WHY DO GOOD MANAGERS MAKE BAD ETHICAL DECISION?

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.

 Rights Approach: The ethical action is the one that most dutifully respects the rights of all affected. Common Good Approach: The ethical action is the one that contributes most to the achievement of a quality common life together. Fairness or Justice Approach: The ethical action is the one that treats people equally, or if unequally, that treats people proportionately and fairly. Virtue Approach: The ethical action is the one that embodies the habits and values of humans at their best. Make a Decision and Test It Act, Then Reflect on the Decision Later

Ethics Principal
Honesty Dont mislead or deceive others. Integrity Do what is right. Trustworthiness Supply correct information, and correct information that is not factual. Loyalty to facility Avoid conflicts of interest and dont disclose confidential information. Fairness Treat individuals equally; always appreciate diversity. Concern and respect Be considerate of those affected by decision-making. Commitment to excellence Always do the best you can do. Leadership Lead by example. Reputation and morale Work to enhance the facilitys reputation and to improve the morale of employees.

FOUR COMMONLY HELD RATIONALIZATIONS THAT LEAD TO UNETHICAL DECISIONS

The first rationalization is : A belief that the activity is within reasonable ethical and legal limitsthat is, that it is not really illegal or immoral The idea that an action is not really wrong is an old issue. 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. Put enough people in an ambiguous, ill-defined situation and some will conclude that whatever hasnt been labeled specifically wrong must be OKespecially if they are rewarded for certain acts. Top executives seldom ask their subordinates to do things that both of them know are against the law or imprudent. But company leaders sometimes leave things unsaid or give the impression that there are things they dont want to know about. In other words, they can seem, whether deliberately or otherwise, to be distancing themselves from their subordinates tactical decisions in order to keep their own hands clean if things go awry. Often they lure ambitious lower level managers by implying that rich rewards await those who can produce certain resultsand that the methods for achieving them will not be examined too closely. How can managers avoid crossing a line that is seldom precise? Unfortunately, most know that they have overstepped it only when they have gone too far. They have no reliable guidelines about what will be overlooked or tolerated or what will be condemned. When managers must operate in murky borderlands, their most reliable guideline is an old

principle: when in doubt, dont A belief that the activity is in the individuals or the corporations best interests that the individual would somehow be expected to undertake the activity. Turning to the second reason why people take risks that get their companies into trouble, believing that unethical conduct is in a persons or corporations best interests nearly always results from a parochial view of what those interests are. Ambitious managers look for ways to attract favorable attention, something to distinguish them from other people. So they try to outperform their peers. 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. For example, you can skimp on maintenance or training or customer service, and you can get away with itfor a while. The sad truth is that many managers have been promoted on the basis of great results obtained in just those ways, leaving unfortunate successors to inherit the inevitable whirlwind. Companies cannot afford to be hoodwinked in this way. 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; the classic crime-and-punishment issue of discovery. The third reason why a risk is taken is belief that one can probably get away with it, is often the most difficult to deal with because its often true. A great deal of the unethical behavior often escapes detection. We know that conscience does not deter everyone. 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. Simply increasing the frequency of audits and spot checks is a deterrent especially when combined with three other simple techniques: scheduling audits irregularly, making atleast half of them unannounced and setting up some checkups soon after others.

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

MENTAL GYMNASTICS BEHIND UNETHICAL BEHAVIOR

Decision making can often result in managerial missteps, even those decisions that involve ethical considerations. Most significantly, 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. Mind Game #1: Quickly Simplify - Satisficing When we are confronted with a complicated problem, most of us react by reducing the problem to understandable terms. We simplify. We tend to make quick decisions based on understandable and readily available elements related to the decision. We search for a solution that is both satisfactory and sufficient. Unfortunately, this process, called satisficing, can lead to solutions that are less than optimal or even ethically deficient. Satisficing leads the managerial leader to alternatives that tend to be easy to formulate, familiar, and close to the status quo. Ways to guard against oversimplifying and reaching less than optimal solutions to ethical challenges Discuss the situation with other trusted colleagues. Ask them to challenge your decision. The resulting dialogue can improve the quality of your ethical decision making. Before settling on a solution, 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, our CEO, the Board of Directors, my family, or society as a whole? Mind Game #2: The Need to be Liked Most people want to be liked. However, when this desire to be liked overpowers business objectivity, ethical lapses can occur. Because they want to be liked, they may have a difficult time saying, No. Such an overriding desire to be liked can ultimately adversely affect the ethics of people in an organization and thus can decrease the firms bottom line. 7

