When Oswald Gruebel, chief executive officer of UBS AG, stepped off a plane in Zurich at dusk on Sept. 14, 2011, he had an urgent message on his mobile phone from investment-banking head Carsten Kengeter.
Gruebel’s decades of experience in finance told him this could only be bad news, he recalled in an interview in October 2012.
“What’s burning?” he asked Kengeter.
“This time it’s really burning,” Kengeter replied.
“Is it more than a billion?”
Kengeter told Gruebel that a young trader in London named Kweku Adoboli had amassed more than $8 billion in unauthorized positions on equity index futures and had hidden them with fake hedges. Adoboli’s wrong-way bets led to a $2.3 billion loss in the biggest rogue trading case in U.K. history, according to an article that will appear in the February issue of Bloomberg Markets magazine.
Gruebel, 69, had come out of retirement in February 2009 to rebuild UBS after it had bled more than $50 billion in the subprime mortgage crash. He was crestfallen at the blow to the bank’s reputation after Adoboli was arrested on Sept. 15, 2011. The CEO offered to step down three days later to minimize the damage, and on Sept. 24, the board accepted his resignation.
During an 11-week trial a year later, Adoboli, 32, argued that he’d never set out to deceive the bank and had simply lost control of his trades. On Nov. 20, a London jury found him guilty of two counts of fraud and innocent of four counts of false accounting. He was sentenced to seven years in prison.
Lack of Integrity
Adoboli’s downfall is the story of how a proud young man lied to his colleagues, and to himself, to win glory on the trading floors of the City of London. His case also sheds light on the permissive environment that helped drive investment banking in the City into its worst spate of scandals in generations.
“We have a culture that ceased to punish people for a lack of integrity in a meaningful way,” says Jon Moulton, chairman of Better Capital LLP, a London-based investment firm. “Instead, they were promoted. It’s make money and don’t worry about the details.”
After Prime Minister Margaret Thatcher deregulated the financial industry as part of her Big Bang policy in 1986, more than 175 foreign financial firms came to the City and turned it into the No. 1 international banking center. Regulators have long trusted the City to largely police itself.
Adoboli, a compact plug of a man with the honeyed voice of a stage actor, plunged into this arena right out of college. Like so many bright young people who flock to London to seek their fortunes, Ghana-born Adoboli was dazzled by the life of the trader.
By day, he and his UBS co-workers wagered millions of dollars on equities as they chased six-digit bonuses. At night, they jammed the bars around Liverpool Street Station to swap stories of their trading victories -- and losses.
Adoboli took up spread betting on securities indexes, a legal activity popular with young London traders, and squandered 123,000 pounds ($198,000). When he hosted parties at his luxury flat in Whitechapel, he gave his neighbors bottles of champagne to apologize for the noise.
London’s freewheeling ways blew up in 2008 when the subprime crisis laid waste to the income statements of big banks and prompted taxpayers to bail out Royal Bank of Scotland Group Plc. Now, regulators in the U.K. and the U.S. have exposed other self-destructive practices.
The intercontinental probe into the alleged widespread rigging of the benchmark London interbank offered rate has revealed how traders in London, New York and Tokyo manipulated one of the most important instruments in global finance for years. London-based Barclays Plc paid $450 million in fines for falsifying Libor rates. Edinburgh-based RBS is poised to settle similar allegations.
On Dec. 19, authorities in Switzerland, the U.K. and the U.S. announced that Zurich-based UBS will pay about $1.5 billion in fines for manipulating Libor and other benchmark rates. Its Japanese unit agreed to plead guilty to wire fraud.
At UBS, Adoboli found himself in a place where recklessness seemed the norm and following rules appeared to be optional, he testified in November. He and other traders often blew through their risk limits with little interference from supervisors.
At age 30, John Hughes, Adoboli’s colleague, was allowed to serve as head trader on the exchange-traded-fund desk even though he failed 17 times to complete training required for supervisors.
Slot Machine Trades
Hughes, who testified that he was lazy, was fond of wagering the bank’s capital on what he called “slot machine trades,” unhedged directional bets on equities based on little more than a hunch.
In this environment, Adoboli dismissed UBS’s written policies as impediments to success.
“There was a difference between policy and practice,” he testified. “If you stuck with the policies, then you wouldn’t make money. It’s as simple as that.”
Adoboli rose from being a clerk to a trader responsible for tens of millions of dollars in less than three years. His father, John, was a United Nations personnel director who trained workers for peacekeeping missions.
