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WHY DO GOOD MANAGERS MAKE BAD ETHICAL DECISION?

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What is Ethics?
Simply stated, ethics refers to standards of behavior that tell us how human beings ought to act in the many situations. The behavior that includes respecting human dignity and vulnerable people and keeping them in mind when making decision in

It is helpful to identify what ethics is NOT
 Ethics is not the same as feelings  Ethics is not religion  Ethics is not following the law  Ethics is not following culturally accepted norms.  Ethics is not science

Why Identifying Ethical Standards is Hard?
There are two fundamental problems On what do we base our ethical standards? How do those standards get applied to specific situations we face?

A Framework for Ethical Decision Making
 Recognize an Ethical Issue  Get the Facts  Evaluate Alternative Actions From Various Ethical Perspectives  Utilitarian Approach: The ethical action is the one that will produce the greatest balance of benefits over harms.

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 Virtue Approach: The ethical action is the one that embodies the habits and values of humans at their best. and correct information that is not factual. always appreciate diversity. or if unequally. that treats people proportionately and fairly. • Commitment to excellence – Always do the best you can do.  Fairness or Justice Approach: The ethical action is the one that treats people equally. Integrity – Do what is right. • Trustworthiness – Supply correct information.  Common Good Approach: The ethical action is the one that contributes most to the achievement of a quality common life together. Then Reflect on the Decision Later Ethics Principal • Honesty – Don’t mislead or deceive others. • Loyalty to facility – Avoid conflicts of interest and don’t disclose confidential information. Rights Approach: The ethical action is the one that most dutifully respects the rights of all affected. • Concern and respect – Be considerate of those affected by decision-making.  Make a Decision and Test It  Act. 3 . • Leadership – Lead by example. • Fairness – Treat individuals equally. • Reputation and morale – Work to enhance the facility’s reputation and to improve the morale of employees.

Often they lure ambitious lower level managers by implying that rich rewards await those who can produce certain results—and that the methods for achieving them will not be examined too closely. How can managers avoid crossing a line that is seldom precise? Unfortunately. ill-defined situation and some will conclude that whatever hasn’t been labeled specifically wrong must be OK—especially if they are rewarded for certain acts. most know that they have overstepped it only when they have gone too far. Top executives seldom ask their subordinates to do things that both of them know are against the law or imprudent.FOUR COMMONLY HELD RATIONALIZATIONS THAT LEAD TO UNETHICAL DECISIONS The first rationalization is : A belief that the activity is within reasonable ethical and legal limits—that is. whether deliberately or otherwise. they can seem. How far is too far? Exactly where is the line between smart and too smart? Between sharp and shady? Between profit maximization and illegal conduct? These are some complex issues that a manager has to deal with. their most reliable guideline is an old 4 . But company leaders sometimes leave things unsaid or give the impression that there are things they don’t want to know about. to be distancing themselves from their subordinates’ tactical decisions in order to keep their own hands clean if things go awry. Put enough people in an ambiguous. When managers must operate in murky borderlands. They have no reliable guidelines about what will be overlooked or tolerated or what will be condemned. In other words. that it is not “really” illegal or immoral The idea that an action is not really wrong is an old issue.

principle: when in doubt. you can skimp on maintenance or training or customer service. They must look closely at how results are obtained. A belief that the activity is “safe” because it will never be found out or publicized. Simply increasing the frequency of audits and spot checks is a deterrent especially when combined with three other simple techniques: scheduling audits irregularly. So they try to outperform their peers. We know that conscience does not deter everyone. don’t A belief that the activity is in the individual’s or the corporation’s best interests— that the individual would somehow be expected to undertake the activity. making atleast half of them unannounced and setting up some checkups soon after others. 5 . is often the most difficult to deal with because its often true. The third reason why a risk is taken is belief that one can probably get away with it. leaving unfortunate successors to inherit the inevitable whirlwind. believing that unethical conduct is in a person’s or corporation’s best interests nearly always results from a parochial view of what those interests are. The most effective deterrent for such wrongdoings is not to increase the severity of the punishment for those who are caught but to increase the probability of being caught in the first place. Turning to the second reason why people take risks that get their companies into trouble. and you can get away with it—for a while. Companies cannot afford to be hoodwinked in this way. Ambitious managers look for ways to attract favorable attention. The sad truth is that many managers have been promoted on the basis of “great” results obtained in just those ways. A great deal of the unethical behavior often escapes detection. Some may see that it is not difficult to look remark ably good in the short run by avoiding things that pay off only in the long run. something to distinguish them from other people. For example. the classic crime-and-punishment issue of discovery.