One way is to solve this problem is to distance yourself from subordinates (e.g., 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. Mind Game #3: Dilute and Disguise In trying to strike a diplomatic chord, leaders can disguise the offensiveness of unethical acts by using euphemisms or softened characterizations. Words or phrases such as helped him make a career choice are used to describe firing someone, or inappropriate allocation of resources is used to describe what everyone knows is stealing. Regardless of whether people want to be seen as kinder and gentler, or just politically correct, this process merely helps wrongdoers and those associated with them to get away with unethical behavior. 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. Mind Game #4: Making Positive The mental gymnastic of comparing ones own unethical behavior to more negative behavior committed by others serves only to avoid self degradation. For example, the salesperson who occasionally cheats when reporting his expenses may say to himself, I do this only a few times a year, while Hardik does it all the time. Unethical behavior appears more ethical by comparing it to worse behavior. To avoid this mind game, 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.

CONSEQUENCES OF UNETHICAL DECISIONS

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

A FRAMEWORK FOR THINKING ETHICALLY

This document is designed as an introduction to thinking ethically. We all have an image of our better selves-of how we are when we act ethically or are "at our best." We probably also have an image of what an ethical community, an ethical business, an ethical government, or an ethical society should be. Ethics really has to do with all these levelsacting ethically as individuals, creating ethical organizations and governments, and making our society as a whole ethical in the way it treats everyone. What is Ethics? Simply stated, 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, parents, children, citizens, businesspeople, teachers, professionals, and so on. It is helpful to identify what ethics is NOT:

Ethics is not the same as feelings. Feelings provide important information for our ethical choices. Some people have highly developed habits that make them feel bad when they do something wrong, but many people feel good even though they are doing something wrong. And often our feelings will tell us it is uncomfortable to do the right thing if it is hard. Ethics is not religion. Many people are not religious, but ethics applies to everyone. 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. A good system of law does incorporate many ethical standards, but law can deviate from what is ethical. Law can become ethically corrupt, as some totalitarian regimes have made it. Law can be a function of power alone and designed to serve the interests of narrow groups. Law may have a difficult time designing or enforcing standards in some important areas, and may be slow to address new problems. Ethics is not following culturally accepted norms. Some cultures are quite ethical, but others become corrupt -or blind to certain ethical concerns (as the United States was to slavery before the Civil War). "When in Rome, do as the Romans do" is not a satisfactory ethical standard. Ethics is not science. Social and natural science can provide important data to help us make better ethical choices. But science alone does not tell us what we ought to do. Science may provide an explanation for what humans are like. But ethics provides reasons for how humans ought to act. And just because something is scientifically or technologically possible, it may not be ethical to do it.

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

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treated equally. Today we use this idea to say that ethical actions treat all human beings equally-or if unequally, then fairly based on some standard that is defensible. We pay people more based on their harder work or the greater amount that they contribute to an organization, and say that is fair. But there is a debate over CEO salaries that are hundreds of times larger than the pay of others; 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 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. 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. This approach also calls attention to the common conditions that are important to the welfare of everyone. This may be a system of laws, effective police and fire departments, health care, a public educational system, or even public recreational areas. 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. 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. Honesty, courage, compassion, generosity, tolerance, love, fidelity, integrity, fairness, self-control, and prudence are all examples of virtues. Virtue ethics asks of any action, "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. There are still problems to be solved, however. The first problem is that we may not agree on the content of some of these specific approaches. We may not all agree to the same set of human and civil rights. We may not agree on what constitutes the common good. We may not even agree on what is a good and what is a harm. The second problem is that the different approaches may not all answer the question "What is ethical?" in the same way. Nonetheless, each approach gives us important

