On this episode of Misfortune: A Financial Crimes Podcast, Adam and Danger discuss Nick Leeson, the derivatives broker who single-handedly brought down U.K’s oldest merchant bank through unauthorized speculative trading.
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Nicholas Leeson was born on February 25, 1967 in Watford, England. After graduating from high school, he began working for the prestigious bank Coutts & Company, then Morgan Stanley before joining Barings Bank in 1989.
Barings Bank, founded in 1762, was the world’s second oldest merchant bank. In 1803, Barings even financed the $15M Louisiana Purchase for the United States.
Nick initially proved to be a valuable employee. He started off working in the Settlements Division of Futures and Options and soon had the opportunity to go to Barings’ Jakarta office
to sort through £100 million worth of unclaimed share certificates. In Indonesia he fell in love with one of his colleagues, Lisa Sims, whom he would soon marry, and together they managed to reduce the bank’s exposure from £100 million to £10 million.
In March 1992, Nick was given the opportunity to set up and run Barings futures trading operation at its Singapore office. He had just turned 25, had no college education or formal training, but was made general manager and head trader. Most notably, as the head trader, Nick was allowed to settle his own trades, something that would normally be done by a second person.
According to Nick, the fraud began in July 1992 when he was trying to cover for a colleague. One of his junior staff members made a trade that lost £20,000. He dusted off a dormant error account numbered 88888 to hide the loss as he figured out what to do.
An error account is designed to hold trades that result from legitimate trading errors such as purchasing the wrong securities, selling instead of buying, etc. If a broker makes a mistake, they are responsible for making the customer whole and they take on any liability from the mistake. Ultimately, the broker is financially responsible for all the transactions stored in an error account.
Within a few days, that loss had grown to 60,000 and he was worried about losing his trading privileges and having to explain why he hadn’t immediately reported the loss in the first place. He continued to hide the loss in the error account and before long started using the account to hide his own losses as well. At the end of his first year in Singapore, Nick was covering up a deficit of £2 million.
Initially, Nick used a combination of clients’ floating funds and even his own commission to cover these losses. However, as the losses grew, he was running out of cash to cover them. He began to disguise these losses as receivables owed by clients. By doing this, he hoped to buy time to sell just enough options by the end of each month, when the bank’s assets and liabilities were reconciled, to cover the loss.
Selling these options meant he was trading with the bank’s money to make up for his losses and hoping they would never catch on. His office was supposed to be trading only on behalf of clients and taking a commission on those trades. The bank did engage in a small amount of proprietary trading, but Nick was not authorized to trade on the bank’s behalf.
Despite this, he began using the bank’s money to purchase and sell Nikkei 225 futures contracts, meaning he was betting on the future performance of the Osaka stock exchange. He made money by recognizing and exploiting the differences in value of these contracts on the Singapore exchange versus the Osaka exchange – he would simultaneously purchase and sell contracts between the 2 exchanges to profit from the difference in price.
However, trading with the bank’s money meant he would need to have enough cash on hand to cover daily payments to the Singapore International Money Exchange, aka SIMEX, which at the time was a futures exchange in Singapore. As Nick explains in Rogue Trader – “Each day SIMEX makes a margin call and requests funds. In a highly complicated calculation, SIMEX demands margin payments to take into account not only any money you’d lost today but also the money you might lose, under normal market conditions, the next day. The contracts in Account 88888 would show up on their screens as a Barings client account, and they would send through a request for a small percentage of the liability, depending upon the market’s volatility.”
This meant Nick had to ask the London office daily to transfer funds to make these margin payments. Amazingly enough, no one at the home office bothered to take a close look at how these funds were being used.
For a while, this worked. In July 1993, one year after he first used the error account, Nick had recovered from a £6 million loss and even made a profit. He should have thanked his lucky stars and stopped at that point.
Unfortunately, he almost immediately began using the error account again. The London office continued to transfer requested funds without question, and the balance in the error account began to once again go from zero to millions of pounds. At the end of 1993, he had lost £23 million, but was credited with more than 10 million in profits – more than 10% of Baring’s profits for that year.
He continued to make increasingly risky unauthorized trades hoping to make back the lost money – but by the end of 1994, his losses had grown to 208 million. He had backed himself into a corner where he wasn’t able to sell any of his options but rather had to keep purchasing futures to prop up the market and keep it within the 19,000 yen range, which was the ideal price for his options. On top of all this, Nick knew that he would need to somehow need to survive Baring’s external end of the year audit.
On January 17, 1995, at 5:46 am local time, the 6.9 magnitude Great Hanshin earthquake struck near Kobe, one of the largest cities in Japan. More than 6,000 people died and the cost of repairing damages was estimated to be more than $100 billion. Not surprisingly, the Asian markets were affected, and over the next few days, the Nikkei fell 1000 points. In the desperate hope that the market would quickly rebound, Nick purchased tens of thousands of futures contracts over the next couple of weeks. He was, single-handedly, trying to make the market rise.
At the end of January, Barings’ auditors, Coopers & Lybrand, sent a status report noting that there was a 7.78 billion yen (about $76 million at the time) receivable from a third party, Spear, Leeds & Kellogg, a New Jersey-based trading firm. This receivable was supposedly a refund of a margin for an option which had expired the previous month – one of many transactions Nick had fabricated.
He managed to duck the auditor’s calls for several days until one day she finally got him on the phone and demanded to see 3 pieces of documentation. She needed confirmation from SLK that the outstanding amount would be paid, a copy of the bank balance the following morning that the money had been received and a note from someone in London that they had approved the original transaction. Nick spent over an hour at the copier forging letters from SLK and his London boss, including cutting up an existing SLK memo and pasting the letterhead and signature onto a new sheet of paper. He called one of his assistants and asked her for the balance in their customer account, which was 3.45 billion yen, and their Citibank house account, which was 1.45 billion. He then asked her to start a transfer from the client account for the missing amount of 7.78 billion to the house account, ask Citibank to immediately send a fax noting the incoming funds, then cancel the transfer. Amazingly enough this worked, and he managed to clear Coopers & Lybrand’s audit.
The following month, however, alarm bells were finally beginning to ring internally. Barings was having cash flow issues, the SLK “receivable” had raised red flags, and the bank sent two London executives to Singapore to investigate. It had been about 2 ½ years since Nick first used the error account for fraudulent purposes.
On February 23, 1995, it was over. The market had fallen below 17,800 and he had lost almost £40 million in one day. That day, 2 days before his 28th birthday, Nick Leeson and his wife fled to Kuala Lumpur. As the news broke the following morning and with all of Malaysia’s law enforcement looking for him, they decided to head back to Europe. They got on a flight to Frankfurt, where Nick was taken into custody upon arrival. He was eventually extradited to Singapore, where he pled guilty to 2 charges of fraud and was sentenced to 6 ½ years in Singapore’s Tanah Merah prison.
In the end, Barings’ losses were estimated to be about £860 million, two times the bank’s available trading capital. The bank was declared insolvent shortly after Nick fled Singapore, and in early March 1995, the Dutch bank ING purchased Barings for the sum of £1.00.
While in prison, Nick published Rogue Trader, his wife filed for divorce and he was also diagnosed with colon cancer and had to undergo surgery and chemotherapy. In 1999, after serving 4 years, Nick was released from prison early for good behavior. He returned to the UK and continued cancer treatment, eventually overcoming it, remarried and received a psychology degree from Middlesex University.
He later said, “I was 25-years-old when I was working in Singapore and I should have turned around and asked for help and advice. And I didn’t. It was my biggest regret.”
- Wikipedia: Nick Leeson
- Rogue Trader by Nick Leeson