David Zeiler: A rogue trader at UBS AG (NYSE:UBS) lost $2 billion on a series of unauthorized transactions, the bank disclosed yesterday (Thursday) despite  internal risk controls designed to prevent such activity.

An employee of the London UBS desk that trades exchange-traded funds (ETFs), 31-year-old Kweku Adoboli, was arrested yesterday  on suspicion of fraud.

“This is a frightening level of wrongdoing in a bank that  was held up as the world class example of good risk management before the [2008  financial] crisis,” Chris Roebuck, a former UBS employee and a current visiting  professor at Cass Business School, wrote in on efinancialnews.com.

The company’s stock fell 11% on the news.

UBS warned that its third quarter probably would be  unprofitable, although analysts say the bank – Switzerland’s largest – should  be able to absorb the loss. Previously UBS had forecast a profit of $1.5  billion for the third quarter.

The UBS rogue trader revelation is just the latest blow to  its finances and its reputation. From 2006 through 2009, the UBS investment  bank division recorded $65 billion in losses, from which the bank had only  recently recovered.

“How many times do we have to see huge UBS losses?” Simon  Maughan, head of sales and distribution at MF Global Ltd. in London told Businessweek.  “It looks unreformed, unwieldy and ultimately unsustainable. This could be a  critical tipping point for UBS’s strategy.”

Some speculated that the incident could tarnish other UBS  divisions.

“The key area of damage in our view is reputational and extends beyond the  investment bank, into UBS’s private banking business,” Goldman Sachs (NYSE:GS) said in a note to clients.

Rogues Gallery

The incident also brought to mind other rogue traders of the  past two decades, including Jerome Kerviel, who cost French bank Societe Generale  (PINK:SCGLY) $6.7  billion in 2008, and Nick Leeson, whose $1.8 billion in losses in 1995 brought  down the British Barings  Bank PLC.

With so many previous examples serving as a warning, not to  mention its own recent history of trouble, many wondered how such a thing could  have happened at UBS.

“No rogue trader works in a vacuum, and UBS’s  management must have taken its eye off the ball to allow a trader to operate on  this scale without sufficient supervision and without the systems to monitor  his trades,” Simon Morris, a partner at UK law firm CMS Cameron McKenna  told Reuters.

Consequences of the UBS rogue trader could extend well  beyond its impact on that bank.

By coincidence, the Swiss parliament had scheduled a debate  on the country’s banking industry with an eye toward more regulation, and  possibly forcing the two largest banks – UBS and Credit Suisse Group AG (NYSE:CS) to split off  their investment arms to avoid a total collapse of the financial institutions.

Swiss lawmakers also are considering changes that would  increase capital requirements for both big banks to 19% of assets.

It’s in Their DNA

That such incidents continue to happen raises questions  about whether anything can be done to prevent them.

When Societe Generale’s Kerviel was in the news, Money  Morning Chief Investment Strategist Keith Fitz-Gerald predicted more  regulation would not deter rogue traders in the future.

“Despite the fact that the world is now clamoring for more  oversight and controls, we suggest that no amount of regulation will help,”  Fitz-Gerald wrote.

For their part most of the rogue traders appear to believe  they’re simply doing what is expected of them – earning profits for their  company.

“I thought it was incredible that no one came to talk  to me about this,” Kerviel  told a court-appointed psychologist at the time. “My positions made money,  so I told myself that it legitimized what I was doing.”

With pressure to juice profits creating such overwhelming  incentives to break rules both internal and external, the UBS rogue trader  really should have surprised no one.

“Clever traders will always find ways to game the system,”  Fitz-Gerald observed. “Their supervisors will unwittingly encourage this  behavior by maintaining the outrageous bonus structures and payouts for which  Wall Street is now synonymous.”

Related: Financial Select Sector SPDR ETF (NYSE:XLF)

Written By David Zeiler From Money Morning

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