Podcast Summary
The Truth About Wirecard: Market Irrationality and Hidden Fraud: Market irrationality can obscure the truth for extended periods, requiring vigilance, empathy, and trust in instincts to uncover hidden frauds.
Markets can be irrational for extended periods, and it can be challenging for individuals to identify and capitalize on the truth when others do not see it. This was exemplified in the case of Wirecard, a European Fintech company once valued at nearly $30 billion that turned out to be a massive fraud. Despite evidence of fraud and journalists' persistent investigations, the truth took a long time to come to light, with many in the financial industry resisting the revelation. It's essential to remain vigilant, maintain empathy, and trust our instincts when faced with market irrationality, while also recognizing that the truth may not always be readily apparent or accepted by others. For more insights, listen to the Odd Thoughts podcast episode on Wirecard and the Visibility Gap podcast presented by Cigna Health Care.
Investigative journalists uncover potential accounting fraud at Wirecard: Wirecard's rapid growth and profitability raised suspicions of accounting manipulation through acquisitions in Asia, as financial statements didn't match local records and showed significant risk.
The rapid growth and profitability of Wirecard, a European payment processing company, raised red flags for investigative journalists Dan McCrum and Paul Murphy. While the ostensible business involved processing credit and debit card payments for online merchants, Wirecard's acquisitions of smaller payment processors in Asia showed signs of accounting fraud. The numbers reported by Wirecard didn't match local filings or press releases, and the audited financial statements of the acquired businesses indicated significant risk. This mismatch between claimed and actual financial performance suggested that Wirecard was using these acquisitions to manipulate its accounting. John Hempton, a hedge fund manager, initially piqued McCrum's interest in Wirecard, and Leo Perry, another short seller, later provided evidence supporting the theory of accounting fraud. The apparent financial success of Wirecard, which grew faster and was more profitable than its competitors, should have been a warning sign in the finance industry, known for its lack of excitement and stability.
Creative bookkeeping and large transactions hide accounting fraud: Large down payments on acquisitions without asset ownership and aggressive responses to investigations can be signs of potential accounting fraud
Accounting fraud can be hidden through creative bookkeeping and large, complex transactions. In the case of Wirecard, the company used a tactic of making large down payments on acquisitions before actually taking ownership of the assets, claiming to have sent the cash out before the year end. This allowed them to hide the fraud when auditors asked to see full bank balances at the start of the year. Additionally, if a company is growing extremely fast and continues to ask for large injections of cash or debt, it may be a sign of potential accounting irregularities. The reaction to investigative reporting on Wirecard was intense, with regulators, short sellers, and even suspected spies getting involved. The company's strange and aggressive responses only fueled suspicions and drew more attention to the situation.
Investigation into Wirecard reveals signs of fraud and illicit activities: A German payments processing company, Wirecard, was under investigation for accounting fraud and suspected involvement in illicit online activities. The heart of the operations was a charismatic Austrian executive, Jan Marsalek, who was a consummate improviser and faced intense scrutiny, online abuse, and phishing attempts.
The investigation into Wirecard, a German payments processing company, uncovered signs of accounting fraud, but also hinted at the company's involvement in illicit activities. John Hampton, a source, initially raised suspicions about "gangsters" involved, and it was later discovered that the real figure of concern was Jan Marsalek, a charismatic Austrian executive who spoke multiple languages and had a mysterious past. Marsalek, who was the heart of Wirecard's operations, was revealed to be a consummate improviser who constantly found himself in scrapes and nearly destroyed the company. The investigation also revealed that Wirecard was suspected of processing payments for unsavory online activities, adding another layer of complexity to the case. The journalists involved faced intense online abuse and phishing attempts, as well as offers of large sums of money, further highlighting the risks and strange nature of the situation.
Trust exploited in high-functioning economies like Germany: Cultural tendency to trust can lead to skepticism towards outsiders and delay in acknowledging fraud, even when evidence emerges
Trust can be exploited by fraudsters in high-functioning economies like Germany, where people assume good faith. The Wirecard scandal, as an example, was able to persist due to this element of trust. The German establishment's collective belief in Dan McCrum's corruption and the destructive articles against Wirecard was a result of this cultural tendency to distrust Anglo-Saxon capitalism. However, when evidence of fraud emerged, it was still met with skepticism. The German press also seemed to align against the Financial Times, further perpetuating the narrative of corruption. This incident highlights the importance of maintaining a healthy skepticism, even in the face of a trusted economy and society.
German media's respectful relationship with sources vs fact-checking: In Germany, journalists prioritize quote approval and respectful relationships with sources, but this can hinder fact-checking and holding corporations accountable. In high-stakes investigations, journalists must balance these considerations with their responsibility to maintain integrity and uphold the truth.
