Switzerland's largest bank warned that it could report a loss for the entire third quarter as a result, sending its shares plummeting.
The bank provided little information on the incident, saying it was still under investigation and no client money was involved. The unauthorized trades could cost UBS almost as much as the 2 billion Swiss francs ($2.28 billion) the bank said last month it hoped to save by cutting 3,500 jobs over two years.
The incident comes as UBS is struggling to restore its reputation after heavy subprime losses during the financial crisis that resulted in a government bailout, and an embarrassing U.S. tax evasion case that blew a hole in Switzerland's storied tradition of banking secrecy.
Shares in UBS AG plummeting more than 8 per cent in early trading on the Zurich exchange. By midmorning shares were down 5.8 per cent at 10.30 francs ($11.75).
In a terse statement shortly before markets opened Thursday, the bank informed investors that "UBS has discovered a loss due to unauthorized trading by a trader in its investment bank."
"UBS's current estimate of the loss on the trades is in the range of $2 billion," it added. "It is possible that this could lead UBS to report a loss for the third quarter of 2011."
In a letter sent to its employees, the bank said it regretted that the incident came at a difficult time.
"Although the news is regrettable, the fundamental strengths of the company won't be affected by this," the note said. "We ask that you continue concentrating on your customers. In these uncertain times they are counting on your support."
It promised to keep employees briefed on developments in the case.
Peter Thorne, a London-based equities analyst at Helvea, said the loss was financially manageable for UBS, Switzerland's biggest bank. But he said it was a blow to the reputation of UBS and its management, and reinforced the case of slimming down the investment banking unit.
UBS chief executive Oswal Gruebel recently warned that the bank, which posted sharply lower second-quarter net profits of 1.02 billion Swiss francs in July, wouldn't achieve its aim for a pretax profit of 15 billion francs a year by 2014.
UBS isn't the first to be hit by a massive loss allegedly caused by a single rogue trader.
Societe Generale, France's second-largest bank, stunned investors in 2008 when it revealed that one of its staff had lost the bank €4.9 billion ($6.7 billion) through a complex scheme of unauthorized trades.
The trader, Jerome Kerviel, was convicted in October 2010 on charges of forgery, breach of trust and unauthorized computer use for covering up bets worth nearly €50 billion between late 2007 and early 2008. He was also banned for life from working in the financial industry and ordered to pay back the vast amount he had caused his employer to lose.
Nick Leeson, a British trader working in Singapore for Barings Bank, made unauthorized futures trades that lost more than $1 billion and led to the venerable bank's collapse in 1995. The infamous case prompted banks worldwide to tighten their internal checks.
Leeson was released from a Singapore jail in 1998 for good behaviour after serving 3 1/2 years of a 6 1/2-year sentence. He claimed he did not make a cent from his disastrous trades but Barings' liquidators sought the return of 100 million pounds on any of his earnings relating to Barings.
John Heilprin in Geneva and Bob Barr in London contributed to this report.