managers should make an example of people who are detected. 6 . A belief that because the activity helps the company the company will condone it and even protect the person who engages in it. or against society itself. Managers must warn employees that a disservice to customers. A good way to deal with these is to ensure that there are strong controls and a well defined code o ethics in place in the organization. and most important of all. Senior executives are responsible for drawing the line between loyalty to the company and action against the laws and values of the society in which the company must operate. cannot be a service to the company. Executives have a right to expect loyalty from employees against competitors and detractors. or against common morality. Top management has a responsibility to exert a moral force within the company. but not loyalty against the law.A trespass detected should not be dealt with discreetly. managers must stress that excuses of company loyalty will not be accepted for acts that place its good name in trouble. Managers should announce the misconduct and how the individuals involved were punished. and especially to innocent bystanders. Since the main deterrent to illegal or unethical behavior is the perceived probability of detection. Finally. These are some justifications that managers give for making unethical decisions.

” can lead to solutions that are less than optimal or even ethically deficient. Unfortunately. the Board of Directors. Ways to guard against oversimplifying and reaching less than optimal solutions to ethical challenges Discuss the situation with other trusted colleagues.“Satisficing” When we are confronted with a complicated problem. However. We simplify. and close to the status quo. The resulting dialogue can improve the quality of your ethical decision making. ethical lapses can occur. they may have a difficult time saying. Mind Game #1: Quickly Simplify . various cognitive processes that leaders often unwittingly employ and which may be called “mental gymnastics” or “mind games” may serve to support and sustain unethical behavior. “No”. We search for a solution that is both satisfactory and sufficient.MENTAL GYMNASTICS BEHIND UNETHICAL BEHAVIOR Decision making can often result in managerial missteps. familiar. my family. Ask them to challenge your decision. Because they want to be liked. We tend to make quick decisions based on understandable and readily available elements related to the decision. called “satisficing. or society as a whole? Mind Game #2: The Need to be Liked Most people want to be liked. even those decisions that involve ethical considerations. this process. our CEO. 7 . ask yourself the following questions: · How would I describe the problem if I were on the opposite side of the fence? · Whom could my decision or action harm? · Could I disclose without reservation my decision or action to my boss. “Satisficing” leads the managerial leader to alternatives that tend to be easy to formulate. Before settling on a solution. when this desire to be liked overpowers business objectivity. most of us react by reducing the problem to understandable terms. Such an overriding desire to be liked can ultimately adversely affect the ethics of people in an organization and thus can decrease the firm’s bottom line. Most significantly.

Such softened characterizations serve to dilute and disguise unethical behavior. The antidote is for leaders to talk straight and to avoid euphemistic labeling or recharacterizing unethical behavior.. 8 . this process merely helps wrongdoers and those associated with them to get away with unethical behavior.One way is to solve this problem is to distance yourself from subordinates (e. while Hardik does it all the time. Mind Game #3: Dilute and Disguise In trying to strike a diplomatic chord. For example. reduce unnecessary socializing) Another successful approach would be to respond warmly and assertively toward employees while still going forward with appropriate but possibly less popular decisions. Regardless of whether people want to be seen as kinder and gentler.g. To avoid this mind game. or “inappropriate allocation of resources” is used to describe what everyone knows is stealing. or just politically correct. Mind Game #4: “Making Positive” The mental gymnastic of comparing one’s own unethical behavior to more negative behavior committed by others serves only to avoid self degradation. Words or phrases such as “helped him make a career choice” are used to describe firing someone. leaders can disguise the offensiveness of unethical acts by using euphemisms or softened characterizations. ask three questions about the comparison: • Am I comparing apples to oranges? • How self-serving is this comparison? • What would three objective observers say about me and my objectivity regarding this comparison? Relativity does not excuse ethical lapses.” Unethical behavior appears more ethical by comparing it to worse behavior. the salesperson who occasionally cheats when reporting his expenses may say to himself. “I do this only a few times a year.

