Dear Editor,
I refer to your editorial dated February 15, 2008 and titled, “Inevitable Risks.” This is a most creditable effort on what has happened at SocGen in particular and the investment community in general, but I submit that the risks are not so inevitable.
Yes, there is fear, pressure to produce, and greed in the unrelenting quest for earnings and profits. However, there are arrangements in place that, if followed or allowed to be followed, seriously mitigate the not so inevitable risks.
Almost all-if not all-investment banks have certain minimum mechanisms in place to oversee their business endeavors. There is a first line of defence/control in the form of line supervisors and group directors. An example would be Equity Derivatives Supervisor, then US or European Head of Derivatives Trading, followed by the Global Head of Derivatives Trading at the top of the chain. On a minute-by-minute basis, these individuals and their cohorts know of exposure, positions, profits, and capital committed. They know this by product, by sector, by trader, by region. It is what they live and breathe. Behind this robust chain of command and control, but less visible, there are several quasi independent ancillary groups dedicated to individual trading desks.
They are: Business Area Controlling, Risk Management, and Asset Quality Control. Intra-day and on the day after trade date (T+1), employees from these units generate stacks of paper: Exception Reports, Routine Reports, and reports customized to identify large volumes, large profits, and large losses. Even further, there are separate Business Managers and Compliance Advisers who are all chained to the trading desks and their activities, as they occur.
This happens day in and day out, all day, and very late into the day. I stop at this point having identified over a half a dozen layers of hands on oversight. I ask: that given the significant electronic “alerts and triggers,” the volumes of records, and the people presence, why do the risks taken occur? Here is why.
Successful traders-including fictitiously successful ones-are all sacred cows. They are untouchable. They know it, and the attendant support (sentinel) structures know it. Their bosses know it and run interference to ensure that this hallowed status stays as it is. Internal Audit and Compliance Examiners (two additional layers of oversight) are tolerated at best as “necessary evils” and are stonewalled into ineffectiveness. It does not help that these two latter groups have a very limited understanding of the subject matter under scrutiny. Just as long as the trader(s) deliver, they are allowed to run, and run unleashed. Here is a situation with which I am familiar: At one investment bank, no less a person than the Chief Compliance Officer intervened and asked a sentinel to “look the other way” in a clear case of fraudulent activity. The reason is that a big trader was involved. When there is protection at all points, how can the risks be contained? When the independent monitors are hobbled, or the top dogs wilfully sleeping, then is it surprising that a SocGen or a Barings or a Kidder happens? It is only surprising that it does not happen more often. That is, at least, publicly.
Additionally, it must be understood that the competition is so fierce-and cutthroat, and the margins so slim that big scores are always known; they do not stay a secret for long in the Wall Street community.
The community-whether American or European-is so small, intertwined, and sophisticated that word quickly gets around about winners and losers. It seems that the only ones not listening are usually those in the house under siege and about to fall.
Therefore, I submit that if trading units and investment firms are really serious, honest, and consistent about oversight and scrutiny in the face of unbelievable pressure, then the risks are not as inevitable as it seems.
Yours faithfully,
GHK Lall
