Traders “Going Rogue” Redux

In connection with volatile stock markets, Warren Buffett once said, “It’s only when the tide goes out that you learn who’s been swimming naked.” One would expect to see some naked swimmers, i.e. traders who are suffering huge losses, when the Dow Jones Industrial Average fell 15% between late July and mid-August, in part due to the debt-ceiling fiasco in Congress.  A subsequent Standard & Poors downgrade of US sovereign debt and the European debt crisis have only fueled the market volatility.

Cue up the recent story that UBS AG (NYSE: UBS) may have to restructure due to over $2.3 billion of losses allegedly attributed to a “rogue trader,” Kweku Adoboli.  The losses were a huge blow to UBS and its shareholders, and led to the resignation of CEO Oswald Gruebel as well as Adoboli’s boss in the Equity Trading department, John Hughes.  Apparently, the trading losses came to light only when Adoboli himself told superiors about them.  Athough Adoboli was allegedly able to conceal huge bets against major European stock indexes using fictitious hedging trades, at a minimum there was a lack or failure of risk management controls that should have alerted UBS’s management before the trader was able to take on such huge risk.

So who suffers? UBS shareholders who’ve watched their stock holdings get slaughtered on the news.  UBS owes its shareholders a duty to implement a reasonable risk management control system so that these $2 billion surprises are prevented.  UBS was on notice regarding the damage other banks, such as Barings Bank, Société Générale, and Kidder Peabody, famously suffered at the hands of rogue traders.

For example, Great Britain’s Barings Bank managed to survive for more than a couple centuries before succumbing in 1995 to the trading folly of Nick Leeson, whose unsupervised trading activities cost Barings $1.3 billion and forced the venerable institution into insolvency the day after Leeson’s 28th birthday.  Investigators agreed that Barings’ demise resulted from poor risk management and lack of employee oversight. 

In 1994, Kidder Peabody, a 130-year-old American institution, fell at the hands of Joseph Jett and equity investors were harmed.  And more recently, Société Générale’s flamboyant junior trader Jerome Kerviel in early 2008 allegedly cost the French bank $7 billion due to poor internal risk management controls. 

After a few of these high-profile catastrophes, one would think that all investment banks would implement reasonable, yet rigorous, checks and balances to reduce the banks’ exposure to rogue trading activities.  But alas, UBS shows that bank management, even after the chastening losses from the bursting of the mortgage backed securities bubble, is incapable of taking, or does not want to take, these steps. Therefore, it’s incumbent on the shareholders to hold management accountable through activism and litigation to protect their investment and stop management from blinding themselves to the very real risk that aggressive traders will always be tempted to roll the proverbial dice with shareholders’ assets.  

As this UBS story develops, some colorful characters have already emerged, making it almost certain that a film will result from the scandal.  Going Rogue may have its place in politics, but shareholders should not tolerate it in their investment bank.

Abbey Spanier, LLP is located in New York City, is a well recognized national class action and complex litigation law firm.