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Why was the True Position not Noticed Earlier?


13.10 In 1992 Peter Norris, as Chief Operating Officer of BSL, started to introduce additional controls into the relatively uncontrolled environment then prevailing at BSL. This process continued under his direction when BSL and BB&CO were combined to form IBG (subsequently BIB), of which he was designated Chief Executive Officer. Even so, as late as 1995, it appears that the objective of imposing a satisfactory level of controls had not been achieved within BIB. The Chairman of Barings plc, Peter Baring, described the failure of controls with regard to BFS as "absolute". We agree. It was this lack of effective controls which provided the opportunity for Leeson to undertake his unauthorised trading activities and reduced the likelihood of their detection.
13.11 We consider that those with direct executive responsibility for establishing effective controls must bear much of the blame. We identify below the ways in which, we have concluded, they failed to discharge this responsibility; and how others at lower levels of management were also at fault for failing to act effectively in relation to their own responsibilities.
13.12 As set out in paragraph 1.70, a number of warning signs were present which, had they been properly addressed, should have caused Barings to detect the the unauthorised activities of Leeson and tne losses that they were generating. This did not happen, mainly because individuals in a number of different departments failed to face up to, or follow up on, identified problems; and because there was inadequate communication between departments and between individuals.

Lack of segregation of Leeson's duties

13.13 The fact that Leeson was permitted throughout to remain in charge of both front office and back office at BFS was a most serious failing. Witnesses whom we have interviewed on this point agreed that the need for a separation of responsibilities was fundamental. Tony Hawes, the Group Treasurer, had relatively early on (in February 1994) identified this as unsatisfactory. He subsequently made his views known to James Baker, prior to James Baker's internal audit of BFS undertaken in July/ August 1994. Although the internal audit did not unearth the existence of the unauthorised activities, the internal audit report did make specific recommendations as to the separation of roles. These recommendations were never implemented.
13.14 At the 1ocal operational level Jones (who had responsibility for Barings' operations in Singapore and was a Director of BFS) seems to have taken no significant steps to give effect to the recommended segregation of duties; even though in his management response to the report he had stated that with immediate effect Leeson would cease to perform certain functions and that he (Jones) would ensure the adequate supervision of all settlement and recording processes. We consider that this failure to put into effect his management response to these recommendations in the internal audit report was reprehensible. Further, Bax (Director of BFS and Regional Manager of South Asian Region) failed to concern himself with, or check as to, the implementation of the internal audit report.
13.15 The internal audit report was circulated widely among management in London and was generally acknowledged as important. Copies were seen by (among others) Norris, Chief Executive Officer of BIB; Geoffrey Broadhurst, Group Finance Director of BIB, who had personally taken an active role in the drafting of the report; Ian Hopkins, Director of Group Trasury and Risk of BIB; Geoffrey Banett, Chief Operating Officer of BIB, and Ron Baker, Head of FPG. Yet by February 1995 nothing had been done to implement the recommendations of the report as to the segregation of duties. Most of those who received the report said that considered that it was the responsibility of others (and particulary Singapore management) to implement. We consider, however, that management in London was not justified in simply assuming that these recommendations would be acted upon. The points raised by the report on segregation of duties were of such importance that we consider that it was necessary for checks to have been made to ensure that they had been implemented. But there was no internal conununication in this respect, and the necessary steps to give prompt effect to the recommendations were not taken. It is significant that when Tony Railton, Futures and Options Settlements Senior Clerk of BIB, was eventually send out to Singapore in February 1995, the discrepancies caused by Leeson's unauthorised trading were uncovered within a relatively short space of time.

