Segregation of duties, and why it exists

Graduate · enrolled learners

This lesson opens with UBS and Kweku Adoboli, 2011.

What happened

Kweku Adoboli was a trader on UBS's exchange traded funds desk in London who had started at the bank as an operations analyst in the back office, the part of the firm that confirms, settles, and records trades, before becoming a trader. From the desk he ran unauthorized positions, mainly in exchange-traded index futures, and the UK regulator found he hid them with offsetting trades that had no economic reality: unmatched trades booked to a generic internal counterparty, real trades booked late into the risk system, and false ETF trades with deferred settlement dates and no external counterparty. His book looked balanced and the real risk stayed off the reports until UBS discovered it on 14 September 2011 and closed the positions, at a loss of 2.3 billion dollars. The bank's reconciliations did flag breaks from the desk, but the operations staff saw their role as facilitating the desk and accepted the trader's explanations. His back-office experience was the key: he knew how trades were verified and recorded, so he knew how to make an unreal trade look real to the systems that were supposed to catch it. The controls existed, but they relied on the trading side and the verification side being genuinely separate, and Adoboli understood both sides well enough to make them agree with a lie. The loss was not that one control was missing; it was that one person effectively spanned the trade and its verification, and a person who controls both can hide anything.

The decision point

Segregation of duties, keeping the people who trade separate from the people who confirm, settle, and record those trades, exists precisely because anyone who controls both the trade and its verification can make a fake trade look real, so it is a structural control and not a bureaucratic formality, and its erosion is how hidden positions survive. UBS and Adoboli are the case: a trader who had come from the back office, and who therefore understood how trades were verified and recorded, hid unauthorized positions with fictitious hedges, late bookings and deferred-settlement trades with no real counterparty, and the bank lost about 2.3 billion dollars because the trade and its verification were not, in effect, in different hands. The principle is old and simple: the person who does a thing must not also be the person who checks it, because if they are, the check is worthless, it will always agree with them. In trading, that means the desk that enters a trade must not control the function that confirms it exists with the counterparty and records it, so that a trade the desk invents cannot pass the check. Adoboli did not defeat a strong control; he stood, through his knowledge and access, on both sides of the check, and a check with the same person on both sides confirms whatever that person wants. So the discipline is to treat segregation of duties as load-bearing, to ensure genuine independence between trading and its verification in fact and not just on an org chart, and to be especially alert where someone has the knowledge or access to span both, because the moment the doer and the checker are the same, the most important control a trading operation has quietly stops working, and UBS is what that costs.

Recorded loss

$2,300,000,000

Orientation and Year One are open: anyone can read them without an account. From Year Two onward the lessons are for enrolled learners, because progress through the later years only means anything if it is tracked against a record.

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