There are insights, then there’s real insight – the value of independent review
2004 was not a year of pandemic, nor of global financial crises, but it was a truly difficult year for a group of financial professionals. In this blog we ask a simple question – could their truly difficult year have been avoided?
Here I look closely at a major trading desk fraud and interview a senior risk executive at the heart of the investigation. One major failing was a lack of effective oversight and particularly some independent review which could have detected the issues well before they detonated.
So what happened?
The 3rd year of the new millennium began with few ominous portents. The Rover lander was settling itself delicately on Mars, a last VW Beetle had rolled off its production line in Puebla, Mexico, and decision-makers in the United States, having chosen to invade Iraq did not appear intent on doubling down on their chase for weapons of destruction, mass or otherwise; financial markets were simply dozing.
Becalmed in the charm of early-year, the S&P 500 had drifted quietly from 1112 and would fail to crack 1200 until December, ten-year US paper opened at 4.25% and would end the year a mere 2 basis-points lower; currency markets snoozed.
Yet, for a relatively small group of Australian financial markets executives 2004 would be a truly defining year.
At 1:53 pm on January 13th the then largest of Australia’s financial services leviathans made a startling market announcement on the Australian Stock Exchange; its risk teams had identified “losses relating to unauthorised trading” and that immediate action had been taken to close out and therefore “minimise any further losses being incurred.” The Bank did venture a little further, curtly confirming that losses were “not expected to exceed $180 million.”
For those whose year the announcement would define the shock of such a short statement must have come as a mixed blessing; the announcement was brief, the loss seemed contained, could there be much more to see and hear on the matter? Would there more to it?
And of course, the answer was yes, a great deal more.
Beyond wild estimate the ultimate cost to the long-proud firm is impossible to calculate, but we know today that it was more than the $180 million posted in that first ASX announcement. It is very hard to account for the costs of a disrupted business and the lost custom that comes when normal offerings are curtailed by regulatory order. Increased capital charges can easily be estimated, but what of distracted management and teams, and what happens when a full-service business can’t offer a full suite of products to customers? Will risk-managing customers wait until you’ve regained composure?
What we can say is that in less than a month the firm in question conceded that the loss was double that conceded in the original announcement. Double. How was that possible? We can’t be sure.
Within six months the firm exchanged its CEO and Chair, sacked the traders deemed responsible, sacked or forced the resignation of eight senior staff, disciplined or moved on 17 others - and carried through on a plan to restructure its board.
What went wrong?
The cheeky answer is lots, but since the prudential regulator devoted undivided attention to the irregular activity and losses it’s perhaps best to let their catalogue of the problems identified stand. In their report on the matter, we find the following:
traders choosing to conceal their true positions;
missed opportunities to detect and close down the irregular activity;
expressions of concern by counterparties at large ignored (by management);
collusive behaviour of the traders involved succeeded in suppressing many of the bank’s early warning signals; and
Line Management turned a blind eye to known risk management concerns.
Which points to too many things for one blog post to mention, but in trying to answer our question (could this have been avoided?) we’ve turned to a former senior risk executive whose intimate familiarity with this story remains very real after seventeen years.
Former Senior risk executive involved in the investigation –
I was involved as a risk executive and dealt with the desk involved. As the APRA review found, I attempted to bring the problem to the attention of senior and executive management, however my concerns were ignored.
Eventually, they were considering moving me away from my position. I was compromised and warned them that without an independent review the desk situation would end disastrously.
Once I stepped away from my duties there was no one of any experience closely monitoring the desk activity.
We asked for his opinion on another simple question – could independent review have made a difference in unveiling the irregular behaviour?
Former Senior risk executive again –
An independent review of that desk at that time may well have allowed genuine discovery.
When management and staff in the depths of any business are blind to fraudulent activities, independent reviewers have the capacity to provide frank and factual advice to senior management and the board.
Independent reviewers bring a fresh set of eyes to issues that are complex in nature and clouded in “noise” and jargon. An independent review dispenses with reporting alignment, routine familiarity and complacency. Independent reviews can highlight deficiencies in reporting requirements and shine a light on those who should have known better.
I truly believe that if this style independent review had been conducted then 2004 would have been a better year.
What’s clear as we look back through the records since this story first emerged is that it’s worth thinking about the right questions and it’s worth thinking about discovery.
Is that business unit, that desk, doing what you expect it to?
Is it aligned to your strategy and complementing the wider business?
Is it conforming to regulator expectations – and the letter of the law?
An independent review can assist with this discovery and help uncover potential issues that may have been overlooked previously.