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Andrew Waxman
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Ten Most Significant Operational Risks of 2012

Andrew Waxman takes a look at the most significant operational risks, including the Facebook IPO and Knight Capital Fiasco, that occurred on Wall Street in 2012.

George Bernard Shaw once said, allegedly, “If history repeats itself, and the unexpected always happens, how incapable must Man be of learning from experience”. Risk managers on Wall Street must surely have often felt that way in 2012. Better, however, to take inspiration from Edmond Burke, “those who cannot remember the past are doomed to repeat it” In that spirit, let’s take a look at the most significant operational risks of 2012 and in the coming weeks we will look at what can be done to stem the flow in 2013.

1. Unauthorized Trading

Only an alleged rogue trader has the ability to bring to the front headlines, a small brokerage firm, Rochdale Securities, tucked away in Connecticut. One wonders how the trade in question- reported by the press as a purchase of 1.625 million shares in Apple for an alleged client order- at this small brokerage firm made it through compliance, limit checkers, counter-party brokerage etc. The trial of Kweku Adoboli has, however, provided much material for those who wonder how rogue traders can thrive over longer periods at larger brokerage houses.

2. IPOs and Technology Risk

The Facebook IPO was going to be the IPO to end all IPOs. It all went wrong, however on the day due to software glitches. The error's ripple effects lasted for days and some market participants experienced significant losses. Another problematic IPO in 2012, though less high profile, was the BATS public filing which had to be cancelled also due to software glitches. Both events threw a spotlight on critical execution aspects of the IPO process.

3. Failing to Protect Segregated Customer Assets

Although the failure of Peregrine Financial Group appears to be a fairly straight forward case of malfeasance, it highlighted, just like MF Global in 2011, some thorny issues in the Futures Business and its ability to protect segregated client assets. The media reported that regulators missed multiple warning signs over the years for client accounts at Peregrine. This event once again highlighted the importance of equipping regulators and firms properly for managing their critical role of oversight and protection of customer assets.

4. Market Making Software and IT Risk Management

Faulty software led Knight Capital to record thousands of erroneous trades with the NYSE leading to huge losses and imminent bankruptcy. It was not wild risk taking or sophisticated algorithmic trades at issue here but boring old IT risk management practices. In addition to reviewing software release practices, more work needs to be done across the industry to plan and create protocols for emergency situations such as this.

5. Insider Trading

In New York alone, since 2009, 75 people have been charged with insider trading and 69 have been convicted or provided guilty pleas, according to the New York Time in December. Investigations are ongoing. Insider trading is an insidious problem but one that threatens the reputation of Wall Street.

Andrew Waxman writes on operational risk in capital markets and financial services. Andrew is a consultant in IBM's US financial risk services and compliance group. The views expressed her are those of his own. As an operational risk manager, Andrew has worked at some of the ... View Full Bio
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