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UBS AG (UBS - Analyst Report) has made headlines yet again for the wrong reasons. The company has been slapped with a fine of £29.7 million ($47.6 million) for failing to prevent significant unauthorized trading that resulted in a substantial loss totaling $2.3 billion.

The losses were incurred mainly on exchange traded index future positions. The penalty was imposed by the British authorities, The Financial Services Authority (FSA). The penalty could have increased by 30% had UBS refused to cooperate.

The rogue trader, Kweku Adoboli, was charged with unauthorized trading between June 1, 2011 and September 14, 2011 on the Exchange Traded Funds Desk in the Global Synthetic Equities trading division conducted from the company’s London branch. The accused has been sentenced to imprisonment for a period of seven years.

According to the FSA, UBS had severe loopholes in its procedures, management systems as well as internal controls. Its computerized system that aids in risk management was ineffective in detecting the fraudulent trading. Further, risk limits were breached by the desk and the front office supervision was inadequate.

Moreover, UBS has been criticized for not investigating the reason behind the significant escalation in profitability of the desk. Such failures on UBS’s part gave the accused trader ample scope to carry on with the unauthorized trading and take risky market positions.

In addition to the penalty imposed by FSA, a series of restraining measures have been imposed on the company by the Swiss Financial Market Supervisory Authority (FINMA). These include capital restrictions and an acquisition ban on the Investment Bank.  The measures are aimed at limiting UBS’s operational risks.

Further, any new or important business initiative which the Investment Bank plans to implement must be initially approved by FINMA. Also, an independent investigator would be appointed by FINMA to review the progress of the measures imposed. Later, an audit firm will be engaged to supervise the effectiveness of the steps taken by UBS.

As a matter of fact, UBS has undergone severe criticism following this rogue trading scandal and has recently announced significant restructuring and layoff plans. Its business has been severely impacted by the financial crisis and the company suffered huge losses on credit bets during that time. However, the Swiss government came to its aid and currently the company, along with Credit Suisse Group (CS - Snapshot Report), is subject to stringent capital norms.

This penalty looks to serve as an example for the industry and help limit such incidences. But it would also drain the company’s funds which could have been steered toward growth purposes. Moreover, though the restrictions would help contain the company’s operational risk, its operational flexibility would be curtailed.

For UBS, which currently retains a Zacks #3 Rank, implying a short-term Hold rating, we believe that the announcement of the penalty as well as the restrictions on the company would further add to its woes and this might lead to negative estimate revisions. This, in turn, could cause deterioration in its Zacks Rank.

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