Friday, January 25, 2008

L'Affaire Kerviel and a rogues' gallery of rogue traders

Societe Generale's L'Affaire Kerviel is unbelievable, and I suspect we'll be learning some interesting details in the coming days. A unique aspect of his case is that he started in the back office before making it to the trading desk, and used his knowledge of SocGen's systems to mask his positions. But why did he do it? If his trades had been successful I don't see how he could have profited personally. As a junior trader he couldn't walk up to his boss and say "See, I made you 4 billion Euros, where is my bonus?" -- he would have been fired right away for taking the positions in the first place. And, despite his back office acumen I don't see how he could have gotten the profits out of the bank without anyone knowing. It almost seems as if his goal from the beginning was to bring down the bank.

NYTimes: A Spiral of Losses by a ‘Plain Vanilla’ Trader

PARIS — On the elite trading floors here, where France’s brightest minds devise some of the most complex instruments in global finance, few people noticed Jérôme Kerviel.

He was lucky to be there at all. Many of his colleagues had been plucked from the prestigious Grandes Ecoles — the Harvards and M.I.T.’s of France — and wielded advanced degrees in math or engineering. Mr. Kerviel arrived from business school and started out shuffling paper in the back office.

But on Thursday the world came to know Mr. Kerviel, 31, as the most dangerous accused rogue trader ever, a young gambler who found himself sucked into a spiral of losses that left a $7.2 billion hole in Société Générale, one of France’s largest and most respected banks.

While Société Générale executives maintained that he had acted alone, many questioned how that was possible given the scope of the losses.

“There are plenty of excellent brains at Société Générale, consequently I find it hard to believe the risk management systems and all the auditors did not indicate anything at any level,” said Hélyette Geman, a professor of mathematical finance at ESSEC, a leading French business school, as well as professor at the University of London.

It is a remarkable turn of events for Société Générale, which since the mid-1980s has built itself into a global powerhouse in trading derivatives like futures and options.

“In France we considered Société Générale a magic bank,” Ms. Geman said.

Until now Société Générale, unlike many Wall Street banks, had seemingly sailed through the turmoil in the financial markets with its reputation intact. The January issue of Risk, a monthly magazine about risk management and derivatives, named the bank its “Equity Derivatives House of the Year.”

But Mr. Kerviel, described by bank executives as a shy junior trader, did not fit the mold at Société Générale. The bank lures its top talent from the country’s premier science and engineering schools in Paris. Mr. Kerviel grew up in Brittany, in western France, and attended the University of Lyon. He joined Société Générale in 2000 as what was effectively a clerk, processing and recording the trades made on the trading floor.

By 2006, Mr. Kerviel had worked his way up to the trading floor, where he specialized in arbitrage, or making bets on small difference between various European stock market indexes such as the CAC in France and DAX in Germany.

A senior banker at Société Générale described Mr. Kerviel “as a very junior trader, not a star.” As far as his superiors knew, this banker said, “he was starting to work on a small portfolio. He’s more of a shy person than an extrovert.”

All the same, covering the billions in market positions would have taken considerable skill. “Hiding it was a full-time job because you needed to know exactly what do,” this banker said.

The chief executive of Société Générale’s corporate and investment banking unit, Jean-Pierre Mustier, insisted that the bank’s own investigation showed what they termed the rogue trader to have acted without the knowledge or cooperation of his superiors.

“We’ve been going through the positions for four days,” Mr. Mustier said. “The research we have made has not shown any link with anyone else at Société Générale.”

Mr. Kerviel’s bad bets in the markets came to light a week ago. According to bankers familiar with the situation who asked for anonymity because the investigation was continuing, risk control specialists at the bank first discovered the suspicious trades on Friday. After combing through trading records all day Saturday, the executives discovered the extent of the fraud.

Mr. Mustier returned to Paris from London to oversee the investigation at Société Générale’s headquarters over the weekend. Mr. Kerviel was summoned and was questioned there Saturday night.

Among financial veterans of other trading floors as well as financial experts across Europe on Thursday, there was widespread incredulity that a junior employee like Mr. Kerviel could have racked up such huge losses without the knowledge of his superiors.

Like Nick Leeson, the trader who brought down Barings bank by making huge secret bets on Asian markets in 1995, Mr. Kerviel was something of an anomaly on Société Générale’s trading floor.

“I had students who have a hard time getting jobs at top French banks because of this elite system we have in France,” said Ms. Geman. “In the U.K. and U.S., it’s less of a club based on where you went to school when you were 19 or 20.”

