In 25 years of writing financial commentaries and research notes I have only received two abusive phone calls from ‘offended’ companies. The first was from the investor relations department of Anglo Irish Bank. In that instance, our caution on there being any value in Anglo’s shares crystalised swiftly, as did the conclusion of that desperate call. The second call was from further afield in 2015 and only an early chapter in a shocking financial implosion beginning to hit the headlines in recent days.
The second caller claimed to be from a German investment fund which owned shares in a “hot” German payment processing technology play, Wirecard AG. My offence was to publish a list of long and short positions in a fund I was running at the time. One of the shorts listed was Wirecard and my “bet” was executed using a derivative instrument, a CFD(remember them!!), which would earn profits if the Wirecard share price fell in value. The weird thing about the call was that, between expletives, the caller’s defence of the company seemed too close to the script coming from Wirecard’s own investor relations department. The other weirdness was that, after the call, my search for the details of this German fund came up with nothing. So did the bet.
The share price rose another 10% over the next few weeks. Wirecard was now a losing position in the fund. That’s a lonely place in the investment world where portfolio managers tend to only talk about their winning positions. Despite excellent analyses by Dan McCrum in the FT and an independent research house, Zatarra, on accounting ‘funnies’ at Wirecard, I was forced to cut my losses. And so, that’s where my personal Wirecard story and my chances of being in a Teutonic version of The Big Short movie ended. But the Wirecard machine in 2015 was really only picking up speed. Here are a few milestones reached before implosion this week:
• More than 300,000 corporate customers wooed onto its e-commerce payment services platform and its “Beyond Payments” tag line….
• Almost 6,000 employees in 26 countries
• A peak market valuation of €25 billion which exceeded the combined market capitalisations of Germany’s largest two banks, Deutsche Bank and Commerzbank AG.
• 2018 entry into the Dax 30 index of Germanys top publicly listed companies.
• A digital partner of choice for all the top global payment players – Visa, AMEX, Mastercard, Google Pay, Apple Pay.
• Wirecard Bank also secured a banking licence.
But the tag line “Beyond Payments” resonated for all the wrong reasons this week as Wirecards’s auditors, EY, stated that €1.9 billion of “cash” was missing, beyond payment so to speak. This number neatly equates to the entire acccumulated profits reported by Wirecard since 2012. The market reaction has been vicious; the Wirecard share price has collapsed by 80% in 24 hours and the CEO/founder has resigned.
The courage of short sellers who endured commercial pain and FT journalists who experienced serious litigation threats was ultimately vindicated but there are serious questions to be asked of the investment community and regulatory authorities who ignored multiple warning signs or “red flags”. Sadly, many of these same questions have arisen before on the post-mortems of the Enron, Anglo and Madoff scandals. However, it is no harm to highlight a few lessons to be learned and hopefully assist earlier discovery of the next fraud. Here’s our lesson list based on what we know so far:
1. The financial world is swamped in regulations and compliance procedures to protect investors, particularly retail investors. Wirecard’s fraud happened in full view of professional portfolio mangagers and regulators. Fraud is a fact of financial life, diversification is too.
2. Overly defensive national regulators should be a risk “red flag”. The German regulator, BaFin, threatened criminal proceedings against the FT journalists and briefly banned short selling of the shares….
3. Equity analysts still try to curry favour with big companies by publishing favourable analyses. Out of 25 analysts covering Wirecard, just 2 analysts had a “Sell” recommendation. What “analysis” were the other 23 doing given the company’s multi-year track record of information blocking, even with its auditors….
4. Heavy acquisition activity is a great way to hide fraud and keep invesment bankers happy with juicy advisory fees. Wirecard was flashing warning signals in the accounting world years ago with dubious profits funnelled through Dubai, Singapore and….. Dublin.
5. Short sellers who make profits on falling share prices don’t usually receive good press. However, they are an essential part of the investment process in shining a forensic torch on financial statements.
6. Big fraud stories tend to happen in clusters particularly during economic shocks. Luckin Coffee didn’t grab the same headlines as Wirecard but a 93% share price implosion and $12 billion spilt out of that China cup in recent months.
7. Short selling strategies are very very difficult. Wirecard was a multi year story with huge pain points along the way; the share price quadrupled from when it first caught my eye in 2015.
8. Fraud “in plain sight” is possibly going to be more prevalent going forward. Thanks to social media, free money/capital, disinformation campaigns and litigation, bad actors can fight facts and the rule of law for a very long time. Look to the recent political world for some startling examples of ‘total denial’.
9. Finance is a global system. Call it a “supply chain”. Interruption can be very damaging. The increasing move against globalism is possibly not in investors’ favour if national regulators hide problems behind national flags.
10. The German authorities have dropped the ball badly on Wirecard. Confidence in the regulator, BaFin, is shot and questions will resurface about the health of Deutsche Bank and its enormous derivatives trading book. BaFin is Deutsche Bank’s regulator but will anybody believe their assurances as to Deutsche’s stability right now?
The Wirecard story has plenty more startling revelations to come. I have no doubt. The movie is also a certainty. There are lots of fawning enablers, dopey regulators and corporate dirty tricks on the money side and a few brave journalists and analysts on the truth side. This story will hopefully end with a positive message that some individuals were, in fact, beyond payment and trusted their senses. Even their dress sense. It turns out that those with a keener eye for fashion and a knowledge of the Theranos “Bad Blood” debacle might have picked up a clue. It seems that CEOs, male or female, sporting black turtleneck sweaters are probably now a “red flag” for investor fraud…..