We have been eager for a long time to hear the other side of last year’s mega losses at Société Générale (OTCPK:SCGLY), where a lone trader allegedly gambled away EUR 4.9 billion without anyone realizing it. Having worked at a French bank for a while ourselves, we have always felt that Kerviel’s losses were possible only due to the acquiescence of his superiors, who chose not to look too closely at his stellar track record. The beauty of that strategy, which we have witnessed on a smaller scale in the enterprise we worked at, is that everyone is happy while things go well. But if there is a turn of events to the worse, you can blame it on a rogue trader.
Thanks to the French equivalent of 60 Minutes, sept à huit on the TF1 network, we get for the first time the inside story from the trader at the center of the scandal. Kerviel is visibly not at ease with the publicity surrounding his person. And that observation pretty much sums up the interview: Kerviel yielded to the pressure of the trading room and his bosses to produce profits, and did not feel at ease to stop before crossing the line.
Kerviel is adopting the good old strategy that offense is the best defense. While accepting responsibility for his actions, he reveals internals that must make his ex-bosses at Société Générale sweat.
He notes that the size of his positions was no secret in the bank. In a trading room where traders sit within a few feet of each other, it was no secret that he was taking positions as large as Eur 10 bn on some days. His unusually large trading was the prime topic at the water cooler. Traders sitting near him overheard the size of orders he was shouting down the telephone. Management was also aware of his activity: Kerviel claims that an (unspecified) outside party sent a letter to Société Générale alerting his bosses that he had placed Eur 2 billion of trades within only two hours. (NB: Based on news reports in early 2008 we believe that this outside party was an exchange) The letter even named the trader who placed these large bets: Jérôme Kerviel. The warnings were ignored, as was an email from internal audit to his bosses that at one point he had run up losses of Eur 90 million that were hidden through fictitious trades. Kerviel says, now in disbelief, that nobody asked him to stop. Instead, he was commended for making profits.
At the end of 2007, the accounts showed gains amounting to EUR 1.5 billion. It is not quite clear how this number reconciles with his 2007 profit that he reveals at another point of the interview, where he gives a year-by-year breakdown of his gains:
|Year||Profit target |
|Actual profit |
It is clear from the evolution of his profit targets that his bosses exerted significant pressure on him. Outperformance of profit targets in a given year just isn’t good enough; last year’s outperformance becomes next year’s minimum requirement. We are not surprised that such an environment pushes people to do funny things. Kerviel claims that at the end of every day, his bosses stopped by and asked how much profit he had made. On some days, he made as much as Eur 1 million for the bank, while most traders would consider Eur 30,000 a good day.
What does surprise us, though, is how little Kerviel benefited personally from the risks he took in the market. He was not eligible for profit-related bonuses until he gained official trader status in mid-2007, by which time he had already accumulated enormous profits for the bank. This sets the Kerviel scandal apart from the typical rogue trader story, where bonuses make people cook the books, hide trades or take exorbitant risks. Kerviel simply kept his bosses happy. And happy they were, as they got to keep the bonuses paid for Kerviel’s profits without having to give him a cut.
All this gives credence to Kerviel’s main assertion: fictitious trades were standard practice in the bank. He did not invent them but admits that he simply went farther than others. It also makes his claims about his last day at the bank credible: on a Saturday afternoon, the bank still supported him and his positions. On Sunday morning, the tone changed. He was told that he would be fired, and that he should leave Paris, lay low and get a new cell phone. On Monday, Société Générale announced publicly that rogue trader Kerviel had fled Paris, could not be contacted and that his whereabouts were unknown. In short, Kerviel was set up to take all of the blame. We wish Kerviel that the trial judge will withstand pressure better than he did.
Thomas Kirchner manages the Pennsylvania Avenue Event-Driven Fund (PAEDX), which does not hold positions in any of the stocks mentioned here. He is the author of the upcoming book Merger Arbitrage: How to Profit from Event-Driven Arbitrage (Wiley Finance, 2009).