The implosion of Wirecard, a German online payments company, vindicated the efforts of a small band of hedge funds who had been investigating it for years — but also showed how difficult it is to make money short-selling.
AFI interviewed Dan McCrum, the Financial Times journalist who exposed the Wirecard fraud, to gain his insights into the saga, thoughts on hedge fund short-selling and how to counter the aggressive tactics used by companies under attack.
Here are five key takeaways from the conversation.
- Short-selling is a waiting game
Leo Perry of Ennismore Fund Management in London was one of the first hedge fund managers on the trail of Wirecard and shared research with McCrum as early as 2014. (Ennismore had first bet against Wirecard in 2008, when Perry was still a junior investor).
The firm’s long series of investigations proved costly as Wirecard stock continued to rise. Many short-sellers were forced out of the trade in 2017, when the share price trebled despite a series of negative reports about the company.
Only when Wirecard collapsed in June 2020 did Perry and Ennismore begin to see their bet pay off. The share price halved after EY declined to sign off Wirecard’s accounts after identifying a €1.9bn hole in the accounts.
“There were so many people who couldn’t believe Wirecard wasn’t what they thought it was — an amazing technology company — that the share price didn’t collapse immediately,” said McCrum. “The share price only halved. It was at that point Leo and the other short-sellers sold as much as they could and they finally made money on this campaign that had been raging for years.”
2. Short-sellers are up against more than target companies
The challenges facing hedge fund short-sellers are well-known: cost of borrow to fund trades, infinite losses if a stock rises, short squeeze attacks. Paul Marshall has said short alpha is “regime dependent” since target companies are likely to be carried upwards during bull markets, bringing more pain for shorts.
Wirecard’s growth came in the post-2008 bull market, an environment which certainly helped them. But their cause was also boosted by the attitude of BaFin, the German regulator, which often seemed keener to investigate those looking into Wirecard than the company itself.
In 2019, BaFin, decided to investigate McCrum and his colleague Stefania Palma for market manipulation. Short-sellers were looked into. A two-month ban on shorting Wirecard was arbitrarily imposed. Journalists are one thing, but the market and regulatory environment facing short-sellers can be a minefield.
3. “If you surprise the management, then it doesn’t give them any time to come up with a good lie”
McCrum’s interest in short-sellers was triggered by a meeting in 2011 with Carson Block, founder of New York-based Muddy Waters. Block had just published his now-famous report accusing Sino Forest, a Toronto-listed forestry company, of being a multibillion-dollar Ponzi scheme.
Over beers in California, Block shared the secrets of his trade — and the line about surprising management, so they can’t prepare lies in defence, stuck with McCrum.
Such tactics have given companies attacked by short-sellers grounds to accuse them of driving the share price down and making a quick profit, in some cases of market manipulation.
But the tactic makes perfect sense when you consider some companies have, on occasion, defended themselves to the point of lying.
4. Short-sellers need impregnable technological defences
The story of Wirecard veers into wild territory, particularly when it comes to the aggressive counter-tactics the company deployed against critics. From following and photographing people around London to industrial-level hacking campaigns, it felt to some of the hedge funds and journalists involved like being in a spy novel.
Greenvale Capital in London was among the funds to short Wirecard. Its analyst Oliver Cobb had returned home from honeymoon to phishing emails, purportedly from his new wife, with “wedding photos” which had been taken from social media. The firm was bombarded with emails for months afterwards and replaced all of its technology, not once but twice, to protect data and communications.
On a trip to meet a source in Singapore, McCrum travelled with only a burner phone and an air-gapped laptop which could not connect to WiFi or anything else. In the office, or even at home, he would put his phone in another room when discussing Wirecard.
These examples show the level of precautions that journalists, and indeed hedge funds, must take when conducting their business in sensitive areas.
5. How journalists work with short-sellers
McCrum had to tread a fine line throughout his years reporting on Wirecard to cover the negative research put out by hedge funds without appearing to be acting with concert with them.
Perry and others gave him research but it was down to him and his editors to decide what to run. “I have to verify it myself,” said McCrum. Some of his reporting trips to far-flung Wirecard offices, checking if the reality matched what was described in the accounts, came about at the suggestion of hedge funds.
McCrum has come away from the experience with a high regard for short-sellers, finding their work fascinating. But despite his experience with Wirecard he says such managers must guard against cynicism.
“There is a downside to the short-seller mindset. If you are too cynical and constantly looking for all the bad things that can happen, then you do miss the Microsofts etc, the companies that do keep growing and growing.”
Money Men: A hot start-up, a billion-dollar fraud, a fight for the truth by Dan McCrum is out now.