A brief history of scandal

Financial disgraces are as old as money itself, the only difference today being a matter of scale, writes Stephen Vines

PUBLISHED : Monday, 17 September, 2012, 12:00am
UPDATED : Tuesday, 18 September, 2012, 4:32pm

It is rare to open a newspaper these days without reading of some new financial scandal and it is notable that the companies and individuals involved are hardly minor. Two leading banks with major Hong Kong operations, HSBC and Standard Chartered, are busy dealing with serious allegations of wrongdoing by the US authorities. While in Hong Kong, property developer Sun Hung Kai, one of the city's biggest companies, is immersed in bribery allegations. Elsewhere in Asia, Japan's Nomura is recovering from a major insider-trading scandal and in both Europe and the United States scandals surrounding financial institutions have made the word "banker" synonymous with other words that cannot be printed here.

All this may produce the impression that something new or even unusual is happening in the world of finance, but the reality is that financial scandals are as old as the creation of money (think of biblical references to money-changers in the temple) the main difference these days is a matter of scale not substance.

Contemporary scandals follow a very well-trodden path of similar motives and outcomes. What is surprising is that the core motivation for many of those at the heart of these scandals is not necessarily greed, indeed, some of the biggest scandals involved little or no monetary gain for their instigators. Many of these scandals have no central player nor even involve any criminal activity, they are little more than wild reckless gambles that end as all wild reckless gambles end.

And, let it not be forgotten that, with few exceptions, these scandals would never have reached the levels they did without the gullibility, and of course, the greed of their investors.

Scott MacDonald and Jane Hughes have written a comprehensive account of financial scandals in the US called Separating Fools from Their Money, which traces the themes common to such disgraces, namely: greed, hubris, media connections, politicians-turned-opportunists, and the fertile atmosphere of booms before they bust.

Revisiting history we find that even the earliest of the big scandals have echoes today. Take Dutch tulip mania, which finally crashed in 1637. Investors throughout Europe persuaded themselves that investing heavily in rare tulip bulbs would yield fabulous returns and for more than three decades they were right. Like all these bubbles there was some basis for the craze, because Dutch bulbs were indeed highly valued and rare colours were richly prized, but sometime during the all-consuming mania sharks moved in and everything erupted way out of proportion.

Naturally we know better today. Or do we? What happened in the 1990s dotcom bubble was every bit as crazy as tulip mania. Investors poured cash into companies that were not making money and showed no prospect of doing so in the foreseeable future. Then when the bubble burst in 2000 some investors were left with nothing. However, as with the tulip bubble, there was a residue of value in amongst all the madness.

And there are contemporary echoes from the 1720 crash of Britain's South Sea Company. The company had planned to assume responsibility for the vast debts Britain incurred during the war with Spain. The plan was simple: debts would be repaid as investors piled into the shares, the increased value of which would pay-off the debt. When the shares failed to rise to the levels envisioned by the company's directors they bribed high-profile personalities to take a stake, hoping to encourage other hapless investors to follow suit.

There have been variations on this theme ever since. In essence, a company or an individual trader takes a bet, usually on a single theme and as the bet turns sour they pour increasing amounts of cash into the gamble hoping both to cover up their losses while praying that ultimately the bet will go their way.

The collapse of America's Long Term Capital Management (LTCM) back in 1998 is a case in point. LTCM was a big-league gambler in derivatives on US Treasury bills, basically betting on the falling value of American government debt. But US Treasuries kept going up in value and the plan collapsed. Fortunately for LTCM the knock-on effects of its collapse for the entire financial sector were such that the government was compelled to rescue it.

No such rescue was afforded to British-based Barings bank, brought to its knees in 1995 by rogue trader Nick Leeson in Singapore, who was gambling on Japanese stock exchange futures. Leeson's gamble ended with a US$1.38 billion hole in Baring's accounts but not before he spent a long time covering up losses and his London bosses turned a blind eye to something that needed closer investigation. At one time Leeson's trading activities accounted for 10 per cent of the bank's profits and no one wanted to touch the rainmaker.

Leeson's fraud was in fact incidental to what was going on as it was in the case of one of Hong Kong's first banking scandals in the late 19th century when Lo Hok-pang, the son of the Hongkong Bank's first comprador, used the bank's money to finance his own speculative ventures, hoping that they would succeed before the bank noticed that the money had gone.

