NEWS ANALYSIS : How Did It Happen? Blame Super-Traders’ Mystique


Eight months before an embarrassed Daiwa Bank Ltd. admitted this week that it had lost $1.1 billion to allegedly illicit securities trading by a single employee in its New York office, two officers of the venerable British bank Barings broke into a trader’s Singapore desk on the trail of a similar problem.

Inside they found the raw materials that the trader, Nicholas Leeson, allegedly used to perpetuate a $1-billion fraud that would soon drive the bank out of existence: scissors, paste and the cut-up remains of routine financial documents he had used to produce fake bank statements.

Just as last February’s Barings bank debacle ostensibly hinged on a laughably flagrant forgery, Daiwa Executive Vice President Toshihide Iguchi allegedly kept questions about his trading at bay by generating a long stream of faked documents.


The fact that in both cases the evidence was at hand but not closely examined shows why many financial experts say the image of the “rogue” trader single-handedly bringing down a major institution is more mythical than real. Although securities traders in today’s supercharged financial markets can deploy tens of millions of dollars of their employers’ money in a single trade, it is much harder to accumulate hundreds of millions in losses over time, unless the institution is routinely violating fundamental auditing and oversight procedures, experts say.

But until financial managers overcome their traditional awe of successful traders and exercise close oversight, such losses will continue to happen, these experts add.

Says Jack Huddleston, a Seattle-based international business consultant who ran the Tokyo offices of Chemical Bank and American Express in the 1970s and ‘80s: “If you think that just because some young, bright kid can sit there and trade like Leeson, you’re fine . . . you’re going to get killed.”

Iguchi, who worked in Daiwa’s New York branch, cost Daiwa $1.1 billion by allegedly making about 30,000 unauthorized trades in U.S. Treasury securities over 11 years. He hid his activities by falsifying account statements, according to U.S. prosecutors who spoke after his arrest Tuesday. The loss amounted to about one-seventh of the capital of the giant Osaka, Japan-based bank.

Iguchi thus became the latest in a long line of traders to cost his institution hundreds of millions of dollars. In the last 18 months alone, there was Leeson, whose increasingly frenetic trading of options and futures on exchanges in Osaka and Singapore sank Barings. There was Orange County Treasurer Robert L. Citron, who lost $1.7 billion in public funds as the county’s elected supervisors failed to question his wrong-way bet on interest rates. And there was government-securities trader Joseph Jett, who allegedly falsified hundreds of millions of dollars in trading results in order to earn himself a higher bonus at Kidder Peabody & Co., which was subsequently sold and broken up.

In each case, auditing procedures in place might have caught the trading before it mushroomed out of control. But auditors and supervisors were loath to confront a money manager who was regarded as being on a money-making roll.


“If a mystique grows around a super-trader, management will close its eyes,” says Michael Ong, manager of the market risk analysis unit at First Chicago Bank. “If you can generate a lot of money as a trader, you will be put on a high pedestal.”

Although all the details of the Daiwa case have not yet emerged, it appears that the bank violated a cardinal rule of thumb aimed at protecting institutions from traders who can move tens of millions of dollars in a single trade: Keep the trading and auditing responsibilities separate.

Until late 1993, Iguchi was responsible for overseeing the documentary settlement of his own trades and those of others at Daiwa’s New York branch. Similar joint authority had been vested in Leeson by Barings; in both cases, the traders were essentially reporting to themselves. Indeed, it was only after his duties were cut back, leaving him only with trading responsibilities, that Iguchi’s pursuit began to unravel and he was forced to confess to bank executives, authorities say.

It is not only the traders’ individual mystique that results in their getting the leeway to rack up damaging losses; it is also the mystique of the trading floor.

Senior executives in many institutions treat trading as an operational stepchild whose rules and practices are necessarily arcane. In fact, say risk management experts, that makes it more important, not less, for managers to have an overall understanding of what goes on in their banks.

“No way in the world could anyone get away with five unauthorized trades--let alone 30,000--without a lot of people in the bank not understanding the big picture,” says Tim Scala, a business consultant who runs seminars aimed at teaching trading principles to non-traders in bank management.


For all that, many of the historic losses registered by unauthorized trading over the last few years have been in financial instruments that are relatively simple.

True, Orange County’s Citron lost his billions in esoteric financing deals and hard-to-sell derivatives, but Leeson lost his in exchange-traded futures and options, the basic building blocks of modern financial markets.

Their losses ran out of control in part because of external factors--in Citron’s case, the record-breaking 1994 rise in interest rates; in Leeson’s, the 1995 Kobe earthquake, which by depressing the Japanese stock market, multiplied his options losses.

Iguchi’s and Jett’s trading, however, involved U.S. Treasury securities, perhaps the safest, most heavily traded and best-understood securities in the world.

In all cases, Scala argues, the traders generated reams of paper records that would have exposed their alleged schemes to anyone who took the time to look.

“The real message here,” he said of the Daiwa case, “is that this is not a market event. It’s not the Kobe earthquake or the backup in interest rates. It’s forgery.”



Times staff writer Evelyn Iritani contributed to this report.