Claims that compensation is owed to investors by Big Four auditor EY as a result of its handling of the Wirecard scandal have reignited concerns about how far investors can trust auditing work completed on investee companies, and has renewed calls for change in market practices.
EY has faced fierce criticism for its role as auditor of Wirecard, which has now filed for insolvency after it emerged that €1.9bn of cash on its balance sheet was unaccounted for, with particular scrutiny of EY Germany's failure to request information from a Singapore bank, allowing a €1bn fraud to go undetected.
Investor group European Investors - VEB now claims EY owes investors compensation having "not properly fulfilled its role" and "not assumed the full width of its responsibilities" as auditor.
Encouraging other investors to join its legal action, the group said EY not only "played a significant role in the whole Wirecard scandal" as a result of its "inability to detect the flaws in Wirecard's escrow account in former years", but had been "harmful" to shareholders and to markets through its "communication behaviours".
In its failure to comment on the extensive Financial Times exposé of Wirecard as recently as mid-June, or respond to investor concerns about the unfolding scandal in earlier instances, EY Germany had "wrongfooted" markets and "left the shareholders out in the cold", European Investors - VEB explained.
For its part, EY Germany would not comment on pending litigations but said in a statement that the Wirecard scandal represented "an elaborate and sophisticated fraud involving multiple parties around the world in different institutions, with a deliberate aim of deception".
It added that "collusive frauds" of this kind are "designed to deceive investors and the public", often "involve extensive efforts to create a false documentary trail", and "even the most robust and extended audit procedures" may not have uncovered it.
Investors placed 'significant trust' in EY
Commenting on the scandal, head of TMT at Mirabaud Securities Neil Campling pointed to the Financial Reporting Council's (FRC) official description of the auditor role; an auditor "identifies and assesses the risks of material misstatement of the entity's… financial statements, whether due to fraud or error, designs and performs audit procedures responsive to those risks, and obtains audit evidence that is sufficient and appropriate to provide a basis for the auditor's opinion".
Campling explained that an auditor "is expected to maintain professional scepticism throughout the audit", and noted that EY did not raise issues in its 2018 audit "despite the numerous red flags being waved by whistleblowers, journalists and events [such as] the Singapore police raid, for example".
He added: "We found it strange at the time, and still do, that EY signed off on group accounts when subsidiary accounts had not been filed - Wirecard's UK subsidiary only filed 2018 reports and accounts with Companies House on 10 May this year.
"Because of the definition of an auditor, as described [by the FRC], investors did place significant trust in EY Germany for the auditing of this company."
The FT had called Wirecard's practices into question as early as 2015. The level of trust placed in EY's auditing of the firm is clear, given Wirecard's share price continued to rise rapidly following a clean bill of health in its 2017 audit report.
Partner and head of stewardship at Sarasin & Partners Natasha Landell-Mills said EY's claim they could not have uncovered the fraud "does not sound credible" and the market "often hears these kinds of excuses" amid scandals of this kind, but the nature of the Wirecard fraud "is precisely what shareholders expect auditors to be looking for".
She added: "We expect them to be sceptical and we expect them to be digging into anything that raises any kind of red flags. If you have a whistleblower in the press raising red flags, you would expect them to have done some hard-hitting follow up to that."
"The auditors' job is to kick the tyres on the accounts and identify any weaknesses that could be a misrepresentation, and it is clear that this was a very major misrepresentation."