Lo's gamble, involving around one million dollars, was ludicrously small (even at today's prices) when compared with the losses of Société Générale's rogue trader Jerome Kerviel, which amounted to an astonishing US$7.2 billion. Like Leeson he tried to cover his losses by recording bogus transactions. Both men appear not to have been primarily motivated by personal gain but by an arrogant self-confidence in their skills as traders. It was their ego and determination that resulted in the law being broken and massive losses occurring.

Deliberate accounting fraud for financial gain is however widespread. The shenanigans of Bernard Ebbers, the boss of US-based WorldCom, is a classic example. Ebbers was forced to resign in 2002 after he milked the company for hundreds of millions of dollars by cooking the books. This involved, among things, booking current expenditure as capital costs and inflating revenues by creating bogus accounts allegedly producing sales. In all, auditors unearthed a US$3.8 billion fraud.

There is also a quite heavily populated school of outright fraudsters who quite literally managed to persuade investors to part with their money without any basis at all for their speculation. Charles Ponzi, whose scam collapsed in 1920, is arguably the godfather of financial scammers. He earned millions of pounds by selling an investment in international reply coupons, allegedly purchased in one country and redeemable for profit in another. This was outright fraud but it took a while to be discovered and when it was some US$20 million of investor's money had disappeared.

This sum is devastatingly modest compared to contemporary scams but Ponzi has the dubious distinction of having this kind of scam named after him. His most notorious successor was Bernard Madoff, whose Ponzi scheme collapsed in 2008 leaving a trail of losses estimated at US$65 billion. Madoff's plan was more elaborate than Ponzi's but essentially followed the blueprint laid out a century before in which investors were paid returns on a largely fictitious investment from the inflow of funds derived from other investors, until the day came when there was not enough left to repay those who wished to redeem their investments.

Hong Kong has had its fair share of financial scandals, including the 1988 stock exchange corruption scandal, which ended in the jailing of the exchange's then chairman Ronald Li Fook-shiu after it was revealed that there was bribery involved in obtaining listings on the bourse. Other high-profile local personalities were implicated and the scandal thrust Hong Kong into the kind of international spotlight it does its best to avoid.

Similar levels of publicity were showered on the extraordinary Carrian saga of the 1980s that left a trail of death, judicial uproar and corruption.

Hong Kong's scandals seem to specialize in bribery and just to prove how little changes, right now one of the biggest companies, Sun Hung Kai, is immersed in legal action over bribery allegations that have reached a new level with Rafael Hui Si-yan, a former chief secretary, charged for accepting bribes, a charge he denies.

It is no coincidence that most scandals begin at a time of frothy stock markets when easy money lures vast flows of cash into speculative investments. This is the background to the collapse of the Hong Kong investment house Peregrine, born in 1988, only to die a decade later. It became the second largest Asian investment bank and was backed by a 'who's who' list of Hong Kong business leaders. The trigger for the collapse was loans made to the Indonesian Steady Safe (yes, that was its name) taxi company, but more generally it was a reflection of what was happening as the Asian boom turned into the Asian financial crisis. As long as East Asian markets were booming Peregrine was able to strut around the region producing fancy paper profits. Caution was required but the degree of hubris surrounding Peregrine's founders, Francis Leung Pak-to and Philip Tose, was such that they could shrug off sceptics and claim a kind of infallibility that once exposed, quickly turned to dust.

The problem with financial scandals is not just that investors lose money (maybe they deserve to do so). Nor is it, as seems to be the main concern in Hong Kong, that they damage the reputation of the jurisdiction where the scandal occurs. It is the human toll as these scams have a terrible impact on people who get caught up without realising what's going on.

A daunting example of this is the collapse of WorldCom that caused the loss of 30,000 jobs while its boss, Ebbers, was busy plundering the listed company's coffers to finance a billion-dollar lifestyle. Then there are the people across the US who lost their homes after banks played fast and loose with home loans. And what of the people who face a dismal life in retirement after their financial advisers sought better returns from companies like WorldCom and AIG, or Enron, which appeared to be making profits that looked too good to be true and turned out to be precisely that.