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What Is a Rogue Trader?
Let me explain to you what a rogue trader is: it's a trader who acts recklessly and on their own, without coordinating with others, and this usually harms the institution that employs them, and maybe even clients. These traders deal with high-risk investments that can lead to huge losses or gains.
But here's the thing: we only call them rogue if they lose money, which sets up incentives that create moral hazard. If their trades make enormous profits, nobody labels them rogue—in fact, they're likely to get a massive bonus. But if those risky bets fail, they're suddenly rogue and can cost the firm millions or billions in losses.
Key Takeaways
- A rogue trader is an employee of a financial firm who engages in unauthorized, often high-risk activities that result in large losses for the firm.
- Rogue traders often try to hide losses after making risky bets since there is a moral hazard situation: if the bet pays off they can earn huge bonuses, if it fails they'll only get fired.
- Famous examples of rogue traders exist, some of which have lost billions of dollars and even brought down otherwise large and stable banks or brokerages.
Rogue Traders Explained
Over the years, banks have developed sophisticated Value-at-Risk (VaR) models to control trading of instruments—which desks can trade them, when they can trade them, and how much in a given period. Specifically, trade limits are carefully set and monitored, not just to protect the bank but also to satisfy regulators. However, internal controls aren't 100% foolproof. If a trader is determined, they can find ways to get around the system to chase outsized gains.
Often, these traders get caught in bad trades and then regulators force public exposure, which embarrasses the bank. You have to wonder how many small-time rogue traders get quietly fired because the bank wants to avoid the negative publicity from admitting that their internal trading controls weren't properly developed or implemented.
Examples of Rogue Traders
One of the most notorious rogue traders in recent years is Nick Leeson, a former derivatives trader at the Singapore office of Britain's Barings Bank. In 1995, Leeson racked up heavy losses through unauthorized trading of large amounts of Nikkei futures and options. He took massive derivative positions on the Nikkei that leveraged the money at stake.
At one point, Leeson held 20,000 futures contracts worth more than $3 billion on the Nikkei. A big part of the losses came from the Nikkei downturn after a major earthquake in Japan triggered a broad sell-off within a week. The total loss to the 233-year-old Barings Bank exceeded $1 billion and led to its bankruptcy. Leeson was charged with fraud and served several years in a Singapore prison.
More recent cases include Bruno Iksil, known as the 'London Whale,' who caused $6.2 billion in losses in 2012 at JP Morgan, and Jerome Kerviel, who was partly or wholly responsible for more than $7 billion in losses at Société Générale in 2007. JP Morgan's CEO Jaime Dimon was slow to grasp the scale of the 'London Whale' losses, initially dismissing it as 'a tempest in a teapot.' Later, he had to admit the truth about his bank's rogue trader, much to his chagrin.
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