Ah! well a-day! what evil looks
Had I from old and young!
Instead of the cross, the Albatross
About my neck was hung.
~•~
– The Rime of the Ancient Mariner
Five Consequences of Errors of Omission
- It can come back to bite you at the worst possible time
- You make other people who depend on you look bad
- It erodes the credibility of what you are working on
- Unless you face it head on, people will think there is more to worry about
- If you deny it, it will look like there is something worse you are trying to hide
Let’s look at how these errors manifest themselves in three areas: political, financial markets, and risk management.
Political
If there is one mistake most people will agree on, it will likely be that the Trump administration, campaign and family members’ omission of pertinent information involving Russia has been very problematic during his first 6 months in office. Seen in the best possible light, it has created the appearance that there is something to hide regarding Russia’s interference with the US Presidential election, even if the Trump campaign committed no wrongdoing. At the very least, it has caused Michael Flynn to resign, AG Sessions to recuse himself from the Russian investigation, and the firing of FBI director Comey.
If sunlight really is the best disinfectant, than perhaps the best way to remove the albatross of Russia around Trump’s neck would be to come clean or at least allow Special Counsel Robert Mueller to conduct his investigation unimpeded. However, Trump has warned Mueller not to investigate his or his children’s finances, claiming it would be a violation (presumably grounds for being fired) even though Donald Jr. appears to have opened that door to transparency willingly. Had Trump been more forthcoming on his finances and tax returns during the campaign instead of omitting this information, the cloud of suspicion around him and his family business finances may have been avoided.
The consequences of the drip-drip release of information has eroded the confidence in the administration and undermined the efforts to pass legislation. It could potentially lead to more direct consequences, the most severe being impeachment, but for now it is putting the stimulus agenda at risk. Even if it turns out that the Trump campaign committed no wrongdoing (no crime), the error of omission will have extracted its pound of flesh on this president’s term in office. For now, this remains a slow moving train wreck, with no final tally of the damage because the omission errors continue to surface.
Financial Markets
In the private financial markets, errors of omission usually have swift and severe consequences such as when a public company reports unexpected materially negative results and the stock craters (such earnings well below guidance). If repeated, this often leads to the removal of C level people. Investors simply have no patience for a lack of transparency when the results are disappointing. A quick market response, by way of selling pressure, discourages such behavior and ultimately leads to more stable markets. This is the very essence of why transparent markets are considered inherently less risky. Even in the case of Uber, a private company, where the behavior of the founder and CEO created a culture that would not be tolerated at a public company, the consequences finally resulted in the dismissal of key management, board members and the eventually resignation of the founder and CEO.
Risk Management
In risk management, errors of omission can go unnoticed for a very long time because risk events occur infrequently. The most common of these are the failure to account for what data is actually being used to measure risk. This is even simpler than garbage in, garbage out. While most commercial risk systems provide an error log for positions that failed to load, what they can’t do is tell you what you forgot to send because there is no “awareness” of what you actually own in your portfolio. There is no AI out there that will do this for you (though maybe there should be). The more complex the portfolio and business structure, the higher the risk of these types of errors. It is the stealth nature of these unaccounted for errors that poses the greater risk. You may only find out about them after a risk event occurs and there is an unexplained loss that the risk system failed to predict. The consequence of these errors may include a loss of trust in the risk process, loss of credibility with investors, investor redemptions, and career risk for risk management.
While we can’t save you from committing political errors, accounting mistakes or issuing misleading earnings guidance, we can help you avoid many common mistakes in risk management that have rather serious consequences.
Fortunately, Red Swan Risk has perfected the tools, consultancy, and best practices that make our clients the gold standard of Model Risk Management.
Contact Red Swan Risk today for a demonstration of our efficient solutions for these challenges and more.
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