INVESTMENT

James H. Freis, Jr., CFA: The Rise and Fall of Warcard


Thursday, June 18, 2020, a day James H.

Overnight, the soft-spoken American was thrown into the center of one of the biggest financial scandals in modern German history: the fall of the wirecard from high-flying fintech to “Germany’s Enron”.

Prior to its fall, Wirecard was a leading global digital payment firm operating across five continents. Freis, a CFA charterholder with extensive experience in legal and compliance activities, due to joining Wirecard Management board to help make the company professional. But he was unexpectedly called in first to assess a serious situation: 2 2 billion has disappeared from Wirecard’s balance sheet and auditors are refusing to sign-off on the company’s 2019 finances.

What happened next?

At the CFA Institute’s Alpha Summit, Freis took viewers and moderator Paul Andrews to his bizarre wirecard Odyssey, from start to finish in a hotel room outside Munich, from his appointment as interim wirecard CEO, to shutting down the company.

Along the way, he shared critical lessons for investors and regulators about the importance of corporate governance and evaluating culture. Most of them: Don’t be tempted by the “secrets” of a company and speak in the face of injustice.

First, to set some context, here is a short workcard timeline:

  • Wirecard was founded in 1999 in Munich.
  • In 2005, Wirecard was listed by Deutsche Welle Bars Frankfurt.
  • A decade later, Financial times Begins publishing its House of Wirecard series, which raises questions about the company’s account FT Alphaville.
  • In May 2020, Warcard announced the appointment of Fries as Chief Consent Officer.
  • On June 18, 2020, Warcard announced that 1.9 billion was missing; Fries joins the management board with immediate effect.
  • On June 1, 2020, longtime CEO Marcus Brown resigned, and on his second day in office, Freis was appointed interim CEO.
  • Wirecard file for bankruptcy on 25 June.
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“Enron of Germany”?

Enron was a family name in the early 2000s. One of the biggest business scandals in U.S. history, the energy giant collapsed with its auditors due to a massive accounting fraud.

Freis says the Enron-Workcard comparison is appropriate: in both cases the auditor missed financial fraud and, subsequently, a lot of questions were raised about regulatory oversight.

“Why [Wirecard] The collapse was an accounting scandal, as Enron was involved two decades ago in a situation where a real business company was effectively ‘cooking the book’, with the final impact on its revenue and balance sheet, which could not be calculated by companies, ”Freis said. .

In Enron’s case, accounting firm Arthur Andersen failed to oversee his audit. Wirecard’s longtime supervisor, YY, said it was fooled by everyone else: “There are clear indications that this was a widespread and sophisticated scam, involving multiple parties around the world in various organizations, with the intent to defraud,” the company said.

“Enron led a large part of the Carbanes-Oxley,” Freis said. Wirecard scams can cause similar regulatory reactions.

“Many issues that have not yet been implemented are being addressed in terms of corporate governance reform, government oversight, and the way the digital economy is challenging some of our traditional theories,” he said.

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Where were the financial analysts?

Freis was not the first to raise doubts about the wirecard: The Financial times The company conducted a five-year investigation and the short sellers were actively betting against the firm.

As the company’s share price has risen, few sellers have repeatedly expressed concern about the financial value of the wirecard, but such warnings have failed to elicit a wide-ranging investigative response from German authorities.

Freis knew that some investors were skeptical and many were skeptical of the veracity of the company’s report. But only on his first day, when he first saw the internal documents of the wirecard, did he understand the real state of the firm? The situation was worse than even the most outspoken wirecard critics suspected.

So why did he fall into the trap of hiding in his hotel room outside Munich to confirm the fraud?

Andrews raises two critical questions: What should analysts look for? And where did they fail to question the C-suit?

“I came to Wirecard from Deutsche Welle Bars The group, which manages the German stock exchange, among other things, and focuses on the importance of ESG in governance in particular, is E-less which is the primary focus in terms of pricing, but G, “Freis said. As a charterholder … we can compare numbers, we can compare. But when we look at the quality of that revenue and the long-term growth potential, the power of leadership is so important.

And this is an important lesson in the defeat of wirecards: financial analysts must go beyond finance and pay close attention to C-suit occupants.

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And, in the case of Wirecard, the leadership team was not right for the company.

“Warcard had a management team that basically grew up with a company that was a little more than a start-up two decades ago,” Freis said. With a market capitalization of ২ 2 billion, the firm is on the path to rapid growth in Germany’s Blue Chips and the country’s second-largest bank – in terms of valuation.

