Trading Scandal at Societe Generale Case Study Assignment Help
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In January 2008, Societe General (SocGen), France’s second largest banking establishment, was a victim of internal fraud carried out by an employee, Jerome Kerviel. SocGen bank lost 4.5 billion (euros) as an immediate result of the fraud. (At the time of this incident, the euro was worth approximately $1.45 dollars.)
In 2007, SocGen was rated the best equity derivatives operation in the world by Risk magazine. Its internal control system of checks and balances was world renown. For example, its trading room has five levels of hierarchy. Each of those levels has a clear set of trading limits and controls, which are checked daily by a small army of compliance officers.27 In addition, “the bank also has a shock team of internal auditors who descend on a corner of the bank without warning and pull apart its operations to ensure they conform to bank rules.”28
During the summer of 2000, Kerviel began employment in the bank, ironically, in its compliance department. Five years later, he was promoted to a junior trader in the arbitrage desk, which deals in program trading, exchange traded funds, swaps, stock index futures trading, and quantitative trading. Kerviel was responsible for generating profits for the bank and its customers by betting on the market’s future performance. His first major win came in 2005 when he shorted stock of German insurer Allianz and earned the bank 55,000 (euros)
Thanks to his years of experience in the compliance department, Kerviel was an expert in the proprietary information system SocGen used to book trades. He knew that while the riskcontrol department monitored the bank’s overall positions very closely, it did not verify the data that individual traders entered into the system. Kerviel also knew the timing of the nightly reconciliation of the day’s trades, so that he was able to delete and then re-enter unauthorized transactions without getting caught.
On November 7, 2007, SocGen received an e-mail alert from a surveillance officer at Eurex (one of Europe’s largest exchanges). The message stated that Kerviel had engaged in several transactions that had set off alarms at the exchange over the past seven months. A SocGen riskcontrol expert responded two weeks later that there was nothing irregular about the transactions. A week later, Eurex sent a second e-mail alert stating that they were not satisfied with SocGen’s explanation and demanding more details. Following another two-week delay, SocGen provided further details, and both Eurex and SocGen let the matter drop.The compliance officer who made both replies to Eurex used accounts provided by Kerviel and his supervisor as well as a compliance officer at a SocGen subsidiary. Kerviel’s supervisor stated that there was no anomaly whatsoever.
Following the Eurex warnings, Kerviel took additional steps to cover his tracks by manipulating portions of the internal risk-control system with which he was unfamiliar. This ultimately led to the discovery of his alleged fraud.29On January 18, 2008 Keviel executed trades, which set off another alarm.This time, upon a more thorough investigation, a major problem became apparent. As SocGen risk-control experts reviewed Kerviel’s latest transactions carefully, they were shocked to discover that they had resulted in a position of 50 billion (obviously far beyond Kerviel’s trading limit) which, when finally cleared, resulted in a loss of more than 4.9 billion!
As of this writing, Kerviel is still under investigation and involved in litigation charging him of using his insider knowledge to falsify records and commit computer fraud. Prosecutors suspect his motivation was to boost his income by making successful trades far beyond his trading limits, thus earning large bonuses (his total salary and bonus for 2007 was a relatively modest 94,000 Kerviel spent five weeks in jail but is currently free on bond. He was hired in February 2008 as a computer consultant by the French firm Lemaire Consultants & Associates, however, he is said to be “traumatized” by his new-found infamy.
Kerviel admits he took trading positions beyond his authorized limit to make transactions involving European index futures. Kerviel told prosecutors “the techniques I used aren’t at all sophisticated and any control that’s properly carried out should have caught it.”30 He insists he did no wrong and that the bank was fully aware of his transactions. Kerviel has said he refuses to be made a scapegoat for the bank’s lapses in oversight. He argues that his superiors tacitly approved his activities—as long as they were generating a profit. Kerviel had earned a profit for the bank of nearly 1.5 billion in 2007 by exceeding his trade limit and executing similar, but successful, trades. The bank meanwhile said the fraud was based on simple transactions, but concealed by “sophisticated and varied techniques.”31 If convicted, Kerviel faces up to five years in jail and fines for as much as 300,000.
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The sterling reputation of SocGen was tarnished badly and the market value of the firm dropped 50 percent over the course of just a few months. The bank’s highly respected CEO and Chairman of the board, Daniel Bouton, was put under enormous pressure to step down; this included requests for his resignation from French President Nicholas Sarkozy. Bouton eventually resigned as CEO in May 2008, but he remains chairman of the board.33 In December 2008, European hedge fund GLG Partners entered into an agreement to acquire the bank in the second half of 2009.34
Several internal and external investigations of the bank’s operating procedures and internal controls have been completed. The French banking regulator stated there were “grave deficiencies” in the bank’s internal controls and fined it million. The Banking Commission said SocGen did not focus sufficiently on fraud weaknesses and there were “significant weaknesses” in the bank’s IT security systems. Another report pointed out that Kerviel’s direct supervisor was inexperienced and received insufficient support to do his job properly. It also stated that Kerviel’s fraudulent transactions were entered by an unnamed assistant trader thus raising the issue of collusion and indicating even more widespread weaknesses in internal controls.
Pascal Decque, a financial analyst who covers SocGen for Natixis (a leading player in corporate and investment banking) commented, “SocGen was brilliant in their achievement, they were the world leader in derivatives. Maybe when you are that good, you think you will never fail.”35
1. Peter Gumble, European editor for Fortune magazine comments: “Kerviel is a stunning example of a trader breaking the rules, but he is by no means alone. One of the dirty little secrets of trading floors around the world is that every so often, somebody is caught concealing a position and is quickly—and quietly—dismissed. Traders do this not infrequently, and the question is how quickly compliance systems pick it up.” [This] “might be shocking for people unfamiliar with the high-risk, high-reward culture of most trading floors, but consider this: the only way banks can tell who will turn into a good trader and who won’t is by giving every youngster it hires a chance to show his mettle. This means allowing even the most junior traders to take aggressive positions.The leeway is supposed to be matched by careful controls, but clearly they aren’t foolproof.”36 What is your reaction to this statement by Mr. Gumble?
2. What explanations can there be for the failure of SocGen’s internal control system to detect Kerveil’s transactions while Eurtex detected many suspicious transactions?
3. Should banks and investment firms permit members of their compliance departments to become traders?
4. Do research on the Web to find out if Kerveil was found guilty and punished. What other outcomes resulted from this incident?
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