Barings Bank

The downfall in 1995 of one of England's oldest established banks was brought about by the

actions of one man, Nick Leeson. His actions have been immortalized in the film, Rogue Trader.

Nick Leeson was a somewhat clever trader with a gift for sensing the way that stock market prices

would move in the Far Eastern (Japan, Singapore, Malaysia, etc) markets. In 1993, he was based

in Singapore and made more than £10 million, about 10 per cent of Barings' total profit that year.

He was highly thought of at that time.

However, his run of good luck was not to last and, when a severe earthquake in Japan affected the

stock market adversely, he incurred huge losses of Barings' money. He requested more funds from

Barings' head office in London, which were sent to him, but unfortunately, he suffered further

losses. The losses were so great (£850 million), that Barings Bank collapsed and was eventually

bought for £l by ING, the Dutch banking and insurance group.

Barings Bank has been criticized for its lack of effective internal controls at that time, which left

Nick Leeson able to cover up the losses that he was making for quite a number of months. The

case also illustrates the importance of having effective supervision, by experienced staff with a

good understanding of the processes and procedures, of staff who are able to expose the company

to such financial disaster. The collapse of Barings Bank sent ripples through financial markets

across the world as the importance of effective internal controls and appropriate monitoring was

reinforced.

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Enron

Enron was ranked in the USA's Fortune top ten list of companies, based on its turnover in 2000.

Its published accounts for the year ended 31 December 2000 showed a seemingly healthy profit of

US$979 million and there was nothing obvious to alert shareholders to the impending disaster that

was going to unfold over the next year or so, making Enron the largest bankruptcy in US history.

Enron's difficulties related to its activities in the energy market and the setting up of a series of

'special purpose entities' (SPEs). Enron used the SPEs to conceal large losses from the market by

giving the appearance that key exposures were hedged (covered) by third parties. However, the

SPEs were really nothing more than an extension of Enron itself and so Enron's risks were not

covered. Some of the SPEs were used to transfer funds to some of Enron's directors. In October

2001, Enron declared a non-recurring loss of US$ 1 billion and also had to disclose a US$ 1.2

billion write-off against shareholders' funds. Later in October, Enron disclosed another accounting

problem, which reduced its value by over US$0.5 million. It looked as though a takeover might be

on the cards from a rival, Dynegy, but in November, announcements by Enron of further debts led

to the takeover bid falling through, and in December 2001, Enron filed for bankruptcy.

In retrospect, it seems that the directors were not questioned closely enough about the use of the

SPEs and their accounting treatment. What has become clear is that there was some concern among

Enron's auditors — Andersen — about the SPEs, and Enron's activities. Unfortunately, Andersen

failed to question the directors hard enough and Andersen's own fate was sealed when some of its

employees shredded paperwork relating to Enron, thus obliterating vital evidence and contributing

to the demise of Andersen, which has itself been taken over by various rivals.

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Lawsuits were brought against the directors of Enron and whilst it was notable that some directors

were able to settle the lawsuits by paying hugely significant sums of money 1 personally, others

received hefty jail sentences. In 2006, Jeffrey Skilling, former Enron Chief Executive, was found

guilty of fraud and conspiracy and sentenced to more than 24 years in prison. However, his

sentence was overturned although he remains in a federal prison pending resentencing. Kenneth

Lay, also a former Chairman and Chief Executive of Enron, was similarly found guilty of fraud

and conspiracy although he died in 2006, no doubt taking to the grave many of the details of what

went on at Enron.

Interestingly one of the employees at Enron, Sherron Watkins had made her concerns known to

Andrew Fastow, the Chief Finance Officer, and to the firm's auditors, Arthur Anderson, about

some of the accounting transactions taking place at Enron as early as 1996. However, no notice

was apparently taken of her concerns and she moved to work in a different area of the company.

In 2001, she was again back in the finance department and became aware that an extensive fraud

was taking place with SPEs being used as vehicles to hide Enron's growing losses. She then

expressed her concerns more openly and became the whistleblower to one of the most infamous

corporate scandals of all time.

