Germany’s auditing industry is seeking to water down government plans to tighten financial regulation laws in the wake of the Wirecard scandal — one of the biggest cases of accounting fraud in the country’s postwar history.
Wirecard, once a high-flying German electronic payments start-up, crashed into insolvency in June after disclosing that €1.9bn in corporate cash did not exist. Wirecard’s auditor, EY, had given the firm unqualified audits for almost a decade.
The Wirecard debacle, which according to Europe’s financial regulator Esma exposed “deficiencies in the supervision and enforcement of Wirecard’s financial reporting”, prompted Berlin to work on a far-reaching overhaul of the auditing industry’s regulation.
“It is hard to understand why [Wirecard’s auditor] did not succeed in uncovering [the accounting manipulations],” Germany’s finance minister Olaf Scholz told parliament in September.
But Germany’s auditing industry is not going down without a fight. It has reacted with dismay to the draft bill published last month which outlines plans to make auditors more accountable and independent. “The government plans are a knee-jerk reaction which isn’t properly thought out and would be a catastrophe,” Klaus-Peter Naumann, the chief executive of IDW, Germany’s association of accountants, told the Financial Times.
Among other measures, the government wants to force companies to switch auditors once every decade. It also wants to significantly limit a firm’s ability to sell consulting services to auditing clients.
Under the plans, the German financial regulator BaFin will be given more powers to launch investigations into suspected accounting fraud.
The German Chamber of Public Accountants, WPK, argues that the proposed regulatory changes would not prevent a second Wirecard case but create “various unpredictable risks” for the profession.
A crucial concern for the industry is the government’s plans to extend liability for professional blunders. So far, auditors in Germany only face an unlimited liability for intentional breaches of duty while damages for other types of mistakes are capped at €4m.
The government wants to abolish the cap for gross negligence altogether and is planning to lift it to €20m for ordinary negligence.
Joachim Hennrichs, professor for accounting law at Cologne University, warns that insurance companies will not offer protection against claims of gross negligence. “This is an uninsurable risk. In combination with an unlimited liability, this creates the risk that the next Wirecard scandal could actually sink the involved auditing firm.” As the market concentration was already too high, this would be highly problematic, Mr Hennrichs argues.
At the moment, the Big Four auditors PwC, KPMG, EY and Deloitte control half of the Germany’s auditing market, according to data by Lünendonk and Hossenfelder, a consultancy.
Another worry in the auditing industry is that smaller accounting firms would be hit particularly hard by the increased liability. Mr Naumann argues that the average fees earned with smaller clients stand between €150,000 and €450,000.
“With a liability cap of €20m, smaller auditors will be on the hook for 50 times the fees, which is excessive,” he argues. As a consequence, he predicts that smaller auditing firms might entirely withdraw from the market. “It is not an unrealistic scenario that some companies may actually struggle to find an auditor at all,” he warns.
Moreover, under the draft bill, individual auditors could be sent to jail more easily, and would face longer prison terms. Ulrich Störk, the head of PwC Germany, warns that these punishments would make it much harder to recruit new staff, which was a problem already. “Increased personal liability risk would lead to a shortage of young talent in the auditing provision,” he said.
Deloitte told the FT it supported the IDW position. EY, which is facing an avalanche of investor’s lawsuits over its work for Wirecard, and KPMG, which harshly criticised EY’s work in a confidential appendix to its special audit into the company’s accounting, both declined to comment on the draft bill.
The IDW and PwC are also taking issue with the government’s plans to force companies to change auditors at least every 10 years – compared to a maximum term of up to 24 years at the moment.
“We know that a change in auditors temporarily tends to lead to a drop in auditing quality,” said Mr Naumann, as it takes time for a new auditor to come to grips with the intricacies of a new client. He also points to evidence that many clients who are forced to switch auditors tend to turn to a larger one.
The head of the IDW also stresses that the new rule would not have changed anything with regard to Wirecard as the company had not been an EY client for more than 10 years.
Mr Naumann argues that the whole focus of audit reforms after the Wirecard debacle is misguided. “We have the suspicion that organised crime is at the core of the Wirecard scandal. No auditor will ever be able to uncover that, as they don’t have investigative powers. This will always be a job for the law enforcement agencies.”