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January 2, 2014

When Good Traders Go Bad

By

Matt Samelson

We, like many others, doubt the Whale's bets were made in the true spirit of hedging. It appears Iksil suffered the sin of hubris, vastly overestimating his ability to succeed and underestimating the potential downside to the bank. While not criminal, his activities resulted in embarrassing losses for J.P. Morgan. That ego drove a colored and faulty view of his strategy is illustrated by the fact that Iksil and his team were literally able to "shout down" and bully the relatively inexperienced risk manager overseeing the group's activities.

 

THE FATEFUL DECISION

Thus we see that decisions to break the law, or less severely "step over the line," are simply extensions of the same decision-making that occurs in the normal course of business. Individuals weigh risks and returns. Time, pressure and desperation may cause transgressors to leap from the relatively benign blue boxes to the more serious red boxes. Once in the red, the "candy" of the gain (or desperation associated with a loss) can be tangible and overwhelming. This is often sufficient to permit continuation of the questionable or illegal activity.

Acting in one's own interest in the role of a fiduciary offers examples of fertile ground for questionable decisions. There is considerable legal ambiguity regarding fiduciary responsibility. It is therefore possible for a fiduciary to make some decisions in their best interests while not specifically breaking a law. Misuse of soft dollars is an illustration.

There are also decisions that have ramifications of criminal or civil liability. Insider trading is a clear example. One chooses-at the risk of fines and civil or criminal action-to trade on nonpublic proprietary information for virtually certain gain.

Decision-making consciously or unconsciously is a risk-based process. The temptation to step into the realm of the "inappropriate," unethical or illegal is arguably within all of us. In most cases, the individuals don't set out to be rule-breakers. They are confronted by situations in which they may be under pressure, may not have the time or focus, or may delude themselves into believing a legal transgression is not really a "line in the sand." Once the transgression has been made, the pull from the immediate benefits, and lack of immediate negative implications, can incite continued behavior in the same vein. That's when the risks overwhelm the rewards, and lives are ruined.

 

Matt Samelson is a principal and director of equities for market research firm Woodbine Associates.

 

 

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