Nick Leeson

SWAY; The Link Between Autism and Influence studies how influential people are similar to those with ASD. Nick Leeson is a great example.

The Influence of Nick Leeson

Nick Leeson may not be a household name, but he did change the world. His influence has everything to do with the psychology of trust and the bureaucracy of hundreds of years of business.

Would you trust the same bank that held the Queen of Englands money? What about a bank that survived WWI, WWII, the French Revolution, and the Napoleonic Wars? Would you feel comfortable having a checking account at the same bank that financed the Louisiana purchase?

If you said yes, you would have been correct, for over 230 years. For two centuries you could’ve slept peacefully knowing that one of the most stable financial institutions in the world was looking after your hard-earned money.

That is until January 16th, 1995.Barings Bank

On that day this British behemoth of money and history was shaken to death by an earthquake. Not physically as in the earthquake reduced the building to a pile of rubble. In fact that would have been a simple fix for the good people at Barings Bank. The earthquake that figuratively piled up Barings Bank happened in Kobe Japan.

Other than exposing the steel and concrete foundations of buildings and fissures in the Japanese ground, the earthquake also exposed a single man, whose fraud and deceit went unnoticed by Barings for years. He caused over $1 billion of losses and murdered a business pillar of England.

That man is Nick Leeson.

The Unusual Suspect

Nick Leeson is exceptionally average looking. He is neither handsome nor ugly with nothing remarkable about his appearance. In fact, if a police sketch artist needed a good starting point from which to draw a middle aged, average caucasian male, Nick’s face would be a perfect place to start.

He does not look like the single protagonist of a multi-year fraud that shook the financial world. Of course he does not look like a man who did time in a prison with members of the notorious Triad gang.

But he is both.

In 1992, Nick Leeson became the manager of Barings Bank in Singapore. He seemed an obvious choice because of his stellar record of producing enormous returns from his trading. It seemed the combination of the Asian market and the spectacular track record of Leeson would be recipe for success.

Except . . .

But, Leeson began exceeding the limits of Barings regulations. His unauthorized trades went directly agains Barings policies. He was speculating that the Nikkei 225, Tokyo’s version of the DOW Jones Industrial, would make massive gains.

In 1990 the Nikkei had reached heights over 38,000 JPY or Yen. During Lesson’s tenure at the Tokyo office of Barings, he watched this particular index slide lower and lower until it was hovering around 20,000 JPY.

In the mind of aggressive traders this was a great opportunity. The index was on sale and at some point it had to bounce back, or so Leeson thought. So he broke rank, created a fake account numbered 88888 to hide his illegal trades and heavily wagered that the Nikkei would rumble back.

This went on for three years without anyone at Barings auditing Leeson’s activity. For three years one man had unchecked access to all of the money managed by one of the oldest banks in existence, and was never audited.

Sliding Deeper

Regretfully during that time the Nikkei slid deeper and deeper into the abyss. Every time it did Barings lost, unchecked money from the 88888 account. So Leeson, like a drunken gambler who lost the rent money, was in a position to cover his losses. And he did it by doubling down on the Nikkei, which would, in turn fall again causing the momentum of the snowball to grow along with it’s massive size. 

Then Leeson made his biggest mistake. He bought the equivalent of millions of dollars of futures in, what he thought, was a hugely underpriced Japanese market on January 16th, 1995.

But Nick Leesons timing was horrible. 

The very next day, January 17th, 1995, Kobe Japan was torn to pieces by a 7.2 earthquake. What seemed to be an undervalued market was crushed along with billions of dollars of buildings, infrastructure and 6000 people. Twice the amount killed in the US during the attacks on 9/11.

The Beginning Of The End

As the world pulled their money out of the Asian market, the Nikkei 225 was reduced from it’s former glory at over 38,000 JPY to less than 15,000 JPY that summer. Nick Leeson made a few attempts at a fast recovery, none of which worked out. When it was all over he left Barings Bank completely broke. His three year tryst lost Barings $1.4 billion and cost over 1000 people their jobs. Many workers, drinking in pubs in England had more money in their pockets than their bank did, as long as they didn’t work for Barings.