The relationship between the financial press and corporations in Germany differs significantly from that in New York or London. In the German media, quote approval and a respectful relationship with sources are common practices due to media law. However, this can make it challenging for journalists to fact-check their sources and hold corporations accountable for wrongdoing. In the Wirecard scandal, the company turned the tables on the Financial Times by accusing its journalists of corruption and colluding with short sellers. This led to a media frenzy and a criminal investigation into the journalists, forcing the Financial Times to double down on their reporting. Short sellers can be valuable sources for investigative journalists, but their motivations must be considered and disclosed to readers. Journalists have a responsibility to maintain their integrity and uphold the truth, even in the face of criticism and attacks.
Understanding Short Sellers' Biases and Motivations: When reporting on financial information, journalists should be aware of short sellers' potential biases and financial interests, verify information through independent means, and maintain a critical and independent perspective.
When dealing with financial information, it's essential to be aware of the potential biases and financial interests of the sources you speak with, including short sellers. While short sellers may be known for their skepticism and deep research, they are not immune to financial motivations. Journalists should approach these sources with caution, verifying information through independent means and avoiding any two-way flow of information. Short sellers often conduct extensive research due to the significant downside risk they face when shorting a stock. However, even with thorough research, they may still face prolonged losses as markets can remain irrational for extended periods. Despite the challenges, it's important for journalists to maintain a critical and independent perspective when reporting on financial information.
Auditors can fail to detect fraud: Despite clear signs, auditors missed Wirecard's years-long accounting fraud due to groupthink, desperation, and belief in the company's growth story. Independent investigative journalism uncovered the truth.
Auditors are not infallible and their oversight can be compromised, even in cases of blatant accounting fraud. The Wirecard case serves as a prime example, where auditors failed to detect fraudulent activities for years, despite clear signs of irregularities. The auditors' groupthink mentality, desperation to sign off on things, and belief in the company's chaotic growth story allowed the fraud to persist. This incident underscores the importance of maintaining a healthy skepticism towards audited financial statements and the need for independent investigative journalism to uncover potential fraud.
Perseverance and determination in journalism: Staying the course and presenting tangible evidence can lead to uncovering the truth, despite adversity and intimidation.
Perseverance and determination in journalism can lead to uncovering the truth, even in the face of adversity and intimidation. The Wirecard scandal, as shared by the journalist involved, highlights the importance of staying the course and presenting tangible evidence to gain credibility and belief from the public. The journalist and his colleague faced intense scrutiny and investigation themselves, but their commitment to exposing the fraudulent activities ultimately led to the truth coming to light. The power of publishing documents and evidence, particularly when it's substantial and cannot be fabricated, played a crucial role in turning the tide and gaining support from the public and authorities.
One lie can uncover more deceit in a company: When spotting potential frauds, look for companies with rapid growth, large debt, or unrealistic profits. Dishonesty is the most significant red flag. If a company is lying about one thing, they may be lying about many others as well.
Finding one lie in a company may indicate the presence of more deceit. The Wirecard case, discussed by Dan McCrum and Paul Hodgson, serves as a cautionary tale. On October 15, 2019, they knew the business was a fraud. Despite this, it took another 7-8 months for the truth to fully disintegrate. To spot potential frauds, look for companies growing rapidly but taking on significant debt, or showing profits that seem too good to be true. Financial indicators such as large receivables balances growing faster than sales can also be red flags. However, the most crucial sign is dishonesty. If a company is lying about one thing, they may be lying about many others as well. The system designed to prevent fraud only functions effectively when all involved act in good faith. When senior executives are willing to go on the offensive and even engage in criminal activities to protect their lies, the system breaks down. It's essential to remain vigilant and recognize that high-trust environments can create the space for brazen lies to go undetected.
The power of deception in markets: Markets can be irrational and deceptive, making it challenging for journalists and auditors to uncover the truth. Unsustainable business models can last longer than expected, allowing companies to manipulate finances or customer numbers.
While systems and processes are in place to ensure truth and accuracy, they can be easily manipulated when people act in bad faith. The discussion highlighted the case of unsustainable business models that can last longer than expected, allowing companies to fabricate money or customers. This phenomenon, known as market irrationality, can drive journalists and auditors crazy, as it takes a long time for the truth to come to light. The quote "Markets can stay irrational longer than you can stay solvent" emphasizes this point. This persistent behavior, despite its dubious provenance, is so true because it's a reminder of the power of deception and the challenges in uncovering the truth. It's important to remain vigilant and not be swayed by short-term gains or easy money, as the consequences can be severe in the long run.
