Rogue Trader Essay
eBARING BANKS THE MOST SHOCKING ALARM BELL ABOUT FRAUDULENT Introduction On February 26, 1995, the oldest British Bank’s declared bankruptcy due to fraud caused the warning bells for many other organizations about the level of danger fraud can cause. Nick Lesson, a guy who comes from a background of the working class, had been working for Royal Bank Coutts, Morgan Stanley for a couple of years until he finally joined the Barings. He was assigned a job in Barings (Jakarta) to sort out a back-office mess that involves about ? 100 million in share certificate.
After successfully completing his job assignment, Nick was transferred to Barings in Singapore to work as a derivative trader for both Singapore and Japan. Nick caused the lost for Barings Bank of almost 1. 4 billion due to the enormous accumulation of trading obligations that he had built up. Nick Lesson thought he could make up the loss by waiting for the market price to go up, but it never happened since the earthquake in Kobe in 1995 was totally out of his plan. Knowing that the bank wouldn’t be able to make up for the loss, Nick ran away with his wife and was caught afterward.
Barings declared bankruptcy in February 1995 and was bought by Dutch Bank for ? 1. In this report, we would like to discuss more about this case based on the COSO Framework to see the bigger picture on how Nick Lesson could commit such a huge fraud and also learn from that mistake. Control Environment • Describe the internal control environment 1. High integrity and ethical behavior: board members and executives didn’t set a consistent example of high integrity and ethical behavior.
For example, in the movie, Nick Lesson as the general manager didn’t practice the ethical behavior and integrity. He told his assistant to create an error account called 88888. Besides, once one of his team members named Kim Wong made mistake that lead to the loss of 20 contracts, Nick helped her to cover up the mistake. 2. Code of conduct: There was no code of conduct written for employees that had been used to communicate adequately. Code of conduct is the set of rules outlining the responsibility for an individual within an organization.
In the movie, for example, all the new employees that Nick recruited didn’t get any appropriate training or taught about the responsibility that they had to take while working for Barings. They even asked Nick about what do they supposed to do and what was their job all about. One interesting thing we found out while doing research is that Nick also didn’t have the trading certificate, so probably he didn’t even understand his responsibility of his job. 3. Performance and incentive compensation: Performance and incentive compensation targets are not reasonable and realistic.
For instance, Jones Simon who was Nick’s immediate supervisor told Nick that he was the bottom line type of guy. We think that that he puts a lot of pressure on Nick for how to make the balance sheet look good no matter what. It’s all about profit. Nick’s immediate supervisor as well as the high executives didn’t really care about the process of how Nick achieved such high profit, but the bottom-line profit itself. Thus, management actually gained incentives that prompt personnel to engage in dishonest, illegal act.
Moreover, rewards, bonuses didn’t foster an appropriate ethical tone but create incentives for employees to act illegally. As mentioned in the movie, Nick got a bonus of 130,000 pounds over the top of 50,000 salaries. 4. Fraudulent financial reporting: It’s not clear that fraudulent financial reporting at any level and in any form would not be tolerated. It depends on the situation and how bad it will affect the organization. In the movie, there’s only one time when Nick was brought to the table due to his inappropriate behavior toward some ladies in the bar.
But he was forgiven due to his accomplishment toward the company. 5. Ethic: ethics were woven into criteria that used to evaluate individual and business unit performance. For example, the girl named Kim Wong who once messed up at the trading floor and when Nick found out about that, he didn’t get mad at her but instead wanted to help her to cover up the mistake. 6. Management reaction: Manager didn’t react properly when receiving bad news from subordinates for example when Simon Jones received letter from SIMEX that Nick has violated the rule by prohibit member financing from trading margin of that customer.
However, after Nick explained to Ron that it was only a customer account number and he will need to take a look at it later, Ron didn’t investigate the case any deeper. 7. Report of noncompliance: when instances of noncompliance are reported, board members and senior executives didn’t take appropriate action and ensure effective action through testing. For example, Simon Jones didn’t take into consideration some suspicious problem that he found out from Nick’s activities such as the 88888 account number and the missing of 7. 89 billion yen.
He believed everything Nick said without doing any check-up on him. Besides, all they care about is the bottom-line profit, so as long as Nick presented to them a huge amount of profit, then they were satisfied. 8. Internal and external information: board members and senior executives didn’t receive internal and external information from accounting and other information system to make informed and timely decisions. Internal auditor was asked to investigate on Nick’s case but she didn’t get a chance to get to the audit due to some emergency calls. 9.
Basic principle control was violated: segregation of duties. Nick were responsible for both the trading floor and the back office settlement. • Risk assessment 1. Business risks: In this case, business risks were identified but managers took it too lightly, so the risks weren’t discussed with the board of directors. Nick was entrusted with too much power so they thought he could handle them as he said. 2. Evaluation of risks: The board and management didn’t properly evaluate risks regarding to new personnel and business activities since they let Nick in charge of the whole team of people that he recruited.
Managers should have recruited employees themselves so they can give them appropriate training for the job and what they are supposed to act when they see illegal action. 3. Control issues when entering new market: The board and manager didn’t discuss and consider control issues when entering new markets since they didn’t take into consideration the distance, as well as how inexperienced the managers are. Thus, when Nick made mistake and they found out, his supervisor Simon Jones wasn’t experienced enough to go any deeper in the case except asking questions and believed in things that Nick explained. . Managing current and new business activities: there aren’t enough sufficient people who are competent and knowledgeable to manage current and new business activities and they haven’t been provided with adequate resources. In the movie, Nick recruited people for his team, but they didn’t know what they were supposed to do until Nick explained to them about their job. Moreover, they weren’t provided with adequate resources to perform their job for example once his assistant asked him about the difference between initial margin and variation margin.