If you think about it in these terms then obviously most people would want to make an investment. if the company just cheated another company out of $50. people may begin to distrust you and/or your judgment. they are taking a risk that they won’t get caught for a short term gain. take telemarketers. if a coworker hears you convincingly lie to a customer then your coworker might think. even to charities. For instance.000.CONSEQUENCES OF UNETHICAL DECISIONS "When a business makes an unethical decision." 9 . "The second level of risk is to your company. Now. ‘Wow. even under unrelated circumstances. not all telemarketers are unethical. then my stealing $50 in office supplies doesn’t seem so bad. For instance. the ones that are have so badly damaged their reputation that the whole industry is tainted. he or she is really good at lying. If you act unethically in one situation then people will assume you might act that way in others. But. "Finally. "The first level of risk is personal…People are always observing other people’s behavior. if you decide to take the risk then you should be aware that you are taking a risk at three different levels. From that moment on. People learn by example. mistrust begins to build. However. being unethical also places your industry at risk. For instance. I wonder if I would be able to tell I was being lied to or not. Consequently. I will absolutely not give out my credit card information. If top management is doing things that are unethical then people might get the message that it is okay for them to do the same.

but others become corrupt -or blind to certain ethical concerns (as the United States was to slavery before the Civil War). Some cultures are quite ethical. But ethics provides reasons for how humans ought to act. but ethics applies to everyone. and may be slow to address new problems. but law can deviate from what is ethical. What is Ethics? Simply stated. it may not be ethical to do it. Ethics is not religion. And just because something is scientifically or technologically possible. children. professionals. Ethics is not science.A FRAMEWORK FOR THINKING ETHICALLY This document is designed as an introduction to thinking ethically. 10 . as some totalitarian regimes have made it. Law can become ethically corrupt. But science alone does not tell us what we ought to do. or an ethical society should be. A good system of law does incorporate many ethical standards. and making our society as a whole ethical in the way it treats everyone. teachers. We all have an image of our better selves-of how we are when we act ethically or are "at our best. Many people are not religious. parents. an ethical government. Most religions do advocate high ethical standards but sometimes do not address all the types of problems we face. Ethics is not following the law." We probably also have an image of what an ethical community. Some people have highly developed habits that make them feel bad when they do something wrong. do as the Romans do" is not a satisfactory ethical standard. It is helpful to identify what ethics is NOT: • • • • • Ethics is not the same as feelings. but many people feel good even though they are doing something wrong. and so on. creating ethical organizations and governments. businesspeople. Feelings provide important information for our ethical choices. Law can be a function of power alone and designed to serve the interests of narrow groups. an ethical business. Social and natural science can provide important data to help us make better ethical choices. Ethics is not following culturally accepted norms. Science may provide an explanation for what humans are like. And often our feelings will tell us it is uncomfortable to do the right thing if it is hard. Ethics really has to do with all these levelsacting ethically as individuals. Law may have a difficult time designing or enforcing standards in some important areas. "When in Rome. citizens. ethics refers to standards of behavior that tell us how human beings ought to act in the many situations in which they find themselves-as friends.

