Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

UBS's Rogue Trader Looks Very Madoff-y

Oliver P. Quillia for

UBS has released more information about how a trader on an equity derivatives desk in London could have wracked up billions in losses.

The size of the losses has jumped an additional $300 million, from $2 billion to $2.3 billion, according to the Wall Street Journal.

The losses did not come, apparently, from a large position on the Swiss franc. The news of the loss came a week after the Swiss central bank announced an intervention to weaken its currency, which had risen rapidly as fears of sovereign debt defaults and bank failures led to a flight from the Euro. (The Swiss central bank was concerned that a rising franc could make Swiss exports unaffordable.) The timing led many to speculate that Kweku Adoboli, the 31-year-old Ghanaian who worked in UBS's London offices, may have put on a position that was hurt by the violent gyrations of Europe's currencies.

But instead of one dramatically wrong trade, it seems that Adoboli allegedly made a number of bad trades, beginning with a relatively small position that violated UBS rules requiring that all positions be hedged. Hedging can protect against losses but the cost of hedging can diminish the profits made from trading.

From the Wall Street Journal:

The actual trading that created the losses consisted of using index futures to bet whether European and U.S. stocks would rise or fall. But to avoid showing naked, or unhedged, trades that would have gotten him in trouble, he needed to show that his trades were offset with bets in the opposite direction of his real trades, according to people familiar with the matter. To do so, he recorded on the company's books transactions that never took place, according to people familiar with the situation.

The trader responsible couldn't have chosen a more difficult time to try to make money in the stock market, and the subsequent real bets he made—alternatively that the markets would rise or fall—backfired as volatility in global financial markets raged over the summer, reflecting investor concerns about the European debt crisis, the U.S. economy and the Standard & Poor's downgrade of U.S. government debt. As a result, the loss snowballed.

What makes this frightening is that UBS apparently had no way of detecting that the trader was recording fictitious trades. It only discovered the fraud when Adoboli turned himself in.

In other words, this case very closely resembles that of Bernard Madoff, the man who has been described as the investment equivalent of Charlie Manson. Madoff told his clients, business partners and regulators that he was trading in a whole variety of stocks—when in fact the trades never took place. They were simply made up—as were the phony gains to client portfolios.

Here it seems that Adoboli was also able to simply make up trades and cover up the fact that he was not hedging. His trades involved UBS's funds, rather than that of clients. But if you are a UBS wealth management client you have to at least wonder whether any part of your portfolio is based on trades that were never actually made. If Adoboli could do it, certainly others could as well.

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