One of the joys of finance is the steady flow of scandals, misinformation and mischance creating numerous opportunities for case studies, articles and indeed the musings in this blog. SocGen erupted over a week ago now - 'rogue trader' loses bank £4.7bn. The airwaves are alive with the dulcet tones of Nick Leeson's Watford accent as he explains the motivation of the rogue trader. The trouble is this scandal smells and it smells bad. Here are some 'factoids' culled from the media:
The Rogue Trader, Jerome Kerviel, was employed as an arbitrageur looking for mispricing between equity index futures and other index related products.
He had some knowledge of back office systems.
He has confessed to making unhedged deals in equity derivatives over a number of years just like many of the other traders on the equity desks.
He claims to have made significant surpluses in previous years of up to £1.7bn which were condoned by management but had to be 'lost in the system' and presented as no more than £55m on his account to stay within the rules.
He was using OTC contracts with the firm's big institutional clients to hedge the market contracts some of which were fictitious.
Eurex, the European derivatives exchange contacted SocGen's management in November worried about the large positions being taken by Kerviel.
The issue is investigated but supposedly the managers who came to look were persuaded by some fictitious OTC contracts that all was well.
On 18th January this year Kerviel's book was in surplus. By 21 January he was in serious deficit.
He leaves his job and the bank unwinds the position supposedly by selling large amounts of stock (!). This stock selling spooks the French and German market and contributes to the crash in share prices which indirectly feeds through to the US market and the Fed is forced into a rapid rate cut.
Kerviel goes to stay with his family for 4 days whilst the French police at a leisurely pace search his flat and his lawