January 23, 2020

DealBook: Arrest of UBS Trader Rattles Banks in Europe

UBS office in the City of London.Sang Tan/Associated PressUBS office in the City of London.A photograph from Kweku Adoboli's FaceBook page.A photograph from Kweku Adoboli’s FaceBook page.

Kweku Adoboli traveled from Ghana to Israel to a Quaker boarding school before attending a leading university in Nottingham, England. With his education pedigree, he landed a coveted job at UBS, the giant Swiss bank, right after graduation.

But his ascent came to an end in the cool, predawn hours on Thursday when Mr. Adoboli, a 31-year-old trader, was arrested in London on suspicion of causing some $2 billion in losses. The bank said the loss could be enough to wipe out its entire quarterly profits. Investors recoiled, sending shivers through European banks that have already been buffeted by the Continent’s debt woes. Mr. Adoboli had not been charged on Thursday.

The rogue trading case is a troubling reminder that the controls and warning systems that banks like UBS have put into place in the three years since the financial system nearly collapsed may not be enough to protect the system and could renew calls for separating investment banking operations from less risky businesses.

“It reminds you that investment banking is a dangerous business, and it’s going to lead to people asking why they really need” the units, said Fiona Swaffield, an analyst at Execution Noble in London. “It’s a knock to confidence we could do without in this current environment.”

While the full details are still being pieced together, the UBS incident bears an unnerving resemblance to the recent financial scandal at Société Générale. In 2008, Jérôme Kerviel, a trader at the Paris bank, was accused and later convicted of generating $6.8 billion in losses.

Both Mr. Adoboli and Mr. Kerviel worked in a relatively plain-vanilla version of a complex derivatives trading business known as the Delta One desk. As part of this business, traders create investments to track customized assets, like a basket of five retail stocks. In some cases, they use computer programs to profit from tiny differences between the prices of derivatives and their underlying assets — the minute variations between an exchange-traded fund, for example, and the individual stocks underpinning it.

The revelation is a rough blow to the beleaguered bank, which has been struggling to regain its footing since the financial crisis. UBS, one of the European banks hardest hit by the American subprime crisis, had just started to turn a profit and attract wealthy clients back to its private bank, before the Continent’s debt crisis hit and earnings slumped again. Last month, UBS announced it would eliminate 3,500 jobs after poor second-quarter results.

On Thursday after the arrest of Mr. Adoboli, UBS once again found itself scrambling to reassure clients, investors and employees. The firm held conference calls with crucial divisions to discuss the trading scandal. In an internal memo, UBS emphasized that “no client positions” were involved in the “unauthorized trading.”

“While the news is distressing, it will not change the fundamental strength of our firm,” the company wrote in the memo.

How Mr. Adoboli came to take center stage in a worldwide financial scandal is a story of hard work and a globe-trotting education.

At Nottingham University, part of a group of leading institutions known in Britain as red brick universities, Mr. Adoboli, who focused on computer science, was an active member of the student union. During “freshers” week, he helped organize social activities for the incoming class, according to a university spokesman.

Shortly after graduation in 2003, he joined UBS, becoming a investment adviser trainee in London a few years later. Like many young financial professionals, he enjoyed the finer things in life, listing photography, cycling and wine among his interests on his Bloomberg profile. Until about four months ago, Mr. Adoboli lived in a pricey loft on Brune Street in London, not far from the UBS office.

A neighbor in the building, who described Mr. Adoboli as “a really nice guy,” recalls that the trader once held “quite a loud party.” When the neighbor, who requested anonymity, asked him to turn down his music, a contrite Mr. Adoboli acquiesced and gave him a bottle of champagne for his trouble.

Efforts to contact family members of and lawyers for Mr. Adoboli were unsuccessful.

At UBS, Mr. Adoboli rose through the ranks, ending up as director in the exchange-traded funds and Delta One trading desk. It was an increasingly important driver of profits at the financial firm, particularly in the investment bank in the aftermath of the crisis.

The investment bank had been a trouble spot at UBS for years.

Leading up to the financial crisis, the group ramped up its risk, plowing billions of dollars into complex investments backed by subprime mortgages. When the real estate market collapsed, UBS suffered serious losses, forcing the Swiss National Bank to bail out the bank.

