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Wirecard's Fraud could have been hedged

Wirecard Scandal Explained

Wirecard AG, one of the largest payment processors in the world prior to its insolvency in June 2020, was fraudulently manipulating and inflating its financials, which included the following:

  • Outright fabrication and the backdating of customer contracts;
  • Opaque and faulty M&A strategy whereby Wirecard acquired companies at very high valuations that were not merited (simply put, the operating cash flow they ended up generating from the companies they acquired was not sufficient to justify the valuations they had paid);
  • Licensing irregularities and regulatory issues with respect to its third-party acquirers that were processing transactions on behalf of Wirecard;
  • Errors and omissions made by its long time auditor Ernst & Young (EY) in verifying the truthfulness of Wirecard's financials, as well as the fraudulent collusion of some of EY's personnel.
wirecard scandal explained

The illustration above tells the story from a risk management standpoint and provides for a good summary of the wirecard scandal.

Fraud Risk is a major type of Operational Risk, the latter being the top source of all business risks. The risk itself can be managed and insured using different products each of which functions differently and has its own cost/benefit. Ultimately, fraud risk management including the use of commercial insurance and financial insurance, impacts stakeholders whether they are equity holders or creditors, or employees and other parties that are reliant on the business.

The role of Commercial Insurance to protect stakeholders

While the European Banking Authority mandated that Wirecard carry commercial insurance against Fraud Risks through the PSD2 insurance regulation, they did not mandate that the insurance had to be audited by risk experts independent of insurance brokers and companies to ensure adequate intended protection. So while Wirecard did meet its insurance regulatory requirement, its commercial insurance did little, if anything at all, to protect stakeholders.

A key type of commercial insurance that could have saved stakeholders of Wirecard is the Fidelity Insurance Bond, which essentially protects a business in case of fraud by its employees whether or not in collusion with third parties, as well as other types of fraud. It was therefore important for stockholders and creditors of Wirecard to analyze the company's Fidelity Insurance Bond to determine whether or not the wording of the Bond was adequate to perform its function as a hedge. Because investors and creditors did not perform this analysis as part of their risk due diligence, they ultimately lost money on Wirecard.

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