Examples of Mega Fraud

A close look at numerous financial crises since the collapse of the Medici Bank in Italy in 1494, which was enabled by the absence of internal controls, and since the late eighteenth century¹⁰ shows, for example, the crucial role that fraud played in many of them. The 1720 financial crisis (the “South Seas Bubble”) was brought about by insider dealing of government debt by the South Seas Company, which was established to trade with South America. The 1792 crisis in the United States was caused in large part by the Englishman William Duer, a former Etonian fraudster and an old friend of the first Treasury secretary of the United States. Duer and his accomplices operated a Ponzi scheme whereby they would borrow from rich friends and from the public by issuing personal IOUs to buy federal bonds. These bonds were then sold to investors to pay for their Bank of the United States shares, and Duer would embezzle companies he ran to pay off his own debts. When general economic circumstances forced the bank to impose significant restrictions on the supply of credit because its supply of hard currency had run very low, Duer and his accomplices could no longer borrow and their scam was revealed, accelerating the financial crisis.¹¹ Similarly, a major cause of the 1825 crisis in England was another fraudster, Gregor McGregor, who cashed in on the enthusiasm of wealthy Britons for investing in the new countries of Latin America. McGregor sold “Poyais” bonds on behalf of a new country that in fact did not exist!¹² In 1929—1933, during the unprecedented slump in the United States, Clarence Hatry, another Briton, enjoyed a life of luxury as a fraudster across the Atlantic. He established several connected firms in the United States, secured loans against forged share certificates, and was thus able to take over the United Steel Company. When discovered, his huge frauds contributed to the London and New York stock markets to crash, accelerating the worst financial crisis in the history of the United States that was already underway. In the early 1970s corporate governance came into vogue through an effort to reduce or even eliminate fraud committed by corporations (Cheffins 2013, 46). Nevertheless, financial scandals continued to occur.

A case ofmega fraud committed against a corporation by a trusted insider, Nicholas “Nick” William Leeson, serves as an example. Leeson was the head derivatives trader/broker working in the Singapore office of Barings Bank, Great Britain’s oldest investment bank. His unauthorized speculative trading in futures contracts brought about the 1995 collapse of the bank, which had been founded in 1762. The bank’s internal auditors discovered Leeson’s fraud,¹³ and the bank collapsed after suffering losses of €1.3 billion. Leeson sought to exploit differences in the prices of Nikkei 225 futures contracts listed on the Osaka Securities Exchange and the Singapore International Monetary Exchange. Contrary to Barings Bank’s strategy, he did not buy on one market and sell straight away on another market for a small profit. Instead, he held onto the contracts, taking the risk that the Japanese markets would go up. When his gamble failed, Leeson reported losses as gains to Barings in London, changing the Singapore branch’s error account, which later came to be known as the “five-eights account,” to avoid discovery by the London office. Using the concealed 88888 account, Leeson falsified trading records in the bank’s computer systems and used money meant for margin payments on other trading. He seemed to be making significant profits, but when the Kobe earthquake caused chaos in Asian financial markets and the Nikkei index did not recover as quickly as Leeson had hoped,¹⁴ his scheme was revealed.

Another mega fraud shook the city of London less than 10 years later. According to the sentencing remarks of Mr. Justice Keith, Kweku Adoboli was a “star” trader with UBS’s Global Synthetic Equities London division. He booked illicit trades to conceal the true exposure to risk. In an attempt to maximize trading profits, Adoboli ended up with huge, unhedged positions on the bank’s behalf. In the process, he caused UBS US$2.25 billion in losses; at times, he risked losses of up to US$11.8 billion. Adoboli was sentenced to 7 years’ imprisonment for being a rogue trader who did not play by the rules. He was released in June 2015¹⁵ after serving half his sentence. Sentencing Adoboli in November 2012, Mr. Justice Keith remarked that Adoboli was responsible for the “largest trading loss in the British banking history” (R. v. Kweku Adoboli, 1¹⁶).

In the United States, Bernard Lawrence “Bernie” Madoff was a highly regarded stockbroker, investment advisor, and financier in New York with impressive credentials—his investment securities company was one of the top market maker firms on Wall Street, and he himself was a former nonexecutive chairman of the NASDAQ stock market. However, for many years the asset management unit of his company was nothing other than a large-scale Ponzi scheme. His financial fraud is thought to be the largest in US history. The court-appointed trustee estimated actual losses to investors of US$18 billion, but client accounts were found to be missing almost US$65 billion.¹⁷ In June 2009, Madoff was sentenced to 150 years in prison, the maximum allowed. Interestingly, the Securities and Exchange Commission (SEC) had failed to unmask Madoff’s Ponzi scheme even though it was known for years that he had multiple violations and was misleading the commission about how he managed his customers’ funds.