1995. Barings Bank collapses, owing millions in futures contracts run up by now infamous 'rogue trader' Nick Leeson in Singapore. 2001. Enron collapses, its true financial position finally exposed, despite years of dubious accounting practices. There are intriguing commonalities between these two high profile collapses. This essay will argue that it is the very fabric of Western business culture which provides the opportunities for, and indeed encourages, the very problems that can result in such corporate failures.
The story of Nick Leeson and the Barings collapse is presented in the 1999 film 'Rogue Trader'. Based on Leeson's 1996 autobiographical account of the same name, the film was adapted for the screen and directed by James Dearden. It stars Ewen McGregor as Nick Leeson, and Anna Friel as his wife Lisa. The film follows the Barings story, from Leeson's original foray to Jakarta to sort out a piece of bank drudgery, to his promotion to trading in futures in Singapore, during which he ran up enough losses, hidden in the notorious 'Error Account 88888', to completely bring down Barings, and to land him in trouble with the Singaporean authorities. He was eventually sentenced to 6 ½ years in a Singapore jail for fraud, forgery and breach of trust.
For Nick Leeson, the losses really began with a mistake by Kim Wong, a new recruit, costing 20,000 pounds. While he disclosed this to his superior, Simon Jones, instead of closing the position and taking the loss as he had been instructed, he decided that he could trade out of it. This failed, and he in fact trebled the loss the next day. Because he had already told Simon Jones that he had dealt with it, he elected not to confess that he had actually made it worse. Instead, he hid the losses in 'Error Account 88888'. Leeson planned to trade out of the loss, but in fact it just got bigger. However, he remained convinced that he could remedy the situation, counting on the Nikkei increasing. It didn't.
While Leeson was sitting on his losses, hoping for the Nikkei to go up, the Kobe earthquake struck. This sent the Asian markets, including Singapore, into a tailspin. His position worsened drastically. However, Barings' Singapore operation accounted for about 40% of the Singapore market, so Leeson began to hold positions and to buy up to try and keep the market buoyant, or it would have completely crashed, and the losses would have been even more massive than they already were. When Barings finally collapsed, so did the Singapore market. However, there were more factors in the collapse than this outline seems to suggest.
To be able to grasp the way that Barings fell down, we need to know something about the futures market. This is what Nick Leeson worked in, in Singapore. As we are told in the film, futures is about making a contract to sell something that you don't yet own, then trying to buy it cheaper than your contract price, in order to fulfil the contract by a set time. Even to those of us with such a rudimentary understanding of the futures market, it is clear that this would be exceedingly risky. However, while Leeson was more than aware of the risks of the business, Chairman Peter Baring was concluding that 'it was not actually terribly difficult to make money in the securities business' (Leeson, 1996), as it turned out, a serious misjudgement.
Interestingly, despite being known as a power company, Enron had their fingers in a vast number of pies. They had evolved from trading energy to trading in the futures and derivatives market, like Barings (Chihara, February, 2002). Furthermore, the recent Allied Irish Bank (AIB) scandal also centred on the futures market. This raises many questions about firstly, the viability of the market, and secondly, whether management are properly assessing the risk, and monitoring activities. Nick Leeson (February, 2002) himself has expressed his opinion that companies involved in futures trading seem to lack any concern for making thorough checks on the operation of this aspect of their business.
But Barings was not merely on a trajectory created by Leeson and the futures market. The bank itself was borrowing heavily to finance the Singapore operations. Barings management believed so strongly in the profitability of the futures market that they failed to notice that if they were borrowing massively, then it was doubtful that they were actually making a healthy profit. A similar situation occurred in New Zealand in the heady years stock-market wise, during the 1980s. During the stock market boom in the first part of the decade, many people borrowed heavily, at massive interest rates, convinced that their share portfolios would not only pay back the loans, but also generate a profit. When the stock market collapsed in 1987, large numbers of both companies and individuals were bankrupted. Barings highly leveraged position was an obvious contributor to its collapse, and Enron was also in a similar financial position.
The financial problems at Barings and Enron would have been picked up much sooner if proper auditing had occurred. The 1995 inquiry into Barings' collapse concluded that 'the true position had not been detected prior to the collapse by the external auditors…' – despite such things clearly being the job of auditors. We are shown this in the film – an auditor is sent out and Leeson is particularly worried due to her reputation as harsh and thorough. However, she is recalled back to Europe on other business, and Leeson rejoices as two much softer auditors are sent in her place. They of course fail to detect the real situation.
