Fraud at Societe Generale: Was this a new lesson for the financial institution?

One more name got added to the list of

rogue traders with the revelation of fraud by Jerome Kerviel at Societe Generale. This seems to be the biggest banking fraud unless a few more traders, who might have taken massive bullish positions in this bearish market, get exposed in near future. A $7.2 billion loss outsmarted all the previous trading losses. Societe Generale is France’s second largest bank and the unauthorized bets on stock-index futures resulted in a loss of euro 4.9 billion.

Jerome Kerviel started increasing the size of his trades in the year 2007 and Bank was informed about that by the authorities of Eurex, but his net position was a profit of $81 million and hence the caution was ignored by the bank. By the end of 2007, Jerome had booked profit of about $2 billion for the bank and this time he was more ambitious. He entered into contract illegally on the name of bank’s clients. His fictitious trades largely involved future contracts on various indices such as Eurostoxx-50, German DAX and FTSE index. Most of these unauthorized contracts were entered in early January 2008 with a bullish view about the market. But marketing started witnessing a downward movement with a negative sentiment about the global slowdown. By then, bank’s client raised the alarm and the senior authority started investigation. Out of surprise, the management found that his market exposure was $50 billion which was even more than the worth of Soc Gen. The news of this isolated fraud of such huge size caused concerned in the market already reeling with the subprime crisis. European market crumbled around 7% on Monday (21’st January 2008) because of the desperate attempt by the bank to clear off the position. Ultimately the virtual loss turned to real loss of $7.2 billion.

One concern arises here about the decision of management to square off the position at the earliest is that why management had to be this hasty? Shouldn’t the bank waited for indices to go up to make huge profit or atleast avoid loss from the bet? Soc Gen., the second largest bank of France, got aware of the gravity of the situation because of such a huge bet on the indices which amounted more than the worth of the bank itself. This news had also reached to the market and the sentiments got further sour in already bearish market. The FTSE100 had fallen from 6456 on January 2’nd to 5901.7 by January 18’th (Fall of more than 8%) from the speculation of global recession. Management had to take the call well in advance to avoid Soc Gen. becoming another Barings. The management claimed that even after losing the $7.2 billion in the market, the bank was going to show profit of euro 800 million for year 2007.

Trading floors all over the world, have witnessed a series of such frauds. But, who should be blamed for such events? The rouge trader, who misuses the information available with him/her or the management, for whom only the gain matters irrespective of source and the means? All such illegal trading had initial clue as well as warning from different internal or external authority, but management has consciously ignored such indication just because the position was bringing money for the company. While traders have been unethical by using fraud accounts of clients without their permission and betting on amount more than the assigned limit; management needs to introspect and reason out their myopic view of such prevailing wrongdoings. A firm regulatory body with close eye on every transaction and proactive decision of management could avoid such event in future.