value and opportunity

Thanks to a week of vacation I was on “read only” mode since I posted my Wirecard story 11 days ago.

Since then a lot of things happened, such as EY suddenly doubting the existence of 1,9 bn in “cash”, Wirecard releasing a really strange 2 minute video Statement, the CEO resigning, the CEO being arrested and subsequently released on a 5 mn bail, the COO having disappeared somewhere between the Philippines and China and the company finally filing for insolvency.

As mentioned in the earlier post, the insolvency is not really a surprise, but to be honest, the speed of the unraveling was clearly surprising. Equally surprising was today’s share price movement of ~+130% at the time of writing, resulting in a market cap of 360 mn EUR.  With the senior bonds trading at only ~18,6% of notional and falling further, it is pretty clear that shareholder will end up with a zero, but the gamblers and day traders seem to have a lot of fun. Personally, I think even the unsecured borrowers (Hi Softbank !!) will end up with a nice “Donut” due to the weak creditor protection in Germany.

The Book/ The Movie

One upfront comment: As I am not a professional journalist, I will clearly not write a book or movie script about this. But to whomever who is currently working on it, I would have a couple of suggestions to dig deeper. The following section outlines my open questions and include some wild speculations with regards to the main cast and the main issues. I hope whoever writes the book on these can uncover some of these topics.

Types of fraud / Storyline

As my long term readers know, I have a certain obsession with financial fraud. Wirecard seems to have committed several types of types fraud.

The main fraud via trust/escrow accounts and the “Third Party acquirer” (TPA) structure is a pretty rare one. What seems to have happened is that either Wirecard invented these TPAs or wrongly consolidated existing ones and then “fabricated” these trust accounts. This is a little bit like if I would create a company, then consolidate for instance Google without actually having any reason to do so and claim that my share of profits is held on a trust account in an exotic jurisdiction.

Normally, fraudulent companies do this the other way round by not consolidating companies that carry a lot of debt and pretending that they are third parties that they are doing very profitable business with (Enron etc.). I will come to that later, but the extent of these accounts, the jurisdiction and the very uncommon structure should have raised some red flags both, at the level of the auditor as well as with the regulators.

M&A related fraud is quite common but really hard to track down. Over-payments for M&A transactions are very frequent and considered part of the game, however uncovering kick backs to involved persons is really hard. The India acquisition of Wirecard in 2015 was such a blatant “mistake” that I am pretty sure that kick backs were paid. The question is only to whom.

There was also the rumor of fraudulent loans especially in Brazil and Turkey, just to complete the currently known types of major financial frauds.

The more interesting question is: When did the fraud  begin ?

In most cases, the path to fraud starts with aggressive accounting and then if this is not enough, moves to small fraud and from there the fraud gets bigger and bigger to keep the flywheel running. Often management initially thinks that they can make this up with real profits at some point in the future but in 99% of the cases the fraud needs to become bigger and bigger.

My own interpretation is that Wirecard always operated in a very grey area in its core business itself. Its early operating business with porn and gambling sites clearly exposed them to many shady characters and  who knows what kind of laws regarding payments (and money laundering) they violated back then. There was always the rumor (starting in 2010 with a shady German research firm Gomopa and for instance in the 2016 Zatarra short report) that they illegally paid out unlicensed online gambling wins for a long time even after it was explicitly illegal. The former COO, Rüdiger Trautmann, who alledgedly colluded with a then imprisoned fraudster left in 2010 and was followed by Jan Marsalek. Trautmann according to Linkedin seems to have founded a copy of Wirecard named Powercash21 right after he left. For some strange reason, his activity at Wirecard is not recorded in his Linkedin profile.

It is clearly not a big step form running a semi-legal payment business to do semi-legal stuff on your balance sheet. When I looked at the company back in 2008, I think there was clearly ultra aggressive and misleading accounting in place and also the M&A transactions back then looked super fishy. The words TPA and Third Party acquisition doesn’t appear in the 2007 report, so this kind of fraud has started later. However even in 2007 they had subsidiaries in Gibraltar, Manila and British Virgin Islands which raises some questions why one would need subs in such difficult jurisdictions.

