Rouge Traders

THERE IS NO SET OF QUALITIES THAT DEFINES A ROGUE TRADER. There is no profile, no red flags to search for. Rogue traders have earned their telling nickname because they are just that, maverick scoundrels who act outside of the normal rules and procedures that govern the rest of us.

So how can you spot a rogue trader before he strikes? You simply can’t. There seems to be no amount of regulations, checks, firewalls, or risk management systems that can thwart an intelligent mind bent on mischief. There have been several rogue traders in recent history — two notable examples just this year — yet rarely do they ever overlap. The markets, the incentives, the motivation, and even the schemes themselves are often as unique as the men who carry them out.

That is what makes the story of a rogue trader so fascinating. We can all understand the motivation and diabolical mind behind most financial crimes. When massive financial fraud takes place, greed and power are usually the driving factors. We have seen Enron executives, inside traders, and just plain evil, money-obsessed villains who will stop at nothing to steal from others. The image of a powerful, fast-talking broker often comes to mind when we think about financial frauds. A Gordon Gekko type that is ruled solely by greed. But just a look at recent history shows us that the actual perpetrators don’t fit any one profile.

The national attention that has been focused recently on rogue traders was sparked by the actions of Jerome Kerviel, 31, a low-level trader at France’s Societe Generale. At the time, SocGen was France’s second largest bank. The story of Kerviel and his actions that cost the bank over $7 billion is now well known.

The company ID picture of Kerviel, which must be his only released photo, has been familiarly visible in every major newspaper and magazine over the past six weeks. The mug shot-esque photo tells an ominous story. Kerviel was a relatively unknown commodity at SocGen at the time. He joined the company in 2000, working in the back office dealing with the bank’s security systems.

A low-key and mild-mannered young employee, Kerviel did not attract much attention, good or bad, from management or his co-workers while working in security. This seemed to be the story of Kerviel’s life. People seemed to know he was there, but few actually cared. Maybe that’s why he did it.

Kerviel joined SocGen after graduating from the University Lumiere Lyon 2. He was considered one of the financial world’s low-flyers due to his background.

“I was held in lower regard than others because of my educational and professional background,” Kerviel complained.

phpSUhOO1After being promoted, Kerviel became a low-level trader on the futures desk at SocGen. Low-level again. Everything in Kerviel’s life seemed to be low-level, except his profession. He worked at a powerful bank, surrounded by powerful and wealthy people. Kerviel must have wondered if he would ever reach another level. Perhaps that explains his curious photo. His brow furrowed with an almost sinister glare, Kerviel appears as if he knows something the rest of us don’t. As if hatching his plan while staring into the camera’s lens, Kerviel morphed his innocent good looks — friends and co-workers often compared him to Tom Cruise — into a much less forgettable identity: The villain of the French bank.

Kerviel’s plan was as simple as it was fiendish in its intricacies. With his knowledge of the bank’s security system and his new position as a trader, Kerviel was able to make huge bets, largely exceeding the risk positions the bank allowed him, and to hide any losses. He made his bets on the Dow Jones Euro Stoxx 50 Index and the German DAX. Every bet he made was largely bullish, as the trader hoped European shares would move up.

For a while, he was right. But soon, as the rest of us have already seen, many markets around the globe began tanking. Kerviel was able to hide his losses using imaginary accounts and stolen IDs and passwords that he had attained from his days at the back desk. He used these accounts to show fictitious trades that would have hedged his large risk.

Kerviel’s plan was working, but only for a time. Like many sinister plans that seem just so simple, Kerviel’s was eventually unraveled just in time for more global market collapse. SocGen finally began unwinding Kerviel’s positions on Jan. 21, the same day that European and Asian markets took a dive that prompted Fed Chairman Ben Bernanke to issue an emergency rate cut the following morning. Why would Bernanke act so decisively after a day when the U.S. markets weren’t even open — all U.S. exchanges were closed due to the Martin Luther King Jr. Day holiday? Perhaps Bernanke knew of Societe Generale’s problem, perhaps not. At this point, it doesn’t really matter.

Societe Generale will survive, but with more trouble related to failed positions in subprime mortgages in store, the French institution has been greatly injured. Kerviel did not stand to gain from his scheme. The only possible gain he could have gotten would have been a very modest personal bonus. So why did he do it?

