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Danger: Traders with middle-office experience

24 January 2008 1 comment

Elton Cane

Digital product delivery

News Corp Australia

The SocGen fraud story, which is flabbergasting the industry and providing a distraction from credit crunch woes and hand-wringing about the dangers of overly complex structured productios, is remarkable for a number of reasons.

The losses don't come from any exotic OTC dealings. Instead, the trader was dealing in plain vanilla futures on European stock market indices.

FT Alphaville points out that, with even the worst performing European equity markets off 20 per cent since the beginning of the year, to rack up a €5bn loss, they would require a delta of at least €25bn. In reality, the position in question may have needed have been between €30bn to $40bn to generate such vast losses. How could such a huge position have been hidden?

According to the bank's statement, the only reason the trader could hide the unfeasibly large positions they were losing on was because of their middle office experience and knowledge of the control systems in place.

Presumably before becoming a trader they had previously worked in the middle office - that relatively new function within banks that was created by many institutions in response to organisational weaknesses exposed by the Barings case. Ironic isn't it?

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Comments: (1)

A Finextra member

25 January 2008

A valid observation. Once the details of this case are formally made public, it may be useful to compare the report with that of APRA 23 March 2004 'Report into Irregular Currency Options Trading at the National Australia Bank' http://www.nabgroup.com/0,,45453,00.html, especially page 23:

'Interviews with staff have suggested that certain Global Markets and

Operations staff engaged in detailed discussions around the confirmation and

reconciliation processes, outside of normal activity. Although parties to the

discussions may have had innocent intent, this may have provided important

information on the back office systems and procedures to the traders who

subsequently undertook the fraudulent activity using this knowledge to avoid

detection.'

In the SocGen case, reports to date indicate that the individual had worked in the back office until 2004 and 'kept up to date'. In my view, the concealing of errors and manipulation of systems, processes and people in trading rooms occurs frequently. Most don't get identified because the ultimate financial consequences (profit or loss) are small or zero, and those which do get identified are not escalated within or outside of the entity unless circumstances force such disclosure. I've always felt that a lie-detector should be compulsory and frequently used hardware in a trading room and its support environment.

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