The Biggest Rogue Traders in Finance…. of All Time: Rogue Trader Hall of Shame

Rogue traders in finance are fascinating because of the huge losses which normally accompany there discovery. Yet what many readers may not realise, is that it relatively easy to go from being a trustworthy trader to a rogue one. This is because traders are given enormous power to place large orders. Due to the speed at which they are required to perform their work, it is difficult to place controls over them. Essentially financial institutions place a great deal of trust in their traders. 

Takeaways

• What is a rogue trader in finance

• Did you know what the biggest rogue traders did?

• Find out how today's headlines are relevant to rogue trading

What are rogue traders in finance?

A rogue trader in finance is someone who has gone beyond their remit. Every trader will have a framework within which they are are expected to operate. There are many different forms of traders:

• A dealer's job is around price discovery, namely finding the best venue to buy or sell a large amount of shares.
• A portfolio manager, who will trade less often but will place larger trades due to their buy and hold strategies
• A trader in the purest form, whose job it is to turn capital into more capital. They will trade all sorts of assets over short or long periods of time.

As can be seen, each of the above interacts with financial markets for different reasons. Yet if the dealer started to take proprietary positions as a trader does, they would be in breach of their remit. This would also apply if a portfolio manager started to behave like a hedge fund manager, and regularly 'churn' the stock portfolio they are managing. In each of the above examples, the trader would be described as having gone 'rogue'.

How can it happen so often?

Because controls are not followed and downside risk is ignored! A case in point is Credit Suisse who approved a loan to Greensill Capital, when it's own risk managers said no. It now looks like Credit Suisse's clients will lose much of their investment.

In this case the founder, Lex Greensill, was a client of the CS private bank which probably resulted in the loan being approved to keep the client happy. You will be surprised how often a risk management framework is ignored or not consulted in a bank.

The spectacular blow up of Archegos capital is another example. How is it possible that major investment banks were lending so much individually to a small time family office? What is the point of having controls when they are not unforced. (Rogue) traders know this.

Traders behaving badly

A trader once said to me they all breach their credit limits regularly. As long as they are profitable, their managers looked the other way. The manager's bonus also depends on their team's traders doing well, so they is often an incentive to tolerate bad behaviour.

Little interest in searching

Active risk management costs money. In such a process you investigate particular parts of the business looking for risks. That means someone has to be paid to do it and this costs money.

Much better (cheaper) for a bank to get someone to run reports, (as part of other work streams that person will handle) and then only investigate something that is abnormal. Examples can include a large number of cancelled trades, or higher than normal trading volumes (with no corresponding profit).

This is passive risk management, where you are passively checking, not actively looking. Problem is, some rogue traders know which reports are run and know how to hide their trades from these reports.

Rogue trader hall of fame

Jerome Kerviel lost €4.9 billion whist working at Société Générale. Incredibly he was only found out when he deliberately created a huge losing trade to hide his hugely (and illegal) profitable trades. It also transpired that he has been trading illegally since 2007, a year before he was caught!

As he had worked in middle office, he knew how to book offsetting trades to hid the extent of his positions from risk and compliance functions.

Yasuo Hamanaka lost $2.6 billion whilst working at the Sumitomo Corporation. His rogue trading actually lasted 10 years and started because he desired to cover some early poor trades. He resorted to forging signatures as well as borrowing from other banks to cover his losses.

Kweku Adoboli lost $2 billion whilst working at UBS. His previous job as a trade support analyst means he seems to have understood how late trade confirmations were issued. This allowed him to hide his trades and quickly input new ones before the confirmations were checked.

It seems he was only found out when he gave himself up. All the more embarrassing for UBS, internal risk and compliance software had previously flagged a trade of his. This was not followed up!

Nick Leeson lost £827 million whilst working for Barings Bank and eventually gave himself up by leaving a note saying 'I'm sorry'. Barings Bank was bankrupted by his rogue trading.

He famously hid his losses in the 88888 error account, which was only supposed to include error trades. He also resorted to doubling down to get recover his losses. As there was little oversight of him in Singapore, he was able to virtually do as he wished far away from head office in London.

How do you spot a rogue trader?

As a result of rogue traders, everyone in finance, especially those in trade facing roles have to take 2 consecutive weeks of holiday. The theory being that you cannot hide rogue trading for 2 weeks. Most rogue traders rarely take holidays as they constantly have to create new fictitious trades to hide their rogue ones.

Anything out of the norm, such as a large number of failed or cancelled trades, a higher than average volume should be investigated thoroughly. Indeed there is an argument for a risk analyst to periodically take a deep dive in a trader's positions.

This will give you an understanding of how they trade, (so you can spot any anomaly). It may just identify ongoing rogue trades before they become material to the bank's balance sheet.

Conclusion

Banking relies on trust. There is no getting away from this. If a trader wants to go rogue, it is hard to stop, even when they use creative accounting. What you need to do is nip it in the bud before it becomes a problem.

Do not do what JP Morgan did with the London Whale incident, where the CEO referred to it as 'a tempest in a teapot'. JP Morgan eventually had to own up to a $2 billion loss.

What can be difficult, is that a suspicious trade could be fat finger error trading. So for a busy risk or compliance analyst they dismiss it as such, as they do not have the time to thoroughly investigate every flagged trade. Indeed at one point in my career as a stock broker, compliance wanted my trades to be authorised by someone else. This was dismissed as impractical due to the amount of trades I processed.

Sadly this contradiction allows rogue traders to get away with it. Until we live in a world where banks place risk management before profit, we are likely to see more rogue traders in finance in future.