But people still tend to find asbestos, nuclear waste and human outcasts interesting – at least for research purposes. They are fascinating, and the rarer they are, the more fascinating they become. Considering how many people work in banking, the number of traders is very small. Trading is a peculiar job, and strong bonds are often forged between traders working together – or even against each other. Within this small group of traders, a few go rogue at some point in their career. Among these, a tiny fraction do so on such a spectacular scale that rumours turn into reality, and secrecy into public knowledge. It is rare to be a rogue trader, LIBOR manipulator, FX cartel member or some other rotten apple from the trading community. Considering the glamour attached to the dealing room environment, it is not surprising that it is an intriguing subject.
***
Towards the end of my PhD studies, I had a coffee in Russell Square with a researcher from Cambridge who was investigating the sociology of rotten apples, rogue traders, whistle-blowers and other outcasts in the financial industry. As I, according to her, belonged to this group, she asked whether I believed there ought to be a network for ‘people like us’. Given that we had all gone through psychological ordeals – ‘deservedly or undeservedly’, she added – our isolation could perhaps be broken by forming a group where we could exchange ideas and express sympathy towards each other. I was so surprised by the idea that my response was to smile and mumble something incomprehensible. I found the proposition absurd. To me, I had absolutely nothing in common with the others in the group she referred to. If anything, being associated with one another in a formal setting would only serve to strengthen the negative perception of who and what we were. Rather I, and I suspect the others too, wanted the exact opposite – to feel less associated with ‘people like us’. The idea of an AA for rogue traders was a complete non-starter to my mind.
Moreover, up until then I had never considered myself a rogue trader, simply because I did not fit the definition of what it represented.
I had been a trader, and it could be said that I had ‘gone rogue’, but the combination of the two words meant crossing a line. Rogue trading was generally associated with criminality, and I had never been subject to a criminal investigation. To me, the term was as charged as ‘terrorist’ or ‘rapist’. There was a stigma attached to it.
‘Nobody reads my blog anyway,’ the Channel 4 newsreader Jon Snow replied to Maria, years after he had written about me on his blog. Maria had bumped into him in a pub and immediately told him: ‘I believe you owe my husband an apology.’ He wasn’t even able to recall who I was, or why he had written about me in a sarcastic way. Presumably, because he could not remember, and claimed he had few blog readers, the content was of little importance in the great scheme of things. Few cared, and even fewer would remember. But I remembered. My family remembered.
When I found out that I had been classified as a rogue trader in a chapter in an academic book, my heart rate increased. The chapter, called ‘From Dishonesty to Disaster: The Reasons and Consequences of Rogue Traders’ Fraudulent Behavior’ made a connection between rogue trading, dishonesty and white-collar crime, stating that ‘rogue, or unauthorized, trading takes place when a trader is buying or selling financial instruments in amounts beyond the organizational risk limits and conceals his/her activities’. The authors then included a list, complied by themselves, of the ‘most noticeable cases of rogue trading in 1991–2011’. Among the 17 names listed, my name appeared alongside the bank, the nominal loss, the financial instruments involved and the year the trading took place.
How could two academics, let alone a serious publishing company, suddenly claim I was a rogue trader? Doubting that many of the other 16 individuals were avid readers of the academic book, I took it upon myself to write to the publisher:
As a fellow academic, I do not object to the overall content, to the definitions or to the theoretical link drawn between rogue trading, dishonesty and white-collar crime. I do, however, seriously object to the inclusion and the publication of my name in Table 2 and in this context – on these grounds: my case (Merrill Lynch/2009) did not involve any unauthorized trading. As such, the term ‘rogue trader’ is not applicable, my case did not involve a criminal investigation and my case (see Final Notice from the FSA attached) did crucially not involve the word ‘dishonest’.