Supervision of BFS

13.16 Leeson was not properly supervised.

13.17 Leeson's back office functions were never effectively monitored; and to the extent that there were other staff in the back office in Singapore they were relatively junior and it would seem, simply obeyed Leeson's instructions. The matter was compounded by the fact that Jones concerned himself primarily with the affairs of BSS and devoted little attention to BFS. Bax took no steps to ensure that the appropriate degree of supervision and internal control was in place. Thus BFS was operated almost entirely by Leeson alone.
13.18 This lack of supervision was reflected in the failure on the part of Jones to deal satisfactorily with the letters of SIMEX to BFS of 11 january 1995 (marked for Jones'attention) and 27 January 1995. These letters were important. The letter of 11 January 1995, which referred to account '88888', queried the accuracy of information provided by BFS relating to certain margin requirements, complained of the lack of information and explanations in the absence of Leeson and referred to a possible violation of SIMEX rules by BFS's financing the trading margins of clients; yet Jones did not send a copy of this letter to Barings in London at the time and essentially left it to Leeson to draft the response. The letter of 27 January 1995 sought an assurance of BFS's ability to fund its margin calls; and, although a copy of this was sent (by Bax) to Barings in London, it should have caused Jones to investigate why such a letter had been sent and to check that adequate answers to it were given, especially in the light of the letter 11 January 1995 received some two weeks earlier.
13.19 The lack of supervision of BFS extended elsewhere. The Head of Financial Products Group in BSL, Fernando Gueler, who was based in Tokyo and was experienced in the operation of Japanese marquets, accepted that he had responsibility for analysing the risk on Leeson's intra-day trading activities from 1992 until the last quarter of 1994 (thereafter Walz had principal responsibility). He did not have a clear understanding of the extent of the supervision which he was to have over BFS's trading activities, and has disputed that he was responsible for supervising Leeson's switching activities. Whatever the precise position was as to his responsibilities in this regard, knowing as at BFS's trading activities were not properly supervised he should not have allowed this lack of proper supervision to continue. We also consider that he should have questioned with management the high reported profitability of the switching activities before he actually did so in October 1994. Further, although they had responsibility for the financial products traded on a proprietary basis within BFS, neither Ron Baker nor Walz checked properly on BFS's trading activities. This unsatisfactory position was made worse by the fact that reporting lines with regard to Leeson were not clearly understood; there were no clearly laid down reporting lines for Leeson through the management chain to Ron Baker; and there was also uncertainty as to whether Ron Baker reported to George Maclean or Norris.
13.20 Nor did senior management in London address the position adequately. Norris had identified Jones as being extremely difficult to manage within the matrix structure of organisation which had been introduced by 1993. Indeed, Norris had formed the view in 1993 that Jones should be replaced; although, in the event, he decided not to do so, mainly because he did not want to cause any upset for Bax. It was also the case that Broadhurst and Jones were barely on speaking terms. We express no sriticism in principle of a matrix structure , but such a structure can only work effectively, especially in a global operation, with tight controls, with a clear understands of individual responsibilities and with managers at the 'hubs' communicating effectively. This did not happen in the case of BFS and, given the perception which senior management of BIB had of Jones (which was that he was a poor communicator and that he undertook little involvement in the affairs of BFS, as opposed to BSS) the risk of a failure of operational controls relating to BFS should have been recognised and acted upon at an early stage.
13.21 A further significant failing was that Barings did not control the high level of BFS 'switching' positions by the use of gross limits or otherwise (and notwithstanding the fact that James Baker had made a recommendation that this be considered in the internal audit report) . This was imprudent. The responsibility for this lay with Ron Baker (as Head of FPG), Walz (as Head of Equity Financial Products), Hopkins (as Director of Group Treasury and Risk) and Norris (as Chief Executive Officer). In addition, Ron Baker and Walz should have taken more vigorous steps than they did to require Leeson not to increase, and where possible to reduce, his positions in accordance with the decision of Asset Liability Committee on 26 January 1995. In fact, Leesonís positions increased after that date.

Funding of BFS

13.22 The manner in which Barings in London funded the trading of BFS was wholly unsatisfactory. Evidence given to the inquiry indicated that Leeson regarded Barings in London as the 'cash cow'. Significant US Dollar amounts were regularly remitted through BSL's client account by way of 'top up' to BFS without any clear understanding on the part of Barings' management on whose behalf those monies were to be applied, and without any real demur. This level of funding became ever higher, both in absolute terms and in terms relative to the authorised 'switching' activities. At the time of the collapse the balance of the 'top up' payments exceeded £ 300 million.

