Next rogue trader could hit banks anytime

By Jim Finkle - Analysis

BOSTON (Reuters) - Forget complex computer software, psychological testing or even morality: Rogue traders can strike anytime, anywhere.

"All of the things that make a great trader make a great fraudster too," says Mark Rasch, a consultant with FTI Consulting who previously ran the U.S. Justice Department's computer crimes unit.

Even the regulator who helped calm U.S. financial markets after the 9/11 attacks worries about the terror a lone trader might wreak on the world's biggest banks and security houses.

"There are no foolproof systems," says Harvey Pitt, who was chairman of the U.S. Securities and Exchange Commission in 2001-2002. "You always worry about the possibility of rogue traders."

There's reason to worry: bankers, regulators and investors are shocked at how a mid-level employee's unauthorized stock trading led to a $7.2 billion loss at French bank Societe Generale and sent European markets into a tailspin.

It's impossible to root out all potential troublemakers, say former regulators and risk management consultants. But banks can take preventive steps. These include regular reviews of credit files and other easily accessible reports, such as real estate purchases or even divorce papers.

"It ought to include a whole variety of checks -- even if somebody has (previously) passed whatever kinds of reviews," Pitt says.

Many frauds require constant attention by the perpetrators so they can maintain the appearance that nothing unusual is going on. That is why the banks with the best controls require employees to take one or two full weeks off per year where they have no contact with the office. Auditors have a chance of identifying long-term fraud if the perpetrator is not around to cover it up.

The SocGen trader, Jerome Kerviel, hardly took any time off.

There are also measures that do not work. Many experts agree that includes psychological testing, because rogue traders often share a mathematical genius with brilliant money makers, and the tests can be overly intrusive and demoralizing.

It's impossible to identify the very best criminals because they are so good at hiding what they do, says Louise Borke, a former State Street Corp risk management executive who now teaches banks how to spot fraud.

Moreover, given the right circumstances, nine out of 10 employees might commit fraud at some point in their careers, Borke says. Factors that boost the chances include pressure to succeed on the job, financial problems, and gambling and drug addictions.

"The same person might be at risk for fraud in different environments and at different times in their lives," Borke added.

If routine reviews turn up red flags, the bank can follow up with whatever measure seems appropriate: from more thorough trading oversight to a full investigation.

Full-scale probes costs more than $100,000, so they are reserved for cases where it is almost certain there is something going on. That is when computer experts are called in to examine the suspect's PC and Blackberry, and dig up evidence.