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Jérôme Kerviel and Société Générale Essay

In brief

Société Générale S.A. (SocGen) is a French multinational banking and financial services company headquartered in Paris. The company has a Corporate and Investment Banking division (Derivatives, Structured Finance and Euro Capital Markets). In the summer of 2000, Kerviel joined the middle offices in the bank Société Générale. He was working in the compliance department. In 2005 he was promoted to the bank’s Delta One products team in Paris where he was a junior trader.

His role was to arbitrage futures contracts on stock market indexes In January 2008, the bank Société Générale lost approximately €4.9 billion closing out positions over three days of trading beginning January 21, 2008, a period in which the market was experiencing a large drop in equity indices. The bank states these positions were fraudulent transactions created by Jérôme Kerviel. The police stated they lacked evidence to charge him with fraud and charged him with breach of trust and illegally accessing computers. Kerviel states his actions were known to his superiors and that the losses were caused by panic selling by the bank.

Why did the incident happen?

On the 24th of January 2008, Société Générale organized a press conference to unveil the case of which they are victims. According to the CEO, a market operator, member of his team, had exposed the bank to market risk even though he was not entitled to; the bank has accused him of exceeding his authority to engage in unauthorized trades totaling as much as €49.9 billion, a figure far higher than the bank’s total market capitalization.

He had accumulated long positions with high leverage in futures contracts on stock market index and concealed the transactions by inserting fictitious opposite transactions into the computer system of SocGen. The bank said that whenever the fake trades were questioned, Kerviel would describe it as a mistake then cancel the trade followed by replacing that trade with another transaction using a different instrument to avoid detection.

The bank then closed out these positions over three days of trading beginning January 21, 2008, a period in which the market was experiencing a large drop in equity indices.

They sold for €60 billion of futures contracts on Euro stoxx, DAX and Footsie indexes, registering a €6.3.billion loss (on an €7 billion annual profit). However, Bank officials claim that throughout 2007, Kerviel had been trading profitably (€1.4 billion profit according to the BBC) in anticipation of falling market prices. After deduction of the €1.4 billion profit, the losses attributed to Jérôme Kerviel are estimated at €4.9 billion. He managed to conceal his trades thanks to his good knowledge of internal control procedures which he had learnt while working in the compliance department.

Though bank officials say Kerviel apparently worked alone, skeptics question how unauthorized trading of this magnitude could go unnoticed. Kerviel’s unassuming background and position have heightened the skepticism that he worked alone.

Kerviel is not thought to have profited personally from the suspicious trades. Prosecutors say Kerviel has been cooperative with the investigation, and has told them his actions were also practiced by other traders in the company. Kerviel admits to exceeding his credit limits, but claims he was working to increase bank profits. He told authorities that the bank was happy with his previous year’s performance. Kerviel was sentenced to three years in prison with another two suspended, and ordered to reimburse 4.9bn euros to Société Générale for its loss, his case is still in appeal.

Conclusion

Despite Kerviel’s excess, the loss could have been less important if the bank had not closed all its positions while the markets where experiencing a large drop. SocGen is still the sixth-largest bank in Europe. Its loss was covered by the national treasury. The responsibility should also be shared because it is unlikely that a single trader could engage such great amount without his superiors knowing. To top it all, objectives set by banks and rewards associated seem highly incompatible with risk management department recommendations. Therefore we can wonder: Would SocGen have blown the whistle at all if the bets had been profitable?

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