That can prove the fact that she didn’t have enough knowledge for the job. 5. Risk assessment process: the board and manager did involve auditors in the risk assessment process since they asked Ash Lewis to come over, but unfortunately she didn’t have a chance to get to the audit. 6. Other internal control weaknesses that allowed Nick Lesson to engage in fraudulent activities: no segregation of duties, unauthorized trading activities, the lack of understanding on derivative, and poor supervision on employee and lack of senior management involvement allowed Nick to engage in fraudulent activities.
Firstly, there is no segregation of duties in the organization. Nick was responsible for both the trading floor and the back office settlement, so that creates opportunity for him to commit fraud. Secondly, unauthorized trading activities such as signing authority, responsibility for inspection in bank reconciliation, signing off trading reconciliation and managing check also lead to deficiencies of internal control in Barings. Thirdly is the lack of understanding on derivatives. Since nobody really understands how it works, then even if Nick made mistakes, not anyone can tell.
Last but not least is the poor supervision on employees and lack of senior manager involvement. Simon Jones as well as Ron Baker-Nick’s direct boss didn’t give enough attention to Nick’s activities, so they let him pass every time a problem occurred. Besides all the above internal control weaknesses that created opportunities for Nick to commit fraudulent, we think there’s another reason which is he was treated differently compared to other employees. He was given more favor because the manager and board thought he was the key person since he has earned a huge amount of profit for the organization. Control activities 1. Control responsibility: board members didn’t demonstrate that they accept control responsibility and they delegated that responsibility to financial and audit staff. We think the clearest example would be board members didn’t know about the loss of the organization until Nick ran way with his wife. 2. Assigning responsibility: Manager didn’t clearly assign responsibilities for employee training and monitoring of internal control since all they are about is the bottom line profit. Simon Jones – Nick’s immediate supervisor even said that himself. . Systematic evaluation: Periodic, systematic evaluation of controls systems weren’t conducted and documented by personnel with appropriate responsibilities, experience and knowledge. All the documentation and reconciliation bank paper were done by Nick, so there’s no internal control at all here. No one was assigned to check-up on Nick’s work or match up the number. 4. Reporting control deficiencies: Control deficiencies were reported to higher level but no actions were taken. Upper manager knew about the error account number 88888 and also the loss of 7. 9 billion yen but after Nick explained to them that it was customer account and computer mistake, they believed him without questioning any further. • Information and Communication 1. Risk –taking activities: The accounting, information and communication systems failed to ensure that risk-taking in the trading activities in Singapore branch were within policy guidelines. According to the dictionary, “Despite these forms of arbitrage being somewhat risky, they are still relatively low-risk trading strategies which money managers (mainly hedge fund managers) and retail investors alike can employ” (http://www. investopedia. om/terms/r/riskarbitrage. asp#axzz1dnmz818G). Because the arbitrage is a low-risk taking, its profits are supposed to be small too. However, in Baring Bank case, Nick’s trading report was a huge profit, which is unlikely to happen without taking the high-risk equivalence. 2. Information: The management’s objectives in terms of budget, profit, and other financial and operating goals are not well defined. Simon Jones, defined his objectives that “I’m a bottom line kind of guy”, which means he does not care about the actual meaning of the profit, financial or operation goal as long as the balance sheet has profit. . Training/orientation for employees: For the trading team that worked with Nick, none of them was officially training when they start the position. There is only one meeting between the team and Nick, and it was occurred right before they start the work. As Nick said, “My team was young, was hungry, and they have no clue”. 4. Personnel roles in the control system: Not all the personnel understand their roles in the control system. As mentioned above, Nick’s trading team has no clue about what they supposed to do with the job. Therefore, they could not understand well their role.
Everything was passed through Nick. 5. Nick was treated differently than the other employees. Instead of having another person for the trading’s back office position, the manager let him had the full control of the office. And when he committed a misdemeanor, the board of directors was supposed to fire him. But they took the advice of the financial advisors that Nick was a brilliant employee and had contributed for the rocket increasing profit. • Monitoring 1. Level of expertise: Audit personnel possess an appropriate level of expertise.
Ash Lewis is the internal auditor of Barings London. At the first glance, Lewis was able to figure out there was something wrong with the trading office. She even asked Nick to confirm if he really in charged with the dealing desk and the back office. 2. Respond timely: The management did not respond timely to the findings and recommendations of the auditor. Even though the senior managers were reported by the internal auditor that the letting Nick controlled both the positions was highly risky, nothing was done to respond the recommendation. . 4. Conclusion Throughout many years, Baring Bank was known as one of the noble, oldest bank. The collapse of the bank is a lesson that needs to be learnt, in order to avoid the repeating mistake. According to McGraw-Hill publisher, “The fraud triangle is included three important elements that can be present in most fraud: pressure, opportunity, and rationalization” ( ). Related to the Baring Bank case, Nick was under a lot of pressure. Bosses thought he was the “golden boy” of the company. His wife and her family were very proud f his achievement in work. And more importantly, the bonuses for the work were huge. Therefore, he did not want to lose everybody’s expectation. Together with his ego and greed, Nick also had the opportunities to carry out his fraud scheme. The bank was too neglectful to not set up the segregation of duties, so they let Nick alone in charged with both trading floor and back office. Moreover, the lack of understanding and experienced risk managers was the main factors that covered Nick’s fraud for such a long period.
Last but not least, Nick’s rationalization is the thoughts that he already succeeded in covering the first loss, he was confidence that he could do the same for the next one. However, the more fraud he committed to, the deeper he could not recover. In any organization, one person cannot commit fraudulent without the lack of internal control. COSO framework contributes to the analysis of the internal control within organization. The structure is a guideline on which aspect is important that we need to consider while doing the report on internal control. Work Cited