“But you still had a lot of problems from this management team,” Freis said.

Another problem from the perspective of corporate governance: a board that has failed to question leadership. Although Wirecard’s board is far from a diverse and homogeneous boys’ club, diversity alone does not guarantee effective supervision.

“So 50% women, 50% men, women of color, people with IT backgrounds – we’re trying to do a lot,” Freis said. “But if we just look at it as a check-the-box, we miss the point, because what they weren’t doing was challenging the management, the way we talk about non-executive directors because we’re shareholder representatives.”

Rumors about the company’s accounting and other public suspicions have failed to inspire hard work among board members.

“There was no audit committee until recently, despite allegations of a public audit,” Fries said. “When you look at a global corporation and you consider things like interlocking management, subsidiary directorships with regulated financial services companies, things like that would look like a red flag to any analyst governance structure.”

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Beware of the greed of the mystic

So what about analysts and investors? What keeps them from catching fraud?

After all, the wirecard wasn’t “a microcap with thin analyst coverage,” but the most traded equity in Germany was at its top.

He believes that the wirecard shows the danger of following the flock and falling into complacency by the “big name” of the business.

Wirecard’s fintech company was a mystic and it defended it, Fries said.

“Extremely frustrating, analysts were overwhelmed by this company,” he said. “The company … surrounded itself – and it’s mysterious – with some of the best names.

It hired the best accounting firms, all four of them. It has given the company not just legitimacy, but prestige.

“It didn’t have a Big Four auditor, as expected,” Freis said, “but everyone in the Big Four was involved in looking at some important issues, so its bank subsidiary audited, advising on some conflicts and came up in a regulatory environment, and not -The executive directors called towards the end of the Big Four to look into the same problem last year.

The mystery does not end here.

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Wirecard had “some next level financial advisors” who suggested acquisitions and consolidation. It had access to large strategic consulting firms, government lobbyists, and all other affiliates associated with a supposedly well-capitalized multinational fintech corporation.

But everything was an illusion.

Still, surely someone has seen something that has not been added? Why weren’t people talking together?

“It was the most traumatic thing for me, because all these people were running towards this company,” Freis said. Yet very few people raised any concerns or severed ties with the wirecard, even after watching closely.

“They were blinded by the numbers, which was hypothetical at first glance,” he said. “So this veil of legitimacy, this mystery – when the critics finally came, the company’s response was,‘ You just don’t understand what it’s like to be a disruptive fintech. Get off the road. ‘”

Was it greed for power? Probably.

“I think a lot of people didn’t have the courage to disassociate themselves from a name that was mostly art, mostly press. . . That huge majority is cheering and appreciating, ”Freis said.

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Lessons from wirecards?

An important question that should be considered, Andrews said, was whether a technology company or fintech company, which was originally a wirecard, should be allowed to operate, which was actually a financial services business.

Fris agreed. Wirecard was originally a publicly listed company, regulated as a technology provider, but was a bank which was a wholly owned subsidiary.

“The debate in Germany was receding that it should have been classified as a financial holding company, which could have given the banking regulator more scrutiny,” Fries said.

From the administration’s point of view, what does it take to make sure something like a wirecard doesn’t happen again?

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“Imbalance is the way the corporate governance framework is set up, unlike the way a global company operates in the digital world,” Freis explained.

“For a digital company or a tech company, you don’t have the cost that we input into a factory, even your labor is now virtual and scattered, and you can book your IP anywhere in the world, so you don’t have to.” There are and you are selling anywhere in the world via the Internet, so we need to think about whether you have included entities separately with local boards and local agreements, and we also have auditors who are not really a global organization with global branding and what they are about. Can help us.

If investors and analysts have a single lesson, it’s this: If you see something, say something.

“People, when they see things, need to talk to them and follow them,” Freis said. “If you need to ask tough questions and be in pain, I encourage you to do it.”

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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.


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Lauren Foster

Lauren Foster is a content director at the CFA Institute’s professional education team and host of the Tech15 podcast. He is its former managing editor Entrepreneurial investors And co-led the CFA Institute’s Women in Investment Management Initiative. Lauren has spent almost a decade on staff Financial times As a reporter and editor based in the New York Bureau, freelance writing for this Baron And FT. Lauren holds a BA in Political Science from the University of Cape Town and an MS in Journalism from Columbia University.



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