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.)

Related Articles
  1. Professionals

    10 Must Watch Documentaries For Finance Professionals

    Find out about some of the best documentaries that finance professionals can watch to gain a better understanding of their industry.
  2. Mutual Funds & ETFs

    Mutual Funds Are Not FDIC Insured: Here Is Why

    Find out why mutual funds are not insured by the FDIC, including why the FDIC was created and how to minimize your risk with educated mutual fund investments.
  3. Savings

    Is It Safe to Send Money Through Facebook?

    Learn how Facebook employs strong measures to keep your information safe when sending money, but understand the rare threats that still exist.
  4. Investing

    How Shackling Offshore Banks Will Impact You

    FATCA regulations have cast a wide net on offshore banking activities, and many innocent account holders might get caught in its tangle.
  5. Investing Basics

    Toshiba's Accounting Scandal: How It Happened

    Learn how Toshiba's corporate culture and lax internal controls led to an accounting scandal that ended with the resignation of the company's CEO.
  6. Professionals

    Is Your Financial Advisor Looking Out for You?

    Financial advisors sometimes aren't looking out for clients' best interests. Regulators are scrutinizing their practices; investors should too.
  7. Taxes

    5 Warning Signs a Charity Is a Scam

    Giving to charities and helping those in need is admirable. Here's how to ensure your good intentions and donations aren't siphoned off by scammers.
  8. Professionals

    Are You Sure You Aren't Ponzi Scheme-Susceptible?

    Anyone can be a victim of a Ponzi scheme — even the most financially literate. Here's how to avoid the next Madoff.
  9. Professionals

    7 Cybersecurity Tips for Advisors

    The digital age has created a new breed of thief who can break into client files at any time, but there are ways to minimize risk exposure.
  10. Professionals

    Tips for Protecting Clients from Scammers

    Predators now have more access to vulnerable clients than ever before; advisors should communicate with clients to better spot potential scams.
  1. Why are mutual funds not FDIC-insured?

    Mutual funds are not Federal Deposit Insurance Corporation (FDIC)-insured because money invested in funds are not considered ... Read Full Answer >>
  2. What are some high-profile examples of wash trading schemes?

    In 2012, the Royal Bank of Canada (RBC) was accused of a complex wash trading scheme to profit from a Canadian tax provision, ... Read Full Answer >>
  3. What are some of the major regulatory agencies responsible for overseeing financial ...

    There are a number of agencies assigned to regulate and oversee financial institutions and financial markets, including the ... Read Full Answer >>
  4. What are examples of inherent risk?

    Inherent risk is the risk imposed by complex transactions that require significant estimation in assessing the impact on ... Read Full Answer >>
  5. Which federal regulatory agencies approved and are now responsible for enforcing ...

    Five federal regulatory agencies approved and are jointly responsible for enforcing the Volcker rule. These agencies include ... Read Full Answer >>
  6. What is the difference between the Volcker Rule and the Glass-Steagall Act?

    The Banking Act of 1933, commonly referred to as Glass-Steagall after one of its most important components, created federal ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  2. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  3. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  4. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  5. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
  6. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!