I have done a quick search in their annual reports and the first mentioning of the third party acquirer structure seems to be in the annual report 2016. On page 87 one finds the following passage (highlights are mine):

Payment Processing & Risk Management
The PP&RM segment accounts for all products and services for electronic payment processing  and risk management. The dynamic business growth in this segment is due to both an increase in European and also non-European transaction volumes. In line with this growth in transaction volume, the proportion of Wirecard’s transaction volume processed in the technical acquiring model via third-party banks, which are also allocated under the PP&RM segment, has also increased. Outside of its European licence area in particular, so-called BIN sponsorship models with third party banks can be used to offer fully integrated acquiring solutions. The business with existing and new customers developed very positively during the period under review.

So this business seems to have existed before but the real “pump” only seems to have started in 2016.

Another indication of a rather early, deeply corrupt company culture was the initial scandal with Sdk. One of the guys who was later indicted (Bosler), reported that he was threatened personally from the lawyer of Wirecard and two “gentlemen” in 2008 with an implicit death threat and some other short sellers were telling similar stories, sometimes with some “Russian flavor”. According to rumours, Wirecard also seems to have used private investigators extensively for surveillance of critical persons as well as direct hacking attacks.

The CEO

One of the big questions clearly is: What was Markus Braun thinking ? How did he think to get out of this ? Often in these situations, fraudsters begin to believe their own lies or “smoking their own dope”. My wild kind of guess is that he planned for a glorious exit via a transformative M&A transaction. Interestingly, especially if an M&A transaction involves “tech” and traditional companies, Due Dilligences can be relatively short and superficial (see Autonomy/Hewlett Packard). There seems to have been potential discussions on combining with Deutsche Bank and indeed as this German stock magazine wrote back in early 2019, a few hundred million losses or so would just “disappear” within Deutsche Bank and they would have had a great Fintech story (for some time). Or he was maybe hoping of doing a deal with other payment providers.

That Markus Braun was not totally delusional however shows the no-recourse loan of 150 mn EUR which he had taken out already in 2017 from Deutsche Bank. This was for him a “Tail hedge” as he would keep the 150 mn in any case. I didn’t follow Wirecard close enough at that time, but these non-recourse loans are in my opinion a very grey area and a big problem. Disclosure is often very thin and investors mistakenly believe that management is all in whereas they have already pocketed a significant amount of money without the risk of paying it back even in the worst case.

On the “plus side” one has to concede that Braun, similar to Bernie Madoff, kept a pretty low profile. In one interview in 2018 with German “Manager Magazin” he seemed to come a cross as an opera loving tech nerd. A lot of fraudsters usually have very extroverted lifestyles but Braun was clearly more the “Introverted fraudster who are relatively rare.

His plan B, that only seems to have worked for a few days, seems to have been to claim that Wirecard is actually the victim of a fraud. Let’s see how plan C looks like. My guess is that he will blame the disappeared COO for everything that went bad.

A small hint (thanks to a nice reader) to any movie director planning to cast the movie: If Kurtwood Smith still is in business, he would be the ideal cast for the CEO role. He became famous for playing the bad guy Clarence Bodicker in Robocop:

Just compare this with the really bad guy:

Honestly, Bodicker looks less evil So there might be a second career available for Dr. Braun at some point in the future.

Supervisory board

Using again the annual report 2016, one can see that until 2015, the supervisory board only had 3 members:

Wulf Mathias, the Chairman until January 2020, was back then a 71 year old former career banker with a strong Austrian connection. He received a quite impressive salary of 411 k in 2015 and still more than 300k in 2015. He only resigned in January 2020, then almost 75 years old. Alfons W. Henseler, the second board member was also a career banker and also 71 years old back then and also received 300 k to improve his pension.

