A London-based trader named Kweku Adoboli at the Swiss bank UBS was arrested Thursday after being accused of "going rogue" and costing his company an estimated $2 billion. What's a rogue trader?
Someone who makes trades that haven't been authorized. Every trader is allowed to take on a certain amount of risk, and if he wants to exceed that value he must get the permission of his supervisors. ("Risk" refers not to the amount of money invested but rather the amount one might expect to lose on a particular gamble given the best available estimate of the odds.) Traders are said to have gone rogue when they've either made investments that are too risky, or invested much more money than they're supposed to. In some cases, unauthorized trading leads to profits, in which case it's less likely to be contested. When it results in a loss, traders often end up having to go even more rogue, doubling down to get out of the red. This can lead to other types of fraud.
A starting employee at a bank like UBS might be allowed to take on risk measuring in the thousands, not millions, of dollars. As a trader gains experience—and demonstrates an ability to make a profit—his authorized risk would increase; a very senior person at a bank might even be permitted a billion dollars' worth of exposure. Nobody has reported just how much Adoboli had been trusted with, but the Wall Street Journal did report that he worked for an equities desk called Delta One that conducted relatively safe trades. Charges against Adoboli allege that he falsified accounting records going back to October 2008. That suggests he was hiding unauthorized losing investments for a long time, as opposed to making one gigantic, really bad bet.
How might Adoboli have gotten away with his chicanery? Banks trade billions of dollars every day, through transactions that happen so quickly it's difficult to monitor them on a minute-to-minute basis. Banks have automated risk-management systems to detect unauthorized trading, but when a potential rogue trader finds a flaw in the system, he can exploit it over and over again.
Jérôme Kerviel, who lost $6.7 billion for the French bank Société Générale in 2008, was able to take unauthorized risks by buying volatile stocks and then pretending to sell others that might have hedged his bets. His roguish predecessor, Nick Leeson—who shuttered the U.K.'s Barings Bank in 1995 after losing more than $1 billion—hid his losses in an obscure company account that wasn't monitored by his managers.
Both Kerviel and Leeson went to prison for their rogue activities. Kerviel was sentenced in 2010 to three years in prison, and ordered to pay back the $6.7 billion he lost. Leeson served four years in a Singaporean Jail, during which time he wrote a memoir called Rogue Trader, which was later adapted into a Ewan MacGregor movie of the same name.
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Explainer thanks Stewart Hamilton of the IMD Business School in Switzerland, Kimberly D. Krawiec of Duke University Law School, Jonathan R. Macey of Yale Law School, Jerry Markham of the Florida International University College of Law, and Robert Webb of the University of Virginia.