Barings was one of the oldest merchant bank of England, stretching back to the days when it had took part in the financing of the Napoleonic Wars. It was also the banker for the Royal Family.
Nick Leeson, the rogue trader, betted on Nikkei 225 futures contract, apparently in the wrong direction especially after the Kobe earthquake took place.
He was not allowed to keep open positions overnight. He was not allowed to trade options, apart from being a broker on behalf of 4 clients.
By Dec 1994 accumulated and concealed losses amounted to some GBP 208 mil (approx SGD 478 mil in today’s terms).
He concealed his trades as matched trades and in profit as he was able to manipulate both the front and back office.
He requested extra financing from London, without much suspicion as the London office big shots were largely out of touch with control on derivatives trading.
The events brought the collapse of Barings in 1995. It became insolvent and was sold to ING for nominal 1 pound sterling, ING assumed all the liabilities of Baring.
Test of internal controls – whether its really working. Both internal and external auditors should be very concerned about the proper functioning of controls which is fundamental to the operations of Financial Institutions.
Management supervision – was it working? There was absence of oversight – the fact that Leeson was allowed to control both trading and settlement at the same time without London interference was a big mistake.
Lack of understanding of the derivative trading business and the risks that it entails. Management should be properly selected for the roles that they play, proper qualifications and experience is required for such high risk business.
Segregation of Duties – lack of segregation of duties between front and back office. He was in full control of the auspiciously named “88888” trading account.
The importance of the internal audit function.
Advances to clients was not properly checked as to the validity of the transactions, they were actually used to pay Simex for margin top ups. Had auditor / finance checked properly against client records or reconciled with client through confirmations and properly reflected statement the losses might have been revealed earlier.
Considerations by Auditors:
~ Auditors have to document and test the actual system of control that is being operated and not based on management claims. Adequate sampling and testing of funding request would have revealed the fraud.
~ Professional scepticism – auditors have to probe deeper when there are tell tail signs that something is amiss. Internal auditor from London provided no major issues during their visit Aug 1994. The interim audits should have been more rigorous, as reconciliations to trading client account could have revealed something was adrift.
~ Supervision – Auditors should pay more attention to the level of management competency with regard to management’s reputation and ability to manage the business that they are in, they should be on top of things.
~ Its clear that segregation of duties is fundamental to any internal control system.