Finally Stefan Klestil, a 53 year old Austrian with a famous father (former Austrian president) is maybe the only one who in theory would understand what Wirecard actually does. As Partner of a quite well known VC (Speedinvest) and Fintech specialist he should be the one most able to judge what Wirecard was actually doing. His Linkedin profile says the following:

Stefan has over 20 years of experience in the international payments and banking technology space as Advisor, Executive, Incubator and Investor. He is non-executive Board Member of Wirecard, and Advisory Board Member of N26, Wefox, Billie, Luko, and Fincompare. Stefan also supports the founders of Fraugster, Lemonway, Predictus, Koin, Factris and Cyberwrite. Previously he was President Central and Southern Europe at First Data, Partner at Roland Berger, and Principal at A.T. Kearney based in New York and Vienna. He holds Masters Degrees from Columbia University and Vienna University of Economics and Business Administration

So he has both, the Financial and tech credentials. I guess for him it will be hard to explain how over 10 years he didn’t have the smallest doubt in the company although no one could ever explain the unbelievable margins thy claimed to be earning. I think for him, the Wirecard supervisory board seat was the entry ticket to the German speaking Fintech scene where he has become one of the most prominent members, with board seats at German unicorns N26 and Wefox. I am not sure if I counted correctly, but at times according to his linked in profile, he had around 10 board seats or so. This is clearly too much for anyone and I guess he maybe just didn’t have the time to deg deeper into this or didn’t want to. And of course, he is a fellow Austrian as well and just might not want to hurt his Austrian comrades in the Wirecard board.

Thomas Eichelmann, the current Chair of the Supervisory board however is a different caliber. He was actually CFO of Deutsche Börse AG and is considered as an expert, both in finance and Fintech. And he is not Austrian. He came in in Mid 2019 and it seems that he was not handpicked by Braun. He was also responsible for hiring KPMG for a forensic review which in my opinion was the final straw for Wirecatd. However it is also hard to understand why he din’t fire Braun earlier, but he clearly helped to stop this gigantic fraud. My guess is that he didn’t understand Wirecard either in the beginning but got a hunch quickly and hired KPMG to cover his back. One also doesn’t know what games Braun (and Marsalek ?) tried to play with him. As a fun fact: It seems that Eichelmann lost around 300 k with a complex derivative because of the collapse of Wirecard.

Overall I would say that the two “old guys” most likely really didn’t fully understand the business and maybe Klestil just didn’t have the time to dig deep enough. But I am still surprised that for instance Klestil didn’t resign after the KPMG report. Eichelmann has performed relatively well given the situation.

When looking for fraud cases, an incompetent supervisory board is clearly a very important part of the puzzle

Rest of C-Suite, employees

Interestingly, before the nomination of the now-CEO Freis, 2 out of the other 3 board members were also Austrians, a lady from Tirol and the now missing COO Jan Marsalek.

Marsalek seems to have been at Wirecard since very early times, even before the reverse merger listing.  The now disappeared Marsalek was clearly “in the know” as has been revealed already in early 2019 but no one seemed to have cared. Marsalek has a pretty “interesting” bio. He joined Wirecard in 2002 already as a “Vice President” at the tender age of 22. I didn’t find a biography anywhere and he doesn’t seem to have a Linkedin profile (there are a couple of people with the same name but no one working at Wirecard). There is also very little other information available about him. He seems to have kept an extremely low profile.

I know from a very close Austrian friend, that especially in the German business community, Austrians tend to hold together very tightly. This can be positive or negative in case of a fraudulent company.

The current CFO is a company insider, working since 2005 at Wirecard, however only since 2017 as a CFO.  He was responsible among other areas also for compliance and investor relation. Even if he was not in the driving seat from the beginning, he should have understood the KPMG report.

