Lecture # 44
• "Bankers who hire money hungry
geniuses should not always express
surprise and amazement when some
of them turn around with brilliant,
creative, and illegal means of making
money." “The quotation is from a speech
by the financial thriller writer on the
Psychology of Risk, Speculation and
Fraud, at a conference on EMU in
Amsterdam.
Baring Bank
• Barings Bank collapsed when one
of the Singapore based employees
of London's Barings Bank, Nick
Leeson, lost £827 million (US$1.4
billion) - primarily on futures
contract
speculation.
Leeson's
actions led the oldest merchant
bank to default on its debts.
• The bank's collapse is considered a
pivotal turning point in the history of
banking and has become a
textbook example of accounting
fraud.
Internal auditing
• The way that Barings Bank's
activities
in
Singapore
were
organized between 1992 and 1995
enabled
Leeson
to
operate
effectively without supervision from
Barings Bank's head office in
London.
• Leeson acted both as head of
settlement operations (charged with
ensuring accurate accounting) and
as floor manager for Barings'
trading on Singapore International
Monetary Exchange (SIMEX).
• Normally the positions would have
been held by two employees. This
concentration of functions placed
Leeson in the position of reporting to
an office inside the bank which he
himself held. Several observers,
including Leeson, placed much of the
blame on the bank's own deficient
internal auditing and risk management
practices.
Corruption
• Because of the absence of
oversight, Leeson was able to make
seemingly small gambles in the
futures market at Barings Futures
Singapores (BFS) and cover for his
shortfalls by reporting losses as
gains to Barings in London.
• Specifically, Leeson altered the
branch's
error
account,
subsequently known by its account
number 88888 as the "five-eights
account," to prevent the London
office from receiving the standard
daily reports on trading, price, and
status.
• Leeson claims the losses started when
one of his colleagues bought contracts
when she should have sold them. By
December 1994 Leeson had cost
Barings £200 million but he reported to
British tax authorities a £102 million
profit. If the company had uncovered his
true financial dealings then, collapse
might have been avoided as Barings had
capital of £350 million
Kobe Earthquake
• Using the hidden "five-eight account,"
Leeson began to aggressively trade in
futures and options on SIMEX. His
decisions routinely lost substantial
sums, but he used money entrusted to
the bank by subsidiaries for use in their
own accounts. He falsified trading
records in the bank's computer systems,
and used money intended for margin
payments on other trading.
• Barings Bank management in London
at first congratulated and rewarded
Leeson for what seemed to be his
outstanding trading profits. However,
his luck ran out when the Kobe
earthquake sent the Asian financial
markets into a tailspin. Leeson bet on
a rapid recovery by the Nikkei Stock
Average which failed to materialize.
Discovery
• Appointed
administrators
began
managing the finances of Barings
Group and its subsidiaries on 26
February 1995. On 26 February, the
Board of Banking Supervision launched
an investigation led by Britain's
Chancellor of the Exchequer.
• The Chancellor released his report
on 18 July. By 27 February, Leeson
had cost the bank £827 million. The
collapse itself cost the bank another
£100 million.
• Barings
Bank
auditors
finally
discovered the fraud, around the
same time that Chairman Peter
Barings received a confession note
from Leeson, but it was too late.
Leeson's activities had generated
losses totaling £827 million (US$1.4
billion), twice the bank's available
trading capital.
• The Bank of England attempted a
weekend bailout but it was
unsuccessful. Barings was declared
insolvent 26 February 1995. The
collapse
was
dramatic
and
employees around the world were
denied their bonuses.
Aftermath
• ING, a Dutch bank, purchased Barings
Bank for the nominal sum of £1 and
assumed all of Barings liabilities.
Barings Bank therefore no longer has
a separate corporate existence,
although the Barings name still lived
on as Baring Asset Management. BAM
was split and sold by ING to Mass
Mutual and Northern Trust in March
2005.
Nick Leeson fled Singapore but was
arrested in Germany and extradited
back to Singapore, where he was
convicted of fraud and imprisoned for
six years. Upon release, he wrote an
autobiography, Rogue Trader, covering
the events leading up to the collapse.
A film maker later dramatized the book
in the film Rogue Trader.
Black Wednesday
Classical Corporate
Scandal in Europe
• In British politics and economics, Black
Wednesday refers to 16 September 1992
when the Conservative government was
forced to withdraw the Pound from the
European Exchange Rate Mechanism
(ERM) due to pressure by currency
speculators—most notably George Soros
who made over US$1 billion from this
speculation. In 1997 the UK Treasury
estimated the cost of Black Wednesday at
£3.4 billion.
• The trading losses in August and
September were estimated at
£800m, but the main loss to
taxpayers arose because the
devaluation could have made them
a profit. The papers show that if the
government had maintained $24bn
foreign currency reserves and
• the pound had fallen by the same amount,
the UK would have made a £2.4bn profit
on sterling's devaluation (Financial Times
10 February 2005). The papers also show
that the Treasury spent £27bn of reserves
in propping up the pound; the Treasury
calculates the ultimate loss was only
£3.4bn.
The Currency
Speculators'
Attack
• The fundamental sterling problem in
September 1992 was that the dollar was
rapidly
depreciating
against
the
deutschmark. Tied as it was to the
ERM,
the
pound
was
hence
appreciating to unsustainable levels
against the US currency. With a large
proportion of British exports priced in
dollars, a pound/dollar correction was
well overdue.
• ERM membership was preventing
this from happening. In anticipation
of the inevitable dam-bursting,
speculators hastened the process
by borrowing pounds (and also lire)
and selling them for DM, in the
expectation of being able to repay
the loan in devalued currency and
to pocket the difference.