The ethical corporate action. what are they based on? Many philosophers and ethicists have helped us answer this critical question. or science. The Fairness or Justice Approach Aristotle and other Greek philosophers have contributed the idea that all equals should be 11 . shareholders. The utilitarian approach deals with consequences. The Rights Approach Other philosophers and ethicists suggest that the ethical action is the one that best protects and respects the moral rights of those affected. law. to be told the truth. it tries both to increase the good done and to reduce the harm done. and so on-is widely debated. then. some now argue that non-humans have rights. produces the greatest balance of good over harm. On what do we base our ethical standards? 2. accepted social practice. On the basis of such dignity. not to be injured. or. and the environment. the duty to respect others' rights. They have suggested at least five different sources of ethical standards we should use. How do those standards get applied to specific situations we face? If our ethics are not based on feelings. it is often said that rights imply duties-in particular. too. religion. the community. Also. Ethical warfare balances the good achieved in ending terrorism with the harm done to all parties through death. to a degree of privacy. injuries. employees. This approach starts from the belief that humans have a dignity based on their human nature per se or on their ability to choose freely what they do with their lives. they have a right to be treated as ends and not merely as means to other ends. to put it another way. is the one that produces the greatest good and does the least harm for all who are affected-customers.Why Identifying Ethical Standards is Hard There are two fundamental problems in identifying the ethical standards we are to follow: 1. The list of moral rights -including the rights to make one's own choices about what kind of life to lead. and destruction. Five Sources of Ethical Standards The Utilitarian Approach Some ethicists emphasize that the ethical action is the one that provides the most good or does the least harm.

There are still problems to be solved. a public educational system. These virtues are dispositions and habits that enable us to act according to the highest potential of our character and on behalf of values like truth and beauty. This approach suggests that the interlocking relationships of society are the basis of ethical reasoning and that respect and compassion for all others-especially the vulnerable-are requirements of such reasoning. fidelity. We pay people more based on their harder work or the greater amount that they contribute to an organization. Virtue ethics asks of any action. tolerance. This approach also calls attention to the common conditions that are important to the welfare of everyone.treated equally. We may not even agree on what is a good and what is a harm. however. or even public recreational areas. effective police and fire departments. each approach gives us important 12 . Nonetheless. Today we use this idea to say that ethical actions treat all human beings equally-or if unequally. We may not agree on what constitutes the common good. generosity. But there is a debate over CEO salaries that are hundreds of times larger than the pay of others. fairness. many ask whether the huge disparity is based on a defensible standard or whether it is the result of an imbalance of power and hence is unfair. The Virtue Approach A very ancient approach to ethics is that ethical actions ought to be consistent with certain ideal virtues that provide for the full development of our humanity. "What kind of person will I become if I do this?" or "Is this action consistent with my acting at my best?" Putting the Approaches Together Each of the approaches helps us determine what standards of behavior can be considered ethical. We may not all agree to the same set of human and civil rights. compassion. and prudence are all examples of virtues. The Common Good Approach The Greek philosophers have also contributed the notion that life in community is a good in itself and our actions should contribute to that life. Honesty. love. and say that is fair. The first problem is that we may not agree on the content of some of these specific approaches. then fairly based on some standard that is defensible. The second problem is that the different approaches may not all answer the question "What is ethical?" in the same way. integrity. self-control. This may be a system of laws. courage. health care.

can we make good ethical choices in such situations. What are the options for acting? Have all the relevant persons and groups been consulted? If you showed your list of options to someone you respect. Only by careful exploration of the problem. Is there something wrong personally. the more we need to rely on discussion and dialogue with others about the dilemma. who have dignity. What individuals and groups have an important stake in the outcome? Do some have a greater stake because they have a special need or because we have special obligations to them? 5. and hopes for a better life together? Get the Facts 3. the different approaches do lead to similar answers. rights. the situation. Having a method for ethical decision making is absolutely essential. A Framework for Ethical Decision Making Recognize an Ethical Issue 1. When practiced regularly. the method becomes so familiar that we work through it automatically without consulting the specific steps. And much more often than not. We have found the following framework for ethical decision making a useful method for exploring ethical dilemmas and identifying ethical courses of action. Making Decisions Making good ethical decisions requires a trained sensitivity to ethical issues and a practiced method for exploring the ethical aspects of a decision and weighing the considerations that should impact our choice of a course of action.information with which to determine what is ethical in a particular circumstance. What are the relevant facts of the case? What facts are unknown? 4. or socially? Could the conflict. Does the issue go beyond legal or institutional concerns? What does it do to people. The more novel and difficult the ethical choice we face. what would that person say? 13 . interpersonally. or the decision be damaging to people or to the community? 2. aided by the insights and different perspectives of others.