Incredibly, when the dust settled Leeson was only sentenced to 6 1/2 years of a possible 80+ year sentence. Of the 6 1/2 years he only served four. Today, the man who crushed Barings is a world famous speaker, author and by most accounts a success. 

The public is still curious how Nick got away with such a short sentence.

The answer has everything to do with the people around Leeson, and their thresholds. 

Thresholds

In May of 1978 the American Journal of Sociology published Mark Granovetter’s Threshold Models of Collective Behavior. Up to that point conventional wisdom held that people either did or did not participate in activities such as spreading rumors, riots, and protests. Either you were comfortable in socially disagreeable settings or you weren’t, the thinking went.

But Granovetter didn’t believe that to be true, so he set out to prove that it wasn’t. In the study he describes his findings in the context of riots. Who does and does not participate in riots and at what point will a typical non-rioter change their mind and join the riot.

His findings show that people are not binary in their thinking, even though most of us claim to be. We feel like we are or are not the type of person who would join a riot. But that isn’t true. The truth is that most of us are not the type of person to join a riot unless a certain number and type of person is rioting. If the people from our church, and our parents and one of our grandmothers are rioting we may decide to join.

The Magic Number

This unknown number of people who have to be rioting for us to join is our riot participation threshold. Some of us have a threshold of 1. All it takes is one person to throw a rock through a window for us to join in. Others may be a 5 and still other are a 30, and need the whole neighborhood to join before they will participate.

In the study Granovetter explains it this way.

-Imagine 100 people milling around in a square-a potential riot situation. Suppose their riot threshold are distributed as follows: there is one individual with threshold 0, one with threshold1, one with threshold 2, and so on up to the last individual with threshold 99. This is a Riotuniform distribution of thresholds. The outcome is clear and could be described as a “bandwagon” or “domino” effect: the person with threshold 0, the “instigator” engages in riot behavior-breaks a window say. This activates the person with threshold 1; the activity of these two people then activates the person with threshold 2, and so on, until all 100 people  have joined. The equilibrium is 100.

Now perturb this distribution as follows. Remove the individual with threshold 1 and replaced him by one with threshold 2. By all of our usual ways of describing groups of people, the two crowds are essentially identical. But the outcome in the second case is quite different-the instigator riots, but there is now no one with threshold 1, and so the riot ends at that point, with one rioter.-

The Reality

Granovetter goes on to explain the reality of threshold distribution. That in a group of 100 there is a mean, or average threshold. As each individual has a threshold, so does the group. If the mean threshold of the group is 25, once 25 people are rioting, the entire group joins in and the riot explodes, sometimes literally. The riot can go from a small group of disgruntled people, to a national event depending on the thresholds of the people involved.

But if it weren’t for the people with low thresholds, the 1’s and 2’s in the group, nothing would happen. The group may have a mean threshold of 25, but if the first 25 people don’t start rioting, the group remains docile.

Every group has a mean threshold before the group acts as a whole, and the dynamic of the group and the situation play a big role as well. Imagine for a moment that same group of rioters is watching a movie in a theater. 

Now what is the mean threshold of the group to walk out of the movie?

Who Is Involved?

It all depends. If the group is rioting out of frustration over a white cop shooting an unarmed black student at a local college with no apparent reason, and the movie is about the struggles of growing up as a black youth in a large city, the group probably won’t leave the theater at all. They have a very high threshold

But if the group is rioting because they are heavily Christian and the Ten Commandments was taken off of a public building, and the movie has swearing, nudity and R-rated content, the mean threshold of that group to leave the theater, in the very same movie is much lower than the previous group.

Dr. Fallon

Dr. James Fallon, the neuroscientist I discussed in an earlier post, who learned that he was a psychopath, offers a perfect example of group thresholds in his book. Between 1990 and 1991 he was in Kenya, when he witnessed an example of mirror neurons at work.

