Thursday, January 31, 2008

Societe Generale: A Story of Failed Risk Control

It appears that CEO Daniel Bouton will keep his head, at least for a short period of time. The board wants him to complete a massive capital infusion program that will keep the bank afloat. However, long term everyone expects that he will go. The New York Times quoted one director as saying it is unclear if "the captain or the boat will sink first."
Bank Defies French Elite and Keeps Chief, for Now

The astounding part of the story is that the entire situation was brought about by a junior trader. Well, at least that is the story which Societe Generale is pushing in the media. The reality is that the entire fiasco is an example of the firm failing to have even the basic suitable practices in place pertaining to risk control. Even worse, this situation appears to be common place at major financial institutions. As long as a trading team is making money, all proper oversight regarding the risk of positions is commonly ignored.

It is interesting that Jerome Kerviel’s managers were hailing him as a hero in early January, and negotiating whether his bonus should be 300,000 or 600,000 euros. Within days of this – by Monday, February 21st – he was told to get lost as his long position from the 18th showed huge losses in a down market. The unwinding of this position led to a crisis.

Extraits des procès-verbaux des auditions de Jérôme Kerviel

The evidence chain at this point indicates that Mr. Kerviel’s sole motivation was to make money for the bank, and his bosses supported him in his endeavors since 2005 --- until he blew up. In the past the management team had covered up poor trading results, and the size of the trade that he put on in mid-January was not unusual. If the position had paid off instead of going against him, then Jerome Kerviel would have been hailed as a hero by his management team. Strangely enough, some of the audit trail manipulations performed by Mr. Kerviel were to cover-up the size of his obscene profits in late 2007 rather than to hide losses.

A recent article at Wall Street & Technology questions if the fraud could have been easily prevented by putting some basic risk control measures in place.

Societe Generale: Could it Have Prevented $7.2 billion fraud?