BIG PICTURE

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.