Big Short: Fintech Fraud Wirecard Explained (EY Accounting Scandal)

Hey guys, Eddie here. Happy Saturday and welcome to another video. Today we're going to be discussing the German payment processing company Wirecard, okay, and explaining the 15-year-long accounting fraud. And this is the biggest accounting scandal in post-war German history. Okay, we're going to discuss how their CEO ended up arrested and all the parties involved. So first of all, who are they? They're essentially this German fintech company. Um, so when you buy something from a merchant online, someone who's selling a product, they essentially collect your payment details and provide it to the issuer, and the money flows from the credit card issuer to this fintech company called Wirecard. Okay, and they were growing extremely quickly, just like all the other technology companies at the moment, um, that seem to be around, like Zoom. And similar to how we saw with Zoom, uh, and not an accounting fraud but a privacy issue, okay, with China, all these companies that tend to grow very quickly, they tend to skip a few things and let their standards slip. Somewhat and hope that they don't get exposed before the— they can fix it, essentially. But essentially Wirecard were putting out these numbers that essentially didn't make sense, uh, and it led to essentially €1.9 billion in cash— not a small amount by any means— um, being unable to be located. And short sellers like Chainos actually said that it's very unlikely that the €1.9 billion was ever there. It was meant to be held in these accounts called escrow accounts, third-party trust accounts, um, that were obviously governed by the trustees. But essentially this ended up never existing. Okay, so it had these third-party companies in Dubai, in the Philippines, in Singapore, uh, in countries where it didn't have licenses, and it was sending payment processing to these businesses and essentially receiving commission. from those third-party companies that it owned. Um, and this kind of feels like, I, you know, other scandals like Enron, uh, and Lehman Brothers, right? So Enron, if you weren't aware, was a Houston-based commodity energy and service corporation. And essentially this led to $74 billion in shareholder value being lost. Thousands of employees, um, and investors lost their accounts and huge unemployment when many of their employees lost their jobs. How did they do it? They kept huge debts off their balance sheet. So different to what Wirecard did, they basically said there was more cash on their balance sheet than there was. Enron said that there was basically less debts than they really had. And the fun fact about Enron was it was Fortune Magazine's most innovative company in America. 6 years in a row prior to the scandal. Another one you may have heard of, a little bank called Lehman Brothers in 2008, a global financial security firm. They hid over $50 billion in loans disguised as sales, and essentially the main players were the Lehman executives and again the auditors. And who was the auditor of Lehman Brothers when they went bust? EY, Ernst Young. Okay, and how did they do it? They allegedly sold these toxic assets to the Cayman Island banks with understanding that they would be bought back eventually. Okay, and this created the impression that Lehman Brothers essentially had $50 million more cash and $50 billion less toxic assets than it really did. And the fun fact about Lehman Brothers, they were ranked the number one most admired securities firm by, again, Fortune magazine. And of course, in terms of sheer scale of these two scandals, the collapse of Enron and Lehman Brothers was much bigger than Wirecard. Um, and Wirecard has actually slid into insolvency, uh, since then. So this is what it looks like from a time frame perspective. The FT started running these ingest, uh, investigative journalism pieces essentially in this at the start of 2019, and and there were warning signs. And essentially, auditors could not obtain the original documents from the banks, and the banks in the Philippines, that confirmed the documents provided by Wirecard to the accounting firm EY, uh, and they were of spurious nature, is the quote. Okay, so they were, they were forging documents. So fortunately, um, it's not— for EY, that is— it's not the only company that or party in this transaction, um, that failed to adequately monitor Wirecard as a company. Germany's BaFin, they obviously bear tremendous responsibility, uh, for this, letting this kind of take place on their own turf, turf. And this obviously has— is a German embarrassment. And any companies looking to do business in Germany, of course, this is what they're concerned about are now in terms of the reputational damage. But as you can see, uh, Wirecard is now trading a very attractive €1, and if you loved it €100 in June, chances are you'll love it a lot more today. And shorts made a killing, okay? So short sellers profited €2.6 billion, almost, or more than the cash that was supposedly there from Wirecard's drop. And of course, short selling is capped at 100% without leverage. But those that took advantage of the 5-year CDS spike, okay, that essentially blew out from 500 bps to around 8,600 bps at the end of last week, essentially benefited greatly. And Jim Chanos, like I referred to early in the, in the video, He was the biggest short position and obviously profited greatly from this, um, going to near zero. Um, but he claims that that $2 billion in cash was never really there. And of course, who are the guilty parties apart from Wirecard? EY have been sued now, and they essentially failed to ask for key financial statements for 3 years. Okay, so you wouldn't really expect, you know, an auditor to audit things or companies, right? Um, you would, right? But, uh, it turns out over the 3 years, um, they didn't. Okay, so they were requesting this crucial, uh, account information from the Singapore bank where Wirecard essentially claimed it had up to $1 billion in cash. And this is a routine audit procedure that would have uncovered the vast fraud, but it turns out they didn't request this. Okay, um, so the big question is, you know, why did they sign off on these accounts? Okay, if you're a— if you've got exposure to Wirecard, if you're an investor, if you're a credit holder, you'd be thinking to yourself, how did EY sign off on these financial statements that were missing crucial accounting information? Okay, and this is the problem. The CEO has obviously been arrested and in Munich on Monday, and prosecutors were essentially investigating the rest of the management board. Again, they did things like failing to disclose minutes from the, from the meetings, as well as everything. So it was very, very fishy from the start, and obviously someone should have, should have caught this. He ended up posting €5 billion in bail after spending one night in police custody. And now they filed for insolvency. They had $2 billion in loans that needed to be paid, and they've actually breached the covenants. Okay, so on Thursday they collapsed, and obviously it once was this high-flying German payment service provider, but now it's filing for insolvency. But they have won a brief reprieve from, from the creditors, postponing by a few days a decision whether to terminate the $2 billion loan. So they're going through now a restructuring, um, just like companies that filed a Chapter 11, uh, like Hertz. Okay, so essentially, um, they're being restructured, um, by banks like Houlihan Lokey, um, that they're now going to sell, have a fire sale of the assets, close their operations, and cut jobs. And this obviously will result in a much smaller Wirecard. Than the €100 giant that operated in the German DAX. Bank of America have got a very nice price target of €1 for Wirecard, um, from there, from their analyst, and that easily, um, has been achieved, unfortunately. And just another party to look at, um, similar to films that you've seen that I'm not gonna name um, in the subprime mortgage crisis where credit rating agencies were mentioned in the film, were almost as guilty as the auditors as they rate their credit, of course. And Moody's actually rated Wirecard's bonds investment grade until last Friday. Okay, so they've just downgraded Wirecard to to the lowest level of junk, uh, and actually withdrew the credit rating, uh, altogether. Um, so essentially the auditors didn't spot this and neither did the credit rating agencies, and of course neither did the equity investors. So it leaves the question, is there any other companies in this fintech space as we've seen this era of, um, software companies rallying dramatically you know, what else is going on behind the scenes at these kind of software companies. Um, so yeah, interesting times for Wirecard and not very interesting time for their equity and debt holders. But I hope you enjoyed this shorter video and more focused. I hope you have a lovely weekend and take care.