Germany Cracks Down on Balance Sheet Fraud

In the wake of accounting scandals in the US, including those at Enron and Worldcom, as well as a spate of homegrown finance scandals, the German government is significantly expanding the powers of its financial market watchdog.

In a speech on Tuesday in front of the Frankfurt stock exchange, Finance Minister Hans Eichel laid out the powers of a new accounting task force that will be part of the country’s umbrella oversight group, the Bundesanstalt für Finanzdienstleistungsaufsicht (BAFin). The new measures will include the ability to conduct snap audits of companies suspected of manipulating their balance sheets. Other oversight rules that once only applied to banks will now be extended to quoted companies.

Spurred on by Costly Scandals

The new rules come after the German financial world has been rocked by several high-profile financial scandals. The most visible and potentially expensive of them is one involving the Bankgesellschaft Berlin, a troubled state-controlled bank that almost collapsed in 2001 and was only rescued by a grant from Berlin to the tune of two billion euro (dollars).

Four years earlier, an independent auditor at the bank had discovered serious problems with the bank and its property lending and loan guarantee practices. However, the auditor’s negative report was suppressed and no action was taken to correct the problems until they had ballooned into the billions. The bank has since fired much of its top management and is considering legal action against the auditing firm that is suspected of signing off on inaccurate balance sheets.

Much of the criticism around the scandal revolves around why BAFin did not intervene earlier when irregularities at the bank became apparent.

Eichel’s proposals, in particular the spot audits, aim to prevent similar meltdowns in the future. Banks in general will come under particular scrutiny in the new regulatory light, since the watchdog group will be able to demand the subsitution of auditors if it perceives the auditors’ objectivity has become clouded. It will also be able to take action against accountants in suspected conflict-of-interest cases where, for example, a firm offers a client both auditing and financial consulting services.

Further proposals include steps to protect investors in private pension funds and improve small and medium-sized companies’ access to capital. Also under the plan, financial regulators will have the right to use information uncovered while examining one company in pursuing investigations against others.

Bourse Support

The German stock exchange has put its support behind Eichel’s balance sheet police. Werner Seifert, head of the Frankfurt exchange, told news agencies that control of financials should not be left in the hands of those paying the auditors, nor should the management of the company being audited get to pick which firm it will use.

“The market itself doesn’t produce trustworthy annual financial reports on its own,” he said.