The Enron case highlights the overriding need for integrity in business: for the directors to act with

integrity and honesty, and for the external audit firm to be able to ask searching questions of the

directors without holding back for fear of offending a lucrative client. This latter situation is

exacerbated when auditors receive large fees for non-audit services that may well exceed the audit

fee itself, thus endangering the independence of the auditors. Enron also highlights the need for

independent non-executive directors who are experienced enough to be able to ask searching

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questions in board and committee meetings to try to ensure that the business is operated

appropriately.

Royal Ahold

Royal Ahold is a Dutch retail group with international interests, and is the third largest food retailer

in the world. The financial scandal surrounding it unfolded during 2003 and was referred to as

'Europe's Enron'. In February 2003, Royal Ahold announced that it had overstated the earnings of

its US subsidiary by US$500 million. Royal Ahold's chief executive officer and chief financial

officer resigned immediately.

There were a few warning signs at Royal Ahold before the further problems became apparent in

2003: the chief executive officer was dominant and had a long service agreement; directors'

remuneration was spiralling upwards; its management had a poor reputation for their relations with

investors; in 2001, Royal Ahold had introduced a voting system for voting on board members

which meant that it was effectively impossible for shareholders to oppose the board's nominations.

These were all signs of a company in which the directors may have been acting in a way that was

detrimental to the shareholders. Royal Ahold is now trying to rebuild its reputation and restore the

trust of its investors. To that end, it has made sweeping changes to its corporate governance

including the appointment of new independent board members and a whistle-blower's programme.

Parmalat

Parmalat, an Italian company specializing in long-life milk, was founded by Calisto Tanzi. It

seemed to be a marvellous success story although, as it expanded by acquiring more companies,

its debt increased and, in late 2003, Parmalat had difficulty making a bond payment despite the

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fact that it was supposed to have a large cash reserve. After various investigations had been carried

out, it transpired that the large cash reserves were nonexistent and Parmalat went into

administration. With debts estimated at EIO billion, Parmalat has also earned itself the name of

'Europe's Enron'.

Calisto Tanzi was a central figure in one of Europe's largest fraud trials started during 2005. He

was accused of providing false accounting information and misleading the Italian stock-market

regulator. In December 2008, after a trial lasting more than three years, he was found guilty on a

number of counts including falsifying accounts, and misleading investors and regulators. He was

given a ten-year sentence.

HIH

HIH was one of Australia's largest insurers and became one of its biggest corporate collapses with

debts of over A$5 billion. It went into liquidation early in 2001 as a result of having sold insurance

too cheaply, combined with not having put enough aside to meet its future commitments. The

situation was made worse by the fact that, during the 1990s, it had expanded by acquiring other

insurance businesses for which it overpaid. The Australian government has had to underwrite

many of the failed policies, an expensive exercise.

HIH highlights the complexities of the insurance business and what can happen when there is a

lack of due diligence. Various board members have been brought to court on charges including

giving misleading information with the intention of deceiving other board members and the

company's auditor.

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China Aviation Oil

China Aviation Oil (Singapore) is the subsidiary of a Chinese state-owned holding company,

China Aviation Oil Holding Company. In late 2004, it suffered near-collapse after losing some

US$550 million on speculative oil derivatives trading. In Singapore, this seemed to echo the case

of almost a decade earlier when Nick Leeson's trading had similarly caused tremendous losses to

Barings Bank. This time, it was the CEO, Chen Jiulin, who was criticized for carrying on with

these trades even though losses had crystallized on some of them. Chen Jiulin was arrested and

investigations into suspected violations of securities laws were undertaken. In Spring 2006 he was

sentenced to more than four years in jail and fined over US$200,000. This case is of particular note

as it is one of the few examples of executives from a Chinese state-owned company being brought

to justice by a foreign court.