The outside auditors of Enron, Arthur Andersen, are currently under legal suspicion for their signing off on Enron's flawed books. David Hilzenrath (2001), in a post-Enron analysis of the state of the auditing system has pointed out four major issues. Firstly, accounting firms make more from other business than they do from auditing. A positive audit has the potential to generate further business with the company, so things may be overlooked in pursuit of this. Klinger and Sklar also discuss this issue, concluding that 'Arthur Andersen was not willing to jeopardize $27 million is consulting contracts by blowing the whistle' on problems discovered during auditing. They go on to say that this sort of situation is common, with high profile companies such as Motorola, Apple Computers and Nike contracting the same accounting firm as both auditors and consultants, with over 90% of their accounting expenditure going on the latter. With this sort of conflict of interest, it is increasingly unlikely that the audit is going to pick up on any problems. The second of Hilzenrath's points is that many auditors follow a career path that eventually leads them into the companies they have audited. This can lead to oversights when former colleagues carry out the audit. Thirdly, client confidentiality has been used to avoid taking responsibility for auditing issues. So, when the auditors themselves are questioned about their work, they simply hide behind their clients' rights to privacy. And finally, auditing fees are often paid in advance, effectively becoming an incentive to 'get in and get out', rather than do a thorough investigative job. Unless this system is overhauled, there is no guarantee that any independent audit is actually presenting a fair and accurate picture of the financial state of the company, and we will continue to be surprised when seemingly successful companies like Enron and Barings collapse.
The forgery that Leeson was jailed for came when he fabricated documents to meet the demands of an outside auditor. In the film he states that 'this was forgery… and there was no going back'. But it begs the question, why didn't the auditor ask for the original documents? While we definitely don't expect people we interact to be dishonest, we can't just automatically rule it out either. Universities and government agencies ask for originals or verified copies because of those very reasons. Surely it is not illogical for auditors, who are employed (at least in theory) to pick up on dishonesty and dubious dealings, to take the same precautions.
Certainly, businesses such as Barings and Enron operate in a regulated environment. Companies are expected to submit reports showing their accounting practices, get their accounts checked by independent auditors, as well as the many rules, both legal and institutional, surrounding the ways they go about their operations. SIMEX, the Singapore Monetary Exchange, had numerous rules regarding the practice of participants on the trading floor. Barings was certainly not exempt from these. However, Nick Leeson was able to work his way around these, primarily through use of the error account.
Leeson's ability to wriggle his way out of meetings, and answering direct questions about the Singapore finances is also highlighted in the film. He treats the London office as a 'cash cow' for the Singapore operation, always managing to avoid the questions of his London financing contact, Brenda. While this is an individual 'talent', it is also symptomatic of flaws within the management of the organisation if they are unable to elicit simple business information from their employees. Furthermore, it calls into question the efficacy of such rules and regulations, when management are unable to use them to hold their employees accountable.
Like the vast majority of businesses, Barings was concerned with expenditure. If something wasn't seen as worth the expense, then the expense wouldn't be made. In terms of the Singapore operation, they did this in two ways. Firstly, they made Nick Leeson the manager of both the trading floor and the settlements office. Because he not only actively traded, but did the accounts at the end of the day, this put him in a conflict of interest position, providing him with the opportunity to hide his losses. Secondly, Barings, through Simon Jones, encouraged Leeson to hire inexperienced, youthful staff, because they would not require high pay packets. This backfired, in particular with Kim Wong, because her lack of experience led directly to her trading mistake.
An Issue constantly reinforced in the movie, is the pressure on Leeson and other Barings staff to achieve their bonuses. If they could show a healthy profit, then they would receive a large cash bonus. We see in the movie that Leeson plans to hold on until 'bonus day', and this is exacerbated by pressure from his wife. This played a role in his hiding of the real situation, because he knew that if it came out, he would lose his bonus. A similar situation was happening at Enron. Klinger and Sklar (April, 2002) point out that incentives such as bonuses and share packages encouraged Enron executives 'to cook the books and overstate profit for personal gain'. They point to US companies Computer Associates, Tyco, and Citigroup as examples of similar incentives at work, and to the widespread nature of the problem. While no-one can blame corporations for attempting to provide motivators for their staff, a completely financially based system is really just setting up the situation for abuse.