(1) Settlements and Treasury

13.23 There was no clear understanding as to whether or to what extent the sums requested by BFS were for client trading or for house trading, in consequence the true position was not reflected in the accounts. The-Settlements Department was simply not able to reconcile the 'top up' payments as loans to clients; and yet that is how the payments seem to have been considered (to the extent that the matter was thought about at all) by most of senior management. The request by BFS to Barings in London were, for the most part, acted on without question. Brenda Granger, Manager of Futures and Options Settlements, BIB, was concerned that she could not reconcile the payments as loans to clients; and was concerned that BSL's client account might be funding house trading. owever, she failed to raise her concerns with Tony Gamby, Director of Settlements, or to ensure that those problems which she had identified were appraised by him. Granger further appreciated that inadequate information for the funding requests was being provided by BFS which could not be verified. She should have had a proper understanding of what these large advances actually represented and for what purpose they were being paid before they were authorised (mainly by her) to be paid. Gamby knew that Granger was authorising payments by SWIFT to BFS, only part of which were recoverable from London clients. He was also aware that Granger had expressed concerns about the flow of information coming from BFS. We consider that Gamby, as Director of Settlements, should himself have taken steps to understand what these payments to BFS actually represented and for what purpose they were being paid. Yet neither Gamby nor Granger took sufficient steps to address the position.
13.24 Granger mentioned her concerns about the lack of reconciliation and about the inadequacy of information provided by BFS to Tony Hawes, Group Treasurer. Tony Hawes had by the end of 1993 himself realised that there was a lack of reconciliation. This issue was eventually (by the autumn of 1994) raised by Tony Hawes with Hopkins. Hopkins told us that he was extremely concerned about it. Furthermore, James Baker (who had himself previously had the point mentioned to him by Tony Hawes) in his internal audit report had recommended a review by Group Treasury of BFS's funding requirements. Yet no effective attempt was made, whether by Hopkins or Tony Hawes or anyone else, to follow up these concerns and recommendations and no prompt and detailed investigation was undertaken into the precise basis for the funding of BFS. Nor was there any significant attempt to consider the Group position taking into account the funding of BFS by Barings both in London and in Japan.
13.25 The upshot was that nothing was done (by the Settlements Department or Treasury Department) properly to respond to the problems identified, in spite of the increasing level of funding and the inadequate details provided by BFS in its requests for payments.

(2) Credit

13.26 There was no system in place to ensure that the credit aspects of this funding were reviewed. Although there were clear credit implications if the sums were indeed considered to be advances on behalf of client, the Credit Committee did not pay attention to the growth in the advances as recorded on the balance sheets. Tony Hawes was, from late 1993 to August 1994, responsible for BSL's credit unit: knowing that the 'top up' payments were not reconciled to client records, while believing that they represented loans to clients, he should have assessed the credit implications. Hopkins, as Director of Group Treasury and Risk from 23 August 1994 with responsibility for credit matters relating to BSL until the end of 1994, recognised that there were weaknesses in the credit department. By the autumn of 1994 he was also aware (having been told by Tony Hawes, as noted above) that there was a lack of reconciliation to client records of the advances to BFS. We consider that Hopkins and Tony Hawes both have responsibility for the credit failings in this respect. Maclean, as Chairman of the Credit Committee, believed that BSL gave credit to clients in a way which the credit department of BB&CO would not have accepted: we consider that, as Chairman of the Committee, it was his responsibility to ensure that proper details about what he understood to be advances to clients were put before the Committee for their consideration. Johnnie Russell only became Head of Credit of BIB on 1 January 1995, but his appointment had previously been announced in August 1994; and he had increasing involvement with BSL's credit department during 1994 and had formed the view that there were shortcomings in it. It was unfortunate that he did not promptly address these shortcomings within BSL from 1 January 1995.

(3) Financial Controls

13.27 There was a failure of financial controls with regard to the 'top up' payments. There should have been a proper understanding of what the large advances as shown on the weekly balance sheets (of which the advances to BFS were, in fact, a major component) actually represented and for what purpose they were being paid. Maclean, as Head of Banking; Barnett, as Chief Operating Officer; Broadhurst, as Group Finance Director (and who had, moreover, agreed with an initial recommendation in an earlier draft of the internal audit report that margin call reconciliation procedures for BFS should be introduced); and Tony Hawes, as Group Treasurer share responsibility in this regard. In addition, Broadhurst and Tony Hawes should have checked that adequate verification of the requests from BFS was being undertaken. Indeed, if it was considered that these advances were advances to clients, there should have been a detailed assessment of the question of charging clients for the costs of the advances, or at the very least, of the cost to Barings of making such advances.
13.28 Norris was aware of a continuing debate about the level of funding of BFS and of the 'switching' activities as a whole. We consider that he must, as Chief Executive Officer, take some responsibility for failing to acquaint himself with the position and to make enquiries as to the precise basis of funding being provided to BFS or as to the reconciliation to underlying records of the sums advanced.

