An unprincipled, deceitful, unreliable scoundrel. A vicious and solitary animal. An organism that shows a variation from the standard. What are we talking about? Rogue Traders! Does the cap fit?
Some people ask why rogue traders still exist. But, that seems as if it’s an easy one to answer. Fool-proof risk management doesn’t exist and never will. At, least it won’t while the rogue traders are being covered by rogue managers.
You see, the definitions at the beginning had one thing wrong. They are definitions of solitary, lone-wolves. But, even lone-wolves belong to a group. They just prefer to avoid the assistance of others in certain matters. The rogue trader’s pack is the howling, fierce management for which he works. Lone-wolves always have alpha members they take orders from, don’t they? Lone-wolves are sometimes excluded from the pack to protect that alpha-male, thus preventing ‘in-breeding’ in the pack. It’s exactly the same in the trading world of finance. The rogue trader is excluded from the pack, forced to work alone, shunned so that if caught, there will be no ‘inter-breeding’. The alpha-male manager won’t be caught and be brought down if the rogue falls!
But out of all the rogue traders that have come and often gone forever (only making a pitiful comeback living on their past as the conference giver, the ‘guy that brought down X bank and Y stock-exchange’) there must be a reason why those guys actually do it. Here are some of the reasons:
Self-worth can be tallied with profit and loss. Make it big and the rogue trader will have high esteem. Lose and he will hate himself. In both cases, the champagne will flow in ostentatious showy brashness, but with the highs the rogue trader will shout “this one’s on me!”
Make a loss, and he will drown his sorrows. The level of profit is proportional to the size of their ego and to the size of the bonus that they will get handed. That bonus will be proportional to the size of the thought that they were doing the right thing. Rogue traders, when caught, have often said that they were not motivated by the gains. Do we believe them?
Traders are allowed to think that amassing great quantities of wealth is good. Their intelligence is measured in doing so. Their daring courage is equated with the money they get. But, their emotions are left on the side-line. They never come into play. They feed only on the greed that fuels their actions. Greed becomes an acceptable trait and human characteristic that is worth the effort. Boundaries are pushed.
The market goes up and then it reaches a peak and drops. It’s cyclical. The winning streak that is experienced is cyclical too. The winner-effect has a big bad brother: the loser-effect. The winner-effect sees a show of testosterone pulse, aggressive behavior bringing about more wins, in an ascending cycle. The winner effect is a psychological impact on the brain. It leads to over-confidence and then mistakes are made. The brain feeds of the dopamine-linked betting against market fluctuations, underpinning pleasure. Success and winning mean that the brains production of cortisol (the stress hormone) removes the downers in people. The winner becomes self-assured, confident and in control. The ego is enhanced and that winning leads to drug-like addiction. Betting on the ups and downs of the market movements is the cocaine-snorted drug of the rogue trader.
4. Double or Quits
When things take a turn for the worse, the rogue trader has just a few options to him to get himself out of that trouble. Either he admits and comes clean. But, that will be hard after the ego boost that was the result of the winning streak. Self-esteem will be lost and the esteem of others. That will be psychologically hard to accept. If he comes clean, he will start a chain of events that will no longer be under his control. He will lose his job, become ‘the guy that brought down the bank’ and the one that ruins the investors. He will become public-enemy number one. That second option is he can use more money and try to right the situation. The winning streak will return, his brain has told him so, because he has no fear. Fear went when the stress hormones stopped being produced. The chances that the guy will become public enemy number one if he admits to everything are 100%. But, there is a fifty-fifty chance of losing and winning if he places more money on his losses. At least, that’s what he thinks. So, he chooses the second option; instead of calling it quits, he doubles and loses again.
So, who are the rogue traders that have experienced all of this? Here’s a small sample (the ones we know of!). They are not in chronological order but in order of how much money they actually lost their banks (from the lowest to the highest):
1. John Rusnak
The guy that brought down the Allfirst Bank and incurred losses of $69.2 million.
