UBS and that missing $2.3bn: Rogue trader, rogue company or rogue industry?

Revelations last week that UBS, the Swiss-based global financial services company, had shipped close to $2.3bn due to "unauthorized trading" in its London investment banking division focused intense media speculation on the derivatives trader at the heart of the scandal, Kweku Adoboli. Earning himself the now familiar epithet of the "rogue trader", Adoboli also claimed the dubious honor of a position at number 3 in the all time Rogue Trader Top 10, placing well behind Jérôme Kerviel at number 1 (with nearly $7bn in losses), but close to Yasuo Hamanaka at number 2 ($2.6 bn) and well in front of Nick Leeson at number 4 ($1.3bn). Like those before him, Adoboli's losses have had grave repercussions for his employer and for the bank's stakeholders. UBS's share price dropped by 10% after the losses were reported, and with almost the entire quarterly earnings of the firm wiped out, the bank is reportedly aiming to accelerate a major restructuring of its business, involving thousands of job losses. Meanwhile UBS was quick to reassure its well-heeled customers that none of their money was at risk, though a downswing in the bank's reputation and overall trust levels seems inevitable.

The narrative of the "rogue trader" is a seductive one in making sense of events like those at UBS. A lone trader going off the rails, committing fraud to make himself rich - what could be a simpler explanation? But as with Kerviel, Leeson and others before him, Adoboli does not appear to have been seeking to profit directly from the unauthorized trades (although clearly would benefit indirectly in terms of a higher bonus if the gamble paid off). In reality it was more a case of taking an illegal route to try and make the firm more money. Likewise, Adoboli hardly fits the stereotype of the evil genius that many will picture when thinking of a rogue trader. By all accounts the Ghanaian born, 31 year old seems to be pretty unremarkable.  He likes art and photography. He's "very polite", "very loyal" to his employers a "really nice guy" according to the neighbors, even his former landlord speaks highly of him. He went to private school and graduated from a respectable university (Full disclosure: actually he studied at the University of Nottingham, and graduated whilst Crane and Matten were teaching there - but did not, we might add, attend our ethics class). Clearly, a major share of the blame for UBS's losses must rest of the person who cooked the books to keep his spiraling losses secret. But he's hardly much of a rogue, it has to be said.

So where does the rest of the blame lie? UBS itself certainly has to take a large proportion of the responsibility. After all, what kind of financial institution doesn't realize that one of its employees is taking such wildly speculative positions and then cooking the books to hide it? Adobodi appears to have been making some unauthorized trades since 2008. In the end it was the trader himself who blew the whistle on his activities, not those who were responsible for exercising financial control. Internal and external auditing, back office controls, risk management, compliance -aren't they supposed to stop this kind of thing happening? Moody's the rating agency is belatedly pointing at "ongoing weaknesses" in the bank's risk management."We have continued to express concerns with regards to the ability of management to develop a robust risk culture and effective control framework," the agency said in the aftermath of the last week's disclosures. But this is hardly news for a bank like UBS that lost $37bn in the subprime mortgage crisis and had to be bailed out by Swiss taxpayers.

Myret Zaki, the author of a best-selling book on the bank has presented the situation as "a never-ending story repeating itself". "I'm not surprised at all about this," she told the UK newspaper the Telegraph "[UBS CEO] Oswald Grubel kept advocating an increase in risk-taking. When you have a CEO talking like that, you are not in a climate where you feel restricted, as a trader. He was on the side of continuing to make money on the markets, even though wealth management was employing 30pc fewer staff for double the profitability." Others, such as Richard Abbey, the senior managing director of financial investigations at Kroll, point to UBS's recent downsizing as a factor: "It's no coincidence that after downsizing and lay-offs these type of losses are more common. There may not be enough people to physically control checks and balances. It may be institutions are too reliant on computer controls and they are the easiest to bypass." In many respects then this was a time bomb waiting to go off - with Adobodi as much the symptom as the cause. This could be "rogue bank" just as much as "rogue trader".

Taking a broader perspective on the scandal, maybe we don't need to stop the blame game at Adobodi  and UBS. As with the recent financial crisis, perhaps this is also a deeper rooted problem of the financial services industry as a whole. According to the Telegraph, "unauthorized" trading could be considerably more widespread than the occasional huge rogue trader incident suggests: "experts and insiders warn the amount of risky unauthorised trading is difficult to quantify and often not brought to the public eye unless losses are huge enough to be announced". The paper goes on to quote a "senior trader" at a London bank: "People are fired every year for having stuff on their book that they shouldn't. All the banks tend to know what has happened and why someone has left, but it doesn't get publicised. It's usually only a couple of million bucks." So while Adobodi may be number 3 in the rogue trader top 10, we never even get to hear about all those entries lower down the charts. Jérôme Kerviel, who's still there at the top of the list has suggested that companies like Société Générale, his then employer, may even tacitly endorse such trades as long as they are making the bank money. It's only when they start registering huge losses that the controls really kick in. As even the Wall Street Journal recently quipped: "what do you call a 'rogue' trader who makes $2 billion? A Managing Director!" These may of course be little more than jokes, rumors and groundless accusations. But clearly the financial services industry has a major task ahead of it to clean up its reputation and regain the trust of its stakeholders. The events at UBS are going to make that task even harder now. We don't just have a rogue trader on our hands. We have a rogue industry.


Photo by Ahmad Nawawi. Reproduced under Creative Commons Licence

Crisis management - European style?

