Topic: The biggest scams in the banking history
Course: Banking
Students: Nino Vepkhvadze, Gohar Trchunyan, Giorgi Menteshashvili & Giorgi Paksashvili
Date: 04.06.2012

A fraud, by definition, is the act of deliberate deception of people to secure an unlawful gain. These are mainly for the purpose of defrauding money as well as prestige rather than immediate financial gain. A study by BBC has revealed that the average woman lies twice a day while a man tells three lies a day. However, the lies they tell differ from each other a lot, both in essence and the results yielded. This is why we decided that the frauds and scams of the banking industry as well as their influence on other financial institutions would be quite interesting and intriguing. Let us together investigate how far a human mind can go to earn as much money and glory as we desire.
Jerome Kerviel’s case-Societe Generale on the edge
In January 2008, A French court sentenced former Société Générale trader Jérôme Kerviel to three years in prison for his role in one of the world's biggest-ever trading scandals and ordered him to repay his former employer €4.9 billion—a sum it would take him 180,000 years to pay at his current salary.
In convicting Mr. Kerviel of breach of trust, forgery, and unauthorized computer use, the judge also handed Mr. Kerviel a lifetime trading ban. The prison sentence handed to Mr Kerviel is for five years, of which two years were suspended.
Throughout the trial, Mr. Kerviel and his lawyers argued that Société Générale turned a blind eye on his illicit behavior as long as he was making money. Société Générale itself acknowledged in 2008 that it didn't have the right control systems in place to correctly supervise Mr. Kerviel. For this lack of oversight, the bank has already paid €4 million in fines to France's banking regulator. Outside the courtroom, many French analysts and politicians criticized the verdict, saying Mr. Kerviel had been made a scapegoat at a time when the banking system is trying to atone for its role in the global financial crisis.
In January 2008, Société Générale shocked world markets when it disclosed it had suffered a net loss of €4.9 billion after unwinding a series of wild bets placed by Mr. Kerviel.
As the probe got under way, Mr. Kerviel immediately acknowledged to engaging in years of unauthorized trades, but said that he was just trying to make money for the bank.
Kerviel is not thought to have profited personally from the suspicious trades. Prosecutors say Kerviel has been cooperative with the investigation, and has told them his actions were also practiced by other traders in the company. Kerviel admits to exceeding his credit limits, but claims he was working to increase bank profits. He told authorities that the bank was happy with his previous year's performance, and was expecting to be paid a €300,000 bonus on a €60 million declared profit (approximately 0.5%) which illustrates the definition of "fair pay" in the French investment banks. Family members speaking out say the bank is using Kerviel as a scapegoat to excuse its recent heavy losses.
"Mr. Kerviel only did what he was paid for: speculate," Pierre Laurent, head of France's Communist Party said in a statement. "He was a cog in a machine and his guilt cannot be detached from the whole system."
Nordea Bank under attack
Internet fraudsters stole around ($1.1m) from account holders at Swedish bank Nordea. The theft, described by Swedish media as the world's biggest online fraud, took place over three months. The criminals siphoned money from customers' accounts after obtaining login details using a malicious program that claimed to be anti-spam software.
The hackers used a phishing email that advised bank customers to download a “spam fighting” program called ‘raking.zip’ or ‘raking.exe’ that loaded what security companies are calling the haxdoor.ki Trojan.
Obviously the phishers have a sense of humor in calling the software ‘raking’ – for they not only clearly intended raking in the cash, they succeeded in doing so to tune over several million Swedish kroner, or over US $1.1m.
Nordea said it had now refunded the lost money to all 250 customers affected by the scam. Police have said they suspect organized criminals from Russia and United States.