In western Capitalist culture, we are constantly told that money is king. Money is the main motivational carrot for managers, and profits are the main measurement of success. It is a culture where the truth will be held back if it has negative financial implications. Nick Leeson was promised an ample bonus if he produced an ample profit for Barings. This pressure to show a profit, in order to keep his own bonus led to him hiding large losses, and eventually to Barings' collapse. Enron executives also received bonuses if the company made substantial profits. Andersen protected their valuable consulting business with Enron by not reporting serious issues with the company's books. In a culture of greed, we virtually encourage these things to occur. We are driven by profit to the point where dishonesty becomes an inherent factor in the work environment.
Aside from the financial side, there were also issues within the organisational culture. The character of Ron Baker functions in the film to show us that Nick Leeson was the beneficiary of a 'hero' culture at work in Barings, as he is frequently shown propounding Leeson's apparent virtues to higher Barings executives. Leeson was praised and held up as exemplary of the sort of success that a dedicated and talented worker could achieve. The upper echelon of Barings management were so carried away by what they saw as his success, that they failed to question how and why he seemed to be doing so well.
The same sort of culture was evident in the case of Enron, although the hero worship instead originated at national government level. Puscas (February 2002) in his analysis of the Enron collapse states that 'few in [government] power … wanted to listen while [Enron] were flying high'. The symptom of problems with the business environment that this points to is a success hang-up. Businesses and governments get so hung up on success that they fail examine the circumstances behind it. Further, when it seems that the success is merely an illusion, they are reluctant to listen.
A similar case also occurred in New Zealand. During April, the news media was full of stories regarding Sovereign Yachts. In 2001, the government sold this Canadian based company ex-military land at Hobsonville. Political fanfare included Helen Clark and Jim Anderton lauding the development as a jobs and export earnings boon, and even being involved in the opening of the Hobsonville outfit. However, it has since come out that the director of the company has in fact been prosecuted in Canada for insider trading, and that the company is heavily in debt with legal action looming. Furthermore, promised jobs have not materialised at all. But despite this obvious lack of success, the government continue to claim that Sovereign is an exemplary company (Small, 2002).
It would be extremism to blame everything on the system. There is certainly a personal quotient. The system may provide opportunities for abuse, but it is up to the individual to take them. Otherwise, absolutely everybody would be a Nick Leeson. In Leeson's case, he made the decision to try and trade out of a loss, instead of disclosing it. His work situation was further exacerbated by the situation on the home front. This is depicted in the film, with Leeson under pressure from his wife to achieve his bonus. Furthermore, when she suffers a miscarriage, he takes it hard. He declares that, in his emotionally distraught state, 'I didn't care how much money it took. I was going to go for broke'.
But just because it is a personal decision to take the opportunities for abuse that the system presents does not mean we should take responsibility away from it. Until the situation changes, there will be plenty more stunning collapses. Barings and Enron are only the tip of the proverbial iceberg. They are the ones who got caught out. This doesn't mean they are the only ones who have been engaging in questionable business practices. And unfortunately, this doesn't mean that there will be change either.
The Western business environment, in conclusion, has inherent flaws. These flaws include a culture of greed and heroism, conflicts of interest, questionable accounting practices, the lack of 'honest' audits, and few thorough monitoring systems. In conjunction, these problems provide ample opportunities for abuse. This results in such spectacular failures as Barings and Enron. Nick Leeson may ever be remembered as the 'rogue trader', but without a business environment that allowed, if not encouraged, his behaviour, he would just have been a 'guy who got fired'.
references
BBC News, (February 2002). Leeson Blames Chiefs for Trader's Losses. [online] available at http://news.bbc.co.uk/hi/english/business/newsid_1806000/1806095.stm
Chihara, Michelle; (February 2002). Top Ten Things You Need To Know About Enron. [online] available at http://www.alternet.org/story.html?StoryID=12326
Hilzenrath, David; (December 2001). After Enron, New Doubts About Auditors. [online] available at http://www.washingtonpost.com/ac2/wp-dyn?pagename=article&node=&contentId=A58165-2001Dec4
Internet Movie Database, (1999). Rogue Trader. [online] available at http://us.imdb.com/Title?0131566
Klinger, Scott; and Sklar, Holly; (April 2002). Titans of the Enron Economy: The Ten Habits of Highly Defective Corporations. [online] available at http://www.ufenet.org/press/2002/Enron.pdf
Leeson, Nick (1996). Rogue Trader. Warner Books: London.
Puscas, Darren (March 2002). A Guide to the Enron Collapse. [online] available at http://www.policyalternatives.ca/publications/enron.pdf
Small, Vernon (April 2002). MP Says Super yacht Builder an Inside Trader. [online] available at http://www.nzherald.co.nz/storydisplay.cfm?thesection=news&thesubsection=&storyID=1442270&reportID=57034