Level of reported profitability of BFS

13.29 There was no sufficiently informed assessment as to how BFS could generate such large (reported) profits from activities perceived to be essentially risk free (being matched 'switching' activities). Given the very high level of reported profitability, this was a serious failure. This issue of the profitability of the 'switching' activities was of such significance that it ought to have been given much more detailed and critical assessment than it received. Yet there was no informed analysis or appraisal of the issue; indeed, to the extent that queries were from time to time raised about it they seem to have been answered without any thorough investigation. We consider that the responsibility for this rests with the highest level of management within BIB, including Tuckey, Norris, Maclean, Barnett, Hopkins, Ron Baker and Broadhurst; and ultimately must be shared by Peter Baring, as Chairman of Barings plc.
13.30 Neither Ron Baker (with responsibility, as Head of FPG, for Leeson's proprietary trading from the end of 1993), nor Walz (as Head of Equity Financial Products and having responsibility for risk for Equity Financial Products) had, in our view, any real understanding of the nature or true profit potential of BFS's apparent trading activities; and even while they expected Treasury to fund BFS's ever increasing requirements, they failed to familiarise themselves with what Leeson was doing or to exercise a sufficient degree of supervision over BFS's trading activities. Moreover, neither Norris, as Chief Executive Officer, nor Maclean, as Head of Banking (of which Division FPG became part), took sufficient steps to satisfy themselves that Ron Baker had proper management control over BFS's trading activities.

Implications of the SLK receivable

13.31 We consider that the incident communicated by Coopers & Lybrand (Singapore) to London by the beginning of February 1995 of the alleged receivable from Spear Leeds Kellogg in the sterling equivalent of around £50 million - which the information now available indicates to be a spurious transaction - required much more prompt and firm action by senior management in London and Singapore than it received.
13.32 There was no clear understanding in London of what had actually happened, but we were told that the matter was regarded at the time as very unusual. On one version of events (known at least to Broadhurst by the beginning of February 1995) Leeson appeared to have involved BFS, in some way, in trading or broking an OTC option transaction - which would have been an unauthorised activity for BFS. On another version of events, known to Norris, Maclean, Barnett and Ron Baker, among others, there had been an 'operational error' (as it was called) within BFS, whereby a payment had in December 1994 wrongly been made to a third party. It is the case that the money was reported as having been repaid on 2 February 1995. But the potential implications were that BFS either had engaged in an unauthorised activity (in the form of OTC option broking or trading) or, at all events, had somehow been involved in the erroneous payment of a very large sum. In operational terms the matter was, on any basis, very serious; and there were obvious risk and large exposure reporting implications. When Hopkins was told of the matter on 6 February 1995 he expressed, serious concerns; and circulated a note on 10 February 1995 for Management Committee, including (among others) Norris, Barnett and Maclean, which referred to the error as being an incorrect payment relating to an OTC option broked by BFS. But that note by Hopkins was not given the attention which it deserved. It is the case that Tony Hawes went to Singapore on 6 February 1995 to look into this matter, among other things; but this was only part of the purpose for his visit and neither he nor anybody else was requested to establish as a matter of urgency exactly what had occurred. In consequence, Tony Hawes had not concluded his report on that point prior to the collapse.
13.33 Because of the obvious seriousness of the matter, the confused and unsatisfactory information available to management in London at the time required an urgent and detailed investigation. Broadhurst and Norris in particular, and also Ron Baker, Maclean and Barnett, should have ensured that the necessary urgent steps were taken to ascertain precisely what had happened.
13.34 As to management in Singapore, Jones and Bax should have taken more effective steps than they did to ascertain the precise circumstances of what they understood, by the beginning of February 1995, to have been an unauthorised payment by BFS relating to an OTC option trade.

13.35 The appreciation by certain members of management that there were very unsatisfactory features relating to this transaction is, we consider, illustrated by the fact that Broadhurst (at the request of Norris, who had himself been so requested by Bax) asked C&L London that no reference to this transaction be made in the auditors' management letter for BFS. We consider that it was inappropriate for Broadhurst, Norris and Bax to have caused such a request to be made, which was done with a view to attempting to avoid potential problems with the regulators of BFS in Singapore.