When a user navigated to the Nordea bank login page, the trojan would kick into action, saving the customers login details. It then displayed an error message asking them to resend the information.
Trade newspaper Computer Sweden said the police had traced the fraudulent emails first to computer servers in the US and then to Russia.
Surprisingly, it was in Finland, not either in the US or Russia where the path led. On May 10, 2011, the Finnish police closed on investigation after arresting 17 people suspected of involvement in the fraud.
Two of the suspects allegedly used malware to compromise the online banking accounts of 89 banking customers before compromised banking accounts were looted by local phishing fraud accomplices prior to the illicit transfer of funds to the masterminds behind the scheme, in Estonia.
Vatican’s God Bankers-the mysterious case of Roberto Calvi
One of the biggest and most intriguing financial scandals of the last century took place in Italy, reaching its peak in London, UK. On June 18, 1982 a man was found hanging beneath Blackfriars bridge. Bricks had been stuffed in his pockets and he had more than £10,000 in cash on him. This was Roberto Calvi, once a member of masonic lodge P2 (Propaganda Due) as well as chairman of Italy’s second biggest private bank Banco Ambrosiano. In the months before his death he had been accused of stealing millions being laundered on behalf of the mafia.
Calvi was a haunted man as he entered his final days. As chairman of Banco Ambrosiano, he was in charge of an organization that laundered money made largely from the heroin trade for the mafia. He knew the dark financial secrets of the Vatican. Letters of comfort to offshore companies which he created were signed by Archbishop Marcinkus, a Chicago-born prelate and key Vatican insider who has never faced an interview or charges.
But more ominously Calvi had intimate knowledge of regular payments made by large Italian companies to political parties. He should have known: the payments went through his bank.
Calvi was on the point of going to prison for violating exchange controls. It was Michele Sindona, once Calvi's mentor, who ratted on him. Calvi had one chance to avert humiliation. Tell the world what he knew. It was this which led to his death, a New York investigator Jeff Katz believes.
'There was a point at which he threatened that if the Vatican and other people who he had been working with did not get him off the hook for the four years in jail for currency exchange violations, he was going to talk,' Katz argues. 'It would have landed the heads of all the major corporations in jail and it would have ended up probably with the indictment of political leaders.'
Weeks after Roberto Calvi's murder in June 1982, the Italian bank he chaired, Banco Ambrosiano, went under with a then staggering $1.4 billion debt.
Mafia, Freemasons and the Vatican are implicated in a tale of drug trafficking, money laundering and tortuous financing spanning the world.
Many believe the death of Pope John Paul I in 1978, just 33 days after his election, happened because he wanted to break the murky links between what was then Italy's largest private bank and the Vatican.
The scandal touched financial institutions around the world and the Italian political elite.
Calvi's bank built its empire in close association with the Vatican bank, the Institute for Religious Works. This was headed by Archbishop Paul Marcinkus from Chicago. While the Vatican never accepted culpability in the collapse of Ambrosiano, it stumped up $250m to creditors. Some believe Marcinkus may yet face trial now a court case in Italy is progressing.
Several movies have been dedicated to explaining the reasons and authors of this famous murder. The Imaginarium of Doctor Parnassus is one among them. Perhaps the director wanted to parallel the Vatican with the travelling show which deceives people with their own imaginations. The owner of the circus, Dr Parnassus, has an immortality deal with the devil, giving him the souls of all the children until they reach the age of 16. And there is Tony ( Heath Ledger), who tries to save the soul of the last girl Valentina, but he himself becomes the victim of the circumstances. Obviously, even after 21 years, the Calvi case must remain closed to save the day for many. However, let us hope that the case will one day be uncovered and the operations of Italian mafia bankers will be shed light on.

