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Rogue Trading at Lloyds Bank International, 1974: Operational Risk in Volatile Markets

Abstract

Rogue trading has been a persistent feature of international financial markets over the past thirty years, but there is remarkably little historical treatment of this phenomenon. To begin to fill this gap, evidence from company and official archives is used to expose the anatomy of a rogue trading scandal at Lloyds Bank International in 1974. The rush to internationalize, the conflict between rules and norms, and the failure of internal and external checks all contributed to the largest single loss of any British bank to that time. The analysis highlights the dangers of inconsistent norms and rules even when personal financial gain is not the main motive for fraud, and shows the important links between operational and market risk. This scandal had an important role in alerting the Bank of England and U.K. Treasury to gaps in prudential supervision at the end of the Bretton Woods pegged exchange-rate system.

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References
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1 There is a large historical literature on corporate fraud, including Markham Jerry, A Financial History of Modern U.S. Corporate Scandals: From Enron to Reform (Abingdon, U.K., 2006); and Sama David, History of Greed: Financial Fraud from Tulip Mania to Bernie Madoff (Hoboken, N.J., 2010). These accounts rely mainly on newspapers, interviews, or court cases, and not on internal archival evidence, although there are exceptions for earlier periods, such as Taylor James, Boardroom Scandal: The Criminalization of Company Fraud in Nineteenth-Century Britain (Oxford, 2013); and Hollow Matthew, Rogue Banking: A History of Financial Fraud in Interwar Britain (London, 2015). But little historical literature specifically addresses rogue trading. Autobiographies of rogue traders include Iguchi Toshihide, My Billion Dollar Education: Inside the Mind of a Rogue Trader (Tokyo, 2014); Bullen David, Fake: My Life as a Rogue Trader (London, 2004); Leeson Nick and Whitley Edward, Rogue Trader (London, 1996); and Kerviel Jérôme, L'engrenage: Memoires d'un trader (Paris, 2016).

2 On the definition of rogue trading, see Cruz Marcelo G., Peters Gareth W., and Shevchenko Pavel V., Fundamental Aspects of Operational Risk and Insurance Analytics: A Handbook of Operational Risk (London, 2015); and Krawiec Kimberly D., “Accounting for Greed: Unravelling the Rogue Trader Mystery, Oregon Law Review 79, no. 2 (2000): 301–38. For a sociological approach, see Greener Ian, “Nick Leeson and the Collapse of Barings Bank: Socio-Technical Networks and the ‘Rogue Trader,’ Organization 13, no. 3 (2006): 421–41.

3 Wexler Mark N., “Financial Edgework and the Persistence of Rogue Traders, Business and Society Review 115, no. 1 (2010): 125 .

4 Langevoort Donald C., “Monitoring: The Behavioural Economics of Corporate Compliance with Law, Columbia Business Law Review 2002, no. 1 (2002): 71118 .

5 Coates John, The Hour between Dog and Wolf: Risk-Taking, Gut Feelings, and the Biology of Boom and Bust (New York, 2012); Herbert Joe, Testosterone: Sex, Power, and the Will to Win (Oxford, 2015).

6 Philip Clarke, Sunday Times, 8 Sept. 1974. Susan Strange noted the high appetite for risk in financial markets in the 1970s, Casino Capitalism (London, 1986).

7 Barberis Nicholas and Thaler Richard, “A Survey of Behavioral Finance,” in Handbook of the Economics of Finance, ed. Constantinides George M., Harris M., and Stulz René (Amsterdam, 2003), 1052–121; Drummond Helga and Hodgson Julia, Escalation in Decision-Making: Behavioural Economics in Business (Farnham, U.K., 2011).

8 Capie Forrest, The Bank of England: 1950s to 1979 (Cambridge, U.K., 2010). There are two early histories of Lloyds Bank: Sayers R. S., Lloyds Bank in the History of English Banking (Oxford, 1957); and Winton J. R., Lloyds Bank, 1918–1969 (Oxford, 1982).

9 William M. Clarke, “Lloyds Bank Europe: A Report,” Oct. 1969, HO/Ch/Fau/20, Lloyds Banking Group Archives, London (hereafter LGA).