g. what would that person say? If you had to explain your decision on television. society? Common Good Approach: The ethical action is the one that contributes most to the achievement of a quality common life together. Make a Decision and Test It 11. Even if not everyone gets all they want. 10. or if unequally. 9. Which option will produce the most good and do the least harm? Utilitarian Approach: The ethical action is the one that will produce the greatest balance of benefits over harms. a person of courage or compassion)? Virtue Approach: The ethical action is the one that embodies the habits and values of humans at their best. Would you want to become the sort of person who acts this way (e. Then Reflect on the Decision Later 14 . community. 8. 7. would you be comfortable doing so? Act. which of the options is the right or best thing to do? 12.Evaluate Alternative Actions From Various Ethical Perspectives 6. Which option would help all participate more fully in the life we share as a family. that treats people proportionately and fairly. Which option is fair to all stakeholders? Fairness or Justice Approach: The ethical action is the one that treats people equally.. Considering all these perspectives. will everyone's rights and dignity still be respected? Rights Approach: The ethical action is the one that most dutifully respects the rights of all affected. If you told someone you respect why you chose this option.

This can be avoided if a manager thinks about stakeholders and not only shareholders. creditors. a chemical factory whose drainage pollutes the river or sea water due to its effluents cannot stop is operations because it is answerable to its shareholders. customers. which defines the Principle-Agent relationship. Implement your decision. According to the Agency Theory. 15 . But as we know that sometimes it is simply not possible to satisfy all the stakeholders simultaneously. So if we speak in a broader context. suppliers. Hence. if a manager wants to takes good decision he might be forced to make bad ethical choices. How did it turn out for all concerned? If you had it to do over again. a good manager has to take decisions which are in favor of all its stakeholders. Stakeholders can be shareholders. society and public at large. what would you do differently? So why really do good managers make bad ethical decisions? First we need to define what we mean by a good manager. employees. a manager is the agent of shareholders and his objective should be to maximize the wealth of shareholders. For example.13.

as its floor manager at SIMEX (the Singapore International Monetary Exchange). However. He had grown up in the Watford suburb of London. While Leeson’s trading role at BFS was intended to 16 . Germany. It had financed the Napoleonic wars.4 billion) speculating—primarily on futures contracts. Leeson was posted to Singapore and was involved in trading at BFS. After attending university. Leeson’s previous history was never communicated to SIMEX and in his application to SIMEX. Over a course of days. he worked briefly for Morgan Stanley before joining Barings. What really grabbed the world's attention was the fact that the failure was caused by the actions of a single trader based at a small office in Singapore. Nick Leeson. It was founded in 1762 as the 'John and Francis Baring Company' by Sir Francis Baring. the bank went from apparent strength to bankruptcy. lost £827 million ($1. the Louisiana purchase. Barings was the Queen's bank. originally from Bremen. Leeson first started working for the UK firm. The failure was completely unexpected. in 1989 and in early 1992 he applied for registration as a dealer with the Securities and Futures Authority (SFA) in England. The collapse of Britain's Barings Bank in February 1995 is perhaps the quintessential tale of financial risk management gone wrong. and the Erie Canal. Barings Securities Ltd (BSL). The SFA queried BSL on this matter and BSL subsequently withdrew the application.CASE STUDY: BARINGS BANK & NICK LEESON ‘The Rogue Trader’ A Brief history of Barings Bank Barings Bank (1762 to 1995) was the oldest merchant bank in London until its collapse in 1995 after one of the bank's employees. Barings was Britain's oldest merchant bank. The trader was Nick Leeson. about unsatisfied judgement debts against him. the SFA discovered that Leeson had made a false statement on his application form. In April of that same year. Leeson made a similar false statement that no judgement in civil proceedings had ever been entered against him. the son of John Baring.