In February 2009, the bank tapped Oswald Grübel, the former head of rival Credit Suisse, to revive the financial firm. As he looked to restore profitability, the new chief executive cut thousands of jobs and reduced riskier activities, like exotic structured products and proprietary trading. He also focused on repairing UBS’s reputation with clients, after its private bank was investigated for facilitating tax evasion by wealthy Americans.

But Mr. Grübel rejected calls by some investors, regulators and analysts to sell or spin off the investment banking operations. Mr. Grübel, a former bond trader, argued the unit was critical to the turnaround, enabling UBS to offer a wide range of products and attract clients to its private bank. As UBS shifted away from proprietary trading and the like, the firm looked to other profit centers to drive growth in the investment banking group.

Mr. Adoboli worked in one of those groups, the Delta One desk.

His team specialized in an especially hot corner of the market, exchange-traded funds, a booming, $1.4 trillion industry. Demand for E.T.F.’s, baskets of securities that track a particular index or assets, such as bank stocks or commodities, have exploded in recent years; hedge funds and big institutions use them to make short-term bets on specific areas of the market or to reduce the exposure in their portfolios.

With the bank suffering in other areas, UBS brought in an estimated $500 million in revenue last year from Delta One products, according to a report by J.P. Morgan Cazenove, a British investment bank.

Now, the group is proving to be a drag on profit.

UBS, in announcing the unauthorized trading, offered no additional details about the transactions and said the matter was still being investigated.

For Mr. Adoboli, the next steps are uncertain. A police spokeswoman, who did not provide the name of the trader in custody, said that the person could be sent home, released on bail or charged with an offense.

Reporting was contributed by Landon Thomas Jr., Susanne Craig, Matthew Saltmarsh and Azam Ahmed.

Article source: http://feeds.nytimes.com/click.phdo?i=fe5f1ac89557be778c5ef7013cdc5bc2

Economix: A Lie That Was ‘Literally True’

Remember market timing?

FLOYD NORRIS

FLOYD NORRIS

Notions on high and low finance.

That was a financial scandal before Wall Street brought on the collapse of the economy. Some mutual funds allowed favored customers to trade mutual funds based on stale prices. In many cases, this involved funds that invest in foreign securities, where a lot of news may have happened after the stocks stopped trading in their home countries but before the 4 p.m. New York deadline. The effect is to transfer money from other investors in the fund to the market timers.

One example was the Gabelli Global Growth Fund, known as GGGF, run by Marc Gabelli, the son of Mario Gabelli, the founder of the Gabelli Funds. He told the fund’s board that the fund was diligently seeking to stop investors from market timing, and that was true, with one not-so-minor exception. He allowed a favored hedge fund to do it hundreds of times. That fund made money in the fund; other investors lost money. The hedge fund effectively paid off Gabelli by investing in a Gabelli hedge fund.

When market timing became an issue in 2003, the fund reassured investors that management was on the case, in a memo signed by Bruce Alpert, the chief operating officer of Gabelli Funds, that said market timers were really scalpers:

For more than two years, scalpers have been identified and restricted or banned from making further trades. Purchases from accounts with a history of frequent trades were rejected. . . . While these procedures were in place they did not completely eliminate all timers.

The Securities and Exchange Commission filed a civil suit against Mr. Gabelli and Mr. Alpert, only to have a federal judge, Deborah Batts, dismiss the suit. That judge concluded the letter was “literally true,” and thus not misleading. After all, some market traders were blocked, and the funds admitted that some succeeded.

On Monday the United States Court of Appeals for the Second Circuit reversed that decision, in a ruling by another district judge, Ned Rakoff, who was temporarily sitting on the appellate court:

“The law is well settled, however, that so-called “half truths” — literally true statements that create a materially misleading impression — will support claims for securities fraud.”

Judge Rakoff concluded that “a reasonable investor reading the Memorandum would conclude that the Adviser had attempted in good faith to reduce or eliminate GGGF market timing across the board, whereas, as Alpert well knew but failed to disclose, the Adviser had expressly agreed to let one major investor . . . engage in a very large amount of GGGF market timing.”

The case will thus be able to go to trial. But I find it amazing that this appeal was necessary. Given the facts as alleged by the S.E.C. (and the judge has to assume they are accurate in considering a dismissal motion), it is hard to imagine a less absurd conclusion than the one reached by Judge Batts.

Article source: http://feeds.nytimes.com/click.phdo?i=b73fd24aa4cef2170c4b22d39efd8562