ECONOMY

Germany’s Post-Wirecard Audit Reform Drive Starts to Lose Steam

Germany is scrambling to catch up with the rest of the European Union on audit reform, but initial enthusiasm for fundamental change inspired by the country’s biggest postwar accounting scandal is waning in the face of political opposition.

“We don’t want to fundamentally change the system,” Matthias Hauer, lead lawmaker in the Wirecard AG parliamentary investigation committee of German Chancellor Angela Merkel’s Christian Democratic Union said in a phone interview. “We think that auditors generally do their job well.”

Reeling from the collapse last year of Wirecard, Merkel’s government in January proposed reforms to strengthen the financial market watchdog and improve the quality of audits done by private firms. Wirecard, formerly a fintech darling, foundered under the noses of its auditors and regulators with a 1.9 billion euro ($2.3 billion) hole in its books. Both Ernst & Young LLP and market regulator BaFin have been heavily criticized for their roles. EY argues that it was the victim of corporate criminals in an elaborate fraud.

The proposed measures include making companies change auditors every 10 years, rather than every 20 years as currently required. Auditors would also face tougher penalties for some audit mistakes: The maximum civil liability for negligence by auditors of listed companies would quadruple to 16 million euros, with regulatory fines of up to 5 million euros and unlimited liability for auditors making grave mistakes.

Legislators have been looking into a continuing stream of embarrassing revelations, including that BaFin employees were trading Wirecard shares in the runup to its collapse. On March 19, Christian Orth, EY Germany’s professional practice director, told the committee that EY hadn’t verified Wirecard’s claimed funds, because German laws hadn’t required that it do so. Rather, he said, it relied on evidence from company trustees, essentially the same management that was carrying out the alleged fraud; lawmakers contest that, saying German law clearly required EY to verify that the money existed.

The government’s proposed reforms also catch up to stricter EU rules introduced after the financial crisis by limiting the amount and type of consulting work EU auditors can do for their clients. Auditors would be barred from offering tax advice, and their consulting fees would be capped at the EU norm of 70% of the audit fee. There is, however, no discussion of introducing wider, U.K.-style proposals to force the so-called Big Four accounting firms to separate their auditing and consulting arms.

Despite the spotlight, parliamentary opponents in Merkel’s ruling CDU and the opposition Liberal party are seeking to water down the package, arguing that the measures go too far and would actually increase the Big Four’s dominance of listed company audits.

“We should not put all auditors on the dock because of Wirecard,” Hauer said. If small and medium-sized auditors are forced to shoulder the risk of unlimited liability, he said, many would be driven out of the market.

“Companies will have problems contracting auditors, as insurance companies won’t be willing to insure unlimited liability in case of negligence,” Hauer said.

The Liberals and CDU argue that the strict liability rules benefit the Big Four, because they put too much of a burden on medium-sized firms. While the Liberals want to introduce a cap on liability, the CDU wants unlimited liability only in cases of intentional mistakes.

“Our reforms fall much behind the reform plans of the U.K. to split auditing and consulting,” Cansel Kiziltepe, a lawmaker with the Social Democrats, the junior coalition partner in Merkel’s government, said in a phone interview.

“We would like to go further, but this is not possible with our coalition partner,” she added.

The U.K., rocked by its own accounting scandals, on March 18 published proposals to audit market reform proposals that would require the creation of a new, more powerful, regulator and would force accounting firms to separate their audit and accounting activities to bolster independence.

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