In my opinion, the previous long term CFO Burkhard Ley who left in 2017 should also be “interviewed” as he clearly should know what has been going on being the CFO for 12 years. Interestingly before Wirecard he was the CEO of Kirch Media which also went bankrupt and according to the statement when he left, he was still advising Wirecard after leaving the management board.

It will be interesting to see if and how many employees will come out and tell their stories. My personal take is that any senior employee in the finance area must have known that something is fishy. Often, as in the case of Madoff, the employees get paid more than they would get anywhere else and then do not complain or even leave. In contrast, often they don’t want to see what is going on.

A certain proof that this was not just a 1 or 2 men show is the Email/message exchange published on a short seller web site where Wirecard employees discuss “brainwashing” a new E&Y partner from India.

The Auditor

E&Y has been appointed in 2009 only. For fun, I compiled a list of who actually signed the auditor opinions from 2007 on:

Year	Audit company	First signature	Second signature
2007	RP Richter	Weigl	Burkhardt
2008	RP Richter	Weigl	Burkhardt
2009	RP Richter	Stahl	Costa
2009	E&Y	Broschulat	Bauer
2010	RP Richter	Stahl	Costa
2010	E&Y	Broschulat	Bauer
2011	E&Y	Broschulat	Bauer
2012	E&Y	Broschulat	Bauer
2013	E&Y	Broschulat	Bauer
2014	E&Y	Broschulat	Bauer
2015	E&Y	Broschulat	Loetscher
2016	E&Y	Dahmen	Loetscher
2017	E&Y	Dahmen	Loetscher
2018	E&Y	Budde	Dahmen

We can see that E&Y came in in 2009 and that for the first 6 years two guys from E&Y with the names Broschulat (Linkedin profile) and Bauer (Linkedin profile) signed off. Both were long time E&Y partners, Broschulat left/retired in 2017 and Bauer in 2018. Interestingly, in the year where Third Party acquiring appeared first in the annual report, both were not part of the Wirecard audit anymore. Not sure if this is pure coincidence.

Mr. Dahmen who signed from 2016-2018 is still an active E&Y partner, Mr. Loetscher now works at Deutsche Bank. He seems to have left E&Y right after signing the 2017 report. Mr. Budde who signed the 2018 reportis an E&Y partner for 33 years (!!) and is still active.

As I have mentioned in the blog several times, Auditors do not have the primary duty to detect fraud. However they do have the duty to analyse the presented material on consistency, plausibility and accuracy. Just a few days ago, the FT uncovered that E&Y didn’t actually get official account statements for the now questionable Escrow accounts. This is a pretty obvious mistake from E&Y and not a trivial one.

What I found interesting is that the Audit opinions were usually quite short, around 1-2 pages with the exception of 2017, where the audit opinion suddenly went over more than 10 pages. Interestingly they claim to have completely checked the third party acquirer part of the company but also explicitly claim that they tried to identify potential misstatements due to fraud.

In the original Enron Scandal, Arthur Andersen, back then one of the “Big Five” Audit firms had to stop doing business due to their role in the scandal.

It will be interesting to see what kind of consequences this will have for E &Y.According to a Manager Magazin article, E&Y was the challenger in Germany with regard to the juiciest mandates at DAX companies and was taking market share from KPMG and PWC. I think a general problem of all audit firms is that the actual work is done by pretty inexperienced youngsters and the experienced partners are more interested in bringing in revenue for their firm and for their own bonus.

What I find especially embarrassing for E&Y is the fact, that KPMG uncovered a lot of the problems with a very limited outside-in audit, without having access to management and with only very little documentation. This makes it even more difficult for E&Y to claim that they had no chance to discover the fraud.

The big question here is if someone at E&Y has profited personally from this “affair” or if the were just so keen to retain the client and gain more business in the industry.

In the latest twist of this story, E&Y now suddenly has doubts that maybe also the 2018 numbers are wrong. I guess their lawyers told them to back paddle now as part of damage control, as I am pretty sure that the fraud goes back much further (see above).

To be continued (including regulators, short sellers, analysts and investors)