The Financial Services Authority (FSA) has fined UBS AG (UBS) £29.7 million (discounted from £42.4 million for early settlement) for systems and controls failings that allowed an employee to cause substantial losses totalling US$2.3 billion as a result of unauthorised trading. The trader, Kweku Adoboli, has been convicted of two counts of fraud by abuse of position and sentenced to seven years’ imprisonment. The systems and controls failings revealed serious weaknesses in the firm’s procedures, management systems and internal controls.
On 14 September 2011 UBS became aware that unauthorised trading had been carried out between 1 June 2011 and 14 September 2011 (the Relevant Period) on the Exchange Traded Funds Desk (the Desk) in the Global Synthetic Equities (GSE) trading division conducted from the London Branch of UBS.
The losses were incurred primarily on exchange traded index future positions. The underlying positions were disguised by the use of late bookings of real trades, booking fictitious trades to internal accounts and the use of fictitious deferred settlement trades.
During the Relevant Period, there was insufficient focus on the key risks associated with unauthorised trading within the GSE business conducted from the London Branch. The significant control breakdowns allowed the trading to remain undetected for an extended period of time.
The FSA believes that UBS failed to take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems and failed to conduct its business from the London Branch with due skill, care and diligence.
In particular UBS' failings included:
- The computerised system operated by UBS to assist in risk management was not effective in controlling the risk of unauthorised trading.
- The trade capture and processing system had significant deficiencies, which Adoboli exploited in order to conceal his unauthorised trading. The system allowed trades to be booked to an internal counterparty without sufficient details, there were no effective methods in place to detect trades at material off-market prices and there was a lack of integration between systems.
- There was an understanding amongst personnel supporting the Desk that the Operations Division's main role was that of facilitation. Their main focus was on efficiency as opposed to risk control and they did not adequately challenge the Front Office.
- There was inadequate front office supervision. The supervision arrangements within GSE were poorly executed and ineffective.
- The Desk breached the risk limits set for their desk without being disciplined for doing so. These limits represented a key control and defined the maximum level of risk that the Desk could enter into at a given time. This created a situation in which risk taking was not actively discouraged or penalised by those with supervisory responsibility.
- Failing to investigate the underlying reasons for the substantial increase in profitability of the Desk despite the fact that this could not be explained by reference to the end of day risk positions.
- Profit and loss suspensions to the value of $1.6 billion were requested by Adoboli during the course of August 2011. Prior to 18 August 2011, these were accepted without challenge or escalation. The combined factors of unexplained profitability and loss suspensions should have indicated the need for greater scrutiny.
These failings are particularly serious because:
- Market confidence was put at risk, given the sudden announcement to the market and size of the losses announced. Negative announcements, such as this, put at risk the confidence which investors have in financial markets.
- The systems and controls failings revealed serious weaknesses in the firm's procedures, management systems and internal controls.
- The failings enabled Adoboli to commit financial crime.
Tracey McDermott, director of enforcement and financial crime, said:
"UBS's systems and controls were seriously defective. UBS failed to question the increasing revenue of the desk and failed to ensure that there was a corresponding increase in the controls in place over the desk. As a result Adoboli, a relatively junior trader, was allowed to take vast and risky market positions, and UBS failed to manage the risks around that properly. We know from past experience that failures to manage risk properly can cause firms to fail and cause systemic harm.
"Failures of this type in firms of the size and standing of UBS not only damage the firms concerned but also wider confidence in the integrity of the markets and the financial system. It is imperative that the markets we regulate are seen by investors to be orderly and a safe place to do business.
"This penalty - fixed at 15% of the revenue of the GSE trading division - is intended to make it clear that the FSA expects much higher standards from the firms we regulate."
In setting the level of the penalty, the FSA took into account the revenue generated by the business area where the poor controls occurred.
It also took into account the fact that in November 2009 UBS was fined £8 million for failings in relation to the systems and controls around the international wealth management business conducted with non-UK resident clients in the London branch of UBS. The FSA expects firms to consider whether the issues identified in an enforcement action are applicable to other business areas and whether remedial action is necessary, UBS failed to do this.
UBS agreed to settle at an early stage and therefore qualified for a 30% discount under the FSA's executive settlement procedures. Were it not for this discount, the fine would have been £42.4 million.
UBS agreed to engage an independent firm to conduct a substantive investigation into the unauthorised trading incident, expending considerable resources (approximately £16 million to date) in doing so. UBS's new senior management has committed significant resources to undertake an extensive programme of remediation.
UBS has taken disciplinary action against employees who were involved in the events which gave rise to these breaches, including clawing back bonuses and withholding 50% of their deferred compensation from relevant individuals totalling more than £34 million.
The FSA conducted its investigation in coordination with the Swiss Financial Market Supervisory Authority (FINMA) which has also made its findings public. FINMA has also taken action against UBS in relation to the breach which is the subject of this Notice and UBS has undertaken to comply with the separate requirements imposed on it by FINMA.
Notes for editors
- The Final Notice for UBS AG.
- UBS breached FSA Principles 2 (due skill, care and diligence) and 3 (risk management systems and controls) of the FSA's Principles for Businesses.
- Adoboli used the following strategies to conceal the unauthorised trading in the trade capture systems:
a. The booking of unmatched trades to internal counterparties: the Front Office risk system allowed internal futures trades to be booked to a generic counter party of 'internal' and did not require an automatic mirror trade or identification of the particular internal counterparty.
b. The late booking of trades: genuine external futures trades were booked into the futures settlement system but were late in being booked into the Front Office risk system which allowed manipulation of the profit and loss.
c. The use of false ETF trades, including false ETF trades with a deferred settlement date, false trades at off market prices and amendments to the prices of ETFs. There was no automatic filter in the trade input systems which identified off market or large notional transactions and the amendment of a price in the Front Office risk system did not alter the price in the Front Office deal capture system.
- The Final Notice relating to the fine imposed on UBS in 2009 for systems and control failures can be found on the FSA website.
- Exchange Traded Funds (ETFs) are a type of investment fund traded on stock exchanges.
- As a result of an incident of rogue trading at Societe Generale, on 11 March 2008, the FSA published issue 25 of its Market Watch Newsletter ('Market Watch') in which it highlighted the measures a firm should consider when reviewing the systems and controls which protect them against 'rogue trader' risks. Market Watch considered: Front Office culture and governance, trading mandates and limits, culture and challenge within the control functions and risk management and limits.
- The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; securing the appropriate degree of protection for consumers; fighting financial crime; and contributing to the protection and enhancement of the stability of the UK financial system.
- The FSA will be replaced by the Financial Conduct Authority and Prudential Regulation Authority in 2013. The Financial Services Bill currently undergoing parliamentary scrutiny is expected to receive Royal Assent in late 2012 or early 2013, subject to the parliamentary timetable.