Satyam

Satyam Computer Services is India's fourth largest information technology group by revenue. In

early 2009 its Chairman, B. Ramalinga Raju, wrote to the Board and confessed to having

manipulated many of the figures in the company's annual financial statements over a number of

years, resulting in overstated profits and non-existent assets. The case has been called 'India's

Enron', and has undermined confidence in Indian companies with the Bombay Stock Exchange

suffering a significant fall in share prices. The Securities and Exchange Board of India (SEBI)

moved quickly to make it mandatory for controlling shareholders to declare whether they have

pledged any shares to lenders as this was one of the contributory factors in this case.

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Royal Bank of Scotland

In 2008, the Royal Bank of Scotland together with a number of other large UK banks was caught

up in the toxic asset scandal which saw mortgage-backed securities tumble in value and along with

that a concomitant fall in the value of banks' shares. The Bank of England had long feared that big

bonuses linked to short-term performance measures encouraged excessive risk-taking by traders

who were in a win—win situation: they were rewarded if they succeeded but if they failed and lost

money for the bank, they did not have to pay the money back. It would have been more prudent to

use at least some longer term performance measures.

Much criticism has also been laid at the door of Sir Fred Goodwin, the former Chief Executive of

RBS, who had followed an aggressive acquisitions policy during 2008, including purchasing part

of ABN Amro at what turned out to be an overly generous price. The excessive remuneration

packages of the executive directors of the banks — for what is now seen as underperformance and

a lack of consideration of all the appropriate risks — have angered investors, the public and the

government alike. So much so, that there have been calls for a cap on directors' pay, especially

bonuses, and the huge pension pot of the now retired Sir Fred Goodwin has caused an outcry

especially now that the taxpayers effectively own the vast majority of shares in RBS, the result of

a government bailout.

Clearly the story of the UK's banks — and indeed the US banks where the default rates on subprime

mortgages began to rise in 2006 — is far from drawn to a close. As further events come to light,

there are bound to be more corporate governance implications. Presently the key questions being

asked relate to what the remuneration committees were doing to approve apparently excessive

executive director remuneration packages; why boards of directors were not more aware of the

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risks, or if they were aware of them, why didn't they take more notice of them; whether the board

composition was appropriate in terms of skills, knowledge and experience; and what lessons can

be learnt for the future.

The eight examples above of high-profile corporate collapses and scandals in the UK, USA,

Europe, Australia, Singapore, and India have had, and continue to have, international implications,

and would seem to illustrate a number of shortcomings in the way that the companies were run

and managed:

• Barings appears to highlight the lack of effective internal controls and the folly of trusting

one employee without adequate supervision and understanding of his activities.

• Enron appears to highlight: a basic need to ensure, as far as possible, that directors are

people of integrity and act honestly; that external auditors must be able to ask searching

questions unfettered by the need to consider the potential loss of large audit/accounting

fees; and the contribution that might be made by independent directors on boards and

committees who question intelligently and insightfully. Royal Ahold appears to highlight

what may happen if the involvement of investors is suppressed: a corporate structure that

had empowered a dominant chief executive officer, that had enabled the directors to have

overgenerous remuneration packages, and that ultimately led to Ahold's demise when

income was found to be overstated. Parmalat appears to highlight some of the weaknesses

that may exist in familyowned firms where members of the family take a dominant role

across the board structure as a whole. In Parmalat's case, the board lacked independence

as, of the thirteen directors, only three were independent. This had a knock-on effect on

the composition of the various board committees where independent directors were a

minority rather than a majority. There was also a lack of timely disclosure of information.

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• HIH appears to highlight some of the dangers inherent in the insurance business and the

complexities of the risks involved. A risk management system appropriate to the

organization, together with relevant disclosure of the risks involved and how they are

managed, is clearly of fundamental importance. Directors have a key role to play in

ensuring that such a system is in place and that the board as a whole is kept informed of

the process, as should be the shareholders via the annual report disclosures.

• China Aviation Oil appears to highlight that some Chinese state-owned subsidiaries,

including those operating outside China, may have a poor level of corporate governance.

