Assume the position

How to hide $8.3 billion

April 4, 2013
April 4, 2013

Today Matthew Taylor, a former Goldman Sachs vice-president who traded equity derivatives, pleaded guilty to concealing a massive trading position that lost the bank $118.4 million in late 2007. He was able to amass an $8.3 billion long position before anyone else noticed in what are called “e-mini futures,” which bet that the S&P 500 will rise in the future. Unfortunately, that didn’t really work out for him, and now he’s probably off to jail.

But not all rogue traders are so unfortunate; for some reason, the rogue trades that win banks money never really seem to get out. And there remains the belief that big bets, even when unauthorized, will be rewarded if they’re successful. Case in point: James Pierpont Morgan, whom my colleague Matt Phillips dubbed “the most successful rogue trader of all time,” founded the illustrious JP Morgan after a highly profitable unauthorized trade.

So if you’re going to throw caution to the wind and go rogue, how would you even do it? According to the Commodity Futures Trading Commission (CFTC) (pdf) this is what Taylor did:

1. The way it works. Generally, S&P e-mini futures contracts are traded on an electronic platform called Globex, which is owned and operated by the CME Group. Trades need to pass through there to be fulfilled. Goldman’s internal risk monitoring system uses data that traders submit to exchanges in order to gauge the size of its portfolio and evaluate the risks of different positions.

2. Accumulate a massive position. Taylor built up an $8.3 billion position on e-mini futures this way. But because it would have violated Goldman’s internal restrictions, Taylor had to find a way to hide the risk he was taking. He also didn’t want his employers to find out about how much money his position had made or lost while he held it.

3. Make fake trades. Enter the wire fraud. Certain derivatives were traded between parties and not routed through an exchange, and so traders had to enter them in manually. As Taylor built his position, he furtively logged what the CFTC calls “fabricated trades” that appeared to reduce the size of his position in this manual entry system.

4. Hide the risk. Those fabricated trades—60 in total—were never actually carried out. They did, however, distort Goldman’s internal risk modeling system. Instead of showing that Taylor’s desk was amassing a multi-billion-dollar position on e-mini futures, the risk system actually showed it reducing its position.

5. Don’t lose money. Unfortunately, November and December 2007 was not a good time to bet on the rise of the S&P 500, and definitely not a good time for S&P 500 futures. The index fell from 1,510 on Nov. 2 to 1,478 on the last trading day of the year. Moreover, that moment was the beginning of a massive loss of faith in stocks, which materialized in 2008.

6. Don’t get caught. If you lose your firm $118 million, you’re probably going to get caught and it’s probably going to sue you. After submitting multiple false reports about his losses to his supervisors and risk managers, Goldman finally found Taylor out. A Goldman spokesman said Taylor admitted to misconduct after his last trades on Dec. 14, 2007. He was fired not long after, and will probably serve 3-4 years in prison.

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