Players who profited from rogue losses

By Neil Behrmann

January 2008:- The financial gallery of infamy has a new member.

Jerome Kerviel, 31, an unknown trader of Societe Generale, has allegedly committed the biggest fraud in financial history.

Kerviel traded European stock index futures that require margin deposits that are only a fraction of the value of trades. Thus the record alleged fraudulent losses of 4.9 billion euros ($7.2 billion) indicate that his overall open positions prior to liquidation could easily have been as much as €50 billion ($73 bn) estimates Socgen.

Bankers and other market participants are questioning how his SocGen superiors managed to ignore the scale of his dealings. Surely someone would have picked up the unauthorised trading.

The buzz around London was that SocGen's desperate race to clear up the damage and unravel Mr Kerviel's trading positions was behind the stock market turmoil on Monday, when share prices across Europe tumbled by 7 per cent. The next day, in the US, the Federal Reserve announced its emergency rate cut. Could a single rogue trader have been at the heart of so much upheaval?

Hedge funds and other derivative bears profited from rogue losses

Traders and bankers are asking who profited on the other side of the loss-making trades. Kerviel, a bull, had bought futures and options, hoping that prices would rise. It is believed that several hedge, managed futures and proprietary investment bank traders had sold the derivatives short, aiming to profit from a price decline. None of these players have published performance figures yet. But the shorts would have yielded sizeable gains.

Kerviel was certainly not one of the high flyers of the bank and was earning only 100,000 euros a year. He had joined the bank in 2000 after studying for a masters degree in finance at a business school in the French town of Lyon. He then worked for five years in the bank's back office, which monitors trading and risk controls.

Two years ago, Kerviel was promoted to the trading desk. He was not a star trader, and unlike Nick Leeson, he was not operating at a foreign branch. He was at SocGen's head office in Paris, within the inner sanctum of the bank. The bank's co-chief executive, Philippe Citerne, said that Kerviel had 'intimate and malicious' knowledge of SocGen's trading procedures and back office. He knew at what dates checks were conducted. 'Each time he took a position one way, he would enter a fictitious trade in the opposite direction to mask the real one,' Citerne said.

Kerviel was found out at the end of last week when one of his trading positions popped up on SocGen's internal system as being over his trading limits. He immediately confessed to senior executives who were so concerned by the brilliant but irrational young man that they even referred him to a counsellor.

Socgen claims don't add up

There is widespread scepticism about SocGen's claim that Kerviel, who earned a relatively low sum in the business, had no financial incentive to make the trades. The bank claims that he made nothing and it has filed an official complaint with Paris prosecutors, accusing him of falsifying records and computer fraud. Asked whether Kerviel rejects the banks' accusations, his lawyer said: "He is not on the run. He is standing by to answer to justice."

SocGen executives claim that they do not understand what motivated Mr Kerviel to overtrade and compound his losses. They claim that he appeared to be acting alone, but some conspiracy theorists in the market allege that there could have been a payoff from traders outside SocGen. Citerne claims that Mr Kerviel 'was mentally weak' and that he had girlfriend problems, but surely his superiors would have realised that long before he ran up losses over the past 12 months.

'It just doesn't add up,' said a London-based hedge fund manager who is active in the derivatives market.

Sexy when right, paralysing panic when wrong, says Leeson

In a series of interviews, Nick Leeson, who was jailed for almost seven years for taking down Barings in a fraud that cost the bank £860 million ($1.7 billion) gave some insight into a trader who tries to deal himself out of trouble.

'When markets are going your way, the feeling is brilliant, more intoxicating than champagne, more exhilarating than sex. But when trades go wrong, you can't tell your colleagues.

'When you are losing such vast sums of money, you try to carry on in the misguided belief that you can beat the market for a couple of days . . . You still think you can pull yourself out of the nightmare and get back to the breakeven position. But ultimately you are living on borrowed time. When things start to go wrong, the creeping paralysing panic takes hold.'

The fear of losing your job and respect, and the fear of going to jail, he said.


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