Issue of the week: A rogue trader rocks the world

Bank regulators and financial leaders worldwide were all asking themselves the same question this week, said Carrick Mollenkamp in The Wall Street Journal: How could one low-level trader in France have pulled off “the most expensive trading scandal ever?” The trader in question is 31-year-old Jérôme Kerviel, whose trading of futures contracts produced losses of more than $7 billion at Société Générale, France’s third largest bank. After Kerviel’s shenanigans came to light last week, Société Générale stock plunged 17 percent, sparking speculation that the bank could become a takeover target. That’s the least of it, said Nelson D. Shwartz and Nicola Clark in The New York Times. When Société Générale discovered Kerviel’s deception, it rushed to sell the $75 billion in futures contracts he had amassed. The frantic selling accelerated the steep decline that decimated global stock markets last week. “This precipitous unwinding created the negative momentum that spread around the world,” said Byron Wien, chief economist at Pequot Capital Management.

Oddly enough, there was nothing particularly complicated about Kerviel’s scheme, said Doreen Carvajal and James Kanter, also in the Times. It started innocently enough. As a trader in the stock-arbitrage division, Kerviel used stock index futures to bet on the direction of European stock indexes. He would offset each wager that an index would rise with a corresponding wager that the index would fall, eking out small profits from infinitesimal price differences between the two bets. There was nothing improper or unusual about that strategy. But “starting in early 2005, he made small unauthorized trades, a strategy that ultimately wound out of control.” Kerviel, who was charged with computer crime and breach of trust, has acknowledged that he would bet that an index would rise, then concoct fake computer entries to make it appear that he had placed an offsetting bet. By playing just one side of the market, Kerviel stood to gain much more for the bank than he would have by betting both sides. But he risked huge losses if the markets moved against him—which is what happened. Now, he risks seven years in prison and a $1.5 million fine.

But it’s hard to believe that the fault lies entirely with Kerviel, said David Weidner in Marketwatch.com. Société Générale says that Kerviel acted alone and that the bank is as much a victim as its shareholders and investors. But at the very least, “there was a lack of supervision.” How exactly could a low-level trader “fool a bank that was considered one of the most sophisticated in the world at managing risk”? Société Générale says Kerviel worked his “fictitious portfolio” for more than a year. But most trades these days are “electronic, recorded, and available almost instantly to bank supervisors.” And let’s not forget that he was making a lot of money for his company. Perhaps his supervisors didn’t see what was going on because they didn’t want to see.

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One simple safeguard could have made all the difference, said Jeff Goldfarb in the financial Web site Breakingviews.com. Kerviel was a self-described workaholic who stubbornly refused to take his allotted vacation. Many big Western banks, though, now require traders to take five- or 10-day vacations at least once a year, and not out of kindness. “It is just hard to keep a fraud going when the day-to-day management of an order book is being handled by someone else.”