Whale Watching on the Trading Floor: Unravelling Collusive Rogue Trading in Banks

The Volcker Rule as part of the Dodd-Frank Act banning proprietary trading for commercial banks became effective on July 21, 2012 with the Federal Reserve (FED) extending the conformance period until July 21, 2017. On February 3, 2017, U.S. President Donald Trump signed an order to review the Volcker Rule and other regulations growing out of the 2010 Dodd-Frank financial reform law. Regulators began working on a potential revision in July 2017. End of May 2018, the U.S. Congress approved a regulatory rollback of the Dodd-Frank Act, leaving a fewer than ten big banks in the U.S. subject to stricter federal oversight, but freeing banks with less than USD 250bn in assets (Rappeport and Flitter 2018). The Liikanen Group, an expert group of the European Commission for structural banking reforms, founded by Erkki Liikanen, governor of the Bank of Finland and European Central Bank (ECB) council member, recommending the separation of proprietary trading and other high-risk trading activities (Liikanen 2012).

Angeletti (2017) investigates the first LIBOR trial involving Thomas Hayes and provides a sociological framework to capture justifications of financial wrongdoings. He finds in most situations (e.g. pleas in court) the multiplicity of rules (i.e. ambiguity) to be used by elites, as users of the rules (versus rule makers and rule interpreters), to their own benefit.

A former JPM trader, Toby Maitland Hudson, responsible for proprietary trading of derivatives tied to commercial-mortgage bonds at JPM, was hired by Saba Capital Management, L.P., a hedge fund founded in 2009 which supposedly profited from Maitland Hudson’s knowledge of SCP’s positions.

For almost six years, JPM failed to disclose any information about its SCP to its primary regulator, the Office of the Comptroller of the Currency (OCC). Only from January 2012 onwards, when the SCP began breaching JPM’s Value-At-Risk (VaR) limit and losses occurred, JPM reported the SCP to the OCC. OCC’s repeated information requests were often ignored and not adequately enforced by JPM, resulting in incomplete, inaccurate and misleading information (United States Senate 2013c, p. 250).

JPM needed to pay a civil penalty to the United States Securities and Exchange Commission (SEC). The firm did not admit liability or even any mistakes (Bealing and Pitingolo 2015, p. 7). Linked research reveals, it is cheaper for financial institutions to settle with the SEC in order to avoid further opprobrium versus trying to attempt to convince the court of the appropriateness of remediation actions taken (Patton 2014, pp. 1719, 1738).

The VaR measures the expected loss of a trading book, while the Risk Weighted Assets (RWA) are a regulatory measure of a bank’s exposure.

In addition to LIBOR, there are other reference rates, such as EURIBOR and Euroyen TIBOR. EURIBOR (Euro Interbank Offered Rate) is defined by the European Banking Federation (EBF) as the rate at which Euro interbank term deposits are offered by one prime bank to another within the Economic and Monetary Unit of the European Union (EU) at 11:00 London time. Euroyen TIBOR (Tokyo Interbank Offered Rate), as per the Japanese Bankers Association (JBA)’s instructions, is the reference rate, of which the panel banks believe a prime bank would transact in the Japanese offshore market at 11:00 Tokyo time. For both reference rates, the trimmed mean methodology applies. For the purpose of this paper, the terminology LIBOR is used to cover all similar benchmarks, including EURIBOR and TIBOR.

The BBA is a U.K. non-profit trade organization funded by subscriptions from its more than 200 voluntary members for which it lobbies (Konchar 2014). The BBA merged with Payments U.K., the Council of Mortgage Lenders, the U.K. Cards Association and the Asset Based Finance Association into U.K. Finance on July 1, 2017.

See https://​web.​archive.​org/​web/​20101013074550/​http://​www.​bbalibor.​com/​bbalibor-explained/​the-basics.

Two former Deutsche Bank traders, Matthew Connolly and Gavin Black, the imprisonment (and potential fine) have not been set at the time of writing.

Many countries, especially in Europe, require providing testimony by individuals involved in an investigation. In light of cross-border convictions, the U.S. law prevents the use of compelled testimony, which makes it difficult for federal prosecutors to pursue charges for cases reaching cross-markets and individuals who are outside the U.S. (Henning 2017).

The BBA, by highlighting, ‘Members of the Committee are currently from contributing banks and believe their independent stance and ability to provide detailed scrutiny of the rates would be strengthened by widening the membership of the committee.’, implicitly confirms concerns around FX&MMC’s independence (British Bankers’ Association 2008, p. 12).

Limitations of our research lie in the case study approach—relying on public available investigation reports (prepared and issued by regulatory authorities/supervisors as well as authorized delegates like accounting or law firms engages by the involved banks), published academic research, news/media information—that is prone to hindsight bias effects.

We deem external audit as being part of the regulatory framework for banks; hence, our policy recommendations for the regulatory role are applicable to external audit as well. We see the mandate of internal audit in the examination of the adherence to operational standards, thereby assessing the control environment (i.e. design effectiveness and control effectiveness) as well as the management awareness (i.e. management’s involvement and pro-activeness in detecting and closing control gaps).