According to officials at the bank, Mr. Kerviel’s losses came from bets made on what they termed “plain vanilla products,” relatively simple futures tied to major European stock indexes.

He had made bullish bets, a senior banker said, which were gradually unwound over the first three trading days of this week. The banker insisted that the closing of those positions had not contributed to the huge losses on European bourses Monday and Tuesday.

Adding to the mystery is the conclusion by Société Générale executives that Mr. Kerviel had not profited from his trades.

“We have no explanation for why he took these positions, and we have no reason to believe he benefited from a financial point of view,” the banker said. “We don’t understand why he took such a massive position.”

The Journal has a bit more; looks like a bit of hacking + rogue trading. A new combination?

WSJ: ...Société Générale's computer systems are considered some of the most complex in banking for handling equity derivatives, that is, investment contracts whose value moves with the value of other assets. Officials of the bank believe Mr. Kerviel spent many hours of hacking to eliminate controls that would have blocked his super-sized bets. Changes he is said to have made enabled him to eliminate credit and trade-size controls, so the bank's risk managers couldn't see his giant trades on the direction of indexes.

Mr. Citerne said the bank didn't notice the unauthorized trading until last week because the trader had "intimate and malicious" knowledge of its procedures and knew at what dates checks were conducted. "Each time he took a position one way, he would enter a fictitious trade in the opposite direction to mask the real one," Mr. Citerne said. According to one person familiar with the situation, Mr. Kerviel used the computer log-in and passwords of colleagues both in the trading unit and the technology section.

According to one person familiar with events, the bank's controls did red-flag an outside trading partner of the bank, whose account showed unusually high finance levels. The client, when asked by the bank about the account's finances, denied knowing of it. Pursuing this matter ultimately led to Mr. Kerviel.

Executives called him in for questioning on Saturday, said Mr. Bouton. The interrogation took a good part of the day because Mr. Kerviel had convinced himself that he had mastered a new way to trade stock-index futures, according to a person familiar with the situation. For a while, he went in circles while justifying the trading strategy, this person said, but finally on Saturday night he broke down and admitted the trades.

Wikipedia has an entry on largest trading losses. I don't really think of John Meriwether of LTCM (or even, I guess, Brian Hunter) as a rogue trader, although I suppose their investors didn't know exactly what they were up to.

Name Amount Lost Citizenship Employer Source of Loss Year

Jérôme Kerviel[1] US$7.1 billion France Société Générale European Index futures 2008

Brian Hunter[2] US$6.5 billion Canada Amaranth Advisors Gas futures 2006

Giancarlo Paretti[3] US$5.0 billion Italy Crédit Lyonnais Loans to Hollywood Studios 1990

John Meriwether[4] US$4.6 billion United States Long Term Capital Management Interest Rate and Equity Derivatives 1998

Yasuo Hamanaka US$2.6 billion Japan Sumitomo Corporation Copper futures 1996

Wolfgang Flöttl, Helmut Elsner US$2.5 billion Austria BAWAG Currency- and interest swaps 2006

Robert Citron US$1.7 billion United States Orange County Interest Rate Derivatives 1994

Heinz Schimmelbusch US$1.6 billion Germany Metallgesellschaft Oil Futures 1993

Nick Leeson US$1.4 billion United Kingdom Barings Bank Nikkei Futures 1995


Anonymous said...

Friends of rogue trader Jerome Kerviel last night blamed his $7 billion losses on unbearable levels of stress brought on by a punishing 30 hour week.

Kerviel was known to start work as early as nine in the morning and still be at his desk at five or even five-thirty, often with just an hour and a half for lunch.

One colleague said: "He was, how you say, une workaholique. I have a family and a mistress so I would leave the office at around 2pm at the latest, if I wasn't on strike.

"But Jerome was tied to that desk. One day I came back to the office at 3pm because I had forgotten my stupid little hat, and there he was, fast asleep on the photocopier.

"At first I assumed he had been having sex with it, but then I remembered he'd been working for almost six hours."

As the losses mounted, Kerviel tried to conceal his bad trades by covering them with an intense red wine sauce, later switching to delicate pastry horns.

[This is going around Bloomberg today, source unknown. I've edited it down a bit. - DB]

Anonymous said...

Thanks,db: you made my day.
The tell-tale phrase "In France we considered Société Générale a magic bank, Ms. Geman said"
should have been a sufficient warning...

Anonymous said...

The whole story sounds fishy to me. Why would someone go to all the trouble of creating false transactions, etc. if there were no profit motive in it? I suspect that someone else was going on (perhaps subprime CDO related losses) and rather than admit that, the bank found a handy scapegoat.

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