I received a lengthy email back, arguing that I was wrong on all three counts. First, they argued that since the term ‘rogue trader’ had entered the public domain, various definitions could be used. The consultancy firm Accenture defined it slightly differently: ‘rogue trading refers to traders engaging in fraudulent practices, while trading on behalf of their institutions with a view of deliberately violating an institution’s trading related rules or mandates’. Moreover, the authors stated that the names had been selected on the basis of the losses the banks incurred as a result or the amount of publicity they had received (whether such coverage was accurate or not). To support their argument, the authors provided references to The Guardian, The Times, The Evening Standard, Forbes, Sky News, The Huffington Post, Reuters and other outlets where my name had appeared in the context of rogue trading or as a rogue trader. Second, there had been no direct inference or suggestion that I was subject to a criminal investigation. Third, they argued that the term ‘dishonesty’ was an incredibly subjective one, and that the definition provided by the Merriam-Webster dictionary defined it as a ‘lack of honesty or integrity: disposition to defraud or deceive’. Despite the fact that the FSA crucially had omitted the word from my Final Notice, the publisher argued that my behaviour could be ‘construed as dishonest conduct’. Dishonesty was subjective, and according to the Merriam-Webster dictionary, people’s perception about me as a dishonest person wasn’t incorrect. Therefore, because of the size of my losses, the media coverage, and a slightly different linguistic definition of what it meant, I could be perceived as a rogue trader.
It seemed pointless to waste more time and energy on this. But it made me realise that the real disappointment I felt related not so much to how the publisher defended the authors, but, to my mind, to the sneaky way in which the authors had gone about writing it. They had never met me. They had never even attempted to talk to me. It followed a familiar pattern. There were plenty of journalists writing about rogue traders and there were plenty of academics spending time in libraries researching rogue traders. Some clearly disliked the rotten apples in the financial industry, but others wrote more sympathetically about Nick Leeson, Kweku Adoboli, Jérôme Kerviel or the others who featured on the shortlist I was now very familiar with. Few, however, seemed to have met any of them, whether in person or electronically. Yet, new theories about how traders behave or why traders sometimes go rogue were continuously proposed based on knowledge in the public domain.
The stage had already been set. Scripts with new interpretations were written. As for those playing the leading roles, it was only about selecting the right costumes for the drama.
***
All the 17 people on the rogue trader ranking list had lost a phenomenal amount of money because of trading. Patrick Bateman in American Psycho, Bud Fox in Wall Street and Eric Packer in Cosmopolis were all incredibly wealthy because of the jobs they did in finance. Money, finance and rogue behaviour linked them together.
However, rogue trading is not predominantly about money and glamorous dealing rooms. Rogue trading is about risk. The publisher was correct in pointing out that rogue trading could be defined in various ways, such as ‘violating an institution’s trading related rules or mandates’. Another definition describes rogue trading as ‘when a trader is buying or selling financial instruments in amounts beyond the organizational risk limits and conceals his/her activities’. Whichever definition we use, we are referring to traders taking risk. First, the trader takes a risk. Then, the trader takes too much risk, breaking the rules of the institution they work for (typically a bank). The activity is covered up, but is then uncovered. As a
result, the trader becomes a rogue trader. It is tempting to presume that everything relates to just money and greed. However, if we really want to understand how traders and rogue traders behave, we cannot ignore the aspect of risk.
Although other people in the market probably saw me as a big risk taker, I didn’t spend much time thinking about it – at least not until it was too late. The reflection came later. Many people I’ve never met got to know me when I was inducted into the rogue traders’ hall of fame in the media. Perhaps my infamy can be compared to a sports personality caught taking anabolic steroids, though with two important caveats. First, sport is associated with popularity and fame, whereas trading and banking are secretive. Second, the public tends to admire sports personalities for their achievements, whereas traders are mostly disliked for their profession. Cheating athletes not only lose their medals, world records and sponsorship contracts, they are also seen as having brought disgrace upon the whole ‘ethos’ of the sport. When it comes to rogue traders, it is debatable whether ‘clean’ (non-cheating) traders are regarded as contributing to society in a similar way to ‘clean’ athletes. Admittedly, there are some people who idolise particular investors or traders as if they were athletes. ‘What do I need to do to become like Warren Buffett?’ I often get asked, as if I not only held the secret to Mr Buffett’s phenomenally successful long-term investment track record, but also believed it could be taught. This admiration, however, quickly fades if the legendary investor or trader loses an awful lot of money. Past performances are suddenly erased. This downfall, of course, is steeper for rogue traders. Almost overnight, their identities as anonymous traders are replaced by the identities of disgraced traders in the public domain.
