I have often thought that the FX trader dismissals, indeed the entire chatroom related scandal in FX, would make a great case study for business management schools. Over the years I have argued there have been weak, misguided, vindictive, panicky and ill-informed decisions made at management level across a range of organisations that has resulted in untold collateral damage – much of which has been fixed after going through the legal system. If that is the case, then I am afraid that Wells Fargo could become the case study to look at in demonstrating how not to run an FX business.
This week, an unfair dismissal claim made by John Guenther, Wells Fargo’s former head of large corporate FX sales, was moved from a local court to the North Carolina District Court for jury hearing. Guenther is not the only person suing Wells Fargo, former head of FX trading Simon Fowler and former FX spot trader Mike Schaufler are also conducting legal actions, in their cases in California.
I know I am a former trader and therefore naturally have some sympathy in that direction, but reading the court documents again, it is hard to see what the trading desk did wrong – in fact what they highlight to me is how the bank wanted to avoid market risk as much as possible and make their profit via a sales mark up only (which loops nicely back to the recent theme of this column, the “broker” model). The transaction was to sell $4 billion USD/CAD related to the Burger King takeover of Tim Hortons and according to the documents an “at worst” price was agreed with the customer on the understanding that any improvement would be split 50-50.
I have suggested this approach before in these columns when discussing other contentious orders and have normally been on the end of a stream of messages telling me it’s not the way it should be done, mainly because the bank is at risk of the market moving against them, beyond the “at worst” level and they lose money. My first response is always, “why should they be afraid of losing money?”, after all the “at worst” price reflects their view of the market and as such, barring unforeseen circumstances, the execution is likely to reflect that price. There may be an incentive for the bank to put a wider “at worst” price on it, but even then the customer will benefit to a degree, from the improvement.
Over the course of a year I would imagine that the balance of these types of deal results in a better than expected outcome on the execution, so what if one goes slightly wrong?
I accept that, as the court documents state, this was the largest FX trade ever handled by Wells Fargo and as such there may have been a reluctance to use this model, but notwithstanding that, the bank did offer that deal to the client, who accepted it, and it went off OK. The documents state that the trading desk made a profit of just shy of $1.5 million on the trade, which was then passed to the sales desk for distribution to the client as agreed.
The waters are muddied a little by the fact that the total revenue to the bank was in the $7 million range thanks to it being an outright transaction – and the spot dealer in me cannot help but note the rather large skew to the forwards desk in that figure! – but generally speaking, as far as the spot desk was concerned, everything was ticked off. It seems as though everyone else involved in the deal agreed, for there were no criticisms of the deal internally or externally.
A rather large wrench was thrown in the works, however, when it was revealed that the US authorities were investigating the deal. Wells Fargo was already dealing with a scandal in its broader business over client charges, this was probably the last thing it needed and so, it seems to an outsider, it took a scorched earth policy to its FX business, firing the three aforementioned men as well as Bob Gotelli, head of FX sales. It reminds me a little of Barclays’ approach to former head of e-trading there David Fotheringhame, who was fired basically because the regulator wanted it done – he won an unfair dismissal claim in the UK, it will be interesting to see how the US legal system sees it. As far as can be judged, the bank has yet to, two years on, actually tell the sacked personnel exactly what conduct rule they broke.
That is the background then to what shapes as another messy process involving a bank and its former FX staff – the traders are arguing they did nothing wrong, Guenther that he explicitly removed himself from the deal because it was being handled by the San Francisco desk when he was in North Carolina.
Clearly something has tweaked the attention of the authorities and perhaps Wells Fargo’s own internal compliance and audit function, but the key to this issue clearly seems to me to be about the mark up – and that’s where I think the modern day FX business model is yet again putting people at risk and where Wells Fargo is most vulnerable.
Wells Fargo’s FX sales staff were on a different incentive scheme to the traders at the time of the deal, the former being paid according to actual revenue they achieved from client deals. It is argued by one of the plaintiffs – Fowles – that this incentivises bad behaviour because staff will see to squeeze as much revenue out of a deal as possible, to the extent they may consider crossing the line of acceptability. I have to confess it used to drive me crazy back in my trading days when my desk was given a client order to execute, did a good job and then had the client complain about the rate because of the sales desk’s mark up. Given we traders knew nothing about how that mark up was achieved, we merely passed on the rate for the deal, it was incredibly frustrating having to join a client call where the skill of me, or one of my traders, was called into question when in fact they had done a good job. That is what such an incentive scheme breeds – it works towards the model that says, “let’s get as much customer business in the door, make a turn on it all, and ignore what markets are doing”.
By that last statement of course, I am referring to the unwillingness of a bank to take a risk and the obsession with making a turn out of every deal – the “broker” model. To be fair, I ought to reiterate that this was the largest deal in Wells Fargo history and so this may have caused some qualms in terms of taking the risk on, but if the trading desk had quoted a few pips inside the “at worst” price they could have taken on the risk, executed out of it skilfully (which they appeared to do) and get rewarded that way.
Unfortunately this leaves the sales desk with what? If there is a pre-agreed mark up that would have been put in the rate, therefore it is hard to avoid the suspicion that this “at worst” method, even with the split, presented a better opportunity to squeeze a few more dollars out of the trade.
The court documents state that Wells Fargo had a “low” risk tolerance and therefore was unlikely to allow the trading desk to assume the risk, although for the life of me, in USD/CAD especially, I don’t know why. One unspoken risk is that the client could have been speaking to other banks about the trade and there is the risk that someone reveals too much and word of the deal gets out – this unintended signalling risk is more pertinent than it may seem, just look at how Hewlett Packard apparently shared details of its Cable trade with Barclays. The details of that customer’s conduct, as revealed in the dismissal of charges against former Barclays FX trader Rob Bogucki, highlight that particular risk and also, into the bargain reiterate why people want the buy side to sign up to the FX Global Code.
No doubt the details of what occurred will come out in these impending court cases, unless, as was the case with John Banerjee’s case against RBC, the bank suddenly, and for no reason, folds and pays out just before the hearing, but it is hard to escape the sense that somewhere there will be an inappropriate mark up that is the direct result of the culture at the bank that promoted sales mark ups over trading profits. There has been so much focus on traders sharing information, and I still don’t get why they would want to do that, that we seem to forget what happens on many sales desks. Banks seem obsessed with ensuring their trading desks don’t make too much money out of client flow by holding the risk for some time, but they seem content to allow the sales desk to include a fee in the spread. In the first case there is a real risk being taken by the trading desk, in the other the mark up compensates for what? Passing on details of someone else’s work? I donlt know about you, but I know which method of making money seems the least fair.
To go back to the Wells Fargo cases, if indeed it is the case that an inappropriate mark up has been included at some stage (and we don’t know it has of course) then one has to wonder why two traders, on a different compensation scheme, were summarily fired for their actions? I have written too often for anyone’s liking about how banks have treated their traders over the past few years, this seems to be the latest example. We cannot prejudge the outcome of these latest cases and it may be proved that there was misconduct by those suing for wrongful dismissal, but it is hard not to think that the root cause of the problem was the culture and structure of the FX business at the bank – and that is what the industry needs to think about. We need to move away from the fee-generating business and back into the more traditional role of risk taker, otherwise I am afraid we will inevitably see more of these cases.