[SOLVED] It was early on a Friday morning

It was early on a Friday morning in London—7:15 a.m. on February 24, 1995, to be exact—that the phone call came for Peter Baring from Peter Norris. Baring’s family had been in banking since 1763. They enjoyed the patronage of the Queen of England and had financed the Napoleonic Wars and the transcontinental railway in Canada. Barings, London’s oldest merchant bank, would soon be owned by foreign interests because of Norris’s news.
Early on the previous day, Norris, the head of investment banking, had been summoned to Singapore by James Bax, the regional managing director of Baring Securities. Its star trader, Nick Leeson, had not been seen since Wednesday afternoon Singapore time, and it appeared that he had left major unhedged securities positions that Barings might not be able to cover. If not, Barings would be bankrupt or owned by others who could pay off what was owed when the uncovered commitments came due.
At the beginning, Barings officials were not sure what had happened or the extent of the potential losses and commitments. When they did discover the nature of their obligations, they realized that the securities contracts were still open so that the upper limit of their losses would not be known until the closing date of the contracts. If the markets involved sank further by that time, Barings’ losses would grow. This was a complete shock because Leeson was sup- posed to deal in fully hedged positions only, making his money on short-term price changes with virtually no chance of losing a significant amount of money. What had happened?
Norris found confirmation of what Bax had told him. Essentially, Leeson had built up two huge securities positions. He had arranged futures contracts committing Barings to buy U.S.$7 billion worth of Japa- nese equities and U.S.$20 billion or more of interest rate futures at future dates. Unfor- tunately, due to the Kobe earthquake in Japan, the Japanese stock market was fall- ing, so the equity contracts were worth less than he had paid, and the projected losses were growing but not yet at their maxi- mum. In fact, it was estimated that every 1% decline in the stock market raised the losses by U.S.$70 million.
When Peter Baring, the chairman of the bank, advised the Bank of England on Fri- day at noon that his bank had a potential problem, he estimated the combined losses at £433 million (U.S.$650 million), a figure that was close to the shareholders’ equity of £541 million. The governor of the Bank of England, Eddie George, was recalled from his skiing holiday in France, and his deputy, Rupert Pennant-Rea, called other British bankers to meet at the Bank of England to pledge funds to help meet Barings’ problem. Prospective purchasers were canvassed throughout Saturday, but the loss estimate rose to £650 million with no cap in sight. On Sunday, several options were pursued, including contacting the world’s richest man, the Sultan of Brunei. The British bankers met again at the bank at 10 a.m., and by 2 p.m. they had agreed to provide £600 million. The question of what their return would be for advancing the money was being debated, but the issue of someone providing an upper cap to the losses remained. An offer arrived from the sultan to do so, which included the taking over of Barings. Unfortunately, this offer was withdrawn before a deal was con- summated, and Eddie George had to sign an Administration Order that essentially put Barings under the administration of the Bank of England. At 10:10 p.m., the Bank of England announced that Barings had failed. Two hundred thirty-three years of steward- ship by the Barings family was over.
One of the prospective buyers, ING, the second-largest insurance firm in the Netherlands, was still interested and had sent a squad of at least thirty people to complete due diligence examinations. ING was particularly interested in assessing the degree of risk of other losses and of the complicity of personnel in the London and Singapore offices in the Leeson problems. And Jacobs, the chairman of ING, agreed to buy Barings for £1 two hours before the Japanese market opened on Tuesday, February 28.