(You may remember that we discussed mirror neurons in an earlier post involving Bernie Madoff, Milton Erickson and mirroring.)

Dr. Fallon explains that he and his brother Tom found themselves in a village led by an elder named Bernard. This was near the Ugandan border and most of the villagers had ever seen a white person, let alone played golf. He and his brother had a set of golf clubs and found a spot in which to practice. This piqued the curiosity of the villagers. After they watched Dr. Fallon and his brother both hit golf balls, Dr. Fallon asked if they would like to learn. This is the story as told by Dr. Fallon.

The Elder

-Among the 100 or so amassed there, a few brave souls stepped forward, including the family elder. A gentleman of about 80 years who was dressed in a full suit and a hat with a Christian cross emblazoned on it. They first watched as I flubbed a shot about 30 yards drawing a chuckle from Bernard and a belly laugh from Tom. 

Tom stepped forward and blasted a 3 wood to the very end of the field and there were gasps of awe from the gathered clan. Then the elder stepped forward, grabbed one of the clubs, an implement he had never seen, let alone used before, and took a quick and furious swing at the teed up golf ball. He whiffed if but no one made a peep. Then within 3 seconds, as if clearing a field with a scythe, he swung at the ball again, catching it on the sweet spot, and the ball took off about 150 yards, with a hint of a slice. 

The Reaction

Applause erupted from all of us. Then one-by-one very man, woman and child stepped forward and missed with the first swing and then nailed the ball with the second. Some of the adult men drove the ball more than 200 yards. This was an example of the mirror neuron system cranking away with all cylinders firing. The next year when I visited the village it was like they had created their own two-hole golf association, an effect I had never intended to curse them with in the first place.- 

In Dr. Fallon’s example, the village had the perfect threshold and influencers for golf, a hideous curse of a game, to infect the entire village. Apparently the elder had a threshold of either 1 or 2 for the game of golf. He need only see Dr. Fallon and maybe his brother Tom golfing before he felt comfortable enough to give it a try. Perhaps the next person who tried had a threshold of 1, 2 or 3, or perhaps their threshold was that the elder had to try first before they would.

This is the crux of influence. The dynamic of thresholds and context is the heart of persuasion and influence. In order to affect a groups behavior, that group needs the mean number of people to make the change first. Those people must have a low threshold and be the right influencers to instigate the change, or it won’t happen. But if that recipe is not just right, the blaze will to catch on.

Justine Sacco and Twitter

For instance, why did Justine Sacco’s tweet go viral? When she wrote, “Going to Africa. Hope I don’t get AIDS. Just kidding. I’m white!” she only had 170 followers, which is nothing in the world of Twitter. Let’s also realize that there are tweets happening daily from people with whom  we are familiar, that are just as inflammatory as this one, but don’t go viral and ruin careers.

Here are just a few inflammatory remarks made on Twitter by famous people that didn’t ruin careers.

World famous movie critic, Roger Ebert tweeted, “Friends don’t let jackasses drink and drive.” after the death of Ryan Dunn from the Jackass movie franchise. Ryan died in an alcohol involved car accident with his friend Zachary Hartwell.

Kanye West wrote, “An abortion can cost a ballin’ nigga up to 10gs maybe a 100. Gold diggin’ bitches be getting pregnant on purpose.”

Finally, after a highly publicized domestic violence incident in which Rihanna was left battered by her then beau Chris Brown, Amanda Bynes tweeted, “@rihanna Chris Brown beat you because you’re not pretty enough”

Those tweets may have spread and become famous, but did not garner near the reaction that Justine’s did. These are people whose tweets are often read by more people in one second that Justine had on her entire account.

The Tipping Point

But Justine’s tweet found it’s way to a man named Sam Biddle. He was the editor of Valleywag which was a leg of Gawker media. When what he saw as a racist tweet from a senior IAC employee he was at his threshold for sharing and mocking a tweet. He shared it on Valleywag’s blog where it exploded and went on to get over 200k responses from an audience with a very low threshold for social shaming.

