Implications Of Rogue Trader Case Look Very Bad For UBS

How in the world did Kweku Adoboli, the London based rogue trader, manage to lose $2.3 billion for UBS, without the Swiss bank's risk management systems detecting his unauthorized activity? This is hard to believe, and the implications of this story are devastating for UBS (NYSE: UBS).

According to the bank, Adoboli, who was a director of ETFs and manned the firm's Delta One trading desk, racked up the losses on wrong-way bets in S&P 500, DAX and EuroStoxx futures amid wild market volatility. He was able to disguise the size of the risk he was taking by creating "fictitious hedges."

Adoboli began his career with UBS in the back office, where he undoubtedly gained significant knowledge of the firm's compliance, risk management and trader oversight functions, which surely assisted him in disguising his rogue trading activity. This explanation, however, still appears somewhat dubious.

Either way, what happened at UBS is wholly unacceptable from the perspective of shareholders. If we are to accept UBS's version of events, it leads to only one conclusion - the firm's risk management is totally incompetent and a bunch of senior employees should be fired immediately.

This would include both the CEO, Oswald Grubel, and first and foremost Chief Risk Officer Maureen Miskovic. Adoboli's shocking losses wiped out the firm's entire Q3 profits, and UBS may not even be paying bonuses this year as a result of his activity.

There are other scenarios that could be at play here, which are not reflected in the bank's official statement. First, it seems possible that Adoboli's superiors were knowledgeable about the risks he was taking and turned a blind eye. This might not be likely, but it is not out of the question.

Depending on the prevailing culture, UBS may have taken a permissive attitude towards traders with a history of making big gains. One detail of this story which might suggest that this is not the case, however, is that Adoboli reportedly ratted himself out - which actually just speaks more to the incompetence of UBS's risk functions if it is true.

The other potential scenario that unfolded here is that Adoboli is indeed guilty of rogue trading, but that his losses were not $2.3 billion. Instead, maybe UBS discovered the unauthorized losses and just kitchen sinked them with other losses in its trading business and pinned it all on Adoboli.

While this sounds far-fetched, UBS is a bank that is no stranger to shady dealings. Bottom line: Either UBS is covering up the real circumstances around Adoboli's losses, or the bank is a completely incompetent risk manager in need of some serious management shakeups.