A brief trawl of media comment on the banking industry over the last few years suggests that the industry is awash with criminals and fraudsters. The picture of traders, often presented in the press, is of amoral risk-takers with bosses who are always ready to turn a blind eye if profits are being made. There has been a public parade of rogue traders from Nick Leeson to Kweku Adoboli and the LIBOR and EURIBOR scandals are setting new records in terms of the number of people implicated. So, is this picture fair, or is something more complex going on?
Criminologists Peter Grabosky and Grace Duffield suggest that fraud is the product of three factors: a supply of motivated offenders; the availability of suitable targets; and, the absence of capable guardians.
The Wheatley review of LIBOR focuses in its prescriptions on the second and third factors. Recommendations concentrate on reducing the opportunities for fraudulent manipulation of LIBOR and on strengthening oversight both through external audit and internal improvements in governance. The first factor, the supply of motivated offenders, is not addressed by Wheatley. It is to this issue that I turn below.
Unpicking the myths
I have been researching and observing the work and behaviour of financial traders since the mid-nineties; interviewing and studying large numbers of traders and their managers, collecting data on their personalities, risk-taking behaviour, performance and more recently on their physiological and emotional reactions to stress and market volatility. The findings do not reflect the press stereotype. To unpick a few myths:
There is not a particular trader personality type. On average traders are slightly more conservative and introverted than the population average but among their ranks you can find the full range of personality types.
Traders are not especially risk-takers: on average traders actually seem more risk averse in their everyday lives than the population mean. Generally traders don’t seek risks for their own sake. They bear risks and learn to manage them in pursuit of other goals.
Traders are not especially dishonest. In many cases we were struck by the emphasis placed by traders on rigorous honesty, with themselves and others.
In truth traders are not extraordinary, they are ordinary human beings with ordinary human failings and problems; perhaps somewhat at the more intelligent end of the spectrum, but not universally so.
So what are the factors that may lead these ordinary people to lie, cheat, and commit fraud? What are the factors that ensure a supply of motivated offenders?
Skill and performance are loosely coupled
Trading is skilled work, but good traders often lose money and poor traders can get lucky. There is a lot of noise in the relationship between skill and performance. Trader managers often found it hard to articulate to us what makes a good trader; falling back on phrases like ‘a certain flair’ or ‘a nose for markets’. However, most agreed that it can take a couple of years to establish if someone is any good; that good managers play down early successes and understand that even top traders have periods when everything seems to go wrong.
This can be a source of enormous performance anxiety for traders. The trader who gets lucky early on and develops an undeserved reputation (and bonus) for good judgement will feel under great pressure to maintain a level of performance that is beyond them. The good trader who is having a period of bad luck and diminished confidence can see earnings and reputation suffer. But traders build up financial commitments that reflect their earnings and faced with an inability to sustain performance (and status) can feel under tremendous pressure to take unreasonable risks or bend the rules. For example, in one of our studies we wired traders up with sensors to measure stress and emotional reactions. Overall the results showed traders struggled to manage their emotions in volatile markets. But one very experienced trader exhibited high stress when markets were quietest. He told us that he was seriously below target and when markets were quiet he had little opportunity to make money; the stress was the “difficulty of resisting the temptation to do something stupid”.
Performance related pay motivates effort not thinking
Recent research suggests that one of the important limitations of performance related pay is that competitive incentives induce people to work harder but not smarter. Excessively high rewards can lead to a ‘choking under pressure’ effect, which can create inverse relationship between incentives and cognitive performance. Whilst some thrive on pressure, others react by increasing effort at the expense of performance. To shortcut the relationship between performance and reward, some may become increasingly willing to bypass controls or expose the organisation to unacceptable and hidden risks.
Fraud is easiest when the victims are faceless
Most of us find it hard to lie to someone’s face in a way that harms them. For this reason successful con artists are rare and often have a degree of sociopathy. However, the more the victim can be distanced, the easier it is to avoid feelings of guilt. That is one of the reasons why internet fraud has become so common. The move to abbreviated forms of electronic communication in the banking industry may also bring about this distancing effect. Further, a culture in some investment banks of seeing customers as ‘marks’ to be exploited and of ‘revenue at any cost’ may encourage what criminologists call ‘neutralisation strategies’ where potential victims are disparaged and described in terms that make them seem unimportant or unworthy of respect. In the case of LIBOR manipulation it may have been easy for traders to tell themselves that for every loser there was a winner, so their manipulation was morally neutral.
Given the right incentive we are very good at fooling ourselves
Any good con artist knows that they don’t need a watertight story; given the right motivation victims will fool themselves and clever people have the most brainpower to devote to their own self-deception. Similarly in banking, if you want to know why clever people sometimes seem blind, look to the incentives. In the recent financial crisis a lot of senior bankers had been noticing unusually high levels of profits in the sub-prime market, yet seemingly failed to ask,” if we are making unusual profits, what are the unusual risks that underpin those profits”. Humans are good at ignoring information that makes them feel bad and often privilege information that shows them in a good light. The same process probably underpins why some managers failed to notice the illegal activity under their noses. While the courts will judge who was complicit in the LIBOR deception, banks also need to ask themselves whether some managers may have been unconsciously complicit.
Rules and systems don’t preclude the need for effective line management
Reflecting on several years of research in investment banks we concluded that “in a combined 70 years of experience, the authors have never encountered so little management development in sophisticated organisations of vast resource” [2: 209]. Many of the issues I outline above are tractable to good line management. There are certainly some good line managers in investment banks but since the route to management is primarily through trading, management skills are variable and there is often insufficient attention paid to selecting for or training the skill-set that trader managers really need. As is common in large organisations the gap in management capability is often filled by complex rules and systems that are difficult to police; both of which may have unintended consequences.
The Wheatley review does perhaps present part of the answer, but without improvements in skilled line management and attention to the role of perverse incentives, the conditions which ensure a continuing supply of motivated offenders are likely to continue.
A version of this article was originally published by Thomson Reuters GRC. ©Thomson Reuters 2013
- „Niemand will die Magie eines Händlers zerstören“ (Handelsblatt)
- Stupid things traders say: The five most incriminating exchanges in the new Libor case (washingtonpost.com)
- RBS fined £390m for ‘widespread misconduct’ in Libor-rigging scandal (guardian.co.uk)
- The Bank at the Heart of the LIBOR Scandal (fool.com)
- COMMENT: Libor cheats to face the law, as global financial system faces up to justice (thisismoney.co.uk)
- ‘It’s just amazing how Libor fixing can make you that much money’: Traders gleefully admitted rate fixing was ‘cartel’ (independent.co.uk)
- Libor scandal: ‘This goes much, much higher than me,’ says trader Tom Hayes at centre of probe (telegraph.co.uk)