• On
September
16
the
British
government announced a rise in the
base interest rate from an already high
10% to 12% in order to tempt
speculators to buy pounds. Despite this
and a promise later the same day to
raise base rates again to 15%, dealers
kept selling pounds, convinced that the
government would not stick with its
promise.
• By 19:00 that evening, Norman
Lamont,
then
Chancellor,
announced Britain would leave the
ERM and rates would remain at the
new level of 12%.
• EU economists' analysis of this
event
concluded
that
stable
exchange rates are the result, not
the cause, of a common approach
to economic management, resulting
in the Stability and Growth Pact that
underpins ERM II and subsequently
the Euro single currency.
Treasury Bond Scandal
• In 1991, Salomon was caught
submitting false bids to the U.S.
Treasury by Deputy Assistant
Secretary Mike Basham, in an
attempt to purchase more Treasury
bonds than permitted by one buyer
between December 1990 and May
1991.
• It was fined 290 million dollars, the
largest fine ever levied on an
investment bank at the time,
weakening it and eventually leading
to its acquisition by Travelers
Group. The scandal is covered
extensively in the book Nightmare
on Wallstreet.
• After the acquisition, the parent
company (Travelers Group, and
later Citigroup) proved culturally
averse to the volatile profits and
losses caused by proprietary
trading, instead preferring more
slow and steady growth.
• Salomon suffered a $100 million
dollar loss when it incorrectly bet
that MCI Communications would
merge with Sprint instead of
Worldcom. Subsequently, most of
its proprietary trading business was
disbanded.
• For some time after the mergers the
combined
investment
banking
operations were known as Salomon
Smith Barney, but reorganization
has renamed this entity as Citigroup
Global Markets Inc. The Salomon
Brothers name, like the Smith Barney
name, is now a division and service
mark of Citigroup Global Markets.
Sandstorm report
• In March 1991, the Bank of England
asked Price Waterhouse to carry out
an inquiry. On June 24, 1991, using
the codename "Sandstorm" for BCCI,
Price Waterhouse submitted the
Sandstorm report showing that BCCI
had engaged in "widespread fraud
and manipulation".
Support of terrorism
• The Sandstorm report, parts of which were
leaked to The Sunday Times, included
details of how the Abu Nidal terrorist group
had held accounts at BCCI's Sloane Street
branch, near Harrods in London. Britain's
internal security service, MI5, had signed
up two sources inside the branch to hand
over copies of all documents relating to
Abu Nidal's accounts. One source was the
Syrian-born branch manager, Ghassan
Qassem, the second a young British
employee.
• The Abu Nidal link man for the BCCI
accounts was an Arab based in Iraq
named
Samir
Najmeddin
or
Najmedeen. Throughout the 80s, BCCI
had set up millions of dollars worth of
letters of credit for Najmeddin, largely
for arms deals with Iraq. Qassem later
swore in an affidavit that Najmeddin
was
• often accompanied by an American,
whom Qassem subsequently identified
as the financier Marc Rich. Rich was
later indicted in the U.S. for tax
evasion and racketeering in an
apparently unrelated case, fled the
country, and received a controversial
pardon from Bill Clinton on January 20,
2001.
• Qassem also told reporters that he had
once escorted Abu Nidal, who was
allegedly using the name Shakir
Farhan, around town to buy a tie,
without realizing who he was. This
revelation led in 1991 to one of the
London Evening Standard's bestknown front-page headlines: "I Took
Abu Nidal Shopping."
Closure of the bank?
• On July 5, 1991, the Bank of England
closed down BCCI. Around a million
investors were affected. Amongst the
customers of the bank at this time was
Garrards and Mappin & Webb, the
jewellers responsible for maintaining the
crown jewels and makers of the trophy for
the America's Cup.
• In 1992, United States Senators
John Kerry and Hank Brown coauthored a report on BCCI, which
was delivered to the Committee on
Foreign Relations. The BCCI
scandal was one of a number of
crimes and disasters that influenced
thinking leading to the Public Interest
Disclosure Act of 1998.
• The report found that former Defense
Secretary Clark Clifford and his business
partner Robert A. Altman had been closely
involved with the bank from 1978, when
they were introduced to BCCI by Bert
Lance, to 1991.
• Clifford and Altman testified to the
committee that they had never
observed any suspicious activity. The
federal
government
brought
indictments against Clifford and Altman
and proposed barring them from
banking for life, but did not pursue
Clifford due to his age and
deteriorating health.
• Altman, however, was indicted and
ultimately tried in New York by the office of
District Attorney Robert Morgenthau.
Despite a failure to convict in the New York
trial, Altman nevertheless agreed to be
banned from banking under threat of
prosecution by the Securities and
Exchange Commission.
• The British government also set up an
independent inquiry, chaired by Lord
Justice Bingham, in 1992. Its House of
Commons Paper, Inquiry into the
Supervision of the Bank of Credit and
Commerce
International,
was
published in October of that year.
• Following the report, the bank's
liquidators launched the Three Rivers
vs. Bank of England case, on behalf of
thousands of BCCI creditors who are
suing the Bank of England for its
failure to properly oversee the bank.
• The BCCI creditors sought £850m in
damages, claiming that the Bank of
England was guilty of misfeasance in
public office. The case collapsed in
November 2005, with the Bank of England
seeking to re-claim legal bills. The cost of
the case to the creditors could be as high
as £100m
• However, in 2002, Denis Robert and
Ernest Backes, former number three of
Clearstream, described as a "bank of
banks" which practices "financial clearing",
discovered that the BCCI had continued to
maintain its activities after its official
closure,
with
"microfiches"
of
Clearstream's illegal unpublished account