He was sentenced to 7.5 years in prison on January 17th 2003 for hiding the losses that he incurred as a currency trader. He hid the losses for a year. He is now under confinement at his home (since January 2009, meaning that he served almost six years for his rogue trading).
He was ordered to pay back $1, 000 per month after his release from prison and despite the fact that he remains in debt to the full sum of $691.2 million he will probably never be able to pay it back. How did it all happen?
- Allfirst Bank wished to make its forex operations go from just hedging to bringing in a yield of profits and thus increase the total profits of the bank.
- John Rusnak was hired to do this.
- Rusnak was bullish on the Yen. He believed that the Yen would not fall any more after the bursting of the Japanese bubble. He believed that the Yen would rise against the Dollar.
- He neglected to hedge his forward contracts believing that the Yen could not fail to rise.
- With the onset of the Asian crisis, the Yen fell.
- He thus entered false options into the systems to make it seem as if the positions were hedged. He also asked for more money from high brokerage accounts in order to try to win back the money that he had already lost.
- The management granted this to him and he invested even more money.
- Rusnak made a personal gain of $550, 000 in bonuses plus his salary.
- The losses only came to light when the bank asked for capital to be released and they realized that Rusnak had been working in the red all the time.
- Rusnak was fired from his position and along with him he brought down 6 senior executives for failing to detect the scam.
One thing is for sure: Rusnak has kept his nose clean since getting out of prison and has managed to fall into relative anonymity. Nobody knows what he’s doing today for work.
2. Toshihide Iguchi
The guy that brought down the Daiwa Bank of Japan and incurred losses of $1.1 billion.
Iguchi was a government bond trader in Japan who made 300, 000 unauthorized trades between 1983 and 1995. As early as 1983 he in fact lost $70, 000 but concealed this from his management for fear of losing his job. He wrote a thirty-page letter to his boss in 1995 explaining that the losses had just got bigger and bigger and that he was unable to do anything to rectify the situation. It seems strange however that for 12 years Iguchi was able to carry on regardless without any control or surveillance from anyone.
Iguchi wrote three books when he was released from prison: The Dollar Conspiracy, My Billion Dollar Education and Confessions. But, he spent four years in prison and his $2.6 million in debts were eaten up by the royalties. He went back to live in Kobe, Japan. He started an English-language school there.
3. Nick Leeson
The guy that brought down Barings Bank and incurred losses of $1.3 billion.
Nick Leeson was a derivatives broker at Barings Bank (the oldest investment bank in the UK). The bank had been founded in 1762 and ceased to operate in 1995, when the Leeson scandal broke.
Leeson was appointed general manager (futures markets) on the Singapore International Monetary Exchange in 1992. One interesting thing is that Leeson had already been refused a broker’s license in the UK due to reasons of fraud in his application. He obtained one in Singapore, however.
Leeson was earning £50, 000 a year in 1992 and bonuses exceeded double that sum: £130, 000. He was undertaking unauthorized speculation on behalf of Barings, netting profits for the bank of up to £10 million (which was about 10% of their annual income). When things took a downturn he used an error account to try to rectify the losses. The account was the infamous number 88888. The account was used to hide his bad debts. The losses were easy to hide since Leeson was working on his own and had no control from anyone.
- Losses in 1992 stood at £2 million.
- By 1994 they were at £208 million.
- Leeson placed a short straddle (a strategy that means that he sold a put and a call at the same time).
- Losses neared £827 million or $1.3 billion by 1995, when Leeson jumped ship leaving a little note just saying“I’m sorry”. The bank was declared bankrupt in February 1995. It was sold for a token £1 to the ING banking group.
Leeson wrote two books when he got out of his six-year stint in prison. One of those books was turned into a film, Rogue Trader. He went back to school and got a degree in Psychology and now gives conferences. Whenever a rogue trader gets mentioned in the press, Leeson is there to tweet.
4. Kweku Adoboli
The guy that brought down UBS and incurred losses of $2.3 billion.