CEOs may be all-powerful and able to take decisions that are not in the best interests of

the company and its shareholders. Limited disclosure may exacerbate the situation.

• Satyam Computer Services appears to highlight the risks associated both with a powerful

chairman who was able to falsify accounts over a period of time, seemingly without raising

the suspicions of the auditors or anyone in the company; and also the effects of a lack of

appropriate disclosure requirements so that controlling shareholders did not need to

disclose information which could have an adverse effect on minority shareholders.

• Royal Bank of Scotland appears to highlight what can happen when the risks associated

with the business' activities are not fully taken into account. It would have been difficult to

envisage the particular circumstances that led to the global financial crisis but nonetheless,

the board should be aware of the implications should the worst arise. The case also

illustrates that remuneration committees need to be more aware of the effects of the

structuring of performance-related bonus measures. Finally, the case illustrates once more

that sometimes a board finds it difficult to question, and limit, the activities of a powerful

chief executive.

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This brings us back to our original questions about corporate failures such as those mentioned

above. Why have such collapses occurred? What might be done to prevent such collapses

happening again? How can investor confidence be restored? The answers to these questions are all

linked to corporate governance.

Corporate governance is an area that has grown very rapidly in the last decade, particularly since

the collapse of Enron in 2001 and the subsequent financial problems of other companies in various

countries. As mentioned above, emerging financial scandals will continue to ensure that there is a

sharp focus on corporate governance issues, especially relating to transparency and disclosure,

control and accountability, and to the most appropriate form of board structure that may be capable

of preventing such scandals occurring in future. Not surprisingly, there has been a significant

interest shown by governments in trying to ensure that such collapses do not happen again because

these lead to a lack of confidence in financial markets. In order to realize why corporate

governance has become so important, it is essential to have an understanding of what corporate

governance actually is and how it may improve corporate accountability.

A fairly narrow definition of corporate governance is given by Shleifer and Vishny (1997):

'Corporate governance deals with the ways in which suppliers of finance to corporations assure

themselves of getting a return on their investment'. A broader definition is provided by the

Organisation for Economic Co-operation and Development OECD (1999), which describes

corporate governance as: 'a set of relationships between a company's board, its shareholders and

other stakeholders. It also provides the structure through which the objectives of the company are

set, and the means of attaining those objectives, and monitoring performance, are determined'.

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Similarly, Sir Adrian Cadbury (1999) said: 'Corporate governance is concerned with holding the

balance between economic and social goals and between individual and communal goals . . . the

aim is to align as nearly as possible the interests of individuals, corporations and society'. These

definitions serve to illustrate that corporate governance is concerned with both the shareholders

and the internal aspects of the company, such as internal control, and the external aspects, such as

an organization's relationship with its shareholders and other stakeholders. Corporate governance

is also seen as an essential mechanism helping the company to attain its corporate objectives and

monitoring performance is a key element in achieving these objectives.

It can be seen that corporate governance is important for a number of reasons, and is fundamental

to well-managed companies and to ensuring that they operate at optimum efficiency. Some of the

important features of corporate governance are as follows:

• it helps to ensure that an adequate and appropriate system of controls operates within a

company and hence assets may be safeguarded;

• it prevents any single individual having too powerful an influence;

• it is concerned with the relationship between a company's management, the board of

directors, shareholders, and other stakeholders;

• it aims to ensure that the company is managed in the best interests of the shareholders and

the other stakeholders;

• it tries to encourage both transparency and accountability, which investors are increasingly

looking for in both corporate management and corporate performance.

The first point above refers to the internal control system of a company whereby there are

appropriate and adequate controls to ensure that transactions are properly recorded and that assets

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cannot be misappropriated. Each year, a company has an annual audit and a key part of the auditor's

job is to assess whether the internal controls in a business are operating properly. Of course, the

auditor has to exercise a certain degree of judgement regarding the assurances given by the

directors, the directors being ultimately responsible for the implementation of an appropriate

internal control system in the company. The directors are also responsible for ensuring that there

are risk assessment procedures in place to identify the risks that companies face in today's business

environment, including, for example, exposures to movements in foreign exchange and risks

associated with business competition.

