How Did a Rogue UBS Trader Lose $2 Billion?

The strange saga of how a rogue UBS trader lost $2 billion and who has since been fired and charged with fraud and false accounting in a London court has raised questions about the bank’s stability and whether it will retain its clients.  Ghana-born trader Kweku Adoboli was perceived as a polite and snappily dressed young man who mixed grueling hours in London’s financial district with a lavish social life in the capital’s nightspots.  But even the 31-year-old Adoboli appeared to foresee his work-hard, play-hard lifestyle coming undone.  “Need a miracle,” he posted on his Facebook page, just hours before his arrest.

Analysts and regulators questioned why the Swiss banking giant UBS and its monitoring systems had failed to spot Adoboli’s alleged fraud.  “Nobody blames the tiger for stalking its prey, but you do blame the zookeeper for leaving the tiger’s cage open,” said Stephen Brown, professor of finance at New York University’s Stern School of Business.  “These top banks hire the best and brightest ambitious young people and when they outperform everyone else the bankers want to believe in their brilliance so they look the other way.  That’s exactly what happened at UBS.”

Said a London based private banker at a rival global institution, “We don’t want to gloat because there but for the grace of God.  But it’s likely to be the kind of thing that if we were in competition with them for a pitch it would help us because it would be another question mark in people’s minds,” he said.

Peter Thorne, an analyst at Helvea said this crisis is less serious than UBS’ previous woes and is unlikely to result in a similar stampede.  “I can’t believe they’re not going to do their utmost to maintain their clients. Also, if you’ve been through the financial crisis and you stuck with UBS you must love them, so I’m not sure you’re going to jump ship,” he said.

The Wall Street Journal’s David Weidner compares this case to that of Nick Leeson.  “Consider the story of Nick Leeson, the first trader to bring down a bank.  He racked up $1 billion in losses and was sentenced to six years in jail.  Barings Bank collapsed under the weight of the exposure.  Leeson said exceptional risk-taking was common.  He actually used an account that his team had set up to cover losses of a junior trader.  And as many accused rogues have argued, Leeson said the bank tacitly approved.  The number of rogue traders — there have been at least 11 since 1995 who have lost roughly $10 billion combined – suggests that Leeson may be right.  So, why is trading beyond internal limits allowed?  Because of the winners.  Enter Philipp Meyer, a former UBS derivatives trader who left the business a few years ago and wrote about the excess of the business.  To be clear, Meyer never said he made unauthorized trades, but he did offer this observation about trading.  ‘It was pretty clear what The Market didn’t like.  It didn’t like being closely watched. It didn’t like rules that governed its behavior.’”

Writing for Business Week, William D. Cohan says that “Whether UBS is shown to have been aware of Adoboli’s trading is almost beside the point.  If the bank was aware of it and did not stop it, then its failure to do so is unconscionable. If it was not aware of the trades, then its compliance and risk management departments’ failure to prevent them from happening in the first place is equally appalling.  In the post-Lehman, Dodd-Frank, Basel-III era, it is nearly unfathomable that a global bank of UBS’s heft, wealth and importance could allow this kind of loss to occur.  Where were the adults?  There will almost certainly be regulatory consequences for the rest of Wall Street as a result of this ill-timed debacle.  The banks will howl, but tighter rules could actually help protect the rest of us from their bad behavior.”

Happily for the United States and the Dodd-Frank laws, it’s less likely that a rogue trader could topple a major U.S. financial institution.  One section of the Dodd-Frank legislation is the Volcker Rule, named after former Federal Reserve chairman Paul Volcker, which limits American banks’ ability to trade their own funds.  That wasn’t true in 2008, when losses from bad bets that banks made on mortgages led to the meltdown of Bear Stearns and Lehman Brothers.  Full implementation of the Volcker Rule is expected to be delayed from its original July 21, 2012 deadline.  A majority of the largest American banks have already sold or closed the desks that make these trades – known as “prop” or proprietary trading desks.  “Banks can put themselves under with dangerous trading and take the commercial side with them as they go down,” said Robert Prentice, a professor of business law at the University of Texas’ McCoombs School of Business.  “A big part of what the Volcker Rule will do is separate out the risky trading from the deposits.”

A majority of the banking system depends on computers to spot abnormal trading activity that could signal unauthorized trades.  Industry watchers still question whether the Volcker Rule in its final form will mandate the spin-off of prop trading from banks or whether it will be watered down.  “You can’t underestimate the lobbying ability of the banking industry in the U.S. and the U.K.” said Stewart Hamilton, a finance and accounting professor at the University of Edinburgh.  “It’s huge.”