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information with which to determine what is ethical in a particular circumstance. And much more often than not, the different approaches do lead to similar answers. 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. Having a method for ethical decision making is absolutely essential. When practiced regularly, the method becomes so familiar that we work through it automatically without consulting the specific steps. The more novel and difficult the ethical choice we face, the more we need to rely on discussion and dialogue with others about the dilemma. Only by careful exploration of the problem, aided by the insights and different perspectives of others, can we make good ethical choices in such situations. We have found the following framework for ethical decision making a useful method for exploring ethical dilemmas and identifying ethical courses of action. A Framework for Ethical Decision Making Recognize an Ethical Issue 1. Is there something wrong personally, interpersonally, or socially? Could the conflict, the situation, or the decision be damaging to people or to the community? 2. Does the issue go beyond legal or institutional concerns? What does it do to people, who have dignity, rights, and hopes for a better life together? Get the Facts 3. What are the relevant facts of the case? What facts are unknown? 4. 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. 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, what would that person say?

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Evaluate Alternative Actions From Various Ethical Perspectives 6. 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. 7. Even if not everyone gets all they want, 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. 8. Which option is fair to all stakeholders? Fairness or Justice Approach: The ethical action is the one that treats people equally, or if unequally, that treats people proportionately and fairly. 9. Which option would help all participate more fully in the life we share as a family, community, society? Common Good Approach: The ethical action is the one that contributes most to the achievement of a quality common life together. 10. Would you want to become the sort of person who acts this way (e.g., 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. Make a Decision and Test It 11. Considering all these perspectives, which of the options is the right or best thing to do? 12. If you told someone you respect why you chose this option, what would that person say? If you had to explain your decision on television, would you be comfortable doing so? Act, Then Reflect on the Decision Later

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13. Implement your decision. How did it turn out for all concerned? If you had it to do over again, 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. According to the Agency Theory, which defines the Principle-Agent relationship, a manager is the agent of shareholders and his objective should be to maximize the wealth of shareholders. So if we speak in a broader context, a good manager has to take decisions which are in favor of all its stakeholders. Stakeholders can be shareholders, suppliers, customers, employees, creditors, society and public at large. But as we know that sometimes it is simply not possible to satisfy all the stakeholders simultaneously. For example, 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. Hence, if a manager wants to takes good decision he might be forced to make bad ethical choices. This can be avoided if a manager thinks about stakeholders and not only shareholders.

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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, Nick Leeson, lost 827 million ($1.4 billion) speculatingprimarily on futures contracts. It was founded in 1762 as the 'John and Francis Baring Company' by Sir Francis Baring, the son of John Baring, originally from Bremen, Germany. The collapse of Britain's Barings Bank in February 1995 is perhaps the quintessential tale of financial risk management gone wrong. The failure was completely unexpected. Over a course of days, the bank went from apparent strength to bankruptcy. Barings was Britain's oldest merchant bank. It had financed the Napoleonic wars, the Louisiana purchase, and the Erie Canal. Barings was the Queen's bank. 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. The trader was Nick Leeson. He had grown up in the Watford suburb of London. After attending university, he worked briefly for Morgan Stanley before joining Barings. Leeson first started working for the UK firm, Barings Securities Ltd (BSL), in 1989 and in early 1992 he applied for registration as a dealer with the Securities and Futures Authority (SFA) in England. However, the SFA discovered that Leeson had made a false statement on his application form, about unsatisfied judgement debts against him. The SFA queried BSL on this matter and BSL subsequently withdrew the application. In April of that same year, Leeson was posted to Singapore and was involved in trading at BFS, as its floor manager at SIMEX (the Singapore International Monetary Exchange). Leesons previous history was never communicated to SIMEX and in his application to SIMEX, Leeson made a similar false statement that no judgement in civil proceedings had ever been entered against him. While Leesons trading role at BFS was intended to

