Hold the algorithms! Fraud risk is high!

Hold the algorithms! Fraud risk is high!

Nicolas Corry, Managing Director, nicolas.corry@skadilimited.co

It sounds somewhat cliched to say that banks are undergoing significant change, nevertheless we are told that HSBC is considering its UK position, Deutsche Bank is undergoing reorganisation, Mizuho has purchased a $3bn loan portfolio from RBS and taken on board 130 US staff. Standard Chartered is experiencing a significant number of managerial departures within its Middle East Franchise. Meanwhile JP Morgan has caught headlines by revealing it is introducing an algorithm which can anticipate rogue employees.

Whether an algorithm can detect rogue trader fraud risk remains to be seen. One observation is that while the JP Morgan development is eye catching, it may have the effect of reducing vigilance, as control staff presume that they can rely on the effectiveness of the new tool.

Having analysed the three significant rogue trading episodes of the past 20 years, namely Barings, Soc Gen and UBS we have identified red flags which equip auditors well when approaching a business. Setting aside the corrupt nature of the individuals, which is hard for auditors to anticipate, all of the episodes had features in common which were a result of the organisational setups they found themselves in. These features had the effect of providing the opportunity for the frauds. This was the nurture combing with the individuals’ corrupt nature.

These include management vacuum, businesses in transition, lack of operational challenge as control staff take on unfamiliar businesses. Our advice is that when auditors approach a business with one or more of the above, they should be on their guard, as these conditions provided the opportunity for Messrs Leeson, Adoboli and Kerviel. No algorithms, no eye catching headlines, just prudent analysis and common sense.