Fame? Infamy? Perhaps, merely for the respect and adulation of the people around him. At this point, no one knows what motivated this seemingly forgettable Frenchman to forever etch his name in the history books. A long prison sentence seems unlikely. But for now, the judgment of many has already been passed on Kerviel. The Wall Street Journal recently offered a sentence for Jerome, placing him in Malebolge, Dante’s eighth circle of hell, as its “new French master.”

Like that of Kerviel, the story of Yasuo Hamanaka is a curious one. Hamanaka was the senior manager responsible for copper trading for Sumitomo Corp., Japan’s largest trader of physical copper. Like Kerviel, Hamanaka was a trader that did not have a great deal of attention paid to him. Unlike Kerviel, however, this was not due to his lack of a professional reputation. In fact, Hamanaka was so respected that the higher-ups at Sumitomo didn’t even bother to regulate his activity. Hamanaka had such a reputation in his field that he was almost completely left to his own devices.

Hamanaka’s devices proved to be much more dangerous than anyone at Sumitomo could have predicted. A man of many nicknames, Yasuo Hamanaka was widely regarded as one of the most powerful men in the world of copper. Known by his peers as the Hammer, Hamanaka was also referred to as Mr. Copper and Mr. Five Percent. The latter name was a reference to his believed control of 5-10% of the world’s copper.

Unlike Kerviel in regard to his success, Hamanaka was very similar to the French banker in terms of personality. Despite his great power and image, Hamanaka was an introvert who was much more comfortable trading alone in his office than anywhere else.

Also known as the Man in a Gray Suit, Hamanaka’s life did not mimic the image many people had of him. Despite being promoted more quickly than anyone else during his 26 years at Sumitomo, Hamanaka earned a very modest living. It is a Japanese custom for employees to be paid on the basis of seniority, rather than performance. Hamanaka was rewarded the same as any other 26-year Sumitomo veteran. Yet he still took the enormous risk to keep his positions and reputation as high as people assumed.

For 10 years as a copper trader for Sumitomo, Hamanaka attempted the unthinkable. He attempted to corner the copper market and wage his influence over the price of the world’s copper. With the autonomy and resources granted to him by Sumitomo, Hamanaka began acquiring large amounts of copper in an attempt to create a shortage. If the market believed copper to be in more of a demand than it actually was, the price would artificially rise.

Also like Kerviel’s, for a while, Hamanaka’s plan worked. Hamanaka continued to accumulate copper while most commodities were priced very low due to poor economic conditions. Keeping much of his copper off the market, the price quickly shot up and Sumitomo could then begin selling its copper reserves at a much higher price. Not everyone was fooled by his ploy, as Hamanaka was twice accused of creating a copper “squeeze,” in 1991 and 1993.

As the price of copper grew, more mining companies and facilities began cropping up to take advantage of the boom. This new glut of copper on the market made the copper that Hamanaka had purchased worth less than he liked. This is the part of the story where greed got the best of him. Hamanaka refused to let his positions go, and he continued his plan to prop up the price of copper.

With his losses accumulating, perhaps the Hammer bought into his own hype a little too much. Hamanaka had been striking off-exchange futures contracts that paid handsomely when the price of copper was high. Unfortunately, these profits came at a much higher cost to the company. These losing deals were recorded in a secret account that Sumitomo claimed only Hamanaka knew of. Throughout his decade of deceit, Hamanaka seemed to be the master of his trade, while losing $2.6 billion for Sumitomo. His entire plan was finally unraveled in 1996, after two documents forged by Hamanaka were sent to a unit of Merrill Lynch. So why did he do it?

Once again, Hamanaka did not stand to gain from these dealings. There were no mansions or luxury cars on the horizon. His was not a get-rich-quick scheme. Quite the contrary. Hamanaka’s scheme was a slow and labor-intensive one that gave him no personal fortune. Until his eight-year prison sentence began, Hamanaka lived in a small, modest house on a plot of land he had inherited from his father. Hardly Gordon Gekko.

Did he do it for the fame? The infamy? Hamanaka was already well known and well respected in his field. While his story is a footnote in the history of financial crimes, Hamanaka has not received nearly the coverage already bestowed upon Kerviel. Many insist that Hamanaka was acting in cahoots with his employer. While this theory certainly makes a lot of sense, nothing formally has ever been done on the matter.