I had never really thought about fame before I received the text message from one of my brokers in March 2009 saying ‘You’re famous now!’ He could just as well have written ‘You’re no longer anonymous!’ I had been anonymous, but I didn’t know the value of it until suddenly it was gone.
Also, sporting achievements are easily measurable in seconds, minutes, metres, kilograms, goals, points and so on. Because professional athletes want to win, the logic behind using forbidden substances is easy to grasp – cheating increases the likelihood of winning. Trading involves money, which is also easily measurable, and traders, it is often believed, are only driven by a desire to make money. This approach is consistent with standard economic theories on incentive structures (carrots and sticks, basically) in banking. Banks are profit-maximising institutions, and risk taking can be said to be fundamental to their existence. Banks therefore need professional risk takers (traders). Banks use incentives (bonuses) in order to induce traders to actively take risk. Otherwise, so the thinking goes, traders might just as well play solitaire all day long and pretend that they are thinking about a clever trading strategy or waiting for the right moment to buy or sell. Because of competition, banks constantly need to provide more lucrative incentive structures (bigger bonuses) than their peers. Otherwise, the talented and hard-working traders will go elsewhere, leaving behind those who prefer to play solitaire all day long.
However, traders sometimes win, but they also regularly lose. Too much risk taking can result in a catastrophe, and even the most experienced traders can make sloppy mistakes. It can happen that a buy order is inputted as a sell order, or the ‘0’ key is pressed one too many times, causing the amount to be multiplied by ten. ‘Fat fingers’ such as these can be expensive. Likewise, a calculation error stemming from having used the wrong day count convention, or even from forgetting whether Christmas Eve is a business day or a holiday in a particular country or currency, is often a costly affair.
The risk-taking activity therefore needs to be managed, supervised and controlled, which is why traders face a number of hurdles that are deliberately put in place to keep them in check. The contract of employment sets out what they are supposed to do, and how they might be rewarded. Managers set yearly targets. People in the back office, middle office, financial control, valuation and product control check that traders trade only those financial instruments they are allowed to trade, and that they are booked and valued correctly. The credit department makes sure that traders do not trade with institutions that might go bust. The compliance department ensures that traders read internal policy manuals on codes of conduct, complete training courses, know what they should do if there is a fire in the dealing room or an earthquake. Risk managers make sure that risk taking is kept within defined and reasonable boundaries. Beyond that, central banks and financial regulators set limits on how much risk a bank can take as a whole.
In sum, it is generally assumed that traders act rationally and that the primary motivation for risk-taking behaviour is the anticipated reward. To tame excessive risk-taking behaviour among traders, therefore, banks and regulators ought not only to have proper controls in place (to prevent rogue trader scandals happening), but also to fine-tune the incentive structures. For instance, rather than be paid out in cash, bonuses could be paid out in shares at some point in the distant future in order to align the traders’ interests with those of the shareholders. This, in effect, is the logic behind a number of banking reforms that have been implemented since the financial crisis of 2007–08. Banks had tolerated, even encouraged, risk-taking behaviour that had almost brought the global financial system to its knees. Now it was time to change the system of carrots and sticks.
