The ‘Big Four’ audit firms – Deloitte, EY, KPMG and PwC – all play a systemic role in economic crimes and State Capture. The evidence suggests that these firms have prioritised profit over professional duties and the law. Accountability and reform of the industry are thus essential. In July, Open Secrets released the latest Corporations and Economic Crime Report (CECR). Volume 2 — The Auditors — draws on information from Open Secrets’ investigations and publicly available information to illustrate the crisis faced by the auditing industry and how this impacts the public. Last week’s instalment in the Unaccountable series examined the role of Deloitte in audit failure and dodgy consulting contracts at Steinhoff, Tongaat-Hulett and Eskom. This week, we focus on EY.
Of the Big Four, KPMG, PwC and Deloitte have all been publicly implicated in instances of corporate fraud and state capture in South Africa. EY has not been in our local headlines. As such, one might assume that EY (formerly Ernst & Young) is the more trustworthy of the Four. That is until one examines the international financial media. There you find a laundry list of illicit dealings by the firm – including allegations of fraud, tax evasion, money-laundering, sexism and whistle-blower intimidation.
Then there’s the Wirecard scam, Europe’s biggest corporate fraud since the end of World War II. The daily revelations about the dodgy dealings of the fintech company have led many to wonder whether its long-term auditor and consultant EY was complicit in the scam. It has also added to the urgent calls for immediate reform of the auditing profession.
Germany’s Enron
On 25 June 2020, Wirecard, the German multinational payments processing company filed for bankruptcy. Yet just a few weeks earlier, on 2June, its long-time auditor EY had given it a clean bill of health in a draft opinion. According to the draft opinion given to Wirecard and obtained by the Financial Times (FT), EY concluded: “based on the findings of our audit, the attached annual financial statements comply in all material respects with German commercial law applicable to corporations and give a true and fair view of the net assets and financial position of the company”.
EY’s draft opinion rejected allegations made by a Wirecard whistle-blower and the findings of a special audit by KPMG, conducted at the request of Wirecard. The allegations, backed up by reports from the FT, were that profits at Wirecard’s key Third Party Acquirers (TPAs) in Dubai, Singapore and the Philippines in particular, were fraudulently inflated. TPAs are businesses licenced by a big payment network (like Visa or Mastercard) to help businesses accept credit card transactions. There were also allegations that Wirecard provided fake customer names to EY.
The allegations were true. Ultimately, EY had “missed” a €1.9-billion hole in Wirecard’s finances. When it filed for insolvency, Wirecard admitted that the €1.9-billion supposedly held in third-party bank accounts simply did not exist.
Despite the extent and depth of the fraud, EY gave Wirecard unqualified audits for a decade. As more is revealed about the inner workings of Wirecard — including the alleged dodgy dealings of its Russian intelligence-affiliated chief operating officer, Jan Marsalek — it is emerging that the company had long been operating a scam using fake sale transactions to inflate its revenue and profits.
There were many signs of fraud which a sceptical auditor should have picked up on. According to FT, as early as 2008, the head of a German shareholder association was questioning Wirecard’s spurious accounts. In 2015, the FT began reporting on unverifiable financial records of Wirecard in its House of Wirecard series. Furthermore, several short-sellers, including Jim Chanos’ Kynikos Associates, had started shorting Wirecard’s stock following whistle-blower allegations of accounting fraud at Wirecard.
Wirecard fired back at short-sellers and the FT, claiming that they were attempting to manipulate its share price. FT journalists Dan McCrum and Stefania Palma reported active surveillance following their reporting on Wirecard. Wirecard was backed by the German financial regulator, the Federal Financial Supervisory Authority known as BaFin. BaFin responded by banning the shorting of Wirecard’s stock and initiated a criminal investigation into FT and its journalists for market manipulation and “unethical reporting.”
BaFin, like so many financial regulators, chose to protect the interests of the corporations it was tasked with regulating, spending most of its energy pursuing the actors who were seeking to reveal criminality. This suspect behaviour by the regulator has prompted a separate investigation in the aftermath of Wirecard’s insolvency.
Short selling or “going short” is betting that the share price of a company will go down. A short-seller borrows the shares/stocks, in the hopes that the price will go down so that once it does, they make a profit. Short-sellers buy a stock and then sell them immediately, at the current market price; then when the stock declines in value they buy them back from the lender at the new significantly lower price Investors will often short a stock if they identify that the company is misrepresenting its finances and overstating its value.
To allay concerns about its accounting, Wirecard commissioned a forensic audit by KPMG in 2019. The report released by KPMG in April 2020 revealed how Wirecard’s management had, after contracting the investigation, undermined it at every turn. They stymied attempts to acquire the contracts, account statements and bank confirmations of its TPAs and commercial partners for the periods 2016-2018 (the period that was the subject of the investigation). These were where the accounts which Wirecard claimed held the €1.9 billion were.
It has since been revealed that for the three years in question, EY was similarly unable to access these documents for verification purposes, but that they were “reassured” by the Wirecard management board’s assessment measures. This is highly questionable conduct for an independent auditor. Professional standards require auditors to use professional scepticism and a questioning mind when analysing the finances of a company. Verifying bank balances is considered auditing 101.
An independent auditor should not simply rely on the word or “assessments” of executives who have a vested interest in obfuscating fraud. This is particularly the case in the context of numerous allegations of such fraud from internal whistle-blowers and financial journalists. EY’s failed audits of Wirecard thus indicate either complicity or negligence, both which paint the firm in a negative light.
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