When the Boss is the Rogue Trader

In a showdown between a wild-eyed trader, looking for the Big Score, and an investing entity’s Chief Risk Officer (CRO), reasonable people (amongst them investors with a long equity interest in the entity, its employees, its creditors and other counter-parties) must hope that at least once in awhile the company’s Chief Executive Officer will step in and support his CRO, reining in the excesses of the speculative impulse.

If the wild-eyed trader manages to evade detection for some time, and thus avoids a showdown with the CRO, imperiling the firm in the process, by recent convention we call this person a “rogue trader.” But what language do we use of the CEO happens to be the one with the wild eyes? The question is of more than semantic interest, and has drawn a good deal of attention since the demise of MF Global in October 2011.

The Global Association of Risk Professionals has surveyed risk managers, analysts and academics to get a sense of the implications of the demise of MF Global Holdings for the role of risk managers. Its findings add to a growing sense that the firm’s last chief executive, Jon Corzine, a former New Jersey Governor and U.S. Senator, was an edge-dwelling trader at heart, eager (as Dealbook put it in an analysis in December) to play a “hands-on role in the firm’s high-stakes risk-taking;” indeed, a man enmeshed in a “romance with risk.”

This spreading understanding of the collapse of the firm, combined with what appears to be a serious, though as yet still an obscure, breach of the firm’s custodial function, could have serious consequences for the policy/regulatory environment in which a variety of investing entities do business going forward.


GARP for example cites Richard Bove, of Rochdale Securities, who expects that the meltdown of MF Global and its consequences for customers will lead the Federal Reserve Board to reconsider which institutions are systemically important, causing a larger number of entities to fell under a heavier load of regulatory supervision than they would have otherwise. It quotes Bove saying, “This could be a significant negative for the industry, increasing the costs of business and decreasing the amount of risks firms are willing to take.”

More hopefully, GARP cited one risk manager, whom it leaves unnamed, as saying that the incident may cause risk managers, CEOs, and boards to show greater understanding of and sensitivity toward liquidity risk. One can always hope.

One remarkable fact about the demise of MF Global is that the bets themselves didn’t lose money. Corzine (understandably) emphasized this point in his own testimony before Congress. The bets cost liquidity, and the resulting illiquidity proved fatal. Still: dead is dead.

Too Big to Fail

Jon Corzine took over MF Global in March 2010. It had been spun off out of Man Group plc three years before that, and Corzine’s plan was to use it as a platform for proprietary trading of a quite aggressive sort.

On February 2, 2012, the two recent Chief Risk Officers of MF Global, Michael Roseman and Michael Stockman, testified before the Financial Services Committee of the U.S. House of Representatives.  Roseman in particular comes out of the affair smelling rather well – he held the CRO post when Corzine came on board, and left in early 2011 after clashes warning Corzine and the board that the liquidity risks of the trading strategy the firm had adopted by then were severe.

GARP also spoke to Jamal Oulhadj, CRO at R.J. O’Brien & Associates, a one-time competitor of MF Global. Oulhadj said that Roseman “did everything he was supposed to do,” in identifying the nature of the risk and reporting it accurately. Because of his efforts, “the board was well aware of the matter.”

Of course, in one sense, MF Global proved that it wasn’t too big to fail. It did fail, neither the central bank nor the Treasury stepped in to prevent that, and there was no cascade or domino-line of consequent catastrophes. But there is the matter of the $1.2 billion in customer funds that seems to have gone missing over the course of the week before its bankruptcy filing. Is that enough of a wrench to the system to count as a ‘systemic failure’?

One of the lessons of such debacles should be this: we should be wary of any system that assigns grave importance to the necessarily subjective answer to such an arbitrary question as that.

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  1. Robert T
    February 16, 2012 at 4:57 pm

    Off to jail Mr. Corzine. (Unless you can write a ck for $1.6 Bil.)

  2. Denise Shull
    February 17, 2012 at 12:44 pm

    The only way we are ever going to protect against this kind of thing is to change the culture around risk management – and in turn the culture of risk taking organizations.

    The right psychological questions need to be part and parcel of all risk taking. This is a qualitative but comprehensive envelope for the quant risk management we do. Until CRO’s, portfolio managers and in this case, Boards of Directors are facile with understanding what is truly known about human decision making (beyond behavioral finance which is only the end-result taxonomy and not the why or the how that leads to a solution), this kind of thing will keep on happening.

    Enough is known, at least by a few people, to actuate the psychological “controls” and to quote Marvin Zonis of The University of Chicago “Yes, this is where we must go with this stuff”.

    Denise Shull

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