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Regulators need to think like short sellers

Tiger forest hunter predator tracking from Adobe 17Jul20 575x375
By Jon Hay
16 Jul 2020

The Wirecard scandal — like other recent debacles such as NMC Health — shows that financial reporting, oversight and governance, as they are currently practised, are woefully inadequate.

This week the European Securities and Markets Authority launched a review of BaFin, the German financial regulator, after the particularly dire saga of Wirecard, the German company whose accounts had been publicly criticised as misleading for years, but were passed for a decade by EY, its auditor, and passively accepted by umpteen banks and hundreds of investors.

BaFin’s failure to properly investigate repeated whistleblowing claims, and its habit instead of prosecuting the detractors, chimes with its reputation among short sellers as a feeble regulator. But it is not alone. The UK is often praised for sharp oversight, but failed to spot alleged fraud at London-listed NMC Health.

ESMA may get tough; the UK has already overhauled its system after the Carillion collapse in 2018.

But more fundamental reforms and culture changes are needed. The best step would be an international consultation process, taking in all major economies, on how to invigorate governance.

Ideas to consider should be a hard limit of three years for which any accountancy firm could audit any company, with no reappointment until nine years later. Auditors must be appointed by, and answerable to, investors, not management. The difficulty of organising this must be overcome.

And regulators’ mindset has to change to a more inquisitorial one, recognising that greed and cheating are inherent features of human nature, and start to accumulate like a fungus whenever they are given a chance. Short sellers know the warning signs and clues like forest hunters — regulators need to learn their tracking skills.

By Jon Hay
16 Jul 2020