Rogue Traders and Level III Assets, What's the Difference?

Morgan Stanley suspended a credit trader today for mismarking his trading positions to the tune of $120 million.  The company was forced to take a "negative adjustment" related to erroneous valuations of his positions.  Morgan Stanley's CFO, Colm Kelleher, was quick to point out that the firm discovered the error and took swift action by suspending the trader.  A suspension may seem harsh for a high school senior headed into final exams (please refer to the movie "Risky Business" if you doubt me.)  However, on Wall Street, where traders are compensated based on their trading profits, a suspension seems a bit weak.  Personally, I'd go after any compensation the trader had received in the past.  Call me crazy for thinking that people shouldn't get paid ridiculous sums of money for phantom profits.

This rogue trading incident, although meager compared to the SocGen fiasco caused by Jerome Kerviel earlier in the year, brings to light a much larger issue:  How trustworthy are the marks on investment banks portfolios of assets?  Banks claim to have highly sophisticated risk management tools in place to make sure that risks are adequately quantified and that prices are indicative of where assets trade in the marketplace.  In light of the recent inaccurate pricing of assets at Morgan Stanley, Merrill Lynch, Credit Suisse, Toronto-Dominion, and SocGen, it is clearly an issue that banks struggle with and should cause investors to wonder how many other rogue trading incidents are occurring right now that have yet to come to light.  Based on anecdotal evidence from personal experience working at investment banks, traders who mismark positions are typically asked to leave, and the embarrassing losses are generally buried into earnings and never disclosed.  They become much harder to hide when there are no earnings to offset the losses.  My guess is that we'll be hearing more of these sorts of incidents in the ensuing bear market.    

A bigger issue still is the assets on investment bank balance sheets that are currently classified as Level III, or assets that have no observable prices or even observable inputs in the market.  Much has been made of this issue recently as banks have been scrutinized for moving formerly somewhat liquid assets into this accounting classification as prices dried up.  While nobody is accusing banks of purposefully mismarking Level III assets (well, other than the accusations hurled at Lehman Brothers by David Einhorn, which turned out to be true) many wonder if the prices are anywhere in the neighborhood of their true value.  Is there any difference between a price that a trader invents to pad his own pocket purposefully and a price that a bank invents because no other prices are available?  One is pure deception, while the other is a best guess with some unknown probability of being in the ballpark.  If there is a difference, does it really matter?