As a boy, Adoboli hopscotched with his family from Ghana to Jerusalem to Damascus before attending a Quaker boarding school in England when he was 12 years old. Upon graduating from the University of Nottingham in 2003 with a degree in computer science and management, he went to work in the back office of UBS’s investment bank.
Full of Opportunity
For the next three years, he learned how trades flowing through computer programs were booked and settled.
“He became intimately aware of how the bank’s accounting controls worked,” prosecutor Sasha Wass said in court. “He would have known what events triggered alarms and how to avoid this from happening.”
Adoboli was thrilled to work at the bank. In the mid-2000s, UBS was expanding in securities sales and trading as part of then-Chairman Marcel Ospel’s bid to make it the No. 1 investment bank in the world.
“It was a place full of opportunity -- one where, if I kept working hard, I would be able to contribute something I was proud of,” Adoboli said in court.
Adoboli jumped from the back office to the trading floor in September 2006. Within a year, Adoboli, then 27, and Hughes, who was two years younger, were granted responsibility for running the ETF desk themselves for several months.
The duo, who had 30 months of trading experience between them, bought and sold equity index ETFs, futures and swaps for clients and for UBS’s proprietary accounts.
Adoboli was astonished at the authority and the market power he suddenly possessed.
“We were babies,” he testified.
In 2009, managing director Ronald Greenidge took over supervision of the ETF desk in addition to his other duties overseeing European cash trading. Greenidge developed a fatherly relationship with Adoboli and trusted him not to exceed a $50 million daily risk limit, Adoboli testified.
When Greenidge recalled this period in his testimony, he became so unnerved that he almost fainted on the witness stand as Adoboli, sitting at the defense table, cried.
Greenidge, a 19-year UBS veteran, relied on the bank’s risk controls to keep his two young traders in check. They were required to book hedges for any trade that imperiled UBS’s own capital. Unhedged trades would show up on a system monitored by accountants.
Fake Hedging Trade
Adoboli was at his desk before 7 most mornings and sometimes worked so late he slept underneath it. His gift for distilling the complexities of ETFs into plain language made him popular with the bank’s sales staff and clients. The trader joined a leadership-training program called Ascent.
From 2007 to 2010, Adoboli’s total annual compensation quadrupled to 360,000 pounds.
As the global financial system quaked in October 2008, Adoboli suffered a relatively minor $400,000 loss in a client account. Rather than take the hit, he booked a fake hedging trade in the FTSE 100 Index showing a $400,000 profit. Thanks to his back-office knowledge, the trader knew his fictitious hedge would hide his loss.
Adoboli also knew the gambit would work only for a short time because the $400,000 shortfall would eventually materialize on the desk’s profit and loss statement, prosecutor Wass said.
So he started faking hedges on his other real trades and plowing profits into a secret slush fund. Then he drip fed cash back into his desk’s books to cover his original $400,000 loss.
He dubbed his invention “the umbrella.”
As Adoboli used his umbrella to cover his losses and goose profits over the next year, he viewed it as a financial innovation and not a dishonest scheme.
“Sometimes to achieve something, you have to experiment,” he said, gripping the sides of the witness stand and holding his chin high.
Adoboli was further emboldened when Gruebel announced in November 2009 that UBS was ready to go back on the offensive after surviving the subprime debacle with a bailout of 6 billion francs ($5 billion) from the Swiss government. Gruebel said UBS was aiming for pretax earnings of 15 billion francs in three to five years.
“The opportunity can come only once, but we will do it, we will not rest,” Gruebel said in an internal company video that moved Adoboli to tears when it was played at trial.
Push the Boundaries
Adoboli interpreted Gruebel’s comments as a license to take more risk.
“The mood at UBS was more confident,” he testified. “It was, ‘We must work harder; let’s push the boundaries.’”
By January 2011, Adoboli testified, he had become so confident his $40 million umbrella could boost the desk’s performance that he had revealed his secret to Hughes and two junior traders, Simon Taylor and Christophe Bertrand.
“It often rains, so I built an umbrella,” Adoboli wrote in an e-mail to Hughes that month.
In confronting the daily turmoil of the markets, the traders had become brothers in arms. They dubbed Bertrand, an intense Frenchman with movie star looks, “Bateman,” after the serial killer investment banker in the 2000 movie American Psycho. Hughes admired Adoboli’s appetite for high-risk trades and called him a “legend” in the countless online chats they shared.
Release a Little Rihanna
“I’m glad there’s someone behind me with the balls of Jericho,” Hughes wrote to Adoboli in early 2011. “I love your testicles.”
Hughes, who felt guilty for telling Greenidge that Adoboli had violated his risk limit in December 2010, chose not to turn him in for the slush fund. Hughes was still nervous.
