Tag Archives: Nick Leeson

Nobody’s Perfect

stockvault-fortune116480

Barings Bank was the United Kingdom’s oldest merchant bank and the second oldest merchant bank in the world. In 1992, the bank sent 25-year-old Nick Leeson to be the general manager at its new office in Singapore. During that first year there, Leeson made unauthorized trades that earned Barings £10 million in profits. The bank should have had a system where one person was a trader, and another was double-checking and then authorizing these trades. Instead, Leeson did everything with no checks and balances. Yes, these trades were unauthorized, but they made the bank a lot of money and so, instead of nipping the unauthorized trades in the bud, Barings paid Leeson a massive bonus and labeled him a rising star. Things changed very quickly, and Leeson started losing money on his trades. Instead of reporting his losses, Leeson hid them in a suspense account, that he created and tried, unsuccessfully, to recoup his losses. He would then hide those losses in this suspense account as well. By the end of 1994, the losses stood at £208 million. In February of 1994, Leeson left a note stating, “I’m sorry”, and fled Singapore, leaving Barings Bank with £897 million in losses (equivalent to $1.4 billion). Barings Bank could not recover from those losses and, after being in business since 1762, collapsed and was bought by ING for £1.

The story of Barings Bank and Nick Leeson is like one of those puzzles where you circle the ten things wrong in a picture – there are that many problem areas and weaknesses that led to the downfall that we could revisit this story many times for lessons. Today we shall focus on Nick Leeson hiding his bad bets. Initially, Leeson made errors and miscalculations on some trades that he made and lost money from those errors. From some of the accounts from Leeson, it is implied that mistakes were not looked upon kindly. Leeson claimed that he first opened the suspense account in which he hid losses after a colleague lost £20,000 after making an error herself. Instead of either one of them reporting the error, they decided to hide this error from leadership. Nick Leeson then went on to hide more of his trading errors here, thinking, in the manner of a gambler, that he could gain the money he had lost back, and his bosses would never find out what he was doing.

I thought about Nick Leeson this week because I am reading Principles by Ray Dalio. In it, he tells the story of how his employee Ross, who was in charge of trading at the time, forgot to make a trade and that cost the business “several hundred thousand dollars”. Dalio tells us that, with such a costly error, he could have dramatically fired Ross and “set the tone that mistakes would not be tolerated. Instead, Dalio recognized that mistakes happen to us all the time, he himself had made mistakes so large that he had essentially lost his business at some point. Dalio’s approach, which is an approach that I am a huge fan of and have tried to follow for a long time, is to think about what to learn from mistakes and how to improve things to minimize the chances of those mistakes happening again, or at least how to minimize their impact should they occur. As I have written before, Dalio recognized that punishing Ross for his mistake would likely result in other people working hard to hide any errors. Dalio saw that would cost his business a lot more in the long run. At his firm, Bridgewater, Dalio and Ross created an error log where errors were tracked and addressed. Instead of people getting into trouble for making mistakes, they would get into trouble when they didn’t report mistakes.

With Leeson (and Barings Bank) and Dalio in mind and the different outcomes that have resulted from their approaches to dealing with mistakes is very telling. One person brought down the second oldest merchant bank and the other has what is considered to be the fifth most important private company in the United States. Some things to keep in mind when considering how to manage responses to errors in your business:

  • Create an environment where everyone is comfortable reporting errors that they have made. Be explicit with this, both in what you say and how you respond.
  • When you discover a mistake, take the time to look, with your team, into how this mistake might have been avoided or recognized and resolved earlier. An example is, with a missed trade, it is likely that Dalio and his team looked at the process and sought to put in checks to make sure that there were others aware of the trade, checking to make sure the trade was made and having a way to check in with Ross to make sure he had not forgotten.
  • Review your systems to see where there are checks and balances and if especially important areas are not put on one person. Make sure that someone else is checking – we all make mistakes and that is why there is a checking system. Not to make us feel bad about ourselves but in recognition of our humanness.
  • Have open discussions about errors and get input from all levels on how to avoid or detect errors. At the leadership level, you may come up with a system, but you may find that staff find that process cumbersome, don’t stick with it and errors can go undetected for a while. And if an error has not even been detected, it can’t be reported.

These are just a few things to think about but the most important part is creating an environment that is open to communication, not just about success, but about the things that have gone wrong. You should think about making the environment open for the hard conversations the priority because it is simple to report and celebrate success but failure and error are what kill our business. With that in mind, are there situations that you have found yourself in where either you or someone on your team made a mistake? How did you respond, how did others respond, and how did things turn out?

Advertisements
Tagged , , , , , , , , , ,

Sweat the Small Stuff

Image

I was reading The Inner Auditor and came across a couple of articles that got me thinking about fraud and how people get away with it. Successful fraudsters are successful because they are good at hiding. They go to great lengths to keep their fraudulent behaviors under the radar of those who check on the books. As mentioned in the Inner Auditor post, often evidence of fraud is ignored because what is found is a small amount. Ignore at your peril. Ignoring something like this could mean ignoring a large fraud made of many small amounts. Armed with the knowledge that small amounts will fall under the radar of anyone policing the books, a person perpetrating fraud could go undetected by only stealing small amounts at a time. Recently, I was reviewing financial statements and I came across a line item for repairs that was several times higher than it had been in previous years. Curious, I looked into the details of the transactions that made up the account balance. Each invoice in that account, and all invoices were from the same vendor, was for less than $300, below the threshold for more rigorous checking. However, in aggregate, these small invoices came up to almost $10,000 in one month. Yes, that’s more than 33 of these small invoices coming in and, pretty much automatically being paid without anyone batting an eyelid. That’s because no one was checking on the small stuff and because no one was checking, a smart vendor, working under the radar, was benefiting quite richly.

Alternatively, a discovered fraud may be small because the fraudster has only just begun their fraud scheme and is testing the waters. Most frauds start out small and, if they are not discovered, they will grow as the thief grows bolder, greedier or more reckless. If a fraud is ignored because it is small, by the time someone decides to take action the fraudster will have stolen a lot of money. Isn’t it better to nip things in the bud and avoid large losses?

People who defraud an entity and go on doing this, undetected, for a while do so because they have understood the system and its weaknesses. They use this understanding to exploit the system and take what they can. If they know that only invoices of over $500 get looked at closely, they will be sure to keep their fraudulent invoices lower than $500. If they know that separation of duties is not implemented diligently, they will offer to take on the duties that could lead to their detection. So, for example, the person making payments should not be the person reconciling the bank account. If they are the same person, who is going to question suspicious payments that pop up on the bank statement? If they know of a balance sheet account that is not reviewed regularly, they will hide evidence of their fraud in that account. When Barings Bank was bankrupted, Nick Leeson hid over a billion dollars in trading losses in an error account that he knew was barely being monitored. One person, Nick Leeson, bankrupted Britain’s oldest merchant bank because he exploited its weakness. And Leeson started small; the first year that he hid trading losses, the amount stashed away in error account 88888 was $2 million dollars. Once he saw that no one cared to check this account, this amount grew and grew, in just a few years, to the over $1 billion it was when the bank collapsed.

When you spot the small fraud in your company is when it is time to call in a forensic accountant to look into things. If the forensic accountant finds that the fraud is small and has only just begun, then you can breathe a sigh of relief, knowing that you have stopped things before they got worse. I have never heard of a fraudster who has stolen just once. On the other hand a deep dive by a credentialed expert may reveal that there is a lot more wrong than you imagined when you first spotted the small fraud.

Tagged , , , , , , , ,
Advertisements