Market concerns in 1995

13.36 There were, therefore, by the beginning of February 1995, features which should have alerted management to the existence of potential problems within BFS. It was also the case that there were rumours in the market concerning Barings' very large position on OSE, and possible client problems, which were known to management in London in January 1995. Indeed, queries were raised at a high level from reputable sources, and even included a query on 27 January 1995 from the Bank for International Settlements in Basle. These rumours persisted in February 1995.
13.37 While management of BIB may initially have been justified in taking no steps with regard to these market concerns, given their perception that the positions in respect of the 'switching' activities were fully matched, nevertheless we consider that at the beginning of February 1995 it would have been appropriate for steps to have been taken to investigate the foundation for them.

13.38 By the beginning of February 1995 the incident of the SLK receivable had been communicated to London - which at the least suggested that there had been a serious operational error within BFS and which remained unexplained. It was also the case 31 January 1995 the letter from SIMEX dated 27 January 1995 had been sent to that indicated that SIMEX was seeking an assurance of BFS's ability to fund margin calls at short notice if market conditions should become adverse. Moreover, the fax of 3 February 1995 from Bax drew attention to the fact that Leeson was, in fact, still in charge of both trading and settlement operations of BFS. As Tony Hawes and Railton had gone out to Singapore and were there by 6 February 1995, there was every opportunity to require them to check whether there was any foundation for these market concerns and whether (by reference to BFS's own records) the positions on OSE were indeed fully matched.
13.39 Given all this, we consider that the basis for the rumours should have been more vigorously investigated at the time; and Norris, as Chief Executive Officer, and Ron Baker and Walz as being in charge of Leeson's proprietary trading, should have taken steps to verify that the positions were indeed fully matched.

Reporting to regulators

13.40 In consequence, to a considerable extent, of the lack of understanding of BFS's trading activities, the lack of reconciliation to client records of the funding provided by Barings in London to BFS and the lack of verification of the (false) information provided by BFS, there were deficiencies and inaccuracies in large exposure reporting to the Bank. The 'top up' payments to BFS were not included in the large exposure reports to the Bank. Concurrently, these 'top upí payments were not included in the Segregated Accounts Reporting Statements returns submitted to the Securities and Futures Authority (until the return for January 1995, delivered just before the collapse).
13.41 It appears that the question of whether the 'top up' account should be reflected in the large exposure reporting to the Bank was not internally discussed within Barings nor was its very existence drawn to the attention of senior management. It is surprising that it was not raised as an issue for discussion. For if the money was considered to be paid as margin for (unidentified) clients, then it should have raised questions as to whether there were large exposures to particular clients; whereas if the money was considered to be paid in respect of house positions, then it should have raised questions as to the large exposure position to BFS at the solo consolidated level and to SIMEX at the consolidated level. Equally, there is no clear explanation of why the 'top up' account (as substantially reflected in the account maintained by Barings from February 1994 designated BSINGCOLL account) should not, until 31 January 1995, have been reflected in the SARS returns to the SFA, if it was indeed considered that these payments reflected advances for client margin.
13.42 There was, overall, an inconsistency in Barings' approach to these 'top up' payments for regulatory reporting purposes. They were not included in the large exposure reports to the Bank because, apparently, they were considered to represent advances to a large number of clients; but, at the same time, they were not included in the SARS returns to the SFA as advances to clients and, on the contrary, were reflected in the balance sheets submitted to the SFA as amounts due from affiliated companies.

13.43 Barnett and Maclean were the members of senior management principally involved in discussions with the Bank on the large exposure reports. They must share responsibility with regard to the inaccuracies in them, even though they did not know of them. Liz Seal, who, as Financial Controller of BIB from September 1994, signed the reports, and before that, as Financial Controller of BB&CO from November 1993, had responsibility for the BB&CO solo consolidated large exposure reports, failed sufficiently to analyse the information provided to her by BSL for this purpose and failed sufficiently to consider whether the 'top up' payments (of which she knew by the end of 1994) should be included. In addition Broadhurst (to whom Seal reported), although he informed us that he did not see the large exposure reports, should have apprised himself, as the Group Finance Director of BIB, as to the reliability of the systems and sources generating the information needed for such reports. He was also responsible for the accuracy of the returns to the SFA, which he did see. Tony Hawes, given the concerns which he had about the payments to BFS (which had implications for risk and large exposure reporting) failed sufficiently to apprise senior management of his concerns for the purposes of reporting to the Bank and to the SFA. Norris, as Chief Executive Officer, must bear ultimate responsibility for the accuracy of the reports to the Bank and, as Chief Executive Officer and nominated Senior Executive Officer under the SFA's rules, for the accuracy of the returns to the SFA.

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