Jerome Kerviel Talks More About His Rogue Trades

As a former trader, I’m somewhat fascinated by the story of SocGen’s rogue trader, Jerome Kerviel.  What confuses me most is how the bank could have been so flat out unquestionably incompetent as to let this happen.  Kerviel basically asserts that they weren’t in the dark about it – that many people knew what he was doing, but that they didn’t complain until things went bad.
I am by no means attempting to abdicate Kerviel of responsibility, but I’m flummoxed by how SocGen could have missed the reality of this situation.  Their lack of risk management is, in a word, remarkable.   Lets talk about some details.
I’ll talk in the first person, although I never in my life booked a fake trade to my system. When I trade, there is a counterparty to all of my trades – someone on the other side – which is to say that I buy FROM someone, and I sell TO someone.  Most of it is booked electronically now, although back in the day we did lots of stuff via phone and wrote manual tickets:  Bot 250,000 IBM @ 108.25 MSCO  4c.  This is pretty self explanatory:  it means I bought 250k shares of IBM @ $108.25 from Morgan Stanley and paid them 4c a share.  I’d probably then type that trade into my electronic order management system, and at the end of the day all of the trades would flow through to an electronic booking system which would send an electronic file of all of my trades to ADP for processing.   Morgan Stanley does the same thing on their side.
The next morning, the first thing that happens is that my operations guys come over and tell me if there are any “breaks.”  A break would occur, for example, if Morgan Stanley’s version of the trade didn’t match up with mine.  Maybe I accidentally put in $109.25 for the price – or maybe they thought it was supposed to be 6c a share commission, or maybe I made the trade up entirely and there was no real trade at all – in any case, there are lots of people whose job it is to figure this out.  There’s an entire settlement system designed to figure this out. 
Additionally, there are internal risk management groups and PnL monitoring groups that watch trader positions and keep a very close eye on the difference in the positions in the trader’s position management system and those that have actually “settled.”
If the operations guys were all on vacation, and everyone decided to ignore the break, there would be another notification at settlement, which is T+3 for stock trades.  If I buy 250k IBM from Morgan Stanley on Monday, the trade settles Thursday – that’s when I actually deliver them the money and they deliver me the shares (electronically, almost all the time).  If I made up a fake trade, it might take MSCO a few days to figure out why I was trying to send them money to pay for IBM that they didn’t sell me, but it shouldn’t take my bank long at all to figure out that MSCO didn’t give us the IBM we were paying for.  This is yet another check and balance in the system.  It’s probably very hard to book a fake trade in common equities.
Now, I think that Kerviel was trading futures – likely DAX (German index) futures (and CAC – French index futures).  I don’t know the intricacies of settlement in European futures markets, but if they are anything like US markets, I cannot fathom how it’s possible for him to “fool” the bank’s systems simply by entering fake “offsetting” trades, unless, of course, the systems were completely inadequate.  My former colleagues suggest that he could have booked fake over-the-counter swaps that don’t have exchange settlement, but again, that’s the point of all the other links in the chain of command within the banks:  the PnL monitoring group, the risk management group – we are talking about $50 BILLION in trades here – that’s not the kind of thing that gets ignored or written off with an “oh, ok – no problem.”  Additionally, the bank would send and receive margin flows for the real positions on a nightly basis.  Someone should absolutely realize that there are not offsetting margin maintenance flows coming from the fictitious trades (cause they’re fake, of course) even though there would be money flows if the trades were real.  This would be yet another red flag.  At the end of the day, the actual daily flow of money from bank to bank is pretty hard to fake from the trading desk – traders have nothing to do with that process.
If there are any European ops experts in my audience, feel free to weigh in.  The basic question is this:  Was SocGen grossly incompetent in operations and risk management?  Or did Kerviel take advantage of some flaw in the European settlement process that I don’t know about?  Either way, again, I’m not trying to absolve Kerviel of responsibility here, but it’s important to hold SocGen accountable as well, as they appear to be complicit in the outsized risk positions (or incompetent in their inability to detect them).  A complicit (or incompetent) bank is just as dangerous to the system as a rogue trader.  It seems clear to me that one cannot pull off this type of fraud alone at a bank with any sort of capable oversight – he’d need at least 2 other key people  in other divisions helping him.  But to clarify again, I’m not alleging that this is a deeper conspiracy, rather, I’m alleging that SocGen’s risk oversight procedures are/were completely unacceptable.

I am confident that I could not have done this at my bank.  Are there traders out there who think that their bank’s risk management procedures are so craptastic that they could pull of this kind of fraud without anyone noticing?  I’d love to hear about it.


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