Slides as presented at the Inaugural ESRC People Risk Seminar at the Centre for Risk, Banking & Financial Services at Nottingham University Business School, 4 Dec 2013, Nottingham.

1. The Inaugural ESRC People Risk Seminar
Centre for Risk Banking and Financial Services, Nottingham University Business School
Markus Krebsz – Author, Strategic Advisor & Head of Risk
www.krebsz.net
4th December 2013

2. - A People Risk analysis
Contents
The Tip of the Iceberg
What is a “Rogue” Trader?
What do they look like?
The Rogue Traders’ Playground
Men behaving badly
Evolution and “Strike-it-rich” birds
Risk-aversion & Gambling
Avoiding losses at all costs
Lessons learnt
Research Ideas
Publications
Contact
References & Further reading

3. • This is just the tip of the iceberg...
• Original size vs. Reported size
• Smaller rogue trades:
 don’t often make it to the news
 might never be discovered
• Appear in cycles
(Source: “Rogue Trading – Risk Management: Controls & Culture”, GARP 2012)

4. The term was originally coined by
Eddie George, a former governor of
the Bank of England:
He described Barings Bank as
having been the victim of ‘massive
unauthorised dealings’ by ‘a rogue
trader’.
= An authorised employee executing ‘Rogue Trader’ is also the title of
Nick Leeson’s memoire.
unauthorised trades.

5. Rogue Traders’ gallery
Joseph Jett,
$74m
Nick Leeson
£830m
Toshihide Iguchi
$1.1bn
Team of 4 Rogues
AU$360m
Jérôme Kerviel
€4.9bn
Kweku Adoboli
$2.3bn
Yasuo Hamanaka
$2.6bn
Valdemort / London Whale
$6.2bn
John Rusnak
$691m
To be continued…

6. Some Stats:
• Single largest trading
floor (Guinness book):
Size of 2 football pitches
• 5,000 monitors,
2,000 computers,
1,400 seats
• 1,689,000 transactions
per day
______________________
Q: How does one stand out
working there?
A: By making money Loads of it!

7. The Six Key Personality Traits of Rogue Traders:
• They have worked in the back- or middle office (= detailed knowledge)
• They are outsiders (or are seeing themselves as such) and act mostly alone
• They are charismatic
• They are clever
• They are control freaks
• They CANNOT STOP and CARRY ON
until the losses spiral completely
out of control or until being caught.
(Source: John Gapper, How to be a Rogue Trader, 2011)
Most of them are male, although there are some know female rogue traders.

8. Animals facing risk of starvation will gamble to survive
Yellow-eyed
Junco (sparrow),
Mexico & US
Option #1
Always 2 seeds
(100% probability)
Option #2
Either 4 seeds
or none (with 50/50 chance)
• If plenty to eat: birds are risk-averse
• When starved: birds are gambling in
search of a bigger pay-off (i.e. food)
• The behavioural driver behind is known
as the negative net energy budget.
• This is not limited to birds – similar
behaviour can be seen in mammals
(shrews) and bumblebees.
• Choices are instinctive rather than
intellectual and make sense for species.
• The greater the ‘evolutionary fitness’ of
an animal the less risks it needs to take.
(Source: Barry Sinervo, ‘Optimal Foraging Theory: Constraints and Cognitive Processes’. )

9. The model for animals applies equally to humans
Daniel Kahneman and Amos Tversky, two Israeli psychologists, identified loss aversion in humans at about
the same time that Caraco and his fellow biologists were observing yellow-eyed juncos.
Their findings, published in 1979 in Econometrica, won Kahneman the 2002 Nobel award for economics.

10. Rogue Traders do what comes naturally
Kahneman and Tversky discovered that risk aversion reverses when humans are
in loss, just as it does with animals.
defining
“The desperate scramble to
avoid losses at all costs is a
characteristic of a rogue trader.
The rogue trader may appear
to be acting strangely, but he
does what comes naturally.”
– John Gapper

11. Employing rogue traders as authorised employees
• Firms need to ensure authorised employees execute no unauthorised
trades – it is part of their business.
• Hence, they need to put appropriate controls in place AND need to
ensure these work as anticipated – i.e. frequently test & amend them.
• Two most important employees are: Rogue trader and Whistle-blower
• Two key objectives: Survival and Survival with a Profit. Rogue traders
threaten both – and in some cases (i.e. Nick Leeson/Barings) can kill firms
off.
Firms need to see the banana skins in their path
and actively manage conduct risk.

