The electronic card scandal casts a shadow on governance

Wirecard’s dramatic fall from grace has put corporate governance and industry regulation in Germany firmly in the spotlight.

The Munich-based payment processor filed for bankruptcy on Thursday and creditors reportedly owed € 3.5bn ($ 3.9bn). The company’s collapse follows a series of Financial Times investigative reports on claims of accounting irregularities.

The revelation last week that € 1.9 billion had disappeared from Wirecard’s balance sheet has seen the company’s share price collapse by 98% and former CEO Markus Braun arrested on suspicion of falsifying accounts.

The Wirecard saga and its broader implications raise many questions, and some experts describe the scandal as the “Enron of Germany.”

Under German corporate law, companies must have a supervisory board and a board of directors. The supervisory board is responsible for supervising management.

Chris Hohn, director of the $ 24 billion TCI hedge fund, had asked Wirecard’s supervisory board to remove former CEO Markus Braun in late April.

“We are of the opinion that the supervisory board is legally obligated to intervene,” he wrote in an open letter published on April 28. “In our opinion, the intervention needed now is to remove the CEO from all management tasks.”

However, Braun had resisted the pressure to leave. He resigned last week after 18 years at the helm and is currently on bail after being arrested in Munich last week. The fiasco has raised new questions about why Wirecard’s supervisory board failed to act prematurely.

“What you see with Wirecard is a disaster,” Peter Dehnen, president of the Association of Supervisory Boards in Germany, told CNBC’s “Squawk Box Europe” on Thursday.

Dehnen is calling for reforms to Germany’s corporate governance rules. Although the German corporate governance code was recently updated, Dehnen believes there is a need for something “new” and “dialogue-driven” that makes companies communicate with all their stakeholders, not just shareholders.

“This is modern corporate governance,” he said. “With the rules currently in place, I feel like we are still back in the last century. And for that we need drastic change.”

The Wirecard scandal is far from the first to shake up the German corporate world. Siemens was hit by a corruption scandal in the late 2000s, while Volkswagen’s reputation was significantly affected by the so-called “Dieselgate” emissions scandal in 2015.

Maximilian Weiss, an attorney with the TILP Litigation law firm, who filed an investor lawsuit against Wirecard in May, told CNBC’s “Squawk Box Europe” last week: “We are at the start of one of the biggest corporate scandals we’ve seen in Germany”. “

“I think there is a lot to do,” Weiss said Wednesday. “Just take a look at the US, what happened after Enron. I think Wirecard is Germany’s Enron.”

Enron was an energy services company that collapsed in 2001 after disclosures of systemic accounting fraud. The scandal was a factor in the enactment of the Sarbanes-Oxley Act, introduced in 2002, to protect investors from fraudulent financial practices.

Weiss said Germany required “better laws” to incentivize whistleblowers. He added that the Sarbanes-Oxley Act could offer a plan for what will happen next in the country: “I think this will become a political problem.”

The scandal has also renewed focus on how Germany’s regulators dealt with the allegations against Wirecard. Many hedge funds have criticized Germany’s financial regulator BaFin for temporarily banning the short sale of Wirecard shares and for filing a criminal complaint against two FT journalists who reported allegations of allegations about the company.

BaFin president Felix Hufeld admitted that the situation was a “scandal” and a “total disaster.” On Tuesday, the regulator filed an updated case against the company seeking “suspicion of market manipulation.”

“BaFin has not been covered in glory at all,” Neil Campling, a technology, media and telecommunications analyst at Mirabaud Securities, told CNBC on Friday. “They are supposed to regulate, all they did was bow to any request from the company.”

The watchdog has also come under fire from German lawmakers. Finance Minister Olaf Scholz told Reuters on Tuesday that the scandal “raises critical questions about the company’s oversight” and is calling for regulatory reform.

“Is BaFin really a financial watchdog? Or is it a puppy dog?” Weiss said of TILP Litigation. “I think they have to be very critical when it comes to what they did in this matter.”

However, the problem could be a cultural rather than a legal problem, according to Jan Pieter Krahnen, scientific director of the Leibniz Institute for Financial Research SAFE in Frankfurt. He said that German regulators lack teeth when it comes to problems affecting capital markets.

“It is basically a consequence of a culture that is not really looking at investor rights,” Krahnen told CNBC. “There really is no real culture of chasing companies that may not be disclosing everything in the right way so that an investor can feel safe.”

Krahnen believes that the EU could also play a role with regard to these capital market problems. This could be under the wing of the European Securities and Markets Authority (ESMA), he said, adding that the watchdog is currently seen more as a rule-setter.

Brussels is now asking ESMA to investigate possible BaFin oversight failures. “We need to clarify what went wrong,” Valdis Dombrovskis, executive vice president of the European Commission, told the FT on Friday.

Analysts say that not only BaFin must withstand scrutiny. There are also questions about why EY, Wirecard’s longtime auditor, did not detect accounting irregularities dating back years.

“There must also be some responsibility for the auditor,” said Mirabaud Securities’ Campling, who claims to have been following the Wirecard case for two years. “It is the role of the auditor to support the credibility of the accounts and documentation.”

Campling says he suspects that the € 1.9 billion of missing funds “never existed in the first place.” Wirecard has said that the lost cash is unlikely to exist.

EY has faced increasing legal pressure on its audit of Wirecard accounts. The German shareholders association SdK has filed a criminal complaint against Wirecard’s auditors. The complaint is directed at two current employees and a former EY staff member.

It comes after the law firm Schirp & Partner filed a class action lawsuit against accounting on behalf of Wirecard investors, alleging it failed to flag incorrectly reserved payments in Wirecard 2018 accounts.

“There are clear indications that this is an elaborate and sophisticated fraud, involving multiple parts of the world in different institutions, with a deliberate goal of deception,” EY said in a statement Thursday.

“Collusive frauds designed to mislead investors and the public often go to great lengths to create a false documentary trail. Professional standards recognize that even the most robust and widespread audit procedures may not uncover collusive fraud.”

The company told CNBC that it does not comment on “pending litigation.”