Reckoning begins for BaFin after it pursued Wirecard foes, not fraudsters
Short sellers who for years have complained that BaFin, the German financial markets regulator, ignored their criticisms of Wirecard, the collapsed payments company, and instead prosecuted the critics, have begun to be vindicated with the news that the European Securities and Markets Authority (ESMA) has opened a review into the organisation. By Silas Brown.
Many investors, short sellers, analysts and journalists — including several who described their experiences to GlobalCapital — had spotted weaknesses and irregularities in Wirecard’s claims about its results and in its business model for more than a decade before its spectacular insolvency in June.
But not only did BaFin fail to investigate Wirecard in a way that uncovered its wrongdoing, it punished Wirecard’s detractors, even instigating criminal charges against them.
“Saying it’s an accounting fraud doesn’t do it justice,” said Marc Cohodes, the veteran US short seller. “[Wirecard]… fooled the German government, the regulators, people responsible for the Dax and many, many market participants. Wirecard was a classic example of messenger shooting — all these guys ever did was shoot, intimidate and silence the messenger, and never focus on the message.”
ESMA announced on Wednesday that it would conduct an accelerated “peer review” of BaFin and the German Financial Reporting Enforcement Panel (FREP), the two agencies responsible for supervising and enforcing financial reporting in Germany. Since 2015, BaFin has been headed by Felix Hufeld (pictured).
“High quality financial reporting is core to investor trust in capital markets and Wirecard’s collapse has undermined this trust,” said ESMA in a statement. “Therefore, it is necessary to assess these events to help in restoring investor confidence.”
ESMA’s review will only cover financial reporting, not BaFin’s actions in penalising Wirecard’s sceptics for crimes such as market manipulation.
Nevertheless, the investigation is highly embarrassing for the regulator.
BaFin declined to comment on the ESMA investigation. But a spokesperson did answer questions emailed by GlobalCapital.
Asked whether the Wirecard scandal showed a failure of financial reporting in Germany, and that controls on reporting were inadequate, the BaFin spokesperson said: “The Wirecard scandal shows structural deficiencies. The German two-stage procedure for financial reporting enforcement follows a strict procedure and seems to be too slow and susceptible for faults, at least in crisis situations. The first stage is an investigation by [FREP], the second stage is an investigation by BaFin.”
Harrying the truth tellers
The fact that Wirecard’s accounts, which were audited for 10 years by EY, gave a completely false picture of its true financial status — including €1.9bn of cash it claimed to have deposited at two Philippine banks — is just one of the affair’s shocking aspects.
Whether the failures to notice Wirecard’s fraud by Germany’s regulators can be explained by structural weakness in the two-stage enforcement process remains to be determined, and is likely to be covered in ESMA’s enquiry.
But for those who have long-known Wirecard was fraudulent, BaFin’s missteps go much further than that. It launched a series of investigations into Wiregard’s critics during the last 12 years.
In 2008, a group of investors in Germany claimed Wirecard’s accounting practices were patchy. They argued that it was more embroiled in carrying payments for high-risk industries, such as gambling and pornography, than it let on, which was the best explanation for why Wirecard’s margins on payments were so high.
When Wirecard claimed this criticism had caused its share price to fall, BaFin investigated the accusers. Two were convicted of market manipulation and given suspended prison sentences.
“German regulators really are first order incompetent,” said John Hempton, chief investment officer at Bronte Capital, an Australian hedge fund, who was short Wirecard for roughly a decade.
Matthew Earl and Fraser Perring, short sellers from the UK, co-wrote a 101-page report on Wirecard in February 2016 under the name Zatarra Research. It accused the company of widespread corruption, fraud, money laundering and breaking US restrictions on internet gambling. This prompted Wirecard’s share price to fall by a quarter.
But rather than focus on the allegations around Wirecard, BaFin again went after the company’s critics. It advised Munich prosecutors to launch a criminal probe into more than 30 critics of the company.