Barings Futures Singapore (BFS). it gradually changed over time and. not properly document or in physically unacceptable condition. On February 24th 1995. Because the stock market had subsequently declined. his bonus was £115. in order to take advantage of price fluctuations between these two places. in other words. The bank was sitting on GBP 100MM in stock certificates and bearer bonds that were not in deliverable form. he worked in operations. His brief was to employ a group of traders working on the floor of the Singapore International Monetary Exchange (SIMEX). Leeson worked his way through the certificates.000. Leeson stood to personally gain out from this success. it was expected to reach £450. He was voted Best Trader of 1994 by the SIMEX.000. His first task when he arrived was working through a back-office mess in Jakarta. by the end of 1994. Leeson was considered to be one of the major contributors to the profits of the Baring Group. In 1993. and to operate channels of communication between this team and traders operating in Japan. and was not only heralded as a star in Singapore. In 1994.be limited.000 At both firms. but shortly after joining Barings. addressing the problems and making delivery. in Singapore when it opened in 1992. the clients trying to avoid taking delivery—they complained that certificates were in the wrong denomination. In 1994. he single-handedly made estimated earnings of £30 million out of a total of £50 million generated by his department. but also in Barings. he was one of the people Barings took on in their subsidiary. he applied for and received a transfer to the Far East. King Midas of the SIMEX Because he had become a successful specialist in the management of derivatives. he was promised a bonus of £450. nine times his salary and four times his bonus in the year before ! His superiors liked him because 17 . Over a period of 10 months. He proved to be very efficient and became general manager of this subsidiary in January 1993. Many of the stocks had been purchased on behalf of clients.

BSS was having to pay commissions for all its transactions. they not only accepted him. but its volume of futures trading on the SIMEX (today's Singapore Exchange) was growing. it had originally focused on equities. When he applied for a position within BSS. He was now general manager. due to his experience in operations. but no one within Barings' senior management seemed to notice the blatant conflicts of interest. The next step was to purchase a seat and hire traders. However. Leeson's 88888 account had lost a total 18 . Leeson's accomplishments in Jakarta attracted the attention of Barings management. As general manager. He claims that he originally used the 88888 account to hide some embarrassing losses resulting from mistakes made by his traders. He lost money from the beginning. Leeson's job was not trading. de facto head of the back office. he seemed to be a safe bet for the company Barings had maintained an office in Singapore since 1987. The sheer volume of his trading suggests a simple desire to speculate. Leeson started actively trading in the 88888 account almost as soon as he arrived in Singapore. He hid his trading in an unused BSS error account. but they made him general manager with authority to hire traders and back office staff. Without a seat on the exchange. Called Baring Securities (Singapore) Limited (BSS). By the end of 1992. Leeson arrived at BSS in 1992 and started hiring local staff. head trader and. A year later. but he soon took the necessary exam so that he could trade on SIMEX along with his small team of traders. when Barings was not doing very well. Such an arrangement should have rung alarm bells. the 88888 account was under water by about GBP 2MM. Leeson took unauthorized speculative positions primarily in futures linked to the Nikkei 225 and Japanese government bonds (JGB) as well as options on the Nikkei. Increasing his bets only made him lose more money. During this period. this had mushroomed to GBP 23MM. Exactly why Leeson was speculating is unclear. By the end of 1994.financially they also profited from his results. number 88888.

