September 22, 2008

Editor's Note: As UBS reels from news of a trader gone rogue, we remember this isn't the first time a trader has gone off the rails. Three years ago, Advanced Trading interviewed Nick Leeson, the infamous trader who in 1995 bankrupted Barings Bank in a rogue trading scandal. Here's how he almost got away with it and what has changed since his forays in the 1990s – and what has not.

More than a decade has passed since Barings Bank, the oldest investment bank in the U.K., was bankrupted by a rogue trader who racked up an astounding $1.4 billion in trading losses. In those 13 years, one would think that Wall Street firms have learned a great deal about detecting rogue behavior, and that technology has come a long way to improve risk management, internal controls and oversight on the trading floor in order to prevent such fraud.

Think again. While firm after firm on Wall Street wrote down billions of dollars in subprime exposures in weathering the credit crisis, the financial industry was blindsided by Paris-based Societe Generale's January announcement that a single rogue trader topped the Barings debacle with record-setting losses of more than $7 billion. Jerome Kerviel, a 31-year-old junior trader, took his place in history as the perpetrator of the largest rogue trading losses ever recorded -- a dubious position previously held by Nick Leeson of Barings infamy.

As news of SocGen's trading scandal spread, theories emerged as to how this could have happened, why it went unnoticed and who should have caught Kerviel. In fact, the investigation into Kerviel's actions still is ongoing, and it has become obvious that it will take time to sort through his devious actions and SocGen's internal missteps.

But Nick Leeson, who has a first-hand perspective that few others can claim, has plenty to say about rogue trading. Leeson's trading losses at Barings Securities (Singapore) amounted to more than $1 billion back in 1995, and he has spent more than a decade paying the penalties -- both public and private -- for his crimes (see related sidebar, below). In an exclusive interview with Advanced Trading, Leeson candidly reflects on how he was able to get away with his misdeeds at Barings and his ultimate downfall, and he offers some essential strategies to help firms avoid rogue trading.

Success Leads to Failure

In many ways, rogue trading ultimately comes down to human frailty -- a person inextricably gets caught up in the drive to succeed and the highs that result from securing huge profits. While firms can build up internal controls and implement risk management systems and other management and technology solutions to prevent fraud, a rogue trader often is familiar with these tactics and, obviously, is highly motivated to not get caught.