As well as being fundamental to investor confidence, good corporate governance is essential to

attracting new investment, particularly for developing countries where good corporate governance

is often seen as a means of attracting foreign direct investment at more favourable rates. As the

emphasis on corporate governance has grown during the last decade, we have seen a sea change

in many countries around the world. Developed and developing countries alike have introduced

corporate governance codes by which abide which companies are expected to abide. The codes

emphasize the importance of transparency, accountability, internal controls, board composition

and structure, independent directors, and performance-related executive pay. There is much

emphasis on the rights of shareholders and an expectation that shareholders, especially institutional

investors, will take a more proactive role in the companies in which they own shares and actually

start to act more as owners rather than playing a passive shareholder role. Corporate governance

is an exciting area, fast developing to accommodate the needs of a changing business environment

where investor expectations are higher than ever before; the cost to companies that ignore the

benefits of good corporate governance can be high and, ultimately, can mean the collapse of the

company.

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The global financial crisis which started in 2006, rippled into 2007, exploded in 2008, and from

which the aftershock is still being felt in 2009 and no doubt for years to come, has already led to

statements about corporate governance in times of financial crisis and the lessons that can be learnt.

The International Corporate Governance Network (ICGN) issued a 'Statement on the Global

Financial Crisis' in November 2008, and stated 'corporate governance failings were not the only

cause but they were significant, above all because boards failed to understand and manage risk and

tolerated perverse incentives. Enhanced governance structures should therefore be integral to an

overall solution aimed at restoring confidence to markets and protecting us from future crises'. The

ICGN describe the crisis as a 'collective problem with many and varied causes' and the statement

is therefore aimed at all concerned 'including financial institutions and their boards, regulatory and

policy makers and, of course, shareholders themselves'. The statement advocates strengthening

shareholder rights; strengthening boards; fair and transparent markets; accounting standards (set

without political interference); remuneration (having a 'say on pay'; encouraging boards to ensure

that their policies do not foster excessive risk-raking; incentives aligned with medium and long-

term strategy and no payments for failure); credit rating agencies (there should be more

competition in this market). A second statement by the ICGN in March 2009 reiterates the ICGN's

view about 'the role that corporate governance can and should play in restoring trust in global

capital markets'.

Similarly, the OECD issued a report in February 2009 'Corporate Governance Lessons from the

Financial Crisis'. The report states that 'the financial crisis can be to an important extent attributed

to failures and weaknesses in corporate governance arrangements. When they were put to a test,

corporate governance routines did not serve their purpose to safeguard against excessive risk

taking in a number of financial services companies'. The report highlights failures in risk

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management systems; lack of information about risk exposures reaching the board; lack of

monitoring by boards of risk management; lack of disclosure relating to risks and their

management; inadequate accounting standards and regulatory requirements in some areas; and

remuneration systems not being related to the strategy and longer term interests of the company.

The report concludes that the adequacy of the OECD corporate governance principles will be re-

examined to determine whether additional guidance and/or clarification is needed.

BERNARD MADOFF

On the 11th of December, 2008. Bernard Madoff, the founder and Chairman of *Bernard L.

Madoff securities*

was arrested, after disclosing to his sons, Mark and Andrew that the investment was "a big lie".

His sons told the authorities that their father had confessed to them that the assets management

unit of the firm was a massive *PONZI SCHEME*. He had defrauded his customers to an amount

of 50 billion dollars.

On match 12, 2009, Madoff was convicted after pleading guilty in all his charges which include

security fraud.

On June 29th 2009, he faced a penalty of 1800 months (150 years) imprisonment, a lifetime ban

from security industry.

His private assets were sold, including his wife's gold watch to refund money for his victims.

He eventually died on the 14th of April 2021, after suffering from cancer

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