“The umbrella is going to get us both fired,” he wrote to Adoboli in March 2011. “Look at all last week -- you can’t stop. There is only one way to stop you, but I’m not going to do it.”
Adoboli, Hughes and Taylor referred to the slush fund as “Rihanna” because of the pop star’s hit song “Umbrella.” “Release a little bit of Rihanna,” Hughes wrote to Adoboli when he needed a jolt of liquidity.
In March 2011, Adoboli told Hughes the desk was up $6.2 million so far that year.
“That’s f...ing incredible, mate. Well done,” Hughes wrote to Adoboli.
“It’s not just me -- we’ve all done it,” Adoboli replied.
“You’re the main driver,” Hughes wrote.
In April, the desk was transferred from Greenidge’s unit to the Global Synthetic Equities team. It racked up $60 million in profits by June 30, more than five times what the desk had made in all of 2010.
Unbeknownst to his three deskmates, Adoboli had started making massive directional bets in June and hiding them with fake hedges.
As his trades blew up, he panicked. Down $50 million on July 1, he switched from short positions in the Standard & Poor’s 500 Index and the Euro-Stoxx 50 Index to a $1 billion long bet on the indexes. The S&P 500 fell 16.4 percent from July 1 to Aug. 8 as President Barack Obama battled with Republicans in Congress to raise the U.S. government’s debt limit and S&P downgraded the U.S. credit rating.
Desperate to recoup his mounting losses, Adoboli kept doubling down until he had $12 billion at risk on Aug. 8. UBS saw only $2.3 million as the desk’s exposure. “I had lost control,” he said in court.
Went to Church
In mid-August, accountant William Steward began asking Adoboli why his hedges weren’t settling. For the next five weeks, Adoboli held off Steward by fabricating convoluted stories about the complexity of his trades.
Adoboli testified that he did tell Hughes, Taylor and Bertrand about his losses in August. All three testified that they couldn’t recall talking with Adoboli about his secret trades.
By Sept. 14, Adoboli realized his deceit had run its course and he was going to have to confess that his counterparties were phantoms. He went to a church near UBS and prayed.
From his home that afternoon, he sent an e-mail to Steward revealing his fraud. He then returned to UBS’s black steel building in the City to unspool his whole story to the bank’s lawyers and executives for 10 hours.
At 3:30 a.m. on Sept. 15, he was arrested by the City of London police.
By early 2012, five senior executives, including Greenidge and Hughes, resigned or were dismissed from UBS for not catching Adoboli. Bertrand and Taylor quit pending disciplinary hearings.
In a lawsuit filed in June, Greenidge accuses the bank of unlawfully firing him because he’s black. UBS denies his allegations in court papers.
Now under CEO Sergio Ermotti, UBS is trying to put the fiasco behind it. On Nov. 26, it accepted the findings of the U.K.’s Financial Services Authority that the bank’s risk controls and management policies had been “seriously defective” and paid a fine of 29.7 million pounds.
Finma, the Swiss regulator, barred UBS’s investment bank indefinitely from acquiring other financial companies. For its part, UBS ended proprietary trading in its equities unit, strengthened its risk control systems and now requires back-office employees to be cleared by the investment bank’s chief operating officer before they can become traders. UBS spokesman Dominik von Arx declined to comment for this story.
Numbers on a Screen
Meanwhile, authorities are moving to rein in the City’s recklessness. Chancellor of the Exchequer George Osborne in November broke three centuries of precedent and tapped a foreigner, Bank of Canada Governor Mark Carney, to serve as head of the Bank of England. Osborne is looking to Carney to bring a fresh approach to regulation.
And in 2013, the FSA will split into two agencies: The Prudential Regulation Authority will become a part of the BOE and ensure the stability of banks and insurers. The independent Financial Conduct Authority will regulate brokerages and other financial firms.
New rules and watchdogs won’t make a difference unless the City’s leaders change the culture that fueled its current crisis, Better Capital’s Moulton says. The difficulty of that task is compounded by the industry’s penchant for creating ever-more-complex securities and speedier technology that accelerates high-volume trading.
Adoboli testified that he became desensitized to the size of his electronic trades. They were just numbers on a screen.
“You have a virtual world and people who make a lot of money behaving with increasing arrogance,” Moulton says. “That’s the nature of the problem.”
Adoboli is now incarcerated in an island prison off the southern coast of England. His great mistake was in believing that as long as he made money for the bank, he could ignore its policies and break the law, prosecutor Wass said.
“You played God in that bank, and the rules were for other people,” she said.
Adoboli will have ample time to ponder this lesson in humility.