After Wirecard, Germany’s Proposed Audit Overhaul Worries Finance Executives

The current proposal stipulates that audit firms pay higher fines for wrongdoing and auditors themselves take unlimited personal liability if found grossly negligent. Companies face a mandatory change of auditors in certain cases and are required to rotate audit firms every decade. The draft legislation also suggests stricter supervision of the banking regulator BaFin.

The proposed law, which was drafted in a matter of weeks, comes after the disclosure last June that Wirecard, a once highflying electronic-payments company, had a $2 billion accounting hole. This triggered various investigations into the company, its auditor Ernst & Young, and how regulators missed it. Companies and auditors said they welcome the intent of the proposed law but worry that rules are being made even before investigations into what went wrong at Wirecard are complete.

“In its current version, the draft law contains provisions whose effects are more than problematic,” said Luka Mucic, chief financial officer of German software giant SAP SE.

Mr. Mucic is among 31 CFOs of German companies who sent a letter in February to the government voicing their concerns about some of the clauses of the planned legislation, including the requirement that a company auditor be removed in cases of perceived conflicts of interest. Such instances can occur, for example, when an audit firm reviews a company’s financial statements and another arm of the firm provides nonaudit services such as tax consulting to a company executive, potentially in another country.

“It would make sense to wait for the findings and results before hastily drafting a new law,” said Andrea Bruckner, a member of the executive board at BDO, a professional services firm.

Germany’s auditing landscape looks similar to that of the U.S. and the U.K., with the Big Four companies—Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers—dominating the market. There are several smaller international and local players that are eager to gain market share, but they worry that the proposed rules could hinder them.

CFOs, especially those at companies with dozens of foreign subsidiaries, point to the practical challenges of switching auditors over a perceived conflict of interest. A sudden order to change audit firms while the audit process is ongoing could be very distracting and endanger companies’ ability to present audited financial statements and pay dividends. “I don’t think this is feasible,” said Ralf Thomas, CFO of industrial company Siemens AG.

Mr. Thomas and other executives also fear that the proposed law could result in higher audit charges. If audit firms take on increased liability, as suggested by the proposed law, it could potentially drive up their insurance costs, which could then be passed on to corporate clients.

The changes could result in increased market concentration, with the numbers of small- and medium-size audit firms shrinking, said Volker Krug, the chief executive of Deloitte in Germany. Deloitte is a sponsor of CFO Journal. EY, PwC and KPMG declined to comment for this article.

Some small audit firms say they are considering whether it makes sense to stay in business.

Karl-Heinz Brosent, who heads up German audit firm Greis & Brosent GmbH in Düsseldorf, expects the company’s insurance costs could rise to about €50,000, or roughly $59,337 annually, up from €30,000 annually. “We would either have to raise prices,” or stop offering these services, he said.

Mr. Brosent, who has worked as an auditor for more than 32 years, fears that a potentially unlimited personal liability will deter some people from choosing or continuing with the auditing profession. For the past couple of years, the number of auditors in Germany has held flat at about 14,650 people, according to the association of auditors WPK.

Lawmakers say that the hefty liability clause only applies in cases of gross negligence. But auditors say it could be a matter of semantics. “It is difficult to differentiate between minor and gross negligence,” said Martin Wambach, a partner at Rödl & Partner GmbH, a German audit firm.

Another industry organization, Institute of Public Auditors, suggests that giving auditors more power to assess a company’s corporate governance and adding a compliance-management program could help, said its CEO Klaus-Peter Naumann.

The draft legislation has the support of Chancellor Angela Merkel’s grand coalition of Conservatives and Social Democrats, and could pass without major changes. Some opposition lawmakers have criticized the proposed law as an attempt to redirect attention away from BaFin, which falls under the finance ministry. Olaf Scholz, a Social Democrat who serves as finance minister, is among the candidates looking to succeed Ms. Merkel.

German regulator BaFin is under pressure for its slow response to Wirecard’s growing problems, which became apparent long before the company admitted that its missing funds likely never existed. The German government dismissed the head of the agency earlier this year.

The proposed law, however, extends BaFin’s powers, giving it more oversight over companies’ financial reporting, strengthening its collaboration with market participants, offering more reporting opportunities for whistleblowers and setting up a new data-intelligence unit. BaFin will also be able to conduct its own forensic investigations and work more closely with public prosecutors.

“The proposal strengthens BaFin,” said Florian Toncar, a lawmaker for the Free Democratic Party, one of the opposition parties. However, he pointed to the regulator’s internal silo structure and lack of communication that also led to problems. “You don’t need to change the law to address these issues,” Mr. Toncar said.

Write to Nina Trentmann at [email protected]