Who's To Blame For Rogue Traders?

By Yolander Prinzel | October 12, 2011 AAA
Who's To Blame For Rogue Traders?



Rogue traders aren't a new occurrence in the financial industry. For as long as there have been companies, with a viable way of making money, there have been people ready to test the limits and take advantage. In the Bette Davis movie, Mr. Skeffington, one of the characters is a rogue bond trader who made $24,000 in commissions placing fake bond orders; a lot of money in 1944.
In the 70 years since that movie was made, you'd think that companies and regulators would have a closed system and fixed policy loopholes, that allow rogue traders to continue with their activities, but as recent news proves, that simply isn't the case. In fact, often, companies and regulators do little to prevent rogue trades, and instead act the part of the innocent and victimized when the fraud of rogue traders is found. In reality, this three-part system of trading, management and oversight could be a monumental trifecta executing capitalist ideals safely, through an effective system of checks and balances, if each entity in the triangle acknowledged their basic responsibilities.

TUTORIAL: Electronic Trading

The Responsibilities of a Trader
Traders execute orders for the firm they work for, or the firm's clients - whether retail or institutional. It's their job to execute orders they receive, with any special instructions, given by the client; as long as they are compliant with regulations. When salary and bonuses are based on the profits made on company trades, or even on the trades of clients, it can be tempting for some traders to "experiment" with company money in order to create quick profits on short-term moves.

Of course, there's also every opportunity for a data entry mistake - the accidental addition of an extra zero in the number of shares to be bought or sold, for instance, which can occur. These mistakes can also be costly because the company, itself, must cover the costs of unwinding the trade - which means that traders also have a responsibility to double and triple check orders, and to send trade confirmations to clients who, by the way, also have a responsibility to check them over. (For related reading, see 9 Tricks Of The Successful Forex Trader.)

The Responsibilities of a Company
Financial institutions like UBS and Societe Generale, which had a $7.7 billion loss in 2008 following rogue trader Jerome Kerviel's unauthorized trades, should have systems in place to monitor the activity of their traders, and alert management to any unusual transactions while also creating a system of checks and balances to provide oversight for extremely large trades.

After the Societe Generale debacle, there was some talk about how the trades that Kerviel made, which eventually led to the loss, had to have set off alarm bells within the company, but since they initially made the company money, no one stepped in to stop the reckless behavior. Whether this is true or if it was simply an oversight, there are obvious problems with the monitoring protocols in place.

All businesses - from grocery stores to tailors to food trucks - are exposed to risks of loss through employee mistakes and theft. In order to prevent these potential losses, they develop a system of oversight through the division of job duties, installation of electronic oversight and notification measures and the hiring of supervisors and managers. Financial institutions, with employees, who routinely handle billions of dollars in transactions should be no different. Internal audits should be conducted more regularly, and it might even be a good idea to consider changing how salaries, bonuses and commissions are paid; so that risky, non-compliant or illegal behavior isn't rewarded. Others suggest separating the banking, investing and insurance functions of large financial institutions to limit the risks that rogue employees can take and the losses that can ensue. (These "rogue traders" are famous for their billion-dollar mistakes. For more, see Trading's 6 Biggest Losers.)

The Bottom Line
Relying on individuals to always act in an ethical manner, and without mistakes is, unfortunately, unrealistic. And waiting for the financial fallout of a rogue trader to occur before taking action, is irresponsible and dangerous. Instead, policy makers, regulators, financial institutions and stockholders must all demand safety and compliance along with smart policies, and must work to ensure that these things are complied with and enforced before losses in the trillions are tallied.

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