3.28.2006

TIP: Stop the cheating traders before they stop you

Wilmott.Forums - ...99% of the trader are honest hard workig individuals. but bad apples do exist. they try to manipulate the trading systems, booking erroneous trades, mis-marking volatility curves... how (and if) it is possible to create a systematic process or a set of checks to minimize such cheating...

There are no people who can be shown to be higher risk than others, because if there were, you could see these things coming a mile away. Highbrow, lowbrow - bad guys don't have a profile. What is identifiable is the set of things that, right here and now seem like a no brainer but are very hard to face when you're in the thick of things:
  • People who are in over their heads. A guy who has never faced an actual market dislocation - suddenly markets move hard because of something unforseen and the guy loses track of stuff, executes incorrectly, and the problems snowball - he drags other people into it who otherwise don't do it all the time and so on. There are a LOT of people working in trading these days who have never seen a real, honest to goodness panic, and who are not qualified to cope. Ok, that's not the cheater you mentioned, but usually big f4rkups happen with guys who start out being well intentioned.
  • Bad politics on the trading desk. Again, good intentions paving the way to hell - if a trading desk boss is really good buddies with one of his traders, he will help the trader out of a jam when the jam should have been examined in the light of day. I saw this and it can be costly.
  • Times of year when things can get tense. This is obvious, or at least should be. If a guy has been losing money all year, and will likely be asked to move on after this accounting cycle, well, do you think he should have the same scrutiny as usual?... I guess at the end of the day I would say that most of the serious crap I have seen starts out with someone who probably meant well...

One approach is the "honeypot"... create an attractive vulnerability and monitor who uses it.

You can make money in anything where the compensation frequency is higher than the trading frequency. Bid it up, get paid, sell it down...

The system was put in place (a while ago) which detects most of systematic abuses. Risk managers and back office who compute PnL are separated from trading desk. This is the case in most of the hedge funds or banks. Banks also have legal compliance departments which is supposed to make sure that even tiny violations are determined. Violations that became profitable are under double scrutiny since ussualy it is zero sum game. In US orgranizations like NASD make sure that if you caught once doing the bad thing you never will get a job in the financial industry.

Sounds convincing and you would presume that JPMorgan are aware of these basic operational risk practices and yet last week a FX salesman was arrested. Terrence Gumbs (a 17-year veteran of the bank, although only 36) entered a non-existent client order to try to win back earlier losses and managed to blow another $6 million. Chump change by the real rogue trader standards of course but he'd been doing it for months which suggests he must have been able to intercept the settlement details going to the client.

Entering fictitious trades should be caught immediately when the external client/counterparty's back office denies all knowledge of them. Mis-marking positions of illiquid and exotic instruments is more difficult - although some independent group should at least be able to put upper and lower bounds on the value.

I interviewed with this MBS risk manager once, who had a very simple way of dealing with traders who do too much P&L management: if he thought a particular position was marked too low, he'd offer to buy it from him...

Category: C++ Quant > Fix the Job You Got

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