Gary Becker, an economist and also a Nobel laureate, wrote an article outlining how it was possible to model optimal policing and punishments using similar mainstream economic thinking. This is my interpretation of the model. Every individual is rational and strives to maximise their utility. Their utility is measured in money, and there are two ways in which money can be obtained: work or crime. The expected utility of any individual at any moment in time, therefore, is a purely mathematical function of the money obtained through honest work and the money obtained from committing a crime. However, there is a catch. When committing a crime, you also need to take into account that there is a risk that you might get caught. And if you get caught, there is a risk that you might be prosecuted and, ultimately, punished. The idea is that policy makers and law enforcement agencies can use this model to figure out how much they should spend on policing the streets (to increase the risk of getting caught) and how much they should spend on the justice system (to increase the risk of getting prosecuted, being fined, sent to prison, etc.). Human beings, it is thought, just want money, and risk is something they take to increase their chances of getting their hands on that money. In standard economics textbooks, the world is portrayed almost as cynically as in the book and film series The Hunger Games. In the latter, the players know the rules of the game: they kill each other until there is only one person left. The players maximise their utility: the time they have left to live. Players collaborate only if it increases the likelihood of surviving a little bit longer. In the end, however, even friends will, quite literally, stab each other in the back. For those who have read all the books in The Hunger Games series and are on the lookout for their next dystopian bestseller, ask a librarian to find you a textbook in economics or finance.
It is true that money and greed may cause people to take risk. But the reality is more complicated than that. As the behavioural finance professor Daniel Kahneman notes: ‘Utility cannot be divorced from emotion.’2 Most people do not like playing roulette or games in which you have to guess whether the next person crossing the street is male or female. Even if the odds are exactly even, the frustration of losing a thousand dollars feels more powerful than the joy of winning a thousand. As a trader, I always felt more like a loser following a day when I had lost $10,000 or $100,000 than I felt like a ‘winner’ when I had made the same amount. The fact that losses loom larger than gains is called ‘loss aversion’. Nobody likes losing, of course, but a potential loss (or ‘negative’ reward) changes the way we approach risk taking.
Another bias that complicates standard
economics and finance theory is called ‘mental accounting’.3 In a nutshell, it refers to the way in which we often segregate different gambles into different accounts, and in so doing use very different criteria to assess how we utilise the various accounts. The brain acts like a chest of drawers, with different types of problems sorted into different compartments. For instance, we might count the pennies when shopping for groceries, but when celebrating a birthday or a special occasion we are often less sensitive to the shockingly high price of a bottle of champagne. Likewise, an individual might speculate on a volatile stock market yet be extremely careful when saving for a future retirement. Traders also do a lot of mental accounting. An FX trader watches every minuscule currency movement in the dealing room during the day, yet when on holiday in Spain will withdraw euros from the nearest ATM, oblivious to the outrageous bank fees and commissions.
A standard question I used to be asked when being interviewed by another bank was to describe my trading style. How much of your trading revenue comes from market making to other banks? How much is generated from customer flows (i.e. from the bank having a customer franchise in the currencies and financial instruments I traded)? How much do you make from arbitrage activities? How much is derived from fundamental analysis, macroeconomic views and proprietary trading (effectively placing bets using the bank’s money)? My answers to such questions might provide clues as to whether I took my own initiatives or largely relied on my current employer’s customer base. They therefore also hint at my risk appetite. Proprietary trading often involves more active risk taking, whereas customer flows less. However, the main question also involves a form of psychological self-assessment on the part of the interviewee, essentially asking: ‘What kind of mental accounting do you perform within your environment?’ A trader might do hundreds of deals during the day in an attempt to profit from tiny short-term price movements and customer deals. Depending on the market in which the trader is active, there might also be arbitrage opportunities from which to profit. At the same time, however, the same trader might have positions that are deliberately left untouched for days, weeks or even months – reflecting a very different, more long-term view of the market. Being able to combine both, sometimes conflicting, approaches often requires considerable recourse to mental accounting. It is not a straightforward process to assess the individual contribution of such ‘accounts’. Market making was what I had been trained to do from the start, while arbitrage and various mathematical strategies were areas where I felt very comfortable. Growing the customer franchise and increasing the market share was something that spurred me on. Proprietary trading interested me. My answer therefore tended to be ‘a bit of everything’, which generally seemed to be regarded as a good answer.
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