KWAME NKRUMAH UNIVERSITY OF SCIENCE AND TECHNOLOGY

(KNUST) - KUMASI

INSTITUTE OF DISTANCE LEARNING

SEMESTER ASSIGNMENT

MSC/MPHIL INDUSTRIAL FINANCE & INVESTMENT

DERIVATIVES AND RISK MANAGEMENT (MIFI 566)

BY: ANTHONY BOADU

INDEX NUMBER: PG5274218

APRIL, 2019
Background
Barings Bank was a British merchant bank that collapsed in 1995 after one of its traders, Nick
Leeson operating in its Singapore office, lost $1.3 billion in unauthorized trades. Barings was
among the largest and most stable banks in the world. However, due to unauthorized speculation
in futures contracts and other speculative dealings, it ceased operations on February 26, 1995.
Enron Corporation was an American energy, commodities and services company based in
Houston, Texas. It was founded in 1985 as a merger between Houston Natural Gas and InterNort,
both relatively small regional companies. Following the merger, Kenneth Lay, who had been the
chief executive officer (CEO) of Houston Natural Gas, became Enron's CEO and chairman. Enron
was rebranded into an energy trader and supplier. The story of Enron Corporation depicts a
company that reached dramatic heights only to face a dizzying fall. In the 1990s, when American
stocks were leading the world and index peaked at record heights, Enron was at the zenith of its
growth and was repetitively acclaimed as one of the most innovative firms on the market by the
Wall Street financial press.
The fated company's collapse affected thousands of employees and shook Wall Street to its core.
At Enron's peak, its shares were worth $90.75; however, when the firm declared bankruptcy on
December 2, 2001, they were trading at $0.26. Enron's complex financial statements were
confusing to shareholders and analysts. In addition, its complex business model and unethical
practices required that the company use accounting limitations to misrepresent earnings and
modify the balance sheet to indicate favorable performance. With the help of Jeffrey Skilling, who
was initially a consultant and later became the company’s chief operating officer, Enron
transformed itself into a trader of energy derivative contracts, acting as an intermediary between
natural-gas producers and their customers. The trades allowed the producers to mitigate the risk of
energy-price fluctuations by fixing the selling price of their products through a contract negotiated
by Enron for a fee.
Similarities and Differences
Barings Bank and Enron corporation collapsed as a result of overtrading based on speculation in
derivative trading. All had the same similar situations creating their downfall. In both cases top
managers were responsible for spearheading fraud at the corporation. In Enron’s case, top
managers, including chief executive officer, Jeff Skilling, and former CEO, Ken Lay, were
responsible for spearheading fraud. They were people who did not only have full access to the
company’s asset but also had the power to have accounts altered to suit their own needs. The same
case applies to Barings Bank, which arose from the fact that there were no checks by the top
managers. Both companies traded with funds they did not actually own hence suffered great losses
when those trades fell through. Some of these unauthorised trades were as a result of poor corporate
governance. A company that does not necessarily micro-manage its employees but pays a closer
look at the employees’ activities would have noticed these trades and prevented them. The
management team did not prevent the making of the frauds and probably contributed to the
structuring of fraudulent transactions sometimes. Also, irrational and risky managerial strategies
backed by an inadequate governance structure led to the continuous application of wrong financial
practices that eventually led to their collapse. Similar to Barings bank where rogue trader Leeson
hid documents from statutory auditors of the bank, which made the internal control of Barings
seem totally inefficacious, Enron was also found guilty of obstruction of justice in 2002 for
destroying documents related to their audit. Therefore, internal controls can also be said to be the
reasons why both institutions collapsed. In the case of Barings bank, an employee who was
working in Singapore office was able to make losses and report same as gains.
Motivation was also present when the two cases of fraud were committed. As far as Enron was
concerned, its top managers were motivated by the need to retain confidence in the company’s
shareholders. Reporting the reality would have led to a drastic fall in the company’s share prices.
The same applies to Barings Bank where an employee was motivated by the need to retain his job.
In all the two cases, fraudsters may have felt they were justified to commit fraud. Enron’s managers
believed that the situation that their organization was going through, (that of making losses
continuously) would soon be reversed. The Baring Bank employee who contributed greatly to the
fall of the bank also argued that he would be able to speculate in the future market, make huge
wins and repay the losses he had suffered.
One instance where the cases of Enron and Barings differ is that Enron through the use of long-
term contracting structures put together contracts for the physical delivery of goods traded while
Barings mainly traded in financial securities. This was backed by the use of risk management
products. It was true that Enron traded in more financial securities than physical goods but unlike
Barings which traded mostly in equities and interest rates, Enron focused its trades on energy
commodities.

