10.62 Lack of Controls over Investments. Follow the instructions preceding the case in problem 10.60. Write the audit approach section like the cases in the chapter. Rogue Trader In February 1989, 22-year-old Nicholas Leeson joined Barings Investment Bank. In 1993, he began trading on behalf of the Barings group as a “proprietary trader” on the Singapore International Monetary Exchange (SIMEX). By 1995, he had wiped out the 233-year-old bank, which had counted Queen Elizabeth as a client. He left behind liabilities totaling $1.3 billion. As a proprietary trader, Leeson was to arbitrage or take advantage of differences between the prices quoted for identical contracts on SIMEX and on other exchanges. This was supposed to be achieved by entering into matching purchase and sale contracts simultaneously to capture favorable price differences. Unfortunately, Leeson entered into very large contracts that were not matched with offsetting contracts, exposing the bank to enormous potential losses from even small market movements. These trades were hidden in a separate account: 88888. Transactions were transferred from other Barings accounts into account 88888 to artificially generate a profit for the other accounts.
During the period, Barings was reorganizing and Leeson reported to local managers in Singapore and product managers in London. Neither set of managers checked Leeson’s activities. An internal audit report had criticized the reporting structure, but its recommendations were never implemented. Funds to finance Leeson’s trades were requested from him to ostensibly fund client positions and were recorded as receivables from clients. The credit control group never reviewed the creditworthiness of the clients because they said they were never informed of the remittances. Leeson’s managers accepted reports of his profitability with admiration. They did not question the unusually large profits from his trading that would have been unlikely from an arbitrage operation.