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Risky business: rogue traders and the road to ruin

Risk Vs Return

Kweku Adoboli is just the latest in a long line of City traders convicted of fraud. How do they justify their actions – and can it be prevented?

In the summer of 2002, a computer science and management graduate and former head boy joined UBS as a summer intern. Within three years he had been promoted to the bank’s trading desk. By 2010, he was a team director, earning £110,000 a year plus £250,000 bonus. Life was looking pretty good for Kweku Adoboli.

Problem was, Adoboli’s success relied on him illegally inventing non-existent trades as hedges to hide the fact that he was exceeding his risk limits. His system came crashing down in the summer of 2011, when he lost the bank US$2.3 billion (£1.8 million). After a grilling by UBS’s compliance department he found himself under arrest. Instead of going home to his girlfriend and his Shoreditch loft, he spent the night in a police cell, was charged with fraud and false accounting and sent to prison.

Banking on trial

The highly publicised trial ran for nine weeks and caused a sensation. Adoboli became the new poster boy for everything wrong with the banking industry. In November 2012, he was sentenced to seven years in prison (he was released in June 2015 after serving half his sentence including time spent in custody). UBS was fined £29.7 million by the Financial Services Authority for having ineffective computer risk controls and “poorly executed and ineffective supervision”.

Adoboli is now about to be deported, having unsuccessfully appealed against a Home Office decision to send him back to Ghana, where he lived until he was 12. He has called this “a crushing final outcome that feels truly disproportionate and unfair”.

So will these drastic consequences be enough to discourage other City traders from similar behaviour; from pursuing profit at any price, even if it means bending or breaking the rules? Unfortunately, the answer seems to be: probably not.

What was he thinking?

Adoboli himself has offered various explanations for why he committed fraud. “Risk-taking is the lifeblood of the industry… Managers would come to you and say things like, ‘Kweku, we need you guys to push the boundaries harder and you won’t know if you’ve pushed the boundaries hard enough until you get a slap on the wrist.” Adoboli’s friends say he’s essentially a good guy. So what went so horribly wrong?

Lisa Shu, Assistant Professor of Organisational Behaviour at London Business School, sheds light on three psychological mechanisms that can come into play:

  • People think they’re more virtuous than they are. “People overestimate their ability to hold onto their integrity and underestimate the pressures of their environment. People believe they will hold true to their own standards, but in fact they’re very likely to be affected by the individuals surrounding them – particularly in a situation that promotes risk-taking.
  • People revise their moral standards to avoid feeling guilty. “If you ask them how unethical the act was after the event, they will say it’s in line with ethical standards. There’s a discomfort between their espoused standards and their actual behaviour: in order to bridge the gap, they change their standards to be in line with what they’ve done.”
  • Strategic motivated forgetting” works brilliantly to suppress those nasty pangs of conscience. “People seem to forget moral rules that would otherwise limit their behaviours. They turn their back on the moral mindset because it’s uncomfortable. Perhaps unconsciously, they let it fade to the back of their mind. It’s a convenient blind spot.”

Once you’ve started on a morally dodgy path, you’re in trouble – lassoed in a continuous feedback loop. “You’re putting yourself in an increasingly vulnerable position because your standards become ever more lenient, your memory for these moral rules that would otherwise limit your dishonesty erodes over time and you’re more likely to succumb to future ethical violations.”

Crossing the line

Then there’s the fact that traders work in teams. “Individuals tend to use the fact that they’re doing the best for their team to justify and license their behaviour. They tell themselves it’s for the greater good. They look to other members of their team and the culture of the firm to assuage their own concerns.”

What other factors played a part in Adoboli’s downfall? Lack of sleep is one. “There’s only so long you can go sleeping three broken hours a night,” Adoboli told an interviewer. “I probably wouldn’t have ended up losing control in the way that I did. I would have recognised at a much earlier point that, ‘OK, we’ve lost x amount at this point, OK, there’s still probably this much downside to go; let me think about it rationally’ but I couldn’t do that; there was no energy left.”

Decision fatigue is a well-documented phenomenon. Decision-making and self-control are known to be physical resources that deplete over time, if a person does not rest. Adoboli lamented: “You live in that bubble day-in, day-out, minute-in, minute-out, with little sleep and that becomes your culture – profit at any cost.”

But how do rogue traders imagine they’ll get away with it? “People assess risks one by one,” says Shu. “They think they’re taking a one-off risk; they don’t see the portfolio of risks over time in the behaviours that they’re engaging in. If you were to average out all the chances that someone would catch you, you’d be less likely to take the risk. But we have narrow bracketing when we’re attention-focused in the moment. You’re in a short-term snapshot.”

The honest truth

The good news is that it is possible to change how people behave. The first part of preventing such fraudulent activities is highlighting ethical dilemmas: encouraging people to step out of their amoral mindset and think about what they’re doing. “It will require a big shift in the culture – one worth making,” says Shu.

Shu points to her research into how where the signature on self-reporting forms such as tax returns and insurance claim forms is located affects their level of honesty. Proof of honest intent is typically sought by having a person sign at the end of the form. Shu and her colleagues found that asking people to sign at the start of the form instead made them more honest.

“The idea is to make morality top-of-mind when it matters most. The default ‘Everything I have stated is true’ at the end is arbitrary. By bringing the decision to the top of a form, it cues people that they’re expected to report the truth in the details that follow. So priming morality and making it salient before the behaviour will actually change the behaviour.”

The banking industry has made some efforts to deal with the issue of rogue trading, voicing concerns about the importance of ethical standards and putting checks and balances in place. Shu says isn’t enough, though. “In order for that to really translate through all the layers, it needs to start from the very top and be woven through every single layer of the banking industry. People are still tempted to stick to the letter of the law but not the spirit, if it means greater profit and success.”

The lure of temptation

There’s so much innovation in the financial industry that just creating more legislation and rules won’t sort out the problem. “Reminding people of the welfare of shareholders and of the company in the long term would be more productive than constantly troubleshooting through finer-grained regulations in response to every new event shock.

“Often the short-term perspective leads to great cost to the firm – there’s a ‘the greater the risk, the greater the reward’ mentality. Evaluating people in financial services not just based on their quarterly performance
Advertisementbut over a longer term, as benchmarked by the market itself, would lighten the short-term pressures to perform at any cost.”

Until then, it seems, it’s only a matter of time before the next thrillingly horrifying rogue trading scandal emerges. “Part of our fascination is that we all like to believe that we ourselves would never be tempted in this manner,” says Shu. “The fact is, we’re at greater risk than we believe ourselves to be.”

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Risky business: rogue traders and the road to ruin” was originally published on the London Business School site and was written by Lisa Shu and Kathy Brewis.

 

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