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Rogue Trader Soc Gen Case Study

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Kerviel - New King of the Rogue traders

How Why and Implications surrounding his actions

Word Count вЂ" 2,439

SOC GEN Case Study

Leeson, Iguchi, Rusnak….and now Kerviel has been unearthed as the new king of the rogue traders. His losses dwarfed that of Nick Leeson (Barings), John Rusnack (AIB) and Toshihide Igichu (Daiwa) combined, with his losses amounting to €4.9bn. Worldwide financial institutions do not seem to have captured the risk surrounding rogue trading and implemented efficient controls to eradicate or minimise this risk but at the same time are aware of the enormity of the potential problems that arise from this activity. The revelation of the scandal is the biggest of its kind in history and unfortunately for Kerviel and Soc Gen, was at a time when the European stock markets were at there lowest since the catastrophic terror attacks on September 11th 2001.

Mr Kerviel was working within the arbitrage Equity derivatives group at the time he was taking unauthorised positions. As the markets fell, losses soon increased which encouraged further bets in which the value of the bet was insignificantly immaterial in the eyes of Kerviel, creating a snowball effect.

This case study we will identify the underlying reasons as to why Mr Kerviel found it necessary to carry out this fraudulent activity and how he accomplished this. We will also analyse Soc Gen’s reaction and response to his activities and did they take the appropriate steps to overcome these? And finally, what would have been the outcome if this was uncovered as a rogue trading scandal resulting in a profitable position rather than a €4.9bn loss?

Jerome Kerviel started work in 2000, working in a number of roles where he learnt about the banks processing and control procedures. Mr Kerviel had an ambition to work within a trading role which was fulfilled in 2005. Mr Kerviel was promoted to an arbitrage trading role perceived as a very low ranking position within the trading hierarchy.

His freedom of investment within this role was minimal which may have lead him to believe that Soc Gen did not have the confidence in his trading capabilities, therefore restricting his ability to gain his much pursued recognition within the company as a �top trader’. This thirst for recognition was instigated by the high pressure environment surrounding Mr Kerviel. The trading industry could be described as �cut-throat’ in which each trader’s performance is based solely on their financial gains. Due to Mr Kerviel’s role, the potential gain he could make was always lower than that of an experienced or superior trader as they have a role with greater autonomy.

Financial reward was not his main incentive but within the industry success is gauged by monetary bonuses. These experienced traders were earning 10 to 20 times the amount of his salary in bonuses and as identified above, Kerviel’s role in the arbitrage department did not enable him to make these supernormal profits which restricted his freedom to invest, hampering his motivation.

A question you may ask is why was he able to generate such huge profits under the noses of his colleagues and higher level management?

Kerviel believed the management closed its eyes as to how he did it and how he bet. As long as profit was made, it was irrelevant how. (O’Doherty, FT Feb. 4th).

It is hard to disagree with the above statement as Soc Gen invests billions of shareholders funds across the market, so strict controls are imperative. So how could a company which is prided upon its stringent controls not recognise the €1.4bn positive position Mr Kerviel held in December 2006?

To enable Kerviel the opportunity of obtaining these supernormal profits comparable to those of colleagues, he started taking bets outside his authorised fields. Mr Kerviel’s extensive knowledge of back and middle office operations proved to be his underlying advantage in outmanoeuvring the controls in place. He was able to do this by embezzling colleague’s passwords and forging hedge documents. The existing controls failed to spot Kerviel’s transactions as they superficially showed to have a �low residual risk’ therefore no cause for concern was raised by management from risk perspective.

EUREX, Europe’s largest derivates exchange raised questions in November upon a number of trades carried out by one Mr Kerviel (Lagarde, FT, 2008). It raises serious doubt into the integrity of management within Soc Gen. If a reputable source such as Eurex identify any concerns; it must be common practice to investigate any case rigorously. If Mr Kerviel’s position was investigated fully at the time, surely his unauthorised trades would have been recognised. Did management identify these anomalies and “close its eyes” due to his profitable position?

It is very likely that Soc Gen IT security staff were conscious of their vulnerability since this has been one of the main audit findings in most, if not all financial institutions over the past 3 years and many organizations have acted to address this gaping hole in their organizational security (Macleod 2008). Either the issue had not been identified by the auditors or it had not been addressed by IT Security. Who knows, we can only guess. This vulnerability surrounding IT security seems to be a pragmatic reason why this was allowed to happen.

Reports lead us to believe that Mr Kerviel did no take any holidays throughout 2007.

“It’s the first rule of internal control. A trader who takes no holiday is a trader who doesn’t want leaves his books to anybody.” (O’Doherty, FT Feb. 4th).

It is extremely questionable that management did not notice this, in particular his line manager. Although this could be perceived as a keen employee from an external point of view, it is likely to be for reasons somewhat more suspicious. Not only is this negligent management, it is also to do with inadequate controls within HR as all employees at all levels should be required to take a significant leave period. This has been recently researched by the UK Regulatory standards (FSA) to implement



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