Now it is official: Wirecard, Germany’s digital showpiece company, had to file for insolvency after an unprecedented share price rally. The trigger was 1.9 billion euros, which could not be confirmed in the Philippine accounts. This is why the audit report by KPMG, which Wirecard CEO Markus Braun actually intended as a liberating blow, had exactly the opposite effect.

This makes it the first company in the history of the DAX listed there to have to file for insolvency. After the lack of the 1.9 billion euros, a further two billion euros in credit lines were called in by the banks.

The damage is now being done to investors, the banks and Germany as a digital location. First of all, there is nothing wrong with Wirecard’s actual business model. As a payment service provider, simplifying and securing the process for small merchants globally is also the success model of digital companies like Square. It got hairy, however, when this was not enough for the company, and apparently there was manipulation in the designation of business activities.

The Background

In 2015, the Financial Times first pointed out inconsistencies in several blogs under the title House of Wirecard. For instance, reported positions in Germany did not match the figures submitted in Singapore. And the prepayment of transactions months in advance of services being provided by financially weak companies seemed unusual. A number of transactions were also opaque. The Financial Times began to suspect that these might be sham transactions designed to disguise something.

As expected, this led to investigations and legal action on the part of the German Federal Financial Supervisory Authority (BaFin). Not against Wirecard, however, but against the Financial Times, with accusations of price manipulation. The conflict intensified over the years, with further lawsuits by Wirecard against the Financial Times.

In the meantime, EY has been auditing Wirecard’s balance sheets for 11 years as auditor until 2019 and has awarded its seal. After the rumors and accusations did not want to stop, KPMG was brought on board to make the report and refute the accusations. And then it turned out that KPMG could not confirm 1.9 billion in deposits in Philippine banks. The banks involved only stated that Wirecard was not a customer of theirs and did not have any accounts.

The Ernst & Young Implosion

How can this happen? As the Financial Times reports, EY auditors had never sought direct information at the source during the audits in the past three years. Ey had been satisfied with screenshots and copies of the deposits from third parties. The first rule for auditors is to ask the bank directly about the deposits.

And that reminds me of the auditor Arthur Andersen, who had been responsible for Enron. When it became clear in 2001 that obvious manipulation and fraud by Arthur Andersen had not been discovered, but had even been supported by him, not only Enron collapsed, but Arthur Andersen as well.

While it is too early to know the extent to which complicity ranges from misconduct to active involvement in EY fraud, one thing can already be said today: EY will implode. Not only is the correctness of all audits conducted by EY in question, but the companies audited by EY will withdraw the mandate from Ernst & Young and hand it over to another auditor simply out of self-interest, in order not to lose the trust of the investors and business partners themselves.

The Failure Of The Regulatory Agencies

As the German journalist Gabor Steingart reports, according to the reports of the Financial Times, the German Financial Reporting Enforcement Panel (DPR) – the “balance sheet police” – has since received three applications from BaFin to scrutinize Wirecard’s balance sheets. First the half-yearly balance sheet for 2018, then the full-year balance sheet for 2018, and then the half-yearly balance sheet for 2019. These reviews were never completed.

Instead, Wirecard and the Munich public prosecutor’s office sought to sue the Financial Times for alleged market manipulation and violations of the German Securities Trading Act on account of its critical reports on Wirecard.

As in the New Economy at the turn of the millennium, there was a systemic failure here. Both supervisory authorities and auditors disregarded basic rules and instructions and did not follow them. It is therefore no surprise that the German Federal Government has to reorganize the supervisory authorities. And there will inevitably be political recriminations that political opponents will not let pass unused.

The Catastrophe For The Digital Location Germany

The insolvency of Wirecard has yet another effect that affects Germany as a digital location. Even today, Germany and Europe in general have already fallen behind the United States and China in terms of digital transformation. SAP as the most valuable German digital company and at the same time the most valuable company in the DAX is the only other prominent digital company in Germany besides Wirecard.

The skepticism about digital transformation runs deep through society in Germany. A nation that has become large and rich through companies that produce “tangible” values such as machines and cars has difficulty understanding and appreciating “intangible” values such as software, algorithms, artificial intelligence, Big Data or Blockchain.

While the most valuable companies in the USA are with Apple, Microsoft, Amazon, Facebook or Alphabet/Google, and with Apple for example is worth more than all companies listed in the DAX together, we lack examples and role models.

If there is already a general hostility towards entrepreneurship in society and the public, this skepticism is even more pronounced for founders of digital companies. The Wirecard implosion will not improve this situation. Digital entrepreneurs are already spending a lot of time and energy justifying themselves to skeptics by not investing in the development of their companies. This then also deters investors from investing in such companies.

Wirecard fraud, promoted by the supervisory authorities and auditors, is causing the capital market for digital start-ups and companies to shrink enormously. The gap to the USA and China will not shrink as a result. And this is the real catastrophe that Wirecard and its helpers have brought upon us.

This article was also published in German.