12. If it smells “fishy” – it probably is!
• Detective controls vs. Preventive controls
• Back-office staff promotion to Front office
needs very careful, close & continuous supervision
• Big data can help identifying illogical trades, but
most banks systems are not able to recognise
such trading and behavioural patterns (yet)
• More and frequent use of Psychometric testing
and Personality assessments
• Increasing the level of team-work in the front office,
including proven control mechanisms such as
the four-eye principle
• More use of common sense, gut feeling
out-of-the-box thinking and instinct is needed

13. Some of which may be somewhat controversial...
• Correlation of Economic cycles vs. appearance of rogue trade events
• Influence of Trading floor environments on the ability to make emotionally
balanced decisions
• Regular analysis of ‘Moral DNA’ as potential predictor for rogue behaviour
• Development of behavioural pattern recognition based on big data to detect
possible rogue trading activity – and prevent them or at least in order to have
some sort of damage limitation
• Frequent/Regular use of lie detector tests as part of behavioural staff
screening
• Protective mechanisms and working incentive structures for whistle-blowers

15. Markus Krebsz
krebsz@web.de
+44 79 85 065 045
www.krebsz.net
www.people-risk.net
www.riskrewardlimited.com
(LinkedIn)
(Private website)
(Company’s website)

16. • Mitchel Abolafia. Making Markets: Opportunism and Restraint on Wall Street. Harvard University Press,
2001.
• Australian Prudential Regulation Authority. Report into Irregular Currency Options Trading at the National
Australia Bank. 2004.
• Bank of England Board of Banking Supervision. Inquiry into the Circumstances of the Collapse of Barings.
July 1995.
• Daniel Bernoulli. ‘Exposition of a New Theory on the Measurement of Risk’. Econometrica, January 1954.
• Thomas Brennan and Andrew Lo. ‘The Origin of Behaviour’. Quarterly Journal of Finance, 2011.
• David Bullen. Fake: My Life as a Rogue Trader. Wiley, 2004.
• Thomas Caraco, Steven Martindale and Thomas Whittam. ‘An Empirical Demonstration of Risk-Sensitive
Foraging Preferences’. Animal Behavior, August 1980
• John Kenneth Galbraith. The Great Crash, 1929. Houghton Mifflin, 1954.
• John Gapper and Nicholas Denton. All That Glitters: The Fall of Barings. Hamish Hamilton, 1996.
• John Gapper. How To Be A Rogue Trader (Penguin Specials) (Penguin Shorts/Specials). Penguin Books Ltd.
Kindle Edition.

17. • Azar Gat. ‘The Human Motivational Complex: Evolutionary Theory and the Causes of HunterGatherer Fighting’. Anthropological Quarterly, 2000.
• Daniel Kahneman. ‘Maps of Bounded Rationality: A Perspective of Intuitive Judgement and
Choice’. Nobel prize lecture, 2002.
• Daniel Kahneman and Amos Tversky. ‘Prospect Theory: An Analysis of Decision under Risk’.
Econometrica, March 1979.
• Jérôme Kerviel. L’engrenage, Mémoires d’un trader. Flammarion, 2010.
• Kimberly Krawiec. ‘Accounting for Greed: Unravelling the Rogue Trader Mystery’. Oregon Law
Review, 2000.
• ———, ‘The Return of the Rogue’. Arizona Law Review, 2009.
• Nick Leeson. Rogue Trader: How I Brought Down Barings Bank and Shook the Financial World.
Little, Brown, 1996.
• Roger Lowenstein. When Genius Failed: The Rise and Fall of Long-Term Capital Management.
Random House, 2000.
• Charles Mackay. Extraordinary Popular Delusions and the Madness of Crowds. Broadway, 1995.

18. • Benedetto del Martino et al. ‘Frames, Biases and Rational Decision-Making in the Human Brain’. Science,
2006.
• PricewaterhouseCoopers. Investigation into Foreign Exchange Losses at the National Australia Bank. 2004.
• Promontory Financial Group and Wachtell, Lipton, Rosen & Katz. Report to the Boards of Directors of Allied
Irish Banks, Allfirst Financial and Allfirst Bank Concerning Currency Losses. 2002.
• Barry Sinervo. ‘Optimal Foraging Theory: Constraints and Cognitive Processes’. University of Southern
California Santa Cruz, 1997– 2006, available at printfu.org/ foraging + animals.
• Tobias Straumann. ‘The UBS Crisis in Historical Perspective’, Expert opinion prepared for delivery to UBS AG,
28 September 2010. University of Zurich.
• Nassim Nicholas Taleb. Fooled by Randomness: The Hidden Role of Chance in the Markets and in Life. W. W.
Norton, 2001.
• UBS. ‘Shareholder Report on UBS’s Write-downs’. 2008.
• Société Générale General Inspection Department. ‘Mission Green Summary Report’. May 2008.
• Andrew Weisman. ‘Informationless Investing and Hedge Fund Performance Measurement Bias’. Journal of
Portfolio Management, Summer 2002.