This guy is the most recent rogue trader to date, but only the second highest in terms of loss and debts incurred. He was a trader at the Swiss UBS bank and was charged on September 16th 2011 with fraud and false accounting. He was found guilty on 20th November 2012 and was sentenced to seven years in prison. On March 1st 2013, Adoboli appealed against the sentence. Adoboli’s salary and bonuses combined stood at £360, 000 before his arrest.
Adoboli admitted during the trial that:
- He was trading in excess of limits.
- He was booking fake trades to hide behind.
- But, he also stated that this was in line with recommendations of the bank.
- He said that his colleagues knew of his hidden account and that his managers were aware of the losses and had pushed him to make sure that he recouped on them (all five of them were fired immediately).
UBS was fined, however, the sum of £30 million when the City of London financial regulators (Financial Services Authority) decided that “UBS’s systems and controls were seriously defective. Failures of this type in firms of the size and standing of UBS not only damage the firms concerned but also wider confidence in the integrity of the markets and the financial system.”
UBS cut its investment side of its operations and trimmed the workforce by 10, 000 in 2012.
5. Jérôme Kerviel
The guy that brought down Société Générale, and incurred losses of $6 billion.
Keviel was a French trader. He was accused of breach of trust, forgery and unauthorized use of IT systems. He was earning bonuses of €60,000 along with a €74,000-salary (2006), which quite honestly is relatively little in the financial world.
The bank that brought the case against Kerviel states that he was working without the authorization of his superiors and the bank had no knowledge of this whatsoever. He began creating fake trades as from 2006 (and he started working for the Société Générale in 2000).
- He is accused of having traded at levels that exceeded the market capitalization of the bank. It certainly begs the question as to how it would be possible to trade at over the market capitalization of the bank without anyone at the bank actually finding out. Was he the scapegoat or the rogue trader of the SG?
- Apparently hundred and thousands of trades were carried out by Kerviel, hidden behind false hedge trades.
- Kerviel was charged on January 28th 2008 and his trial began on June 8th 2010. His sentence has been suspended while appeals are made.
Kerviel got three years (five years with two years suspended sentence) in prison and was banned from working in finance for life. After his arrest in 2008 he was hired as an IT consultant for Lemaire Consultants and Associates (with a salary averaging at $1, 200 a month) as he appealed against the sentence. He also wrote a book called Trapped in a Spiral: Memoirs of a Trader. But, he was banned from making any profit from either books or films and has to hand over any royalties to the Société Générale. Kerviel lost a court case today (July 4th 2013) in Paris in which he was demanding that there be independent experts to look into his case. That means the final sentence will be pronounced on 24th March 2014 and his fate will be sealed. In an interview he gave to French television July 4th2013 on leaving the court he said that it was “impossible for him to be solely responsible for the $6 billion that had been lost”.
Some might say that the rogue trader should only limit the losses by taking the profits before they turn into losses, rather than continuing to take that second option of double or quits. The rogue trader should use tools of analysis rather than going with gut feelings and intuition. Intuition only works by a stroke of luck. They should not hide the trades that make losses and learn by their mistakes. All very easy to say, but harder to do! But, that would be reason talking, not the drug-addicted investment and playing the markets that stop them sleeping.
Like wolves, traders establish territories that are greater than they really need to survive. Just like the prey that tries to escape from the claws of the wolf, with the rush that ensues, the wolf pursuing it, the rogue trader attempts to catch up with his losses. This is the most critical stage of the trader’s hunt for profit. Once the prey is caught, the trader feeds excitedly, ripping at the carcass of the profit, tearing off chunks and bolting it down. The profit is nothing more than an ephemeral feed. When the losses set in, the lone-wolf trader usually avoids howling in the presence of the alpha-male or the dominant wolves in the pack, it would do no good to get caught. But, thankfully, there are whistleblowers that still exist to trumpet and proclaim loudly what has been going on and just how much has been lost in investments that turned sour.
Why do you think rogue traders are incurring greater losses to their banks?
Originally posted: The Men that Broke Banks – Rogue Traders