What the SEC can learn from its German peer BaFin

The Federal Financial Supervisory Authority, otherwise known as BaFin, is Germany’s version of the U.S. Securities and Exchange Commission (SEC), a supervisory body working to ensure the functioning, stability and integrity of the German financial system. BaFin was created following a 2002 merger between Germany’s Federal Banking Supervisory Office (BAKred), the Federal Securities Supervisory Office (BAWe), and the Federal Insurance Supervisor Office (BAV), which explains BaFin’s extensive remit.

In addition to its supervisory function to ensure credit institutions, insurers, and financial service providers are able to meet their payment obligations, BaFin is also responsible for preventing money laundering abuses and terrorist financing. To effectuate its broad mandate, BaFin has sweeping powers of investigation and intervention. Most significantly, BaFin is authorized to wind up institutions whose continued existence poses a threat to financial stability.

Despite these widespread powers, BaFin failed spectacularly at detecting and taking timely enforcement action on the now infamous accounting scandals at Wirecard, a German payment processor and financial services provider headquartered in Munich, Germany, where €1.9 billion went “missing” from the company’s accounts in Singapore.  Although Wirecard’s unique business structure, merging banking and non-banking operations, made its accounts harder to compare with its contemporaries, BaFin’s shortcomings are nonetheless particularly glaring here where both short sellers and whistleblowers provided major early warning signs about the fraud.  In 2016, under the pseudonym Zatarra, anonymous short sellers published a dossier of documents accusing Wirecard of money laundering.  Three years later, further allegations of fraudulent activity were brought to public attention via Financial Times (FT) investigative journalists Dan McCrum and Murphy whose reporting was based on sources who were Wirecard whistleblower insiders like Pav Gill. Rather than address Wirecard’s wrongdoing, however, BaFin unwisely opted to strike back against the FT for its articles by investigating the FT for market manipulation and declaring a two-month ban on the short selling of Wirecard shares.  BaFin’s rationale for this action was Wirecard’s “importance for the [German] economy” and the “serious threat to market confidence” that the shorting of Wirecard stock posed.  Four years after the anonymous short sellers Zatarra first leaked the documents exposing Wirecard, BaFin finally took action against Wirecard in 2020 by filing a criminal complaint against Wirecard to the police for misleading investors.

BaFin’s mishandling of the Wirecard scandal prompted an investigation by the European Securities and Markets Authority to address its supervision and enforcement of financial reporting, while back home earlier this year, the German Finance Minister announced a seven-point reform package aimed at improving BaFin’s response to tip-offs about fraud, including a commitment to take whistleblower tips more seriously.  Most significantly, BaFin has created a novel new unit called the Market Contact Group (MCG), affiliated with its whistleblower office, which acts as a designated and dedicated line of communication with hedge funds and short sellers to flag potential wrongdoing and prevent the next Wirecard.  Hedge fund and short seller whistleblowers can submit information anonymously via BaFin’s electronic system, enabling BaFin to constantly monitor and act upon allegations, rather than ignoring and silencing such tips (which BaFin was accused of doing during the Wirecard scandal). The anonymity of the electronic submission system provides a welcome channel for short sellers and hedge fund owners who place themselves at greater risk by flagging such accounting irregularities and inconsistencies.

BaFin’s steps to affirmatively recruit and embrace short sellers as whistleblowers with its newly dedicated Market Contact Group is a silver lining of the Wirecard scandal.  The U.S. Securities and Exchange Commission (SEC) would do well to follow BaFin’s lead and affirmatively signal that it too welcomes short seller whistleblowers.  The Dodd-Frank SEC whistleblower program was inspired by Harry Markopolos, the prototypical whistleblower outsider who warned the SEC’s Boston office of the Madoff scandal from his vantage point as an investment advisor, not a Madoff insider.  The SEC’s Office of the Whistleblower, in announcing rewards to whistleblowers, has frequently noted when the payment is to a whistleblower outsider when recognizing the whistleblower’s assistance.  Despite this history, the SEC historically has been neutral on the role of the particular breed of whistleblower outsider who is the short seller.  Short sellers like Muddy Waters’ Carson Block, Gotham City Research’s Daniel Yu, and Hindenburg Research’s Nathan Anderson, to name a few, have demonstrated the vital information that short sellers can provide securities regulators in exposing fraud and protecting investors.  It is high time that the SEC took a page from BaFin’s book and rolled out the welcome mat for short seller whistleblowers.

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