Wire-card or Wire-Fraud

Wire-card or Wire-Fraud
Wire-card may be a familiar brand to consumers in Singapore. Singaporeans whom have paid for their food through EFTPOS terminals through Visa / Nets /Mastercard will have noted the terminals featuring this particular company. Never could I imagine such a large scale fraud could have happened within the shores of the Singapore financial center. Large scale fraud that I thought to be prevalent in S Chips (Missing cash and regulatory breakdown) in distant shores turned up at my doorstep.

Although I am not vested in this company, to have directly used the payment services of a company that is engaged in large scale misrepresentation / fraud is jarring. A scuttlebutt analysis from vendors whom used its payment systems may simply have expected late payments from wirecard, instead of the entire insolvency of the company, which has a market cap of 18.26B as of 23 April.

To quote some choice excerpts from the FT investigator / whistle blower

Quote
https://www.ft.com/content/a9deb987-df70-4a72-bd41-47ed8942e83b

https://www.ft.com/content/76e424bb-177c-4c2a-b54a-fa6156f61ca2

EY failed for more than three years to request crucial account information from a Singapore bank where Wirecard claimed it had up to €1bn in cash — a routine audit procedure that could have uncovered the vast fraud at the German payments group.

The accountancy firm, which audited Wirecard for a decade, has come under fire after the once high-flying fintech company filed for insolvency this week, revealing that €1.9bn in cash probably did “not exist”.

“The big question for me is what on earth did EY do when they signed off the accounts?” said a senior banker at a lender with credit exposure to Wirecard. A senior auditor at another firm said that obtaining independent confirmation of bank balances was “equivalent to day-one training at audit school”.


The Big Four accounting firm had issued unqualified audits of Wirecard for a decade despite increasing questions over suspect accounting practices from journalists and short sellers.


A special audit by KPMG could not obtain original documents from the banks to prove deposits existed. EY was told this month by the banks that paperwork it had previously seen on the Philippine accounts was “spurious” and they did not exist. 

The head of audit at a rival accounting firm to EY said: “It is beyond the realms of reality that EY wouldn’t have had [the bank balance confirmations] unless they did a very poor audit. Cash is easy to audit. If investors can’t trust the cash number, what can they trust?”


In February 2019, BaFin imposed a controversial two-months short selling ban on Wirecard shares. Two months later it filed a criminal complaint against two Financial Times journalists who reported on whistleblower allegations of accounting fraud in Wirecard’s subsidiary in Singapore.

Unquote

Conclusion

1) Complete breakdown of the internal and external audit function and inability to detect fraud

i) E and Y Lacking due diligence and skipping basic required steps in the audit process

ii) Little knowledge of the intention behind complex accounting, before auditors issuing an opinion.

iii) Conflict of interest in fee structure,  whereby you are supposed to be auditing your boss whom is paying your audit fees. Auditors have a misaligned incentive structure to check their client, keep the client happy so that they can continue to be a valued long term partner and collect more fees.

iv) Possible lack of internal controls within the organization to track and reconcile fund flows, and possible negligent / No oversight of the board of directors.

v) Lack of skin in the game by auditors, whom will NOT suffer a material and personal loss if their opinion goes sour and they did not do their due diligence.

vi) I do not know if this is an Arthur Anderson moment whereby EY could possible lose their entire audit license or continue to maintain the trust /integrity of its brand. However, considering the size of the audit industry,  I think it is very unlikely that EY will be severely punished within SG jurisdiction as they support a large number of jobs in Singapore.

2) Over dependence of the regulatory authority to police the companies and protect the shareholders.
(Red highlighted points to contrast similar corporate scandal)

Investors whom had invested in Hyflux (yours truly included) will have been lambasted by many

self proclaimed guru course providers, whom use the disgraced name as a convenient scapegoat for all things wrong with investing as well as to bolster their ego.

Surprisingly enough, there is barely any averse opinion raised publicly back at 2015-2016 when the troubles started brewing. As a novice investor then (and still now), I bought a small position into Hyflux as a turnaround play and the rest is history. Institutional investors whom had positions in it will have quietly written off / removed from the investment book once the scandal unraveled .

It is a different environment then. Hyflux perpetuals, bonds and equity are being touted by Brokers and distributed by local banks. Allowing for CPF funds to be invested in the company is an implicit endorsement of institutional backing of the stock, least to say the use of photographs with prominent Singapore politicians and the appointment of the CEO to various political and visible appointments. Students are being indoctrinated about the perils of water security and how the third tap of Singapore is a game changer and deal breaker. Every NDP, you will see the Hyflux flag being flown along with other SG Inc companies which are supposed to be the pride of Singapore. And most surprisingly, the CAD and the MAS only stepped in to investigate Hyflux 2 years after its suspension, whereby all of the dirty laundry has been analyzed and reviewed by the financial press.

Regulators often act too slow and step in too late. The importance of restraint to prevent overt intervention in the free market is important, but often a times there is no hard rules to suggest when to step in. And when regulators step in like the German case to unreasonably protect the fraudulent company, short sellers got discriminated for the courage to go against the flow.  An investor is ultimately responsible for  his own due diligence and actions and be wary of the perils of buying and short selling.

3) Stay away from traditional financial / modern fintech companies unless there is strong checks and balances within the organization.

Bill Miller is a disgraced Value Investor whom is portrayed in the Big short. He had a strong track record of beating the market for 15 continuous years, before under-performing after 2008. Despite planning a comeback through Legg Mason after the fiasco, investors got fed up with him for years of under-performing and he was kicked out.

Even for someone whom has a strong track record in investing, financial companies are intricately complex due to the huge mass of transactions and funds / financial instruments flowing in and out on a daily basis. Even for employees of a financial organization, the nature and background of funds can be hard to determine, least to say the lumped up aggregation which forms the balance sheet. 

Mark to market accounting for financial instruments, as well as derivatives made the actual value of its assets hard to determine, and a simple low Price to book value MUST be supplemented by a fundamental analysis of the company loan book, loan loss provisions, and possible use of questionable accounting, volatile assets and derivatives. Apart from specialized investors like Buffett, most traditional value investors noticeably stayed away from banks / FI due to the complexities involved.

4) Importance of considering alternative points of view or even short seller reports for holes in your investment thesis

The rewards of short selling to earn large amounts of money within a short time frame present exciting prospects to many. Getting clobbered by institutional investors creating short squeezes (Ichan vs Ackman) , Central Bank intervention (Greenspan Put and  Federal Reserve Unlimited QE), incurring large interest expenses and manufactured dividends to maintain the short , as well as the getting the entire thesis of shorting wrong. You can be right on the fundamentals but not profit from the time and effort incurred.

As a retail investor, the risk of short selling is too great and I will maintain a long only portfolio. Nonetheless, as part of due diligence, before any investment decision, I might want to scan through short sellers reports to look out for any possible blind spots. Some short sellers reports are more fluff and fiction than facts. I need to have a circle of competence to determine facts from fiction in order to determine whether to buy more or cut loss.