The management of Barings broke a cardinal rule of any trading operation - they effectively let Leeson settle his own trades by putting him in charge of both the dealing desk and the back office. This is tantamount to allowing the person who works a cash-till to bank in the day's takings without an independent third party checking whether the amount banked it at the end of the day reconciles with the till receipts.
The back-office records, confirms and settles trades transacted by the front office, reconciles them with details sent by the bank's counterparties and assesses the accuracy of prices used for its internal valuations. It also accepts/releases securities and payments for trades. Some back offices also provide the regulatory reports and management accounting. In a nutshell, the back office provides the necessary checks to prevent unauthorised trading and minimise the potential for fraud and embezzlement. Since Leeson was in charge of the back office, he had the final say on payments, ingoing and outgoing confirmations and contracts, reconciliation statements, accounting entries and position reports. He was perfectly placed to relay false information back to London.
Abusing his position as head of the back-office, Leeson suppressed information on account '88888'. This account was set up in July 1992 - it was designated an error account in Barings Futures Singapore system but as a Barings London client account in Simex's system. But Barings London did not know of its existence since Leeson had asked a systems consultant, Dr Edmund Wong, to remove error account '88888' from the daily reports which BFS sent electronically to London. This state of affairs existed from on or around 8 July 1992 to the collapse of Barings on 26 February 1995. (Information on account '88888' was however still contained in the margin file sent to London.)
Error accounts are set up to accommodate trades that cannot be reconciled immediately. A compliance officer investigates the trade, records them on the firm's books and analyses how it affects the firm's market risk and profit and loss. Reports of error accounts are normally sent to senior officers of the firm.
Barings' management compounded their initial mistake of not segregating Leeson's duties by ignoring warnings that prolonging the status quo would be dangerous. An internal auditor's report in August 1994 concluded that his dual responsibility for both the front and back offices was "an excessive concentration of powers." The report warned that there was a significant general risk that the general manager (Mr Nick Leeson) could override the controls.
The audit team recommended that Leeson be relieved of four duties: supervision of the back-office team, cheque-signing, signing-off SIMEX reconciliations and bank reconciliations. Leeson never gave up any of these duties even though Simon Jones, regional operations manager South Asia and chief operating officer of Barings Securities Singapore, had told the internal audit team that Leeson will "with immediate effect cease to perform the[se] functions."
