Monday, January 28, 2008

The real failure of controls at Soc Gen

(Naked Capitalism) Disclosure (or apparent disclousues, who knows if we will ever learn the true story) of how equity derivatives trader Jerome Kerviel caused the biggest trading loss in banking history continues to dribble out.

Today, Bloomberg in "Societe Generale Says Trader Built Up Positions of EU50 Billion," gives more detail on how the trader caused so much damage:
Societe Generale SA said trader Jerome Kerviel built up positions in European stock index futures of 50 billion euros ($73 billion) before the French bank discovered the trades and unwound them last week.

Kerviel, 31, who is being questioned by France's financial police for a third day, took advantage of the bank's practice of checking only net trading positions rather than gross bets to conceal his subterfuge with phony hedges, Paris-based Societe Generale said yesterday. The trading loss of 4.9 billion euros was the biggest in banking history.

The failure to look at gross as well as net exposures is a basic shortcoming and the press and competitors will make a great deal of noise about that.

While further comments will no doubt leak out about the specific failings in SocGen's risk control system, one glaring lapse leaped out:
He took only four days off last August and postponed a vacation at the end of the year, Societe Generale said.

Huh? It is Trading 101 to make staff take a minimum of a full week off at least once a year, better twice, precisely because it is well nigh impossible for sole actors to keep frauds going from afar. For example, the $1.8 billion in losses at Sumitomo Corporation were generated by a copper trader who hadn't taken a vacation in over two year.

This factoid alone says that SocGen's systems (and by that I mean not just computerized risk controls, but broader management practices) were woefully deficient. Managing traders isn't just about designing computer systems to find anomalous patterns; it also involves a certain amount of judgment about overall risk, staff capabilities, procedures, and organization design. The discussion of how Kerviel did what he did appears to be focusing unduly on computer and system failures, and missing the point that they might have reflected or even reinforced larger organizational design failures.

Note I don't dismiss the possibility that the charges against Kerviel are either trumped up or considerably exaggerated. If they fail to hire an outside firm like Eugene Ludwig's Promontory Capital, which is full of former regulators and has conducted a number of high profile rogue trader investigations, to prepare a report and recommend improvements, that suggests there may be more to this story than SocGen is revealing.

...And according to “Le Monde” Jerome Kerviel was promised a 300 000 euros bonus for his 1.5 billions euros record profit in 2007. He asked for double that. The rest is history. (Alea)

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