10 Ibid.

11 Ibid.

12 E. S. Tibbetts to E. O. Faulkner (chairman of Lloyds Bank Ltd.), 3 Nov. 1969, HO/Ch/Fau/20, LGA.

13 M. R. Luthert for Chairman's Committee, “Lugano Branch – Recommendation for Closure,” 13 Apr. 1977, F/1/SS/Pre/2, LGA.

14 Gary Burn, The Re-emergence of Global Finance (London, 2006).

15 Robert Gras (manager of foreign exchange at LBI), testimony, 18 Sept. 1974, London, HO/Gr/Off/2, LGA.

16 Sir Reginald Verdon-Smith (chairman of LBI) to all heads of divisions and departments in London, overseas chief managers, branch managers, and representatives, 19 Sept. 1974, F/1/SS/Pre/2, LGA.

17 Marc Colombo, testimony before public prosecutor for the jurisdiction of Sottocenerina, 6 Sept. 1974, Lugano, HO/Gr/Off/2, LGA. Contemporary translation from the archive.

18 Colombo, testimony, 24 Oct. 1974, Lugano, HO/Gr/Off/2, LGA.

19 Ibid.

20 Francis Paveley (LBI London), testimony at a hearing at Lugano Court, 7 May 1975, HO/Gr/Off/2, LGA.

21 Colombo, testimony, 6 Sept. 1974, LGA.

22 Marc Colombo, “Methods Used in the Foreign Exchange Business to Conceal Exchange Positions or Losses,” written testimony, 29 Oct. 1974, Lugano, HO/Gr/Off/2, LGA.

23 Ibid.

24 Ibid.

25 As the deals matured, London arranged a series of transactions to unwind them. N. S. Lister to R. J. R. Gras, memo, 7 Mar. 1975, F/1/SS/Pre/2, LGA.

26 Egidio Mombelli, statement to Police of the Ticino Canton, 5 Sept. 1974, Lugano, HO/Gr/Off/2, LGA.

27 Colombo, “Methods Used” statement, 29 Oct. 1974, LGA.

28 Mombelli, statement to police, 5 Sept. 1974, LGA.

29 Verdon-Smith to all Heads of Divisions and Departments, 19 Sept. 1974, LGA.

30 D. A. Ferguson to LBI board, memo, 20 Sept. 1974, F/1/SS/Pre/2, LGA.

31 LBI board, minutes, 24 Sept. 1974, F/1/D/Boa/1.1, LGA.

32 Ibid. The Rule Book was written under the direction of LBI director Francis Paveley.

33 Egidio Mombelli, testimony, 9 May 1975, Lugano, HO/Gr/Off/2, LGA.

34 Chairman's Committee, minutes, 17 Sept. 1974, F/1/SS/Pre/2, LGA.

35 Mombelli, testimony, 9 May 1975, LGA.

36 Egidio Mombelli, testimony before investigating magistrate, 13 Nov. 1974, Lugano, HO/Gr/Off/2, LGA.

37 Court hearing, 7 May 1975, Lugano, HO/Gr/Off/2, LGA.

38 Dario Clericotti (advocate, Lugano) to Erich Whitle (director, LBI), 19 Nov. 1974, HO/Gr/Off/2, LGA.

39 Mombelli, testimony before investigating magistrate, 14 Feb. 1975, Lugano, HO/Gr/Off/2, LGA.

40 Francis Paveley, testimony at court hearing, 7 May 1975, Lugano, HO/Gr/Off/2, LGA.

41 Colombo, “Methods Used” statement, 29 Oct. 1974, LGA.

42 Chief Inspector to Vice Chairman's Committee, “Inspection of Swiss Branches – August/November 1974,” 2 Jan. 1975, F/1/SS/Pre/2, LGA.

43 Ibid.

44 Ibid.

45 Hans-Ulrich Doerig, “Operational Risks in Financial Services: An Old Challenge in a New Environment,” Credit Suisse Group, London, 2000, http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.28.2951&rep=rep1&type=pdf.

