Rogue Traders -- How Does It Happen?
Although we don't know precisely what happened here, presumably some trader at UBS side-stepped proper procedures to make trades that he or she was not authorized to make. While we don't know for why this trader took the action that led to a huge loss, in the past rogue traders sometimes try to fix their bad trades with a few unauthorized trades. But if those also go bad, a trader's losses can keep piling up until they're too big to hope to correct, and eventually the firm notices.
And that's the problem here: how do banks get into this position to begin with? Did this rogue trader forge signatures to permit him to engage in these unauthorized trades? Did he or she hack a supervisor's computer? Or were there insufficient barriers in place to prevent unauthorized trades like this from occurring? If it's the latter, then really the bank only has its own shoddy systems to blame.
More Bad News for UBS
As far as the size of this loss, $2 billion is real money, even to a bank the size of UBS. It's not the biggest instance of rogue trading, however. In 2008, Societe Generale lost $6.7 billion when one of its traders took unauthorized positions. But UBS's $2 billion loss does exceed one of the most famous cases of rogue trading -- that which inspired the 1999 film Rogue Trader. It featured Ewan McGregor playing Nicholas Leeson, who brought down Barings Bank when his unauthorized trading cost the firm $1.4 billion.
According to that Bloomberg article, UBS Chief Executive Officer Oswald Gruebel, told employees in a memo, "While the news is distressing, it will not change the fundamental strength of our firm." Good luck convincing investors of that. This is a serious black eye for the firm, which has been struggling to keep its investment banking business competitive. From 2007 through 2009, the division recorded $65 billion in pretax losses.
So investors who thought investment banking wasn't a great business for UBS certainly won't be comforted by this news. Even if fraud was involved, if UBS lacks the sophistication to stop a rogue trader from costing the firm $2 billion, can it really expect its trading business to flourish?
Unfortunately, unauthorized trades like these are pretty hard to stomp out entirely. Even if you have a few layers of authorization to go through, a determined employee may be able to sneak by. For this reason, banks really need iron-clad systems that do not allow individual traders to risk the firms' capital beyond a specified limit. With today's computing technology, building such barriers should be possible.
Image Credit: REUTERS/Arnd Wiegmann