Smith Newcourt

Partners at the British trading firm Smith Newcourt ^[5] managed to deftly balance the risks and rewards of decentralized decision making by placing their trust in their junior traders, demanding honesty in return, and correcting mistakes on the spot.

Like any other large market-making firm in Britain in the mid-1980s, Smith Newcourt was a partnership. If a member of the firm were to make a really bad trading decision and then fail to work off his or her position, the partners, who were personally liable, would share in the losses. And if the mistake were large enough to consume all the capital the partners had, they would all be individually bankrupt. As one senior partner liked to joke, this was not U.S.-style bankruptcy but real, old-fashioned British bankruptcy. None of this keep a house, keep a car, keep some clothes comfortable bankruptcy. This was live in a station on the London Underground, walk around in a barrel bankruptcy. ^[6] This high degree of personal liability could have resulted in very conservative behavior on the part of the partners and in suffocating control over all decisions made by junior personnel.

But trading decisions needed to be made quickly, often nearly instantaneously. If interest rates were to rise, Smith Newcourt traders would need to reduce their holdings of long bonds before everyone else did. If a window for equity arbitrage were to open , Smith Newcourt traders would need to short cash immediately and write a futures order in a minute or two. There simply was not sufficient time for junior traders to ask for permission before making a decision.

Clearly, the need for speed necessitated decentralized decision making and absolute trust among junior traders. By virtue of their limited experience, they did make mistakes, which caused losses, sometimes significant, for the firm. But if juniors did not trade, they would never earn money, nor would they ever gain the experience or confidence they needed to become effective traders. To balance risk and reward, speed and safety, short-term losses and the long- term value of experience, partners at Smith Newcourt started junior traders with smaller position limits and taught them that only cowardice, dishonesty, and a failure to ask for help when in trouble were unforgivable.

In 1988 a junior trader interrupted a meeting and approached Smith Newcourt s head of equities trading, Tony Abrahams. Looking sheepish, the junior trader explained a mistake he had made seconds before. Abrahams looked at him, pretended to throw a punch, laughed, and said Oy, meshugena (which loosely means Woe, silly one in Yiddish). He then put an arm around the young trader s shoulder, walked over to the desk, and worked him out of his difficult trading position.

The young trader had gotten into a difficult position because of his lack of experience, but he was not punished because had done exactly what he had been asked to do. He saw an opportunity and acted; when it turned out badly , he went to a senior trader for help. This incident, while featured here in isolation, was indicative of an overall culture of candor and mutual trust at Smith Newcourt. Individuals could act rapidly to exploit opportunities consistent with their understanding of their objectives, and the firm could respond rapidly to manage any risks that might arise as a result.

Leadership Lessons

The partners willingness to place their trust in juniors while maintaining firm yet forgiving vigilance reinforced the right behavior throughout Smith Newcourt. Junior traders knew they could trade aggressively without being punished, provided that they immediately informed their seniors of slipups; at the same time, they knew there would be zero tolerance for timidity, indecision, or lapses in integrity. Partners, in turn , knew that they could free junior traders to make the rapid decisions necessary to capitalize on market opportunities without fearing that small mistakes of inexperience would become firm- threatening mistakes.

^[5] Now acquired by Merrill Lynch.

^[6] Conversation with Anthony Abrahams, head of trading at Smith Newcourt.