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The Scandal of Barings Bank and Olympus

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Future Academic Programme:

MSc Accounting and Finance (2018/2019)

 

The University of Nottingham

Word count: 2480

 

 

 

The scandal of Barings Bank and Olympus

 

 

 

 

 

 

 

 Dec 2018

 

 

Introduction

According to Bhasin (2013), Scandals are often the ‘tip of the iceberg’. The most of ‘visible’ catastrophic failures” represented are related to corporate governance. This paper chooses two representative companies, Barings and Olympus.

As for the Barings Bank Scandal, the main reason for it is the ineffective internal control system. Nick Lesson, the chief trader of the Bank of Barings in Singapore, used a neglected account 88888 to deposit all failed transactions and finally caused losses up to 860 million pounds, which led to the bankruptcy of the Barings bank.

As for Olympus, the main reason for the scandal is the lack of a reasonable division of responsibilities and supervision. Managers instructed the financial staff to cover up failed investments by using multiple premium acquisitions, which were finally disclosed by the last CEO, Woodford. In addition, this scandal is called the biggest scandal in Japanese history.

This paper takes the Barings Bank Scandal and Olympus Scandal as the research objects to introduce and discuss the key aspects of corporate governance in each company, their similarities and differences through comparative analysis, and to analyze the relationship between the two scandals and their corporate governance.

More information about scandals is in the Appendix.

1.The key aspects of corporate governance in Barings and Olympus

  1. The key aspects of corporate governance in Barings

1.1.1 Board of Directors

Board of director is an important part of corporate governance. Hogan (1997) states that there are forty-six members of the board in the Barings Securities Limited (BSL), but only three are non-executive directors (NEDs). According to Pass (2004), NEDs should account for more than one-third of board of director. Therefore, the board of director of Barings company has a serious imbalance between executive directors and NEDs. As a result, NEDs are difficult to monitor the executive directors.

1.1.2 Internal Audit

Barings bank had a formal management structure supported by the audit committee and internal audit. However, Barings lacked effective communication mechanisms between internal auditors and their management (Drennan, 2004). Although the Barings Bank headquarters sent auditors to audit the Singapore branch, they did not find problems related to fraud and raised some questions except for fraud, but these problems were ignored by the management.

1.1.3 Ownership Structure

The equity capital of Barings Group can be divided into two parts: non-voting equity capital and voting equity capital. According to Horgan (1997), a registered charity called Barings Foundation held the most part of non-voting equity capital and the senior management held most of the voting equity capital. This means that it is the senior managers who determine the fate of the whole group and shareholders have poor potential power to monitor management.

1.2 The key aspects of corporate governance in Olympus

1.2.1 Board of Director

As reported in the 2011 Olympus annual report, Olympus’s 15-member board included 12 company executives and 3 outside directors, which means independent directors take up only 20% of the board. Moreover, one of its three outside directors performed poorly on the test set by authoritative proxy voting firms which designed to test the level of independence (Nathan, 2011). In this case, it seems that too many rights were given to internal members and the lack of segregation of duties paved way for fraud.

1.2.2 Internal Audit

Olympus had a four-member ‘Board of Auditors’ which supervised and audited directors' performance. Compared with external auditors, internal auditors should have a better knowledge of the whole company and take more rigorous monitoring. However, internal auditors in Olympus failed to fulfill their duty. According to an investigation report issued in 2009, there was no illegality found by audit board in the transaction (Verschoor, 2012). Moreover, one of the internal auditors, Hideo Yamada even got involved in these illegal processes and was a key player of this scandal.

1.2.3 Ownership Structure

In terms of the shareholding ratio, according to the 2011 Olympus annual report, the structure of ownership is highly diversified (none holding more than 10%). Furthermore, although the cross-shareholding and creditor shareholding made the equity stable, the rights of outsiders who became substantial shareholders were limited, they had a slight voice in corporate affairs compared with internal shareholders, it often made the board of directors keeping silence in corporate governance.

2.The corporate governance weaknesses in Barings and Olympus

2.1 The corporate governance weaknesses in Barings

2.1.1 Inefficient management

The management must fulfill their responsibilities to maximize the profit of shareholders and ensure the company grows healthily. Nevertheless, they failed to do that. According to Drummond (2002), every afternoon Lesson was faxing requests millions of pounds in margin and he was extremely reluctant to explain how the money was being used. Obviously, there must be some problems in the margin requested by him, but management was not alerted by this cue. They failed to analyze the associated risks. Besides, the absence of questioning by NEDs may be an important reason which gave rise to ineffective management.

2.1.2 The lack of segregation of duty

Barings Bank collapse stated weaknesses in the segregation of duties. Nick Leeson, a manager of the back office in Barings Futures (Singapore), was in charge of both the front desk transactions and back office (Drummond, 2003; Drennan, 2004). Specifically, he was responsible for trading and settlement, which was equivalent to keeping his trading records and reviewing them by himself. This kind of unclear segregation of duties led to opportunities for Leeson to make speculative transactions. According to Abid and Ahmed (2014), Leeson hid losses and concealed his illegal behavior by forging an account, known as 88888 account. When losses became too great to make up for, Lesson and Barings Futures (Singapore) was in an embarrassing situation, facing the tragedy of bankruptcy.

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