Yesterday, I began a series of articles, highlighting some of the most heinous Wall Street shenanigans that affect investor’s pocketbooks. My first topic was the recent failure of MF Global and how over-leverage of businesses can have far-reaching effects—on both corporations and their investors.
Today, let’s turn our eyes to rogue trading—a long-accepted Wall Street practice (as long as the profits are piling up!).
According to Wikipedia, a rogue trader “is an authorized employee making unauthorized trades on behalf of his employer”. At least, this is what manager’s call them when they lose scads of company money. But what most investors don’t realize is that this practice is pervasive, can go on for years, and instead of being punished for it, when these “rogues” make their employers tons of money, they are wined and dined, patted on the back and paid mega-bonuses.
We only hear about them though, when their big bets go awry, such as:
· 1994, bond trader Joe Jett of General Electric Co.'s Kidder Peabody tried to hide his trading losses by booking $330 million in phony profits on U.S. government bonds. He was barred from the securities business, ordered to pay back his $8.2 million bonus and a $200,000 fine, but was ultimately cleared of securities fraud charges. The following year, Kidder Peabody was no more—a victim of bad bets in an illiquid bond market.
· 1995, Barings Bank derivatives broker, Nick Leeson, singlehandedly caused Britain’s oldest merchant bank to fail, after he repeatedly doubled his positions as prices fell, losing $1.3 billion. He went to prison for more than three years and the bank that had been founded in 1762 went kaput.
· 2002, John Rusnak, a foreign-exchange dealer at AIB’s Allfirst subsidiary, was so bullish on the Japanese yen that he neglected to hedge his positions and lost $691 million in the currency markets. He was sentenced to a 7 ½-year sentence, Allfirst was bought and more than 1,100 employees lost their jobs.
· 2008, Jérôme Kerviel of French bank Société Générale, changed his strategy, betting that the markets would rise instead of fall (you will recall the opposite occurred!) and parlayed his unauthorized trades in equity-linked futures into a $7.1 billion loss for the bank. He was sentenced to at least three years in prison and ordered to repay $6.7 billion.
· September, 2011, Kweku Adoboli, equities trader at giant Swiss bank UBS, caused losses of $2.3 billion, from his Delta One desk—a profit center prevalent in large financial companies, that makes big bets on index arbitrage. Charged with false accounting, Adoboli has until January 30 to enter his plea. And you may be interested to know that he is receiving government assistance for his legal defense.
These are just a few examples of large bets gone bad, and they barely scrape the surface of the kinds of huge trades that take place on a regular basis on trading desks at the world’s largest banks and investment banks.
You don’t hear about the ones that make the banks significant sums of money. But it’s common knowledge in the investment banking world that those profits are encouraged—and celebrated—and a blind eye turned to their “unauthorized” nature.
And while it’s certainly fitting that these “rogue traders” are severely punished, what about their supervisors—the same ones that are lauding them when their bets go as hoped?
The answer is not much. Sure, the next rung up—and sometimes even the CEO—often lose their jobs, but rarely do they suffer criminal charges, or even fines. Yet, they certainly participate in the profits made by the rogues.
The problem is systemic. The thing is, the reason that these folks hired for these trading desks is that they are risk-takers, and on average, taking huge risks can also bring huge rewards—just like the over-leveraging I wrote about yesterday. And just like greed that created the housing boom and subprime mortgage markets and eventually resulted in the biggest financial crisis since the Great Depression.
Lehman Brothers, Bear Stearns, and AIG are all prime examples of companies whose executives enjoyed the largesse of extreme risk-taking, yet walked away with mostly a slap on the hand after seeing their firms either go out of business or get bailed out by the government.
When the money is rolling in, the powers on Wall Street ignore all the warning signals. It’s only when they are caught flat-footed by bets gone awry do they promise to clean up their acts.
We’ve heard the same tune after the massive savings and loan failures of the late 80s, following every “rogue trading” incident, and banking reform is still on the lips of every regulator since the financial meltdown and the 2008 recession.
But time and time again, we see that they really don’t make any long-term changes. Instead they give lip service to “policing” themselves, and hey, you don’t have to be a genius to see just how well that is working. So far, banks score 100, consumers and investors, 0.
Tune in next for “5 Ways to Protect your Portfolio from Wall Street’s Excesses”.
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