As part of the deal, he agreed to keep the Barings name on the bank. In addition, he subsequently agreed to pay out most of the
£105 million in bonuses that the Barings management had agreed to give its staff two days prior to the famous phone call.
How did this debacle happen? Bits and pieces of the puzzle came out slowly until the Report of the Bank of England’s Board of Banking Supervision emerged. On Tues- day, February 28, Nick Leeson still had not been found, and he would not be detained until he and his wife arrived in Frankfurt on Thursday, March 2, having spent time in Kuala Lumpur and Kota Kinabalu, Malaysia. He would ultimately make a deal to assist investigators but would still be sent back to Singapore to stand trial.
Nick Leeson had gone to Singapore as the head of a unit that traded in futures, and he had prospered. He made money by buying and selling futures contracts for baskets of Japanese stocks known as Nikkei 225 futures. These Nikkei 225 futures contracts were traded on both the Osaka stock exchange and the SIMEX, Singapore’s financial futures exchange. Since the prices on each exchange were slightly different, a sharp-eyed trader could buy on one and sell on the other exchange, making money on the spread. This was relatively safe since for every purchase, there was an immediate sale—if not, Barings would be exposed to very large risks since the transactions were highly leveraged. In 1992, his unit made £1.18 million; in 1993, it made
£8.83 million; and in the first seven months of 1994, it made a total of £19.6 million, or more than one-third of the total profit for the whole group. Nick was a star.
Barings did send out its internal auditors to see that all was well. Although the twenty- four-page report condemned the lack of controls and particularly having one man in charge of both the front (investing) and the back (record-keeping) offices, it was not acted on for fear that Leeson would be aggravated and leave for a job at another broker. Leeson’s profits, after all, provided bonuses for every- one. Even though Leeson’s behavior was get- ting somewhat bizarre, no action was taken.
For example, five months before, he was fined $200 (Singapore) for dropping his pants in a pub and daring a group of women to use his cell phone to call the police.
It appears that his ego and the pressure to make more and more profits pushed him in the direction of more risky investments, and he began to make unhedged transactions in which there was no immediate sale or purchase to offset the initial transaction. As a result, since the market was declining, his transactions required funds to meet margin calls. Since he reported not to Bax but rather directly to the head office in London, he contacted the head office, and £454 million was sent in late January and early February.
Somehow, he had convinced them that his operations were safe—but how? It seems that his ability to control the back office pro- vided him the opportunity to do so. Earlier, when he began to trade heavily, the back office was swamped with transactions that included lots of errors made in the trading pits at the stock exchanges. He had been allegedly advised by Gordon Bowser, former derivatives trading chief, to set up a fictitious account, Error Account No. 88888, to put trading problems through and not to send reports to London so that the auditors would not be aroused. Instead, Leeson used the account as the hiding place for his losses—which totaled £2 million in 1992, £23 million in 1993, £208 million by the end of 1994, and £827 million by February 27— after Barings went into receivership. When the computer reports came off the printer for the fake account, Leeson destroyed them. By happenstance, Anthony Hawes, the treasurer of Barings, visited Singapore. Over a sumptuous lunch on Wednesday, March 22, he told Leeson that he was to get a bonus of at least $2 million (Singa- pore) on Friday, March 24. In addition, he told Leeson that the bank had a new pol- icy of control and that he wanted to review the backroom operation and check the accounting operation. Pleading that his wife was having a miscarriage and needed him, Leeson rushed from a meeting with 1 “Busting the Bank,” The Observer, March 5, 1995, 25.

Hawes on Thursday and left for Kuala Lumpur. He had evidently realized that the jig was about to be up and he would be caught. Later, after he was caught, Leeson’s wife revealed that the pressure for profits had become too much and that he had begun to take more risks. At the end, he was just trying to make back the losses. Before he was caught, Leeson reportedly phoned a friend from his Malaysian hotel and said, “People senior to me knew exactly the risks I was taking. Lots of people knew.… But it went wrong and now they’re trying to lump all the blame on me.”1 Will we ever really know for sure?
Questions
1. How would you deal with a star trader who would be extremely sensitive to additional controls that implied he or she was not trusted or would generate more time on paperwork and explanations?
2. What ethical and accounting controls would you advise ING to institute at Barings?
3. Who was more at fault—top management or Nick Leeson?

Question: It was early on a Friday morning