If Kerviel is the new French master of Malebolge, perhaps Hamanaka can be given a nice cozy office there, where he can feel at home, next to his rogue colleagues.

Kerviel’s and Hamanaka’s staggering losses dwarfed those of any who had come before them. The deceit with which they were carried out suggests a malefic intent. Kerviel and Hamanaka knew they were doing wrong, and no matter what the motivations, they continued to deceive.

This is not the case with our newest rogue. Forty-year-old Evan Dooley, a Memphis, Tenn.-based commodities trader for MF Global, an ETF and options broker, has recently earned the dubious title of rogue trader. Dooley was a day trader for MF Global, making trades on behalf of clients in the futures markets. Dooley was a low-level employee who did much of his work from home.

Despite his years in finance, Dooley had only one client who had not made any trades in some time. Despite his relatively nonexistent roster of clients, Dooley stayed busy, trading for his own personal account. This is not unusual for MF Global, which collects a commission from any trades made on behalf of its traders’ personal accounts.

What is unusual is for a trader to blatantly overextend his own capital to make trades based on seemingly nothing more than a hunch. In the early hours of Wednesday, Feb. 27, Dooley began making his ill-fated trades.

Dooley purchased and sold short more than 15,000 wheat futures contracts. The money he used for this was not his own — it was MF Global’s. The profit, however, would have almost all belonged to Dooley, had his hunch been correct. Unfortunately, his hunch not only failed, but it failed catastrophically. Just hours later, Dooley abandoned his trade and left MF Global holding a $141 million bag. In just a few more hours, Dooley’s employment was terminated.

Dooley made the mistake of believing the wheat market was overpriced. His hunch wasn’t completely unfounded. Wheat futures have been gyrating violently as of late, with the grain reaching record levels. Yet Dooley was not as bright as he thought he was. He believed he knew more than everyone else, and he bet someone else’s money trying to prove it.

So how could one trader get access to all that money? MF Global puts limits on the amount of money traders can use for their personal accounts. Since MF Global has to pick up the tab for any losses, it wants to make sure that it has some say in what’s being bet. However, these limits cause the transaction time to slow considerably. In a high-pressure futures trade, sometimes a matter of seconds can make the difference between a successful trade and a colossal failure. Dooley’s risk controls were abandoned in an effort to give him more agility to trade for his clients.

When friends and family of Dooley were tracked down for questioning, they all gave expected responses. Apparently, Dooley was the last person you would expect to do something like this. He’s a devoted husband and father, active in his church, and as mild-mannered as his rogue brethren. His father claims he was a low-flyer who was interested in basketball and fishing. Funny how normal a person seems when you mention their hobbies. After all, Hitler enjoyed drawing cartoons. John Dillinger collected cars.

Dooley’s actions cannot be compared with villains of that order, but his actions were despicable, nonetheless. Dooley believed in himself too much and may have let his arrogance get the best of him. Unlike Hamanaka and Kerviel, it is not hard to figure the motives of Evan Dooley.

Why did he do it? For the money.

Dooley’s name will be printed alongside those of Kerviel and Hamanaka in the coming weeks, yet history will most likely forget him. He didn’t hatch a fiendish plot to deceive, only to have it unraveled in the public eye. He simply made a bad bet. He made a bet that lost, and he was fired for his mistake. Malebolge would not be fit for someone of Dooley’s stature. Dante would have Dooley spend eternity with Plutus, toiling endlessly in the fourth circle with the other covetous criminals.

When all is said and done, the sad sordid tale of Jerome Kerviel will most likely stand the test of time. Like Nicholas Leeson before him, Kerviel seems destined to be immortalized on the silver screen. Hamanaka was too bland. Dooley, too low-level. But Kerviel went for it all, and lost even more. Kerviel’s story has not had its ending written, but the moral is easy to figure out. We haven’t seen the end of rogue traders, and we could someday see Kerviel’s dastardly losses bested. But we can expect that the story will be unique, the perpetrator hard to spot, and the punishment often not fitting the crime.

Until next time,
Jamie Ellis
March 5, 2008

The Daily Reckoning