Spying and intimidation
Perring told GlobalCapital that he had sent his report to BaFin in February 2016, and then contacted the regulator more than 30 times about Wirecard.
“Despite [me] raising serious concerns, they [BaFin] completely ignored everything I had to say,” he said.
Perring told GlobalCapital he discovered BaFin had instigated a prosecution of him from a journalist, not from the regulator.
Perring’s solicitors wrote to BaFin in mid-December 2016, according to a person familiar with the situation, filing a complaint against Wirecard.
In the letter, which has been seen by GlobalCapital, Perring’s lawyers say people acting on behalf of Wirecard had broken into Perring’s house and stolen telephones and a laptop. It also claims Perring’s neighbours found hidden cameras in their garden, which faces his house.
In the most serious claim, the lawyer said Perring had been held against his will in his car after dropping his child at their primary school. One of the men, who told Perring he had a gun, accused him of colluding with the Wall Street Journal, among other publications.
The letter asks BaFin to conduct an investigation into the company, saying: “Wirecard is a regulated company. Plainly, BaFin has a duty to ensure that unlawful actions are not carried out by agents of such institutions.”
Perring’s lawyer received a response a few weeks later, also seen by GlobalCapital, saying BaFin could not help with the matter.
It was not just short sellers who sent BaFin material.
Neil Campling, an analyst at Mirabaud Securities, noticed serious problems with Wirecard long before others in his industry did.
In a December 2017 filing, Wirecard disclosed that its CEO Markus Braun had a €150m margin loan outstanding which used nearly half of Braun’s shares in the company as collateral.
Deutsche Bank was the lender, according to people familiar with the situation, which exposed the bank to the risk of a collapsing share price. Fortunately for Deutsche, it decided not to renew the loan in November 2019, and by the time Wirecard filed for insolvency it had no outstanding debt to Braun.
Campling told GlobalCapital that he had sent a copy of Wirecard’s filings of Braun’s margin loan to German regulators in January 2019.
“Every single time the stock got near [falling] to €95, which is where the margin loan would be called, you’d see an acceleration of positive press releases from Wirecard,” said Campling.
He claimed the only company that had issued more press releases in the past year than Wirecard was Apple.
In 2019, BaFin banned investors from shorting Wirecard — the first time it had ever extended such a protection to a single company — and opened investigations into two journalists and 10 short sellers, according to the Financial Times.
GlobalCapital asked BaFin whether the Wirecard scandal showed BaFin erred when it moved to file criminal complaints against people for manipulating Wirecard shares.
The spokesperson said: “No. We reported our clues to the prosecutors’ office in Munich. As a legal rule, we have to report facts that give rise to suspicion of a criminal offence to the prosecuting authorities, who are responsible for taking and presenting evidence.”
Asked whether the scandal showed the ban on short selling Wirecard stock had been wrong, the spokesperson said: “No. At the time of our short selling ban, we observed a) big (and growing) net short positionings, b) significant losses in share price, c) high volatility and d) specific hints on manipulation of share prices (via coordinated short selling attacks). This set of factors forced us to take action. Our target was neither evaluating the outstanding accusations nor shielding a single issuer, our focus was on protecting market confidence.”
Considerable soul searching and reforms are likely to be necessary now to restore market confidence, and that process is beginning with ESMA’s probe.
It will focus on whether BaFin and FREP correctly applied ESMA’s Guidelines on the Enforcement of Financial Information (GLEFI), which it issued in 2014 to try and ensure national regulators in the EU applied International Financial Reporting Standards in the same way.
In 2017, ESMA conducted a peer review of regulators in Germany, Italy, Malta, Norway, Portugal, Romania and the UK, to see whether they were implementing three of the GLEFI guidelines properly. It gave BaFin and FREP four areas to improve on.
ESMA is to make its confidential report on Germany from that 2017 review public, “in view of the overriding public interest in this particular case”.
Additional reporting by Jon Hay