There are so many financial scandals. In our series of the biggest financial scandals in recent history, we cross continents, borders, ethnicities, and different industries. Some were financial scandals involving average Joes being scammed out of their hard-earned cash, others involved corporate fraud, insider trading, some of the biggest names on Wall Street and Ponzi schemes. A number of them have even been turned into documentaries and movies, such as the Wolf of Wall Street, Madoff, or the wine trader Rudy Kurniawan. Some scandals involved big names such as Martha Stewart and Bernie Madoff, whereas others are less known to the wider public but had a massive impact on the financial world and corporate governance.
So in our series of the biggest financial scandals, scandal number seven involves the biggest bank collapse before Lehman Brothers. It involves a really ambitious young trader who single-handedly brought down a very reputable bank (if you will, he was the first Jerome Kerviel) and put the queen's bank out of business.
Who was Nick Leeson?
Nick Leeson was a promising trader when he joined Barings Bank in 1981. Extremely ambitious and hard-working, he quickly climbed the hierarchy within the bank. Three years after joining the bank he was put in charge of the futures markets division in Singapore.
At the start of his stint in Singapore, Leeson did indeed prove management right in entrusting him with that much responsibility. He made the bank a substantial amount from futures trading. In 1992, he earned 10% of the bank's annual profit - £ 10 million, thus cementing his standing as a top trader at Barings.
The case of Nick Leeson and how he destroyed Barings Bank
Ever wondered if the Queen of England has her own bank? She did for some time until it collapsed. She didn't own the bank, but it was her personal trusted financial institution. The oldest English bank that the Queen of England entrusted her personal fortune with until Nick Leeson entered the picture and over a span of three years brought the bank to its knees. In fact, not only that, Leeson destroyed the once oldest English bank.
But how did Nick Leeson destroy Barings Bank given that he was so successful in his early years? As it frequently occurs in futures trading gains are followed by losses and vice versa. After losing £ 2 million, Leeson doubled down on his losses. In case you aren't familiar with the double-down strategy, it is simply doubling the amount previously lost in the next bet. For instance, if one were to put £ 1 on red in roulette, only to find that the ball lands on a black number, the gambler would put £ 2 on either red or black in the next round. A dangerous strategy.
For Leeson and subsequently Barings Bank, this strategy meant that he had multiplied his losses from £ 2 million in 1992 to £ 208 million in 1994. In order to hide his losses, Leeson used a so-called error account. An error account is used to track erroneous transactions while the origin of the error is investigated. Once the cause of the error is determined, the transaction is posted to the appropriate account. It thus helps to separate erroneous items from the rest of the transactions. It is thus much simpler to identify the cause and the problem, as one does not need to comb through everything, but only the error items to identify the problem.
Error accounts do not serve as instruments to hide a massive string of trade losses, however. Yet Leeson hid the losses from his speculative trades in this infamous account with the number 88888. Even more intriguing is the fact that he repeatedly asked for money from London to keep the trading business in Singapore afloat. Through numerous fabricated stories, Leeson managed to persuade London for ever more cash to continue trading.
While Leeson pulled off his fraud for years, all was to come to an abrupt end in mid January 1995 when losing a number of short and long bets on the Japanese stock market. But as with most of these fraudulent schemes, such as Madoff, Ponzi, and Kerviel, a catastrophe predated the revelations of all wrongdoings. This time it was an earthquake in Japan. Asian markets dropped 6.6% in one week following the Kobe earthquake. Within the next six months the Nikkei fell by 25%, only to recover all the losses.
Leeson bet on a quick rebound of the Asian stock market following the earthquake. But his long-positions were the last nail to his coffin. On February 23rd, Leeson wrote a note reading merely “I'm sorry” and went on the run. Three days later Barings had to declare bankruptcy with losses amounting to a staggering £ 827 million. An astonishing figure if you think about it being due to one person placing bad trades. Mindblowingly, only a couple of weeks prior Barings' CEO Peter Norris met with Leeson in Singapore to congratulate him on his successes and to tell Leeson that he had earned himself $ 2 million in bonuses.
A few days later after first going on the run, on March 2nd, Leeson was captured at Frankfurt Airport in Germany and subsequently extradited to Singapore. In December 1995, following the events, Leeson was sentenced to 6.5 years in prison of which he spent four and a half years incarcerated. He was freed earlier due to his cancer diagnosis.
Who was involved in the Financial Scandal?
Nick Leeson and many others claim that the bank's management was involved to some extent. Not that the management had done anything illegal, but the claims are that they were negligent in their auditing and risk management. If it had been done properly there were enough signs to ring warning bells and potentially stop the escalation of Leeson's practices and the downfall of the bank.
Victims of the Financial Scandal:
The investors and many employees of Barings Bank. Many of the employees lost their jobs after the bank collapsed and in the aftermath during the takeover by ING. After its collapse, the Dutch bank ING snapped up the remains of Barings for the meager sum of £ 1.0. Yes, you read that right, one single pound sterling. What would not even buy you half a pint today was the value of Barings after Leeson's escapades.
Besides Leeson's former colleagues, it was the investors who were left with nothing, among them many private investors as well as charities. Senior management, however, walked away with a large chunk of a final £ 100 million splash out.