The Wirecard AG case has shown that an overhaul of the current system of auditing and financial reporting enforcement is needed. On 7 October 2020, the Federal Ministry of Finance presented the federal cabinet with an action plan, which it developed in cooperation with the Federal Ministry of Justice and Consumer Protection.
The goal is to eliminate any deficiencies in financial reporting enforcement, to strengthen the independence of auditors, increase their liability for misconduct, and to improve internal controls in companies and safeguards against financial reporting manipulation. To implement the action plan’s measures swiftly, the Federal Ministry of Finance and Federal Ministry of Justice and Consumer Protection will shortly present corresponding draft legislation.
Fundamental reform of the financial reporting enforcement system
The Federal Financial Supervisory Authority (BaFin) will be given further powers of intervention vis-à-vis the companies concerned: in future, BaFin will have sole responsibility for all ad-hoc and suspicion-based inspections. These inspections by BaFin will be financed by the companies concerned.
The German Financial Reporting Enforcement Panel (Deutsche Prüfstelle für Rechnungslegung, DPR) will continue to be responsible for carrying out spot checks and routine inspections. However, BaFin will have the right to obtain information from the DPR and the DPR will have to report to BaFin on a regular basis.
Improving the work of auditors
The independence of auditors in relation to their clients and the quality of audits will be enhanced, so that investors, consumers and all other market participants can rely on financial statements and annual financial statements that have been audited. This will be achieved using three levers:
- Rotation mechanism: Auditors will be obliged to move on from a client after 10 years at the latest in order not to become blinkered to possible shortcomings. This already applies to listed banks.
- Separation of auditing and consulting: A far-reaching ban on providing companies with both auditing and consultancy services will prevent financial and other conflicts of interest.
- Increasing liability: Auditors’ civil liability for breaches of duty will be increased in order to improve the quality of auditing activities. In cases of gross negligence, auditors will have unlimited liability. The liability limit for slight negligence will be increased from the current maximum of €4m to €20m.
Strengthening internal financial reporting
In future, all listed companies will need to have an appropriate and effective internal control system and a corresponding risk management system. Furthermore, the supervisory boards of companies that are public-interest entities will be obliged to establish audit committees.
Enhancing the quality of stock-exchange listings
In future, stock exchanges will be obliged to publicise the imposition of sanctions and be able to exclude issuers from the quality segments more easily if they violate regulations, e.g. in the case of insolvency. Enhanced admission criteria will thereby apply to companies wishing to trade in the qualified market segments of the stock exchange.
Harsher penalties for violations of financial reporting regulations
Criminal and administrative offence provisions with regard to financial reporting will be tightened in order to prosecute and penalise cases of fraud more effectively. False assurances regarding financial statements will thereby become a criminal offence and providing deliberately false information will be punishable with up to five years’ imprisonment. Penalties will become harsher in a number of other ways, too, and administrative fines will be increased, for example for breaching reporting obligations through negligence.
Strengthening BaFin with new internal rules
Employees of BaFin will be largely prohibited from privately trading in financial instruments in order to allay any concerns regarding the independence and impartiality of BaFin. For example, it will be strictly forbidden for BaFin employees to privately trade in shares of DAX companies or banks in the EU. Trading in other financial instruments will continue to be subject to a disclosure obligation.
More powers of intervention for BaFin
BaFin will be given direct powers of intervention vis-à-vis companies to which important banking functions have been outsourced. Outsourcing is common practice in the financial sector but can sometimes lead to risks that are hard to identify. In future, these risks will be easier for BaFin to identify and control.
Improving investor and consumer protection
For investments in precious metals and gold, it will be necessary to publish a comprehensive prospectus for investors. Business models in which precious metals are invested and then released with interest at the end of the investment term will be categorised as investments. This means there will be an obligation to publish a prospectus, and other investor protection provisions will also apply. This will also enable BaFin to clamp down on unfair practices more effectively.
Strengthening the Financial Intelligence Unit (FIU)
When it comes to preventing and combating money laundering, the FIU plays a key role as the central agency that receives all suspicious transaction reports. It will now have the right to retrieve certain basic tax data by automatic means, and thereby be able to prevent and combat money laundering even more effectively.