Goldman’s CFTC Fine Is A Joke But Highlights The Importance Of Risk Controls

Last week, the U.S. Commodity Futures Trading Commission (CFTC) slapped Goldman Sachs (NYSE:GS) with a $1.5 million fine over inadequate control measures in its trading system which allowed an employee to falsify trades worth $8.3 billion in 2007. (CFTC Orders Goldman, Sachs & Co., a Commission Registrant, to Pay $1.5 Million for Supervision Failures, CFTC Press Releases, Dec 7 2012)) Goldman lost $118 million in the process of unwinding the positions.

We believe the global investment bank has been lucky on both fronts: while the fine amount in itself is too small to be material to the bank, the loss from the position is but a fraction of what the bank could have potentially lost. After all, we have witnessed the damage that wrong multi-billion dollar trading decisions by a single individual can do to a bank’s reputation and business on two distinct occasions in the recent past – the unauthorized trading incident at UBS (NYSE:UBS) last year (see Questionable Risk Controls Cost UBS More than Rogue Trades) and the hedging portfolio loss at JPMorgan (NYSE:JPM) this June (see JPMorgan’s Trading Losses Could Climb, Sold Profitable Securities To Cushion Impact).

We maintain a $127 price estimate for Goldman’s stock, which is about 5% above the current market price.

See the full Trefis analysis for Goldman Sachs

In late 2007, Matthew Marshall Taylor bypassed Goldman’s risk management, compliance, and supervision systems and manually recorded a series of fake trades to hide a huge position in e-mini S&P 500 futures contracts he had entered into. The bank had already made losses of $118 million on the $8.3 billion portfolio by the time the fabricated trades were detected and could be unwound.

Goldman’s equity trading yield is captured in the chart above. As you can see by making changes to the chart, Goldman’s share value is pretty sensitive to this yield. A trading glitch can potentially wipe out a significant amount of Goldman’s value – especially if it is of the magnitude seen at UBS or JPMorgan.

But Goldman emphasizes that it has implemented various “enhancements to its U.S. futures-related trading and risk management controls and supervision policies and procedures” since the incident was discovered. ^[1] We really hope so, because given the alarming scale of losses stemming from similar incidents with competitors, the last thing Goldman should do is take its internal controls lightly.

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