Braun, von Erffa and Bellenhaus were arrested in July and remain in custody. Mr. Marsalek remains at large and is on Interpol’s most wanted list.

Burkhard Ley, a former Wirecard finance chief, also was arrested in July. He was released on bail in November after prosecutors concluded that most of the alleged misconduct happened after he left the company’s management board in 2017.

Lawyers for Messrs. Braun, Marsalek and Ley declined to comment. Lawyers for Messrs. von Erffa and Bellenhaus didn’t respond to requests for comment. Mr. Braun has previously denied wrongdoing.

Wirecard’s business, which focused on extracting fees for processing credit-card and online payments on behalf of other businesses, was largely unregulated when it began. Once it reached a certain size and provided financial services in multiple countries, the company needed a different type of management and control structure, Mr. Freis said. The company outlined a series of changes to its management structure in May 2020 when it announced the appointment of Mr. Freis to a seat on its management board.

Mr. Freis believed he would be given the support to help enact real change at the company. His responsibilities included securing banking licenses for the group in countries such as the U.S. “It was not meant to be, ‘We have some problems; bring in someone to clean up,’ ” he said. “It was the entire strategic direction. It was, ‘We need people who can lead us in that direction.’ ”

‘Many others should have seen indications here that were, frankly, not plausible and not tolerable.’

— Former Wirecard CEO James Freis

Instead, Mr. Freis became the executive who would lead the unwinding of Wirecard. The company faced a $1.3 billion revolving line of credit that was coming due soon after he became CEO. Mr. Freis, working with the supervisory board, ultimately decided that Wirecard should file for insolvency, which it did on June 25, a week after he had begun.

A German court-appointed administrator has since sold a string of the group’s businesses, including units in the U.S., U.K. and Brazil, as it attempts to recover funds for lenders and bondholders, who are owed about €3 billion, according to the administrator’s report. Members of the supervisory board, including Mr. Eichelmann, resigned in August.

At the beginning of the insolvency process, Mr. Freis played a role in helping the floundering business retain what value and jobs it could in light of the circumstances. He also ran the company’s day-to-day operations and sought to reassure nervous employees, said Andrea Farace, who was recruited last year by Wirecard to head a banking services group and was later tapped to help sell off its various assets and business units. “Jim did an admirable job of trying to keep the house together,” Mr. Farace said.

Mr. Freis’s role at the company was curtailed in September after the insolvency administrator canceled the contracts of the company’s management board members. A representative for Wirecard’s insolvency administrator declined to comment.

Mr. Freis brought a quarter-century’s worth of regulatory and banking experience to the job, but someone with less experience should have been able to see that the company’s financials were overinflated, he said. “Many others should have seen indications here that were, frankly, not plausible and not tolerable,” Mr. Freis said.

That includes its internal control functions as well as external auditors and legal advisers, he said.

Payment processing company Wirecard was the darling of Germany’s fintech industry until auditors uncovered a $2 billion hole in its accounting. WSJ explains what we know about the missing money, as investigators are still trying to understand what happened. Photo composite: George Downs

Former members of Wirecard’s now-disbanded supervisory board declined to comment, citing confidentiality obligations or ongoing investigations. Other top executives who oversaw the company’s financials, internal controls and legal affairs didn’t respond to requests for comment.

In the days that followed his appointment as CEO, Mr. Freis delved deeper into Wirecard’s financials and concluded that there likely had been a range of other fraud perpetrated within the company, involving misappropriation of assets to the tune of about $1 billion.

Munich prosecutors have said they are investigating potential cases of embezzlement by Wirecard, including instances related to the company’s prior acquisitions.

Auditors at EY GmbH, a German arm of Ernst & Young, are being investigated by prosecutors in Munich as part of the Wirecard probe. The firm had been the group’s auditor since 2008. Sunny Tucker, an EY Germany spokesman, said the firm was cooperating with investigations into Wirecard, and that EY Germany wasn’t aware of any illegal conduct on behalf of the firm.

Jaimie Godden, a spokeswoman for advisory firm Baker Tilly International Ltd., said its office in Germany advised Wirecard on various acquisitions but that its services didn’t include audit or valuation activities. Ms. Godden declined to comment further.

In Germany, where the scandal is sometimes likened to the 2001 collapse of U.S. energy firm Enron Corp., officials have explored legal and regulatory overhauls that could prevent a similar debacle.

More From Risk & Compliance Journal

Lawmakers have criticized the German financial watchdog, BaFin, and the country’s accounting oversight body, Apas, for failing to act earlier on red flags, including Wirecard’s use of external offshore trust accounts purported to hold large portions of the group’s assets. Dominika Kula, a BaFin spokeswoman, declined to comment. Apas said its investigation into Wirecard’s auditors is ongoing.

Key to the alleged fraud was the dual role Wirecard played as a commercial services firm that controlled a bank, Mr. Freis said. “The bank would make loans in the strategic interest of the parent company,” he said. “That’s something that a third-party bank at arm’s length might have treated differently.”

Mr. Freis also questioned whether Wirecard’s control functions had been sufficiently independent of its many subsidiaries. A review of its organizational chart shows that many individuals held positions with conflicting fiduciary duties, he added.

German and European Union laws allow commercial entities to own banks without the parent being subject to extended oversight by regulators such as BaFin and the European Central Bank. German car manufacturers in particular have taken advantage of the rules, with companies such as Volkswagen AG and Daimler AG owning banking subsidiaries that provide financing to dealers and consumers.

Following the Wirecard scandal, German lawmakers have considered changing the definition of a financial holding company to give regulators greater oversight over companies that own banks. Such a reform could require changes at the EU level, said Sven H. Schneider, a lawyer at the German law firm Hengeler Mueller.

German lawmakers also are considering changes to the country’s two-tiered corporate-governance system, which would give nonexecutive supervisory boards more control over management.

“The proposed changes will be helpful,” said Mr. Schneider. “The million-dollar question is whether any or all of them would prevent a highly organized rogue senior management from committing a similar fraud.”

Write to Dylan Tokar at [email protected] and Paul J. Davies at [email protected]

Copyright ©2020 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8

This post first appeared on wsj.com

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