46 Chief Inspector, “Inspection of Swiss Branches – August/November 1974,” report to Vice Chairman's Committee 2 Jan. 1975. F/1/SS/Pre/2 LGA.

47 Ibid.

48 “Suspended terms for 2 in Lloyds case,” New York Times, 31 Oct. 1975.

49 Vice Chairman's Committee, draft minutes, 18 Oct. 1974, F/1/SS/Pre/2, LGA.

50 Ibid.

51 LBI board, minutes, 28 Aug. 1974, F/1/D/Boa/1.1, LGA.

52 Vice Chairman's Committee, minutes, 5 Sept. 1974, F/1/SS/Pre/2, LGA.

53 LBI board, minutes, 24 Sept. 1974, F/1/D/Boa/1.1, LGA.

54 LBI board, minutes, 17 Dec. 1974, F/1/D/Boa/1.1, LGA.

55 D. G. Mitchell (CEO, LBI) to R. B. Hobson (secretary, head office), 11 Nov. 1975, F/1/SS/Pre/2, LGA.

56 LBI Exchange and Money Market Policy, 10 Feb. 1975, HO/CH/Fau/30, LGA.

57 Ibid.

58 Lugano Branch balance sheet, F/1/SS/Pre/2, LGA.

59 LBI board, minutes, 10 Aug. 1976, F/1/D/Boa/1.2, LGA.

60 Ibid.

61 M. R. Luthert, “Lugano Branch – Recommendation for Closure,” 13 Apr. 1977, 9034, LGA; LBI board, minutes, 19 Apr. 1977, F/1/D/Boa/1.2, LGA.

62 Douglas Wass to Lawrence Airey (financial secretary), memo, 12 Aug. 1974, T233/2942, The National Archives, London (hereafter TNA).

63 Derek Mitchell, memo, 22 Aug. 1974, T233/2942, TNA.

64 Derek Mitchell to Postmaster General, note on a lunch with Hollom, 23 Aug. 1974, T233/2942, TNA.

65 S. A. Robson (Chancellor of Exchequer's office) to Private Secretary to Financial Secretary, 29 Aug. 1974, T233/2942, TNA.

66 Derek Mitchell, note, 28 Aug. 1974, T233/2942, TNA.

67 John L. Sangster to Sir Kit McMahon, memo, 19 Sept. 1974, 349A/2, Bank of England Archive (hereafter BoE). See also Schenk Catherine R., “Summer in the City: Banking Scandals of 1974 and the Development of International Banking Supervision, English Historical Review 129, no. 540 (2014): 1129–56.

68 Richard Hallett to Governor of Bank of England Gordon Richardson, memo, 5 Sept. 1974, 349A/2, BoE.

69 Ibid.

70 Meanwhile, on October 15, 1974, the Banque de Bruxelles announced losses through irregularities in its foreign-exchange office amounting to about 1 to 2.5 million Belgian francs from unauthorized trading. For other scandals, see Schenk, “Summer in the City.”

71 Governor to Chairmen of British banks, draft letter, 25 Oct. 1974, 349A/2, BoE. The main points of the letter are detailed in Schenk, “Summer in the City.”

72 George Blunden to John Fforde and Sir Kit McMahon, note (not expressing his own views), 29 Oct. 1974, 349A/2, BoE.  The chief cashier, John Page, was opposed to the letter's tone and wished it to be “exhortatory.” Blunden to McMahon and Fforde, note, 6 Nov. 1974, 349A/2, BoE.

73 Roy Fenton to Blunden, note, 30 Oct. 1974, 349A/2, BoE.

74 Richard Hallett to Blunden, 4 Nov. 1974, 349A/2, BoE.

75 Blunden to Fforde, 18 Nov. 1974, 349A/2, BoE.

76 Schenk Catherine R., “The New City and the State, 1959–1971,” in The British Government and the City of London in the Twentieth Century, ed. Michie Ranald and Williamson Philip (Cambridge, U.K., 2004).

This research was supported by ESRC ES/H026029/1 with the assistance of Dr. Emmanuel Mourlon-Druol and Humanities in the European Research Area HERA.15.025, Uses of the Past in International Economic History.

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