Rogue trading occurs when an employee of a bank or investment firm makes unauthorized trades in the name of his or her employer. While this is illegal, there have been cases of this practice being overlooked as long as the trades were making money. Only when losses were involved did the banking institution notice, or press charges. (For more on how Rogue Traders started on that path, check out The Rise Of The Rogue Trader.)
TUTORIAL: Options Basics
In the wake of the recent "rogue trading" scandal that cost Swiss bank UBS nearly $2 billion, banking rules and regulations are being scrutinized. The UBS isn't the first case of its kind. In 1995, Nick Leeson, a rogue trader was responsible for the bankruptcy of Barings, one of Great Britain's oldest banks. Fortunately, for UBS, its rogue trader was caught before doing more financial damage.
Problems Rogue Trading Causes
As an employee of the financial institution, a rogue trader may have access to insider information and usually knows the company's inner workings. The employee is usually never suspected in any wrong doing. Employees can easily fall into "corporate cracks," allowing them to trade for years undetected. Usually a bank's only indication of this type of trading is when the rogue trader begins losing significant amounts of money.
The losses, as in the case of Barings, can not only bankrupt the financial institution itself, but they can put customer and retail deposits at risk. This would mean federal involvement, as customer and retail deposits are insured by the FDIC. Many experts agree that the global financial and banking systems are in very fragile condition caused mainly by lack of diligent oversight from bank management.
Can Rogue Trading Be Prevented?
With sophisticated software and oversight audits, it would seem impossible for any individual to conduct speculative trades without corporate knowledge. Curiously, there aren't many systems in banking that oversee individual traders. This lack of control makes it rather simple for rogue traders to conduct business. There are many regulations and procedures in place both within banking and from the federal government to prevent rogue trading. The single most effective method is to continually reassess those systems, and constantly monitor internal trades. (For more, read Who's To Blame For Rogue Traders?)
Prevention and Regulation
The outcry for more banking regulation is being heard not only in Europe, but in the U.S. One regulation under consideration is the Volcker rule, named after Federal Reserve Chairman, Paul Volcker. This rule limits financial institutions ability to trade within their own accounts; it would also prohibit the use of personal deposit account monies from being used in speculative trades. Parts of this rule would extend to foreign banks with offices in the U.S. This rule has European banks threatening to relocate their offices and employees outside of the U.S. if it becomes strictly enforced.
Another idea being suggested to help prevent future rogue trades is to re-institute the Glass-Steagall Act of 1933. This act created the Federal Deposit Insurance Corporation (FDIC), and introduced banking reforms after the stock market crash of 1929. It oversaw interest rates on savings accounts, and required separation of a financial trading company from client banking services. This act was repealed in 1999, thus allowing investment firms and banks to merge. Some analysts believe this repeal contributed directly to the current banking crisis. Others however, think it helped prevent a much worse financial catastrophe as it allowed investment firms like Bear Sterns to be purchased by JP Morgan Chase. In today's global economy where European and Asian banks are allowed this ability, many think the reinstatement of the Glass-Steagall Act would only hurt U.S. business and banking.
The Bottom Line
Measures are continually being put in place to prevent fraud, theft and rogue trading. Vigilance from banking management is the single best weapon the financial segment possesses. The same can be said for individual traders and investors. No one is going watch over your money or investment accounts like you are. Even with the best of technology and strict oversight, a rogue trader will succeed at "breaking" the bank. (For more on rogue trading, see 3 Worst Rogue Traders In History.)