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Wirecard investors set for legal battle as accounting questions mount

As Wirecard AG files for insolvency, institutional investors have been selling off their holdings in the beleaguered German digital payments firm and some are taking or contemplating legal action as questions about the company's accounting, compliance and governance mount.

Once a darling of investors and analysts, impressed with its rapid growth and innovative technology, the company announced June 22 that a missing €1.9 billion its auditor Ernst & Young could not account for may not exist, leading to the arrest of CEO Markus Braun, who resigned June 19. The revelations raise questions about the role of the company's auditors, German supervisors and the government, particularly since concerns about the group's finances had been flagged for some time, experts said.

"There was a degree of: Wirecard was a new kid on the block, the German rising star in fintech, and 'we don't want people to talk badly about it,'" Fabio De Masi, a Die Linke party member of the German parliament, told S&P Global Market Intelligence.

For the past 18 months, the Financial Times has investigated alleged manipulation of Wirecard's accounts. According to the newspaper, staff at the company's Dubai and Dublin subsidiaries provided EY with inflated financial figures for about a decade.

Shares of Wirecard, which provided payment systems for the online gaming industry and software for online and contactless payments, dropped nearly 75% on June 25 after the company filed for insolvency. In 2018, Wirecard replaced Commerzbank AG in Germany's blue-chip stock index, the DAX 30. Its share price has fallen 98% since the beginning of 2019.

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The Frankfurt stock exchange, which is owned by Deutsche Börse AG, did not respond to a Market Intelligence request for comment. Wirecard declined to comment.

"We have been amazed how the Wirecard share price has been so impervious for so long to cumulative substantiated accusations of wrongdoing which waved more red flags than you might witness at a communist rally," Barry Norris, CEO of Argonaut Capital Partners, a fund manager and short seller of Wirecard's shares, wrote in a blog.

Lawsuit

Wirecard's supervisory board commissioned auditor KPMG in October 2019 to address the accounting allegations. At the end of April, KPMG said it was unable to verify certain revenues booked with Wirecard's Third Party Acquiring business because it had not received the necessary information and signaled "deficiencies" in the firm's internal organization. Wirecard announced April 28 that "no incriminating evidence" had been found regarding the allegations of "balance sheet manipulation."

But German investment firm and publishing company Effecten-Spiegel AG filed a lawsuit against the company in a regional court in Munich May 12, citing failings in the company's compliance. The investor is claiming damages for a 32% loss in value of its Wirecard shares.

Marc Schiefer, a lawyer representing the investor, told S&P Global Market Intelligence his law firm may expand its lawsuit to include the most recent allegations about the company's balance sheet. Institutional clients have also contacted the law firm about a potential larger lawsuit, he said.

"One thing was clear. It was the compliance system that was not working properly, and if you are in the DAX 30, you should have compliance systems that are indeed working really well," he said.

The law firm where he works, TILP Litigation Rechtsanwaltsgesellschaft, which represented plaintiffs in Germany's "Dieselgate" emissions affair against Volkswagen AG and other carmakers, expects to act on behalf of "hundreds and probably in this case thousands" of retail clients and between 100 and 500 institutional investors, judging by past cases, he said.

One investment company with a holding in Wirecard, German asset manager Union Investment, part of Union Asset Management Holding AG, did not rule out potential legal action against the firm.

"As part of its fiduciary duties, Union Investment regularly checks whether the interests of its investors are affected in the event of possible misconduct by persons acting on behalf of an issuer of securities. Union Investment has taken the reporting on Wirecard as an opportunity to examine the possible impairment of investor interests and the possible initiation of legal action," the company told S&P Global Market Intelligence via email.

The investment firm held a 2.14% stake in Wirecard as of April 28, according to S&P Global Market Intelligence data, but Union Investment Portfolio Manager Andreas Mark said it had cut its shareholding in recent weeks to below 0.1% before June 18.

Investors

A spokesperson for Deutsche Asset & Wealth Management, or DWS, said the investment firm was "analyzing the situation" and "considering legal action."

DWS has reduced its position in the company by around 60% as of market close June 17 and no longer holds any material position in Wirecard in its actively managed funds, the spokesperson said.

Other investors such as BlackRock Inc., Jupiter Asset Management Group Ltd., Vanguard Group Inc., and Merrill Lynch Pierce Fenner & Smith Inc., which have all held stakes in Wirecard according to S&P Global Market Intelligence data, declined to comment on their holdings in the company.

Ingo Speich, head of sustainability and corporate governance at Deka Investment GmbH, said he had been "stunned" by the news that Wirecard's auditor could not account for €1.9 billion in funds. Deka had a 1.71% stake in Wirecard as of May 29, according to S&P Global Market Intelligence data.

U.K.-based activist investor TCI Fund Management Ltd also filed a criminal complaint against the company following the publication of the KPMG report.

Berlin-based law firm Schirp & Partner is taking legal action against auditor EY because it believes it has more chance of recovering money lost by investors via that route.

"I am a little pessimistic about Wirecard's future so if we sue them for three-digit millions of euros, we need somebody who is still strong and able to pay in two or three years from now when the legal cases are hopefully won," Schirp & Partner founding partner Wolfgang Schirp told S&P Global Market Intelligence.

EY should have been able to read the "red flags" and look behind figures presented by Wirecard, he said.

EY did not respond to a request for comment.

Regulation

The case has also sparked questions about how the company was regulated.

"Financial supervision largely failed," according to De Masi. Regulators failed to adapt their supervision to fintech companies such as Wirecard, the Die Linke politician said. Technological advances in financial markets require supervisors to have an understanding of the changes that are taking place, he said.

Germany's financial regulator, BaFin, filed a complaint against two Financial Times journalists and 10 short sellers of stock over alleged market manipulation in April 2019 after banning short selling in the stock temporarily Feb. 18, 2019, according to the FT's sources. The complaint was made to the criminal prosecution office in Munich.

However, it fined Wirecard in September 2019 for the late disclosure of earnings and in May said it would investigate Wirecard statements made before the release of the KPMG report.

German Finance Minister Olaf Scholz, of the Social Democrat Party, told Reuters June 23 that regulators appear to have been ineffective in this case, and that any mistakes made "need to be identified and eliminated quickly." Valdis Dombrovskis, the EU executive vice president responsible for financial services policy, is asking the European Securities and Markets Authority to investigate whether BaFin failed in its supervision of Wirecard, the Financial Times reported June 26, citing Dombrovskis.

BaFin did not respond to a Market Intelligence request for comment. The regulator's head, Felix Hufeld, told a panel discussion June 22 that "a whole range of private and public entities including my own ... have not been effective enough to prevent something like [the Wirecard failure] happening," Bloomberg News reported.