The spectacular revelation of Société Générale’s $7.2 billion loss at the hands of a rogue trader is a huge dose of deja vu, though its financial impact is far greater than prior incidents involving young, ambitious traders who commit such crimes.
The case of Jérôme Kerviel, the 31 year old alleged to have executed the unauthorized trades—it has been reported that he built up combined trading positions in recent months totaling $73 billion—raises an obvious question: How could such activity occur for so long without being detected, and, even more, how can banks prevent this in the future?
The industry has asked itself this question in the past. In 1995, Nick Leeson, a 28-year-old derivatives traders, lost $1.3 billion while executing and settling his own trades in a outpost of Barings Bank, the U.K.’s oldest investment bank. Leeson’s speculative trading eventually caused Barings’ collapse, he was tried and sent to prison.
SocGen’s losses are five and half times greater than Barings, though its losses would have been far larger had it not been for a margin call that triggered alerts. Great enough are the losses, however, that the bank is seeking a capital infusion of €5.5 billion, largely from its shareholders. The financial industry has long obsessed over the need to impose more stringent risk controls that monitor, red flag and prevent the activities of rogue traders. A look at the differences between the Kerviel and Leeson cases may provide some insight into how varied rogue traders can be in motivation, approach and consequences.
So what went wrong at Société Générale? One factor that separates Kerviel’s actions from that of Leeson is motivation. Leeson was benefiting handsomely through his activities; Kerviel, as far as authorities can determine, didn’t make any money.
Further, what made it possible for Kerviel to amass such losses is also very different. In Leeson’s case, the risk controls were completely overlooked; Leeson was allowed to execute and settle his own trades, a task normally handled by two persons, each acting separately. Leeson also worked remotely, so oversight by supervisors was lacking to none-existent.
For his part, Kerviel is believed to have orchestrated large unauthorized trades on stock index futures by hacking into computers—a distinctly different approach than Leeson’s to his financial crime.
If Kerviel wasn’t looking to make money, what was behind his behavior, and can such personality types be vetted during the hiring process? Even more, Kerviel acquired intimate knowledge of the back office and was able to override risk controls in the system, trading at will and without regard to size or credit exposure.
The simple truth: Risk management technology is only as good as those who use it within an institution. It’s no substitute for the sound judgment and oversight of those charged with protecting an institution and its assets, a costly lesson for SocGen.