Lessons
The Enron and Barings scandals offer financial institutions, investors and regulators an opportunity
to develop strategies in several disciplines - corporate governance, banking supervision, financial
management, auditing, regulatory compliance, corporate ethics, internal controls and so on. An
examination of both cases showed that weak supervision and inadequate enforcement coupled with
weak internal controls played a significant role in aggravating the crisis. Deep and comprehensive
measures should be instituted to help restore normalcy thereby putting the economy back on track.
In the case of Barings Bank, Leeson operated in both the dealing desk and the back
office(operations) hence he was able to confirm and settle trades transacted by the front office and
could hide what he wanted. This was a total lack of segregation of duties and rotation of duties of
senior management. In a properly structured organisation, one employee should not be able to
initiate and approve transactions regardless of the position he/she was in and if their positions were
routine rotated, the scandals would have been noticed a longer time. A maker-checker process
should be instituted for all transactions. Lack of effective supervision exposed these companies to
systemic risks. Supervisory roles have to be revised and clearly defined to ensure more scrutiny of
a company’s financial dealings/transactions and how they are reported.
Common mistakes most retail investors often make, trading on leverage without having a back –
up plan. Fundamentally, trading on leverage is not exactly bad, especially in a bull market.
Doubling down is basically a strategy adopted by gamblers where they double their bets plus a
small amount each time they lose money. That way, it does not matter how much money you lose
because you will earn back your capital and some profits if you do win. However, it is based
entirely on luck, which Leeson lacked and maybe because Japan was in a recession and was hit by
an earthquake, compounding Leeson’s losses.
In Leeson’s last days at Barings as a General Manager, he bought over 20,000 contracts worth
about $180,000 each. That made up almost three-quarters of the total amount that he had lost for
Barings, according to his autobiography. The total cost of 20,000 contracts worth about $180,000
each surmounts to some US$3.6 billion. Imagine that amount of money flooding a single index
over a short period of time. No wonder some indices and stocks can move in such huge movements.
Next time you see a huge discount in any asset, do not be too sure that it is a buying opportunity.
Regardless how much the discount is, be sure that you know the company of the stock very well,
if not extremely well before buying. Therefore, as the saying goes that “caveat emptor” let all
investors beware.

Financial institutions should have risk management systems which are kept separate and distinct
from its trading functions and which have independent lines of reporting authority reaching to the
highest levels of senior management. Virtually every study of derivatives markets over the past
few years have emphasized the basis for firms to separate risk management from trading functions.
It would be for the client to reevaluate its internal controls to ensure that this basic principle is
being followed. From the case of Barings, management lacked knowledge in sub tile trading
techniques and financial markets and so did not seem to be aware of the risks incurred by the bank.

To ensure financial stability, regulators should put in mechanisms and policies that will ensure full
compliance to rules and regulations set up. It was observed that Leeson (Barings) and Enron made
false declarations to regulatory authorities which allowed them to accumulate losses and to avoid
margin call which should have been audited. It could be said that false declarations did not attract
the attention of control authorities. More so, nothing was detected by statutory auditors despite
forged documents which were released so account regulation procedures within these institutions
were completely inefficient. Regulators should adopt forensic and risk based audits and not just
accept any kind of audit report from financial institutions.
Turnitin Originality Report
 Processed on: 28-Apr-2019 07:36 GMT
 ID: 1115930055
 Word Count: 1522
 Submitted: 4

Barings Assignment By Anthony Boadu

Similarity Index
19%
Similarity by Source
Internet Sources:
12%
Publications:
0%
Student Papers:
18%
exclude quoted exclude bibliography exclude small matches download print
mode:

10% match (Internet from 13-May-2018)

http://aspire.sharesinv.com

7% match (student papers from 29-Sep-2014)

Submitted to Deakin University on 2014-09-29

7% match (student papers from 26-May-2014)

Submitted to Deakin University on 2014-05-26

5% match (student papers from 09-May-2018)

Submitted to Zambia Centre for Accountancy Studies on 2018-05-09

4% match (student papers from 22-Jan-2019)

Submitted to Beykent Universitesi on 2019-01-22

4% match (Internet from 16-Apr-2019)

https://www.investopedia.com/updates/enron-scandal-summary/
3% match (Internet from 18-Aug-2018)

https://www.research.manchester.ac.uk/portal/files/54523406/FULL_TEXT.PDF

3% match (student papers from 22-Mar-2018)

Submitted to University of Wolverhampton on 2018-03-22

3% match (student papers from 27-Feb-2017)

Submitted to Metropolitan College of New York on 2017-02-27

3% match (Internet from 24-Aug-2018)

https://www.antiessays.com/free-essays/Case-Study-The-Enron-661978.html

2% match (student papers from 20-May-2018)

Submitted to Southern New Hampshire University - Continuing Education on 2018-05-20

2% match (Internet from 17-Feb-2019)

http://tattoomajik.com

1% match (Internet from 11-Nov-2018)

https://thepublisheronline.com/banking-scandals-what-lessons-for-future-generations/

1% match (student papers from 07-Jan-2015)

Submitted to HELP UNIVERSITY on 2015-01-07

1% match (student papers from 23-Feb-2018)

Submitted to Gateway College on 2018-02-23

1% match (student papers from 02-Aug-2011)

Submitted to American Intercontinental University Online on 2011-08-02

1% match (student papers from 30-Nov-2016)

Submitted to Buckinghamshire Chilterns University College on 2016-11-30