The Collapse of Barings

This month marks the twenty year anniversary of one of the biggest financial scandals in British banking history. On the 25th February 1995, Barings, Britain’s oldest merchant Bank collapsed. A trader by the name of Nick Leeson had lost over eight hundred million pounds in unauthorized trading on the Singapore International Monetary Exchange. Despite desperate attempts, Barings was unable to secure a bailout for the business and the company was declared insolvent; at a stroke 1200 people lost their job and over one hundred million pounds was lost by Barings bondholders.

The collapse at the time was unprecedented; how possibly could a single rogue individual bring down such a prestigious financial institution?

The resulting Bank of England report highlighted many failings at Bearings, but some simple and fundamental principles had been neglected.

Segregation of Duties

At the root of the Barings catastrophe was fraudulent behaviour by a rogue individual compounded by the failure of the institution to segregate duties sufficiently within their Singapore office.
In the years prior to the collapse Barings was expanding quickly and Nick Leeson had been put In charge of both the front and back office functions. In normal circumstances best practice would have demanded that these activities should have been segregated, Barings appears to have turned a blind eye to this as a matter of convenience. The seeds of what later transpired had already been sowed.

A lack of Oversight

Leeson was asked to build a team from locally recruited employees, he was only 25 when he went to Singapore; the people who he recruited locally were very junior and inexperienced. He appears to have been well liked by his team and they did not have the experience, authority or confidence to challenge some of the suspicious practices that he was later to be involved in.

Leeson alleges that the spiral of deceit in which he was later to become embroiled was initially driven by the desire to conceal a £20,000 error made by a junior member of his team. The ease with which he was able to conceal this loss started him on a path of increasingly bold deceitful behaviour. Leeson became entangled in a spiral of increasingly loss making trades while at the same time misrepresenting these as impressive profits to head office.

There can be little doubt that the confused and poorly defined reporting line meant there was little effective oversight to what Leeson was doing and allowed him to repeatedly deceive London.

Character Flaws

While Leeson seems to have been regarded as an intelligent individual within the bank it seems from reading his own accounts that his level of maturity had not kept pace with his level of responsibility, his evenings were often characterised by drunkenness and excess. Before he had been in Singapore for long he had been banned from the The Singapore Cricket Club after an altercation in which another member was punched.
Not long after this event, Barings was to learn that their star trader was on a charge of public indecency after another incident in which he had ‘Mooned’ at a group of girls in a bar. Leeson narrowly avoided imprisonment for this offence, if he had been Barings may well have fired him and been saved from some of what later transpired. However Leeson was seen as a top performer within the Bank, his transgression was quietly ignored and after he was released with a two hundred dollar fine he was allowed to continue in his position with the bank. What was not known at this stage was that Nick was already engaged in a spiral of highly risky unauthorised trading and was desperately trying to cover his tracks from internal Audits. Barings was oblivious to the fact that the huge profits that Nick Leeson was reporting were entirely fictitious.

Where did it go wrong?

There were a number of failings in this case:

1) Serious segregation of duties failures. Functions that should have been clearly divided were not. In his dual role in charge of the front and back office he was able to both trade futures and also book and report the various trades. Internal audits had highlighted these risks but they had not been acted upon.

2) Poor oversight. Leeson was essentially operating with no supervision from the London head office.

3) The lack of an unambiguous reporting line. There was a confused reporting line that helped obfuscate Leeson’s fraudulent behaviour.

Developing effective internal controls that can keep ahead of a rapidly evolving business processes is a challenge that all organisations have to take seriously. Segregating functions greatly complicates an individual’s ability to conceal fraudulent behaviour.

Barings were unaware of the personality flaws that might cloud Leeson’s moral judgement. Leeson lied on a frequent basis throughout his employment at Barings to cover his misdeeds. Had Barings had some idea of Leeson’s moral compass they might of considered him a high risk individual.

Since the Bearings scandal there have been at least eleven other known Rogue trader scandals, the most disastrous being the 4.9 billion Euro loss made by Jerone Kerviel in 2008 at Société Générale. Unfortunately it is unlikely that this will be the last example of this behaviour.

Ultimately any organisation has to recognise that people are fallible. Segregation of duties and internal controls are an essential component in the armoury of techniques that protect organisations from rogue individuals.