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Fraud and the family business – why it’s less likely

And so it’s happened again. This time it’s Swiss bank UBS that is having to swallow its pride and explain just how a rogue trader was able to lose $2 billion, and even worse, how it only found out when the trader himself confessed.

And so it’s happened again. This time it’s Swiss bank UBS that is having to swallow its pride and explain just how a rogue trader was able to lose $2 billion, and even worse, how it only found out when the trader himself confessed. Kweku Adoboli joins the rogues’ gallery that includes Nick Leeson, Jerome Kerviel and Yasuo Hamanaka.

Why does this keep happening? Clearly there is a failure of oversight at banks. But that’s not the whole story. There will always be a way to evade capture; there are always loopholes.
The real failure is one of ethics. It’s not enough to make rules. Coercion alone is not enough to make people obey the rules. The trick is to make people want to obey the rules. But how do you do that?

In the 70s the political theorist Michael Taylor wrote a book called Community, Anarchy and Liberty, which set out to look at whether you can have a functioning society without a central authority to coerce people. You can, he said, as long as people want to obey the rules that support the society.

And for that to happen, you need two things, Taylor said. One is information. Obeying the rules, paying your taxes and so on are almost always in your interests, if only you have enough information to realise it. Tax-evaders might be better off in the short-term, but if nobody pays tax then nobody takes your rubbish away and everybody is worse off.

Paying is actually in your interests. The more complex a system you are in, the harder it is to understand how your actions affect others. Sitting at a desk in an investment bank staring at numbers on screens it must be easy to forget that your trades could lose thousands of people their jobs, and their savings. That is sobering knowledge which would cause most people to pause.

The second thing you need, said Taylor, is a multi-faceted relationship with other people. In organisations like communities and families people often have complex relationships - emotional, economic, social and so on. In that case, they are less likely to screw each other over because they don’t just stand to lose their job, but their life. The more ways that employees feel connected to a business and other employees, the less likely they are to blow it up.

In many ways, family businesses are like Taylor’s communities: they are often identified with towns or regions, giving work to generations of the same families, and they pride themselves on being more than money-making machines. Their work has meaning, above and beyond making money. Employees surely feel less willing to take risks that could destroy such businesses.

They also bring some of the ethos of a family into the business sphere. Families know that young men with something to prove and testosterone coursing through their veins need to be supervised, guided and mentored.

Family businesses can fail in this too, of course: Barings, which was destroyed by Nick Leeson, was a family business, perhaps the reason that that episode felt more like a tragedy than a bankruptcy.

But in general family businesses can teach the banks about the value of parental guidance.
Rules, regulations, circuit-breakers and alarm-bells are all very well, but they are no replacement for a responsible adult.


And Mr. Madoff reminds us that regardless of relationships, affinity, community or family ties we suspend disbelief and retire vigilance at our peril.
The question is how to mitigate, because you can never eliminate, the risk. The starting point is identifying the incentives and motivations at work -- especially for those employees who sit in positions where firm vulnerability exists. Compensation, bonuses in particular, can be structured in ways that motivate bad behavior -- as has been seen too frequently in recent years. However, as the "testoserone" comment alludes to, there is often a strong emotional component to the motivations of a rogue employee. A culture with inappropriate "positive feedback" can shift the focus from the success of the business to the success of the individual -- to the drive to be the top producer rather than the drive to do the right thing for the clients and the firm. On the otherhand a culture of "negative or non-existent feedback" can be even worse.
Whether an "outsider" or family member, an employee who feels underappreciated, disrespected or undervalued is much more likely to violate the employer's trust because the employer, in the mind of the employee, has already violated the agreement. My guess is we will find that one of these emotion-based motivations was at least part of the story with UBS's bad boy.

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