Nick Leeson – How Leeson broke the Bank
I would like to present the case of Barings Bank, one of the most famous histories in the world when one man led to the bankruptcy the oldest British bank. Barings collapsed on February 26, 1995, due to the activities of one trader, Nick Leeson, who lost almost $1.4 billion. The loss was caused by a large exposure to the Japanese stock market, which was achieved through the futures market. Nick Leeson had totally wiped out the venerable 233-year-old Baring Investment Bank, which proudly counted Queen Elizabeth as a client. He left behind huge liabilities totaling $1.4 billion, more than the entire capital and reserves of the British institution. In the aftermath of the activity of Leeson, Barings collapsed and was purchased by the Dutch bank/insurance company ING for the nominal sum of £1.

Brief History of Baring Bank

Barings Bank, the oldest merchant banking company in England, was founded in
1762. Barings strong presence is confirmed with the words of the French Foreign Minister, Duc de Richelieu, who in 1818 said: “There are six great powers in Europe: “England, France, Prussia, Austria, Russia and Baring Brothers.” However bank had bad times too. In 1890 it faced bankruptcy after a significant amount of investment loss in South America. At that time, they had been bailed out by the Bank of England and other London banks. From then on, however, Brings continued in traditional merchant banking, building up a reputation based on corporate finance, strong investment management, and the trading it did for one of the best clients in London, including the Royal Family. In 1984 it acquired the stockholding business of small stock broking company, Henderson Crosthwaite, with a staff of 15 based in London, Hong Kong and Tokyo. Baring Brother and Company (BB and Co) then established Baring Securities Limited (BSL), as a separately and liberally managed business within the group. BSL was very successful, enjoying the fruits of the 1980s Tokyo Stock Market boom. Shortly afterwards as management saw that Asian market was highly profitable they established Baring Futures Singapore company (BFS), which soon became the member of Singapore International Monetary Exchange Ltd ("SIMEX").

The Barings board decided to send to Asia in 1992 a young trader from a humble background, Nick Leeson, who seemed to know how to deal in derivatives, a quite new game that few in the financial fraternity really understood. The Bank wanted to become one of the first active banks in this region of the world and also from this reason the board gave a trader a lot of freedom in his activity. In 1993, Nick Leeson was appointed general manager of the bank's Barings Futures subsidiary in Singapore, with responsibilities both for trading and the accounting and settlements activities.

Leeson dealt in 6 main financial futures and some options on them, as follows:

1. Nikkei 225 contract traded on SIMEX in Singapore;
2. Nikkei 225 contract traded on OSE (Osaka Stock Exchange) in Japan;
3. 10-year JGB (Japanese government bonds) contract traded on SIMEX in Singapore;
4. 10-year JGB contract traded on TSE (Tokyo Stock Exchange) in Japan;
5. 3-month Euroyen contract traded on SIMEX in Singapore;
6. 3-month Euroyen contract traded on TIFFE (Tokyo Financial Futures Exchange) in Japan.

One of the primary trading strategies they implemented was arbitraging baskets of stock in the Japanese Stock Markets. The trading volume handled by Leeson gradually increased over time and by early 1993, Leeson was involved in executing proprietary trades as well as trades for the external clients of the Barings Group.

In his trading strategy Leeson experienced several methods of trading.

i. Switching:
As a result of Asian market development, a new business opportunity arose, in which
Leeson would play a major role, i.e. arbitrage trading of the Nikkei futures contract between SIMEX and the OSE. Apparently, large price differences existed between the two contracts that were very similar in design. Usually the profits from exploiting such price differences between exchanges are small and therefore trading volumes tend to be large. Still, the risks are low, because every long position on one exchange is offset by a short position on the other.

In addition to arbitrage trading, Leeson developed an even more lucrative activity, namely ‘switching’. As Barings was able to trade in Japan as well as in Singapore, it could select the cheapest market to execute a client’s order. For example, it could tell a client it would buy 1000 Nikkei futures contracts in Osaka, while in reality it made the purchase on SIMEX, where at that moment the price was lower. Barings would charge the client the price quoted on the Osaka Stock Exchange or slightly better, which was still worse than the price in Singapore. The difference meant extra profit for Barings. This selection of the more profitable location of the two to do business was referred to as ‘switching’. The end result of all these activities was that the Structured Products Group, which includes Leeson’s activities, showed an operating profit over 1994 which was five times more what had been planned for that year. Nobody within Barings questioned these impressive figures from a business that should be virtually riskless.

In particular in the Nikkei futures market, headquarters believed it occupied a niche, because Barings were members of both the OSE and SIMEX and had developed the business, clientele and reputation to deal in and between those markets. Chairman Peter Baring concluded that “it is not actually terribly difficult to make money in the securities business” Specifically commenting on Barings’ main profit center, Leeson’s direct boss in London, Michael Killian, said in February 1995: “That guy is a turbo arbitrageur!”

Downfall

ii . Manipulating with accounting tools

Only two days after Barings was granted membership by SIMEX, Leeson opened Account 88888 and that same day, the first transaction was booked in this account. On BFS’s system, this account was described as an error account. It is common for traders to set up such an account for the purpose of netting minor trading mistakes.

During 1993, the main focus of Leeson’s unauthorized speculative positions in
Account 88888 was the generation of profits in the ordinary trading accounts of BSL, and
BSJ for their clients or proprietary traders. This enabled Leeson to gain a reputation as a star trader on SIMEX and enhanced his executive standing. However, by the end of 1993 the cumulative losses in Account 88888 were over ¥ 4 billion (about US 35.8 million) which made the situation much more complex. Leeson’s main problem became the management of the flow of funds to support the margin calls from SIMEX.