Our more longstanding friends, i.e. those who have worked with the first edition of our Business Ethics book, will remember that its success was very much predicated on the proposition that it was the first text book to talk about business ethics from a European perspective. OK, we toned it down for the second edition, but still the main focus of the book is to provide an account of business ethics beyond the Anglo-American version of capitalism – which still is the backdrop of most textbooks in the field.

There has been some debate about whether – and if so, how – a specific European perspective on business ethics is warranted. A good way to learn about these things is to look at how different economies deal with ethical scandals (e.g. Ethics in Action 6.1 in our Business Ethics book). A newspaper article in the Canadian Globe and Mail discusses the recent scandal in France at the bank Société Générale in the context of the Enron case and comes up with some really striking comparisons.

We talked about Jérôme Kerviel in one of our latest blogs and it is indeed fascinating to watch how the French public, rather then seeing him as a villain and a crook, views the bank and its managers as the ones who are responsible for what happened (you can give your own assessment here, see the box on the right). The general mistrust of capitalism and big corporations still seems pretty entrenched in Europe. On facebook, there are now numerous support networks for Kerviel. For instance the group “Jérôme Kerviel should be awarded the Nobel Prize in Economics" has no less then 2,517 members! Could you imagine this happening to Ken Lay or Jeff Skilling in the wake of the Enron disaster…

It is also conspicuous to see the reactions. While the US government took a fairly hands-off approach to the actual downfall of Enron, incl. the plight of many employees who lost jobs, savings and pensions, Nicolas Sarkozy’s government is anything but ‘laissez faire’. Worried about a foreign takeover of Société Générale it appears that the French government has now elected to micromanage the case and has even considered a fairly unrealistic bail out. While the magnitude of this case probably will not allow for this, European governments have a longstanding history of becoming directly involved in managing these issues. And this even at a time where we would expect newly wed Sarkozy to have other things on his mind…

This hands-on approach contrasts significantly with the US, where the main reaction of the government was to issue new legislation with the Sarbanes-Oxley Act, setting tighter rules for the game, rather than trying to become a player in the game itself. It is also interesting to see differences within Europe here. The Globe and Mail article refers to how Gordon Brown has dealt with the recent collapse of a major British bank (Northern Rock): While Brown was actively (as it were, European-style) involved in protecting the savings and mortgages of millions of British working men and women, the solution was in the end left over to the market: brokering the takeover of Northern Rock by Richard Branson’s Virgin empire appeared the best solution, showing strong reliance on markets and free enterprise in the running of the economy – something we can associate more strongly with the Anglo-American system of capitalism.

It will be fascinating to watch how the personal fate of Kerviel will develop over the next couple of weeks. He will hopefully not end up as Enron’s vice chairman John (Clifford) Baxter who committed suicide, unable to deal with the personal shame about his role in the scandal. But it will also be fascinating to watch the further fate of Société Générale. Our money is on a take over by another French bank, brokered in some backroom of the Elysée Palace!

Rogue trader, latest edition

One of the bets you can place these days at Ladbrokes (a British chain of betting shops) is who will play the role of Jérôme Kerviel in a movie some people are planning to make this year. It is a dubious honor for Kerviel, whose covert trading gambles at Société Générale in Paris has brought down the bank last week. The funny thing though is that if a movie script writer would dream up this story, including the whopping €4.9bn losses Kerviel amassed, the plot would sound way too unrealistic to be credible screen material.

It is amazing that since legendary Nick Leeson, whose hidden trading brought down Barings Bank in the 1990s, these cases have keeping happening with a certain regularity (see Ethics in Action 4.1 in Crane & Matten). What’s different in this case is not only the magnitude of losses but also the fact that Kerviel had no immediate personal gain of his dealing and was acquitted of attempted fraud by a French court this week. The focus of the public is much more on the bank rather than the employee who caused the scandal.

While it is yet unclear how much the management at Société Générale actually knew about the secret deals the case is yet another example how unavoidable business ethics has become for companies. By all accounts, Kerviel himself has no record of criminal behaviour, on the opposite; he was a highly successful, skilled and appreciated employee of the bank. His bonus in 2007 was a nice €300,000. What the case makes blatantly obvious is the role of the organizational context in either encouraging or subduing ethical behaviour.

With ever more complex financial products, electronic systems and multifaceted global markets it appears to be increasingly challenging for senior bank managers to keep up with the pace of innovation and to design policies which would allow for better control of traders such as Kerviel. It also appears that rules at Société Générale, in so far they existed, seemingly were open to interpretation and discretion, though much of these things are just about coming out as a result of the ongoing investigation.

This case then ultimately leads us back to the old question why unethical behaviour occurs in business. Is it because the individual managers are inherently evil? Or is it because the organizational and bureaucratic context incentivized individuals to cut corners and take advantage of infringing the rules? Just today, French investigators published the first transcripts of the interrogation of Kerviel. What seems to emerge then is that Société Générale for some time had somehow known about his dealings, not at least as he allegedly made a profit of €1.4bn for the bank in 2007. His own explanation for his gambling is that he just wanted to show his superiors that he is better than his colleagues. His strongest argument for why the bank should have been suspicious much earlier: he only took 4 days of holidays in 2007: “One of the hard and fast rules of auditing is that a trader who never takes time off is a trader who just wants to keep auditors away from checking his books!” Whether Jérôme Kerviel will get away with this stance however will be a question of future investigations. It will continue to be a fascinating piece of corporate crime to watch over the next couple of weeks…