In this series of posts on the Jérôme Kerviel trial, I’ve
argued that, contrary to Société Générale’s contentions that they were duped by
a genius, the bank itself is to blame for Kerviel’s massive losses. Soc Gen ignored
major warning signs regarding the size and scope of Kerviel’s trades, and ultimately
was complicit in the risky activities of Kerviel and other traders, throwing
aside risk management in the pursuit of trading profits.
Now, you might say, “Sure, Kim’s so insightful with the
benefit of hindsight.” (Well, you might not even say that, but let’s pretend
that you did.) “But, if these
warning signs were so clear, why didn’t anyone notice them at the time?”
Well, many people did notice them at the time. Société
Générale ignored inquiries regarding Kerviel’s trading anomalies from both outsiders
and its own risk management personnel. On two occasions, in April and May 2007,
trading managers failed to react to reports from risk management personnel
regarding trading anomalies uncovered during a review of Kerviel’s trades, in
which his responses to questions were evasive and incoherent.
Later, in November 2007, the bank failed to respond to two
written inquiries from EUREX, one of the world’s largest derivatives exchanges
and Europe’s leading clearinghouse.
One of these inquiries mentioned the purchase by Kerviel of 6000 DAX
futures contracts in just two hours (a value of about EUR 1.2 billion).
Similar organizational indifference is evident in the case
of Nick Leeson at Barings Bank (previously discussed here
and here),
whose activities failed to arouse suspicion within Barings, long after rivals
at other firms had noticed his increasing positions and risky trading strategy,
generating market rumors that Leeson was engaged in substantial unauthorized
trading activity. At the time of
Barings’ collapse, its positions on the Osaka exchange were eight times greater
than its nearest rival, and its positions on the Singapore exchange were even
larger.
Yet Barings’ ignored repeated inquiries from SIMEX officials
highlighting trading violations regarding account 88888—an account about which
Barings’ management later professed complete ignorance. Those within the firm who expressed
concern with Leeson’s activities were put off with reassurances that management
was investigating the matter.
AIB had similar incidents, in which it ignored inquiries
from other banks, the SEC, and market sources (see here
and here). Kidder Peabody also ignored several
inquiries from the Federal Reserve regarding Joseph Jett’s trading activity,
which by May 1993 had grown to represent 40–50% of all recon activity in the
United States. By this time,
Jett’s recon trading had grown so large that his false profits accounted for
45% of Kidder’s 1993 profits, and his forward recon instructions on some bonds
were so large that they exceeded the world-wide availability of the component
STRIPS. Despite this, four former
Kidder employees claimed in litigation that their complaints that Jett’s
forward recon trading strategy made no sense and could not possibly produce
real profits were ignored. (I previously discussed the Jett case here).
NAB went a step further when another Australian bank raised
concerns in March 2002 regarding the size and risk of the currency options trades
emanating from NAB. NAB accused the inquiring bank of failing to comprehend
NAB’s pricing models and trading strategy, and warned that if rumors regarding
the bank’s concerns leaked into the marketplace, NAB would terminate its
dealing relationship with the bank. (See prior NAB posts here
and here)
In each of these cases, the “rogue” traders were rarely
questioned in any depth about unusual trading activity and the back-office
confirmation of those activities was half-hearted or, in some cases,
nonexistent. Skeptics within the
firm were deterred with vague assurances that all was well or that the
questioner lacked the skills to sufficiently understand the trading strategy
and/or the explanations given. In
some cases, back and middle office personnel were essentially bullied into
submission. In all cases,
relatively senior management ignored or failed to adequately investigate
inquiries or alerts from their own employees, regulators, exchanges, and other
market participants, treating such inquiries more as public relations problems
than as a potential signal of rising operational risk levels.
Today is the last day of the trial, which means that this
series of posts is drawing to a close (what excuse will I find now to avoid
work?) I’m planning to wind up by
answering two lingering issues raised by the trial: (1) the contention, raised
by Daniel Bouton in testimony this week, that no bank would knowingly allow a
trader to take such risks as Kerviel’s and (2) a reminder of the potential
systemic implications of these types of events, which is why they should
concern us.
All facts, figures, and calculations used in this post, and
the sources and citations from which they are derived, are detailed here.
Related
Posts:
It’s
The Stupid Culture
It’s The Culture, Stupid
Kerviel’s Fake Trades: Genius Or Copy Cat?
Kerviel’s Fake Trades: The Anatomy of A
Cover-Up
On Warning Signs II: Follow The Money
On Warning Signs: You Can’t Get There From
Here
Rogues Versus Scapegoats
Kerviel Trial Opens to Fanfare
Société Générale: Back In The Saddle Again
Jérôme Kerviel to Société Générale: Stand By
Your Man