seeking to profit from differences in the prices of Nikkei 225 futures contracts listed on the Osaka Securities Exchange in Japan and the Singapore International Monetary Exchange. If he hadn't been so misfortunate. one is buying something at one market while selling the same good at another market at the same time. Though a person would have bought and sold nearly 200 million. Barings management remained blithely unaware. in arbitrage. Such arbitrage involves buying futures contracts on one market and simultaneously selling them on another at higher price.001. Since everyone tries to take advantage of a price difference on a publicly traded futures contract. however. The market was aware of this and probably traded against him. Nick Leeson hopped on a plane to Kuala Lumpur leaving behind a GBP 827MM hole in the Barings balance sheet. Leeson gambled on the future direction of the Japanese markets.of GBP 208MM. However. the margins on arbitrage trading are small or even wafer thin. By mid February 1995. we probably wouldn't have ever heard of him. On February 23. Consequently. he had accumulated an enormous position—half the open interest in the Nikkei future and 85% of the open interest in the JGB future. Consequently. Prior to 1995. The fact that he was so unlucky shouldn't be too much of a surprise.000. As a trader. Leeson was supposed to be arbitraging. one could buy a futures contract on Nikkei worth $100 million on one day but at the same time sell the same product in Singapore for say $100. 1995 collapse At the time of the massive trading loss. Leeson had extremely bad luck. their profit is only $1. Certainly it would not have bankrupted the bank. 1995. instead of hedging his positions. almost all risks are hedged and the strategy is not very risky. that is 1. If one uses the above example. one could buy $100 million worth of Nikkei 19 . the volumes traded by arbitrageurs must be very large to gain any meaningful profit.000.000 dollars for a 100 million dollar investment. However. For example. he just made consistently bad bets.

Internal auditing Under Barings Futures Singapore's management structure through 1995. In this instance.000. Mr Leeson began doing this at the end of January 1995. 20 . Corruption Because of the absence of oversight.futures contracts then hope that the contract price goes up in future. Leeson doubled as both the floor manager for Barings' trading on the Singapore International Monetary Exchange and head of settlement operations. In effect. Leeson claims the losses started when one of his colleagues bought contracts when she should have sold them. several observers. Leeson reported to the head of settlement operations. Leeson was able to make seemingly small gambles in the futures arbitrage market at Barings Futures Singapore and cover for his shortfalls by reporting losses as gains to Barings in London. to prevent the London office from receiving the standard daily reports on trading. Leeson was able to operate with no supervision from London. placed much of the blame on the bank's own deficient internal auditing and risk management practices. costing Barings £20. After the collapse. Due to a series of internal and external events. Specifically. which shortcircuited normal accounting and internal control/audit safeguards. the Governor of the Bank of England. subsequently known by its account number 88888 as the "fiveeights account". and status. an office inside Barings Bank which he himself held. his unhedged losses escalated rapidly. price. According to Eddie George. In the latter role. The positions would normally have been held by two different employees. Leeson altered the branch's error account. even a percentage change of the price would create 1 million dollar worth of profit or loss. As trading floor manager. including Leeson himself. he was charged with ensuring accurate accounting for the unit.

Leeson had cost Barings £200 million. 21 . collapse might have been avoided as Barings had still had £350 million of capital. If the company had uncovered his true financial dealings then.By December 1994. He reported to British Tax Authorities a £102 million profit.

His decisions routinely resulted in losses of substantial sums. Barings was declared insolvent on 26 February 1995 and appointed administrators began managing the finances of Barings Group and its subsidiaries. As Leeson lost money. but he used money entrusted to the bank by subsidiaries for use in their own accounts. his luck ran out when the Kobe earthquake sent the Asian financial markets into a tailspin.4 billion). The collapse cost another £100 million. However. which failed to materialize. but it was too late this time. What is amazing about Leeson's activities is the fact that he was able to accumulate such staggering losses without Barings' management noticing.Kobe earthquake Using the hidden five-eights account. Leeson needed cash. Discovery On 23 February 1995. Leeson left Singapore to fly to Kuala Lumpur. Leeson began to aggressively trade in futures and options on the Singapore International Monetary Exchange. Barings Bank auditors finally discovered the fraud around the same time that Barings' chairman. Employees around the world did not receive their bonuses. He falsified trading records in the bank's computer systems. By falsifying accounts and making various misrepresentations. and used money intended for margin payments on other trading. As a result. Leeson bet on a rapid recovery by the Nikkei. The Bank of England attempted a weekend bailout. he was able to secure funding from various companies within the Barings organization and from client accounts. but it was unsuccessful. received a confession note from Leeson. he had to pay those losses to SIMEX in the form of margin. Peter Baring. Leeson's activities had generated losses totalling £827 million (US$1. he appeared to be making substantial profits. twice the bank's available trading capital. His 22 .

