Germany may someday compose a manual for how not to ensure that securities markets function properly for both companies and investors.

Until then, it can print out and bind its authorities’ response to the Wirecard affair, an episode that top market regulator Felix Hufeld belatedly acknowledged last week as a “complete disaster.”

Wirecard, the payments-technology company whose market value topped €24 billion, and which got an investment-grade rating for a bond it sold last year, filed for insolvency on Thursday after acknowledging that €1.9 billion of cash it had claimed to hold in escrow accounts in the Philippines didn’t actually exist.

The company stands accused of systematically falsifying its accounts for years to pump up its share price. Auditors at Ernst & Young failed to check the authenticity of its bank statements for three years, the Financial Times reported on Friday.

Just the prospect of a company on Germany’s DAX blue-chip market index duping business partners, lenders and investors is enough to inflict incalculable damage to the reputation of the financial marketplace in Europe’s largest economy.

“I salute those, let it be journalists, analysts or, yes, let it be short-sellers, who have been digging out inconsistencies persistently and rigorously” — Felix Hufeld, BaFin chief

But what makes it worse is that for over three years, the Federal Financial Supervisory Authority — BaFin, to use its German acronym — sat by and watched, despite repeated warnings from self-interested yet sincere market participants. It failed to investigate documented and legally researched reports arguing the company was overstating revenue and profits.

In February 2019, BaFin did more than overlook the brewing problem. When a whistleblower within Wirecard helped unearth more evidence of fraud, it sided with the company in trying to silence the allegations. The regulator filed a criminal complaint against Financial Times journalists for reporting the allegations, and it banned short sales of the company’s shares to ease downward pressure on the stock price.

In response to a complaint filed by Wirecard, the district court in Munich, near the company’s headquarters in Aschheim, sought to fine those whose reports led to the ban.

BaFin chief Hufeld last week admitted he was wrong in trying to thwart negative reports. He said, “I salute those, let it be journalists, analysts or, yes, let it be short-sellers, who have been digging out inconsistencies persistently and rigorously.”

Speculative ‘attacks’

In a short sale, a trader borrows a stock then sells it, hoping to buy it back at a lower price. Good-faith short-sellers often publish their research, exposing it like scientific peer review in the hope of convincing others. If the research doesn’t stand up, the share price may rebound, and the short-seller loses money. The practice is common in developed markets, and most traders — not only short-sellers — see it as a counterweight to exuberance and hype.

However, German companies and authorities have long viewed short-selling with suspicion. Brought up on compounding interest in savings accounts — at least until the European Central Bank lowered interest rates into negative territory — many Germans resist the notion that pricing of securities is an ever-changing process that inevitably overshoots both high and low. The act of driving prices lower to make a profit is seen as manipulative rather than corrective.

In announcing the shorting ban, BaFin described “short attacks” against Wirecard as “followed and facilitated by negative reporting in the media,” while saying, “such attacks posed a risk to market integrity in Germany and to trust in fair and efficient price determination.”

“They call a short report an ‘attack’ and, in doing so, they create victims,” said Viceroy Research’s Fraser Perring, who published his first research on Wirecard in 2016, with all its accusations referencing publicly available sources. “I did everything aboveboard and legally, and they pursued me to the end.”

Wirecard declined to comment for this article. It has always denied being responsible for personal harassment that Perring has reported.

A spokeswoman for BaFin rejected the suggestion that the agency under-appreciated the role of short-sellers, and said it won’t be apologizing to Perring.

Short-selling opponents, including internet trolls and Wirecard defenders in the media, often point to the activity as coming from “Anglo-Saxon” speculators such as Perring, who’s English.

In other respects, too, German financial circles rallied around the local champion. Deutsche Börse was happy to add some financial-technology stardust to its DAX benchmark index, better known for industrial companies and insurers, even though the allegations of fraud had hung over Wirecard for two years already.

Bank stock analysts were loyal until the end, with 10 of them — not all German, to be sure — having “buy” recommendations as recently as a week ago.

This month, analyst Heike Pauls of Commerzbank — one of Wirecard’s biggest lenders — dismissed the allegations as “fake news” and argued in research notes that a special audit by KPMG had vindicated the company. (Spoiler: It hadn’t.)

Consequences are already being drawn in Berlin. The government is having second thoughts about giving more powers to BaFin.

A spokesman for Commerzbank declined to comment on the work of individual analysts and said its “Chinese Walls” — internal barriers to stop such conflicts of interest — are “appropriate and functioning.”

Prosecutors and regulators

Perring’s complaints that thugs and security firms held him at gunpoint, hacked his computer, leaked his medical records online, planted cameras in his garden and broke into his house drew no action from the prosecutors’ office.

“I was told, ‘We’re not interested in the fraud,’” Perring said in an interview. When he told prosecutors of the harassment, “they said it didn’t happen in their jurisdiction.”

Well, he’s got their attention now: Markus Braun, until recently Wirecard’s chief executive officer, was arrested on suspicion of fraud and released on bail last week.

Anne Leiding of the prosecutors’ office told reporters June 23 that the authority acted only when Wirecard itself admitted the scale of the fraud in a filing to the stock exchange.

“Arrest warrants are only issued on the grounds of sufficient grounds for suspicion, so you need some initial evidence, and we got this with the ad-hoc release,” Leiding said of Braun’s arrest. None of the three TV crews or other local journalists covering the comments mentioned the red flags waving over the company for the past four years, which included a criminal investigation in Singapore and a civil lawsuit against the company in London.

Leiding told POLITICO, “For us to be able to intervene legally, we need more than ‘tip-offs’ in the media.”

“The state attorney’s office is not a financial supervisory body that oversees or regulates companies, rather, it is responsible for the investigation and prosecution of criminal behavior,” she said.

Consequences are already being drawn in Berlin. The government is having second thoughts about giving more powers to BaFin. A bill on entrusting the supervision of independent financial advisers to it was hastily taken off the Bundestag’s agenda for last week.

Ironically, BaFin may end up getting more powers in any case. The government is seeking to end the contract of its Financial Reporting Enforcement Panel and give BaFin the power to investigate company accounts, according to a Financial Times report.

Markus Braun, until recently Wirecard’s CEO, was arrested on suspicion of fraud | Christof Stache/AFP via Getty Images

We won’t have to wait long to see if Germany’s financial establishment has drawn other conclusions. Perring said he has already notified BaFin of his next target and has given it four weeks to respond.

“This time I will change tack,” he said. “I’ll film the courier delivering the documents to the relevant authorities. If they come after me again, I will sue BaFin for defamation.”

“It’s not about punishment,” he said. “The German people should be able to trust their regulator.”