The opposite happens when a group has a very high threshold for something. In a situation where change needs to happen, if the group is resistant to the change, or lacking the influencers to reach the threshold, the culture of, “this is how it’s done around here” runs rampant. Unfortunately for the customers of Barings bank, the employees had a very high threshold for pointing out glaring problems

For example, the now famous 5-8’s account where Nick Leeson made the illegal trades, showed up every day in the bank’s fledgeling IT department. Every day when the odd account number showed up, the IT professional would simply delete it off of his screen, rather than investigate.

Nick Leeson explains the culture around the fraud in an interview with Nick Batsford on CORE Finance. He says, “I was never challenged, lots of diaspora, technology not communicating with each other, people not asking sensible questions and any challenges that were made were completely superficial, easily to divert, pretty much me just giving cock and ball answers on the spot as the questions were asked.”

He faked it and no one had the appropriate, personal threshold to question what he was doing.

The Sentence Explained

This is part of why Leeson received such lenient sentence. Yes he perpetrated a fraud that ruined entire lives. Certainly he lied, cheated and stole. But he did it in a bank with over 200 years of experience. The people who trusted Barings did so based on their sheer amount of time they had been on the planet. When you have been in business 230 years you should have some regulations in place, which they did.

Unfortunately no one wanted to be disagreeable enough to enforce those regulations. The IT person didn’t take the time to check account number 88888. Leeson’s own management let him facilitate this fraud for three years. Much like Bernie Madoff, it may never have come to light if it weren’t for outside forces. In Bernies case the 2008 sub-prime lending collapse, in Nick Leeson’s case, an earthquake.

So Nick Leeson gets a portion of the blame, but so does Barings, for allowing a culture with such a high threshold to exist. The Board of Banking Supervision of the Bank of England launched an investigation led by Britain’s Chancellor of the Exchequer who released a report on July 18, 1995. Lord Bruce of Donington, in the House of Lords’ debate on the report, said:

A Scathing Report

-Even the provisional conclusions of the report are interesting. I should like to give them to the House so that we may be reminded what the supervisory body itself decided at the end of such investigation as it was able to make. It stated on page 250:

“Barings’ collapse was due to the unauthorised and ultimately catastrophic activities of, it appears, one individual (Nick Leeson) that went undetected as a consequence of a failure of management and other internal controls of the most basic kind”.

The words I venture to emphasise to your Lordships are these:

“as a consequence of a failure of management and other internal controls of the most basic kind”.

Nick LeesonNoble Lords who have read through paragraph 14.2 of the report will be aware that it specifies these deficiencies. The report states:

The Report

“Management teams have a duty to understand fully the businesses they manage”.

Really! They really have to understand the businesses! I would have thought that it was an elementary assumption to make that the controllers should understand the nature of the businesses they are trying to control. The next requirement is this:

“Responsibility for each business activity has to be clearly established and communicated”.

Hooray for that! I wonder how businesses in this country manage in their generality to continue without that qualification. The third requirement is:

“Clear segregation of duties is fundamental to any effective control system”.

Tut, tut! We are now treating the real elementum of the whole art and science of management, and it needs to be repeated here. The report continues:

“Relevant internal controls, including independent risk management, have to be established for all business activities”.

Common Sense

Hooray for that! These are matters of plain, ordinary common sense. One does not need to be an accountant or a management consultant to be aware of that. Finally:

“Top management and the Audit Committee have to ensure that significant weaknesses, identified to them by internal audit or otherwise, are resolved quickly”.

Well, well, well! These are all respects which this control body finds were absent from Barings. Do noble Lords really know what is being said? It is being said that Barings ought not to have been authorised bankers from the beginning, because any business — I do not care whether it is a whelk stall (one must not insult whelk stall owners in the context of this catastrophe) or what — knows that these are the basic conditions for the continuance of the business. It seems to me that the Bank of England ought never to have authorised this concern without verifying that all these conditions were in place.-

In other words, Barings threshold for questioning their own business was way out of whack.

And so is ours.

To understand why, click here.