98007 and 98008. Due to the lack of effective control and supervision. During 1994. and he gave a technical argument related to how the SIMEX collected margin as justification. Why Did it Happen? Industry analysts felt that the fall of Barings served as a classic example of poor risk management practices. Leeson booked GBP 28. fabricated letters and made up elaborate stories to deflect questions from management. While he was secretly accumulating losses in account 88888. the funds would have been needed only temporarily—until the client could make payment. auditors and even representatives of SIMEX. For example. he claimed that he needed funds to make margin payments on behalf of BSS clients.misrepresentations were flimsy at best. there was little incentive for employees to question the unusually high arbitrage profits. but it ensured that Barings employees earned bonuses that year. Leeson continued to ask for ever more funding.5MM in false profits. Another issue was that Leeson was an accomplished liar. Leeson was somewhat of a celebrity within Barings. Leeson got an opportunity to conduct his unauthorized trading activities and was able to reduce the likelihood of their detection. Instead. numbers 92000. If anything. Needless to say. Leeson actively played on people's insecurities. This claim was false. He falsified records. Leeson was able to achieve profits in the arbitrage accounts while placing offsetting losses in the 88888 account. Leeson was viewed as a star trader who was not to be interfered with. By performing futures transactions at off-market prices. Even if the claim were true. It was actually against SIMEX rules for a broker to post its own money as margin for a client. financial and operational control system. Such concerns went largely unheeded. The bank had completely failed to institute a proper managerial. he was publicly recording profits in three arbitrage trading accounts. 23 . This was accomplished through cross-trades with account 88888. This was a staggering profit to earn from futures arbitrage.

matters were allowed to get worse. The firm then chose a number of extreme risk takers. As both Chief Trader and Head of Settlements. Leeson was introduced to the chief executive of Baring Securities. as the ‘red-hot trader’ from Singapore. An analysis by prominent researchers suggests that what Barings did was to respond to the massive changes that were taking place as a result of the ‘Big Bang’ .the de-regulation of the UK financial services market . a ‘shadow’ to themselves. BFS was internally audited. in the form of the highly risky ‘Baring Securities’ operation. After the Baring Group’s failure. An internal audit report specifically highlighted this point. Leeson transacted his fraudulent activities through a special account that Barings said was unauthorised and that they had no knowledge of.by creating as a ‘saviour’. would behave in such a manner. Instead. by taking timely action to prevent it. until February 1995. and his product managers in London. including Leeson. stating that it created a significant risk. as internal controls could be over-ridden. an old established firm of merchant bankers with links to the aristocracy of England. The auditors were concerned at the powerful position that Leeson was occupying. But the Baring Group already knew this. he was in a position to record the trades he had made. in any way he wanted. In the third quarter of 1994. 24 . and nothing was done to remedy the situation. senior management of the company continued to deny knowledge of Leeson’s activities This analysis raises the question as to why Barings. Barings could have averted financial collapse. or should have known. but the inspectors investigating the collapse took the view that they either knew. second to none.The management systems required Leeson to report to both his local managers in Singapore. It was probable that. but this did not work in practice. about it and of the losses incurred through the transactions on that account. to run this operation.

25 . Barings’ senior management either would not. believe it. further. or could not. They continued to support him till the bitter end. failed to understand the responsibility they bore for the events that unfolded. It is events such as these that have focused increasing attention on corporate governance. responsibly and in the best interests of its shareholders and other stakeholders.As the evidence of Leeson’s misdeeds built up. Barings’ directors failed to assess the risks of the strategies that they were employing and. The scale of corporate misjudgement was staggering and the resulting collapse of the firm was spectacular. as a means of ensuring that the Board operate effectively.