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Rogue trad­ing con­tin­ues to cost firms mil­lions de­spite ini­tia­tives to curb bad boy be­hav­iour.

>THOMAS WAT­SON Nick Lee­son, the fa­ther of se­ri­ous risk man­age­ment, re­cently gave an in­ter­est­ing talk to Ivey Busi­ness School MBAs on why man­ag­ing risks taken by the fi­nan­cial sec­tor re­mains chal­leng­ing de­spite the lessons learned from the bank­ing cri­sis. Lee­son, of course, isn’t an ex­pert on en­forc­ing rules, but as the orig­i­nal rogue trader, he is an ex­pert on why traders break them. In 1995, the former Sin­ga­pore-based Bar­ings Bank trader kick-started the risk man­age­ment in­dus­try by los­ing US$1.3 billion on unau­tho­rized trades. “It wasn’t about greed for me,” he says. “I thought that I would have the op­por­tu­nity to try and cor­rect the sit­u­a­tion.”

The first time Lee­son used the tricks of the trade to hide one of his own losses, he ex­pected risk man­age­ment to knock on his door the next day. It didn’t hap­pen, so he ex­pected to be caught the fol­low­ing day. But a strange thing hap­pened: no­body asked any ques­tions. “When there’s this lack of chal­lenge,” he says, “you slowly start to be­lieve you’ve got more time to cor­rect the sit­u­a­tion. That was the only fo­cus that re­ally mat­tered to me. How long did I have to cor­rect this sit­u­a­tion?” But af­ter years of try­ing to cover hid­den losses, he only man­aged to top­ple the Queen’s per­sonal bank.

Rogue trad­ing since 2008 has cost fi­nan­cial sec­tor em­ploy­ers at least US$10 billion de­spite nu­mer­ous ini­tia­tives aimed at elim­i­nat­ing bad boy be­hav­iour, not to men­tion the abil­ity to hide it. But what Lee­son says hasn’t changed is the ten­dency of se­nior man­age­ment to want to be­lieve top per­form­ers are get­ting the job done in ac­cept­able ways — nudge, nudge, wink, wink. And that de­prives risk man­agers of the author­ity re­quired to ef­fec­tively chal­lenge traders. Mean­while, study af­ter study of rogue trad­ing in­di­cates most ma­jor cases, in­clud­ing Lee­son’s, are driven by the fear of ad­mit­ting fail­ure, not greed, which makes ex­panded com­pli­ance programs that aim to strengthen moral sen­si­bil­i­ties in­ef­fec­tive.

Lee­son’s ob­ser­va­tions sup­port “Char­ac­ter’s Crit­i­cal Role in Strength­en­ing Judg­ment in Fi­nan­cial In­sti­tu­tions,” a re­cent aca­demic white pa­per that ar­gues fram­ing bad be­hav­iour in fi­nan­cial mar­kets as strictly a moral­ity prob­lem is an is­sue in it­self. Ac­cord­ing to the authors — On­tario Se­cu­ri­ties Com­mis­sion di­rec­tor Bill Fur­long (ex­ec­u­tive-in-res­i­dence at Ivey’s Ian O. Ih­na­towycz In­sti­tute for Lead­er­ship), and Ivey pro­fes­sors Mary Crossan and Jef­frey Gantz — it would be far more pro­duc­tive to in­ter­pret bank­ing mis­con­duct as a fail­ure of judg­ment caused by char­ac­ter weak­nesses. Lee­son agrees such an at­ti­tude would open the door to sus­tain­able change be­cause strength­en­ing judg­ment is some­thing most am­bi­tious peo­ple are will­ing to do.

Keep in mind that it is not al­ways just the traders who make bad calls. In 2012, so-called London whale trades de­signed to al­low JPMor­gan Chase & Co. to elim­i­nate a short-risk po­si­tion lost the bank bil­lions of dol­lars, but they were ac­tu­ally au­tho­rized by se­nior man­agers who didn’t want to pay the US$500 mil­lion that traders es­ti­mated a safe strat­egy shift would cost. Mean­while, a labour court in France raised eye­brows this sum­mer with a ques­tion­able judg­ment that called for So­ciété Générale SA to pay more than US$500,000 to Jerome Kerviel, the con­victed rogue trader whose unau­tho­rized trades cost the bank US$7.2 billion in 2008. Why? The court ruled he was fired with­out se­ri­ous cause be­cause man­age­ment was aware of his rule break­ing.

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