There have been many cases over the years of rogue traders losing huge sums of money. Sometimes these rogue traders are institutions, other times they’re just individuals who think they have the midas touch. One such individual is infamous French trader, Jerome Kerviel.
Born and raised in a working-class family, he studied finance and later got a Master’s degree in back office finance. Kerviel was a mediocre student and after finishing his Master’s program, he started working at Société Générale. The bank is the French equivalent of JP Morgan, providing all sorts of retail and investment banking services.
When Jerome Kerviel joined SocGen in 2000, he was assigned to a middle office job doing compliance work. He was in charge of verifying trades and making sure activities of the front office traders were in accordance with company rules.
Over several years, he made a name for himself in the finance department and was eventually offered a position in a front office job in the securities trading business. He was put on the Delta one desk as a junior trader, where he traded equities and ETFs. His new role was well paid but he had ambitions to progress within the company.
After a year on the trading desk, Kerviel started making certain trades that he was not allowed to make. The trades he put on became bigger, overstepping his authority as a junior trader but nobody noticed. Throughout 2006, his trades became bigger and by 2007 he was placing billion dollar trades. He would hold for a few days and then sell before a three-day alert system that would notify higher-ups.
During the latter half of 2007, he was net short the market – betting that stocks would go down. Sure enough credit worries and the gradual unfolding of the great financial crisis rewarded his bearish trades. As the markets continued to go down Kerviel made bigger bets. Eventually placing tens of billions of dollars of SocGen’s capital at risk with his trades.
He used futures contracts to increase his leverage on his bets. Futures contracts are financial derivatives whereby a trader can get 100% of the exposure to an underlying security without putting up the capital to buy the security. Using these derivatives, he was placing tens of billions of dollars and it was working.
At the beginning of 2008 the Dow Jones had fallen nearly 20% from its highs, netting SocGen more than a billion dollars in profits due to Kerviel’s trading. The only problem was he made too much money and attempted to lose money to reduce the attention from the firm’s compliance officers.
He was bearish on stocks so he placed long bets on the market, planning to close them once his account’s profit looked normal. Unfortunately, the market crash only accelerated in 2008 dropping even more than 2007. The Dow crashed 778 points in a single day – the largest point decline in Dow history up until that point. The S&P 500 index dropped 8.8% in a day and the Nasdaq fell 9.1%.
By the time the smoke had cleared, the total losses to the bank came up to more than $7 billion. This loss was a significant portion of the entire value of the bank, around 10% of the market cap. Along with accelerating credit losses of three billion dollars at the same time, the bank was forced to try to raise new capital from investors. Kerviel’s supervisors were all fired and Kerviel himself was taken into police custody.
After 48 hours of police questioning, Kerviel was charged with abuse of confidence and illegal access to computers. Two and a half years later he was sentenced to five years in prison and ordered to pay back $6.7 billion dollars to SocGen. That hefty penalty to an individual was considered to be a joke and no one expected Kerviel to pay back anything.
Questions still remained about how the fiasco was even allowed to happen. In 2008 the French finance minister, Christine Lagarde spearheaded a campaign to investigate the bank’s involvement in making the fraud possible. She concluded that SocGen failed to apply appropriate controls on Kerviel.
Only a couple years before the incident SocGen was told to strengthen their operational security protocols, but they did not. A potential reason why SocGen may have allowed Kerviel to place the outsized trades was because SocGen itself was the one benefiting when the trades were going well, not Kerviel. His trades had resulted in more than a billion dollars of profits for the bank before it all unraveled.
SocGen said that Kerviel hid his activities by telling company authorities that large trades were mistakes and then closing them just to put on similar positions later. Among other things, he allegedly also faked emails to his superiors to shift the focus away from himself. However, certain experts have cast doubt on whether these measures would have been enough to hide the trades from Kerviel’s supervisors.
In particular, Kerviel’s lawyers have said that SocGen knew about the trades all along and allowed them. They said that SocGen was trying to use Kerviel as a scapegoat to detract attention away from their own corporate losses around the same time. Another kink in the story is that no motive for Kerviel taking such large positions has been found.
He would not profit from the trading gains, his superiors on the other hand would be likely to receive high bonuses on good trading results. This could have incentivized them to
either allow or possibly even encourage Kerviel to make the risky trades after they realized that they were so profitable.
The police investigated if Kerviel had accomplices but no such evidence was found. In the end Kerviel spent just five months in prison. These days he is out of prison and is working a normal job just like an average citizen.
After making more than a billion dollars in 2007, it seems implausible for SocGen not to have looked into how the money was made. A billion dollars would have been a very significant fraction of the entire company’s profits.
The idea he was working alone without knowledge of his superiors until a massive position came crashing down, seems absurd. It’s more believable that others were condoning or even coordinating the trades and using Kerviel as the face of their activities. The potential motives in the form of bonuses for the leadership within SocGen would have been millions, orders of magnitude more than Kerviel’s compensation for the trades.
James Kelly is my name and penny stocks are my game! Former day trader turned long-term investor with a decade of experience in the market. Over the years, I’ve joined dozens of trading services and I aim to provide honest reviews to help traders make better decisions!