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

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

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

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

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

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Kobe earthquake Using the hidden five-eights account, Leeson began to aggressively trade in futures and options on the Singapore International Monetary Exchange. His decisions routinely resulted in losses of substantial sums, but he used money entrusted to the bank by subsidiaries for use in their own accounts. He falsified trading records in the bank's computer systems, and used money intended for margin payments on other trading. As a result, he appeared to be making substantial profits. However, his luck ran out when the Kobe earthquake sent the Asian financial markets into a tailspin. Leeson bet on a rapid recovery by the Nikkei, which failed to materialize. Discovery On 23 February 1995, Leeson left Singapore to fly to Kuala Lumpur. Barings Bank auditors finally discovered the fraud around the same time that Barings' chairman, Peter Baring, received a confession note from Leeson, but it was too late this time. Leeson's activities had generated losses totalling 827 million (US$1.4 billion), twice the bank's available trading capital. The collapse cost another 100 million. The Bank of England attempted a weekend bailout, but it was unsuccessful. Employees around the world did not receive their bonuses. Barings was declared insolvent on 26 February 1995 and appointed administrators began managing the finances of Barings Group and its subsidiaries. What is amazing about Leeson's activities is the fact that he was able to accumulate such staggering losses without Barings' management noticing. As Leeson lost money, he had to pay those losses to SIMEX in the form of margin. Leeson needed cash. By falsifying accounts and making various misrepresentations, he was able to secure funding from various companies within the Barings organization and from client accounts. His

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misrepresentations were flimsy at best. For example, he claimed that he needed funds to make margin payments on behalf of BSS clients, and he gave a technical argument

related to how the SIMEX collected margin as justification. This claim was false. It was actually against SIMEX rules for a broker to post its own money as margin for a client. Even if the claim were true, the funds would have been needed only temporarilyuntil the client could make payment. Instead, Leeson continued to ask for ever more funding. Another issue was that Leeson was an accomplished liar. He falsified records, fabricated letters and made up elaborate stories to deflect questions from management, auditors and even representatives of SIMEX. Leeson actively played on people's insecurities. Such concerns went largely unheeded. Leeson was somewhat of a celebrity within Barings. While he was secretly accumulating losses in account 88888, he was publicly recording profits in three arbitrage trading accounts, numbers 92000, 98007 and 98008. This was accomplished through cross-trades with account 88888. By performing futures transactions at off-market prices, Leeson was able to achieve profits in the arbitrage accounts while placing offsetting losses in the 88888 account. During 1994, Leeson booked GBP 28.5MM in false profits. This was a staggering profit to earn from futures arbitrage, but it ensured that Barings employees earned bonuses that year. Needless to say, there was little incentive for employees to question the unusually high arbitrage profits. If anything, Leeson was viewed as a star trader who was not to be interfered with. Why Did it Happen? Industry analysts felt that the fall of Barings served as a classic example of poor risk management practices. The bank had completely failed to institute a proper managerial, financial and operational control system. Due to the lack of effective control and supervision, Leeson got an opportunity to conduct his unauthorized trading activities and was able to reduce the likelihood of their detection.

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The management systems required Leeson to report to both his local managers in Singapore, and his product managers in London, but this did not work in practice. Leeson transacted his fraudulent activities through a special account that Barings said was

unauthorised and that they had no knowledge of, but the inspectors investigating the collapse took the view that they either knew, or should have known, about it and of the losses incurred through the transactions on that account. In the third quarter of 1994, BFS was internally audited. The auditors were concerned at the powerful position that Leeson was occupying. As both Chief Trader and Head of Settlements, he was in a position to record the trades he had made, in any way he wanted. An internal audit report specifically highlighted this point, stating that it created a significant risk, as internal controls could be over-ridden. But the Baring Group already knew this, and nothing was done to remedy the situation. It was probable that, until February 1995, Barings could have averted financial collapse, by taking timely action to prevent it. Instead, matters were allowed to get worse. After the Baring Groups failure, senior management of the company continued to deny knowledge of Leesons activities This analysis raises the question as to why Barings, an old established firm of merchant bankers with links to the aristocracy of England, would behave in such a manner. 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 - by creating as a saviour, a shadow to themselves, in the form of the highly risky Baring Securities operation. The firm then chose a number of extreme risk takers, including Leeson, to run this operation. Leeson was introduced to the chief executive of Baring Securities, as the red-hot trader from Singapore, second to none.

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As the evidence of Leesons misdeeds built up, Barings senior management either would not, or could not, believe it. They continued to support him till the bitter end. The scale of corporate misjudgement was staggering and the resulting collapse of the firm was spectacular. Barings directors failed to assess the risks of the strategies that they were employing and, further, 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, as a means of ensuring that the Board operate effectively, responsibly and in the best interests of its shareholders and other stakeholders.

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