An important way to arrange the funding was by manipulating the trading and accounting records. This was done in a number of ways. First, most transactions booked in account 88888 were initially booked in the accounts of BSJ and BSL. If these positions had been correctly reported to BSJ or BSL, it would have been clear that risk limits had been exceeded since such transactions were not hedged. However, Leeson would execute offsetting trades about thirty seconds before market close to place transactions from BSL or BSJ accounts into Account 88888. With these so-called “transfer trades”, Leeson avoided disclosure of unhedged positions in the reports to BSJ and BSL. The prices of these transfer trades were later adjusted to favor BSL or BSJ, at the expense of Account 88888, in order to confirm his reputation as an exceptional trader. This would often require complicated alterations between different sets of records.

A second way to manipulate the records was to record fictitious trades between the accounts of BSL and BSJ and Account 88888 in the BFS daily list of transactions, when no transfer trades had been executed. The effect was that unhedged positions were transferred from the BSJ or BSL accounts to Account 88888, so that no unhedged positions were reported at the end of the day Finally, Leeson often instructed his settlements staff to record fictitious trades in the accounting system. These fictitious trades were reversed at the opening of the market on the following day. The purpose was to reduce end-of-day open positions in Nikkei and JGB futures in BFS’s accounting records and consequently in the SIMEX computer system. This practice effectively reduced margin calls from SIMEX

Downfall

By the end of 1992, the account's losses exceeded £2 million, which ballooned to £208 million by the end of 1994.

The beginning of the end occurred on 16 January 1995, when Leeson placed a short straddle in the Singapore and Tokyo stock exchanges, essentially betting that the Japanese stock market would not move significantly overnight. However, the Kobe earthquake hit early in the morning on 17 January, sending Asian markets, and Leeson's trading positions extremely unprofitable. Leeson attempted to recoup his losses by making a series of increasingly risky new trades, this time betting that the Nikkei Stock Average would make a rapid recovery.

However, the recovery failed to materialize. Leeson left a note reading "I'm Sorry" and fled Singapore on 23 February. Losses eventually reached £827 million (US$1.4 billion), twice the bank's available trading capital. After a failed bailout attempt, Barings was declared insolvent on 26 February. Leeson increased the size of his open positions even as his losses increased due to volatility in the markets. When an earthquake (23 January 1995) in Japan caused a steep drop in the Nikkei 225 equity index, Leeson's unauthorized trading positions suffered huge losses and his operation unraveled.

On March 3, 1995, the Dutch bank ING purchased Barings for the princely sum of £1, providing the final chapter in the story of the 223-year-old bank.

To sum up, it can indicate the major reasons of the collapse of Barings:
1. Lack of internal checks and balances even when segregation of duties was suggested by internal audit, the concentration of power in the Leeson's hands was scarcely diluted.
2. Lack of understanding of the business If Barings' auditors and top management had understood the trading business, they would have realized that it was not possible for Leeson to be making the profits that he was reporting without taking on undue risk, and they might have questioned where the money was coming from. Arbitrage is supposed to be a low risk, and hence low profit business, so Leeson's large profits should have inspired alarm rather than praise. Given that arbitrage should be cash-neutral or cash-rich, additional alarms should have gone off as the Bank wired hundreds of millions of dollars to Singapore.
3. Poor supervision of employees Although Leeson had never held a trading license prior to his arrival in Singapore, there was little oversight of his activities and no individual was directly responsible for monitoring his trading strategies.
4. Lack of a clear reporting line Leeson's fraud may have been facilitated by the confusion caused by two reporting lines: one to London, for proprietary trading, and another to Tokyo for trading on behalf of customers.

Summing up, we reviewed four of the most popular and well-known cases in the banking scam history. Unfortunately, we are unsure about the under-the-table dealings of modern financial institutions, but clearly, we will never have access to the real, impartial information about what the banks really hide from us even today. And although guilty, we still know that the first and the last characters of our today’s story were simply chosen as scapegoats of banking failures.

Bibliography: www.wikipedia.org http://news.bbc.co.uk/ http://www.spamfighter.com http://ibnlive.in.com
http://www.guardian.co.uk