Monday, September 26, 2011

Rouge Traders and Double Standards

You may have seen the recent news of a rouge trader at UBS whose trading activity led to a $2 billion loss for the company.  In a recent blog post, the WSJ highlights what may be a double standard in unauthorized trades:
Trading on Wall Street, of course, is a thinly controlled game of dice. Traders put their firm’s capital at risk, but must do so with authorization. As this latest scandal shows, authorization is either easy to come by or circumvent. And as nearly every “rogue” has said in their defense, there were winners making unauthorized trades, too. The difference: they were winners.
We've discussed some of the cultural aspects of Wall Street that can lead to questionable behavior on a broad scale.  If the double standard described by the WSJ blog really exists, should we really be surprised to see major losses like this?  The post continues:
So, why is trading beyond internal limits allowed? Because of the winners. Enter Philipp Meyer, a former UBS derivatives trader who left the business a few years ago and wrote about the excess of the business for The Independent. To be clear, Meyer never said he made unauthorized trades, but he did offer this observation about trading. ” It was pretty clear what The Market didn’t like. It didn’t like being closely watched. It didn’t like rules that governed its behavior.” 
Then there is Jerome Kerviel, the ultimate rogue trader who lost $7 billion at Societe Generale in 2008. Kerviel claims he exceeded his credit limits regularly and that when he made money for the bank in 2007, he received a $416,000 bonus for $60 million in profits for SocGen. 
Ultimately, the difference between trading floor rogues and royalty is how their bets pay off, not whether they take extreme risks. As Leeson said, there’s no excuse for not catching rogue trading today or even 18 years ago: “a very simple check would have exposed it.”
So basically the relevant internal controls are only relevant if violators aren't making money for the bank...   That doesn't sound like much of a control to me.  Banks with this kind of implicit control environment are inviting control violations and leaving the door wide open to huge losses.  Boards of directors and top executives are responsible for establishing the right tone at the top.  Are they any less responsible for these major losses than the traders who seem to be passively encouraged to engage in unauthorized trading?  

I am interested in seeing how this case will unfold.  In particular, I am curious to see whether this case leads to any repercussions for E&Y, UBS's auditor.  E&Y signed off on internal controls as of December 31, 2010.  If these control violations were taking place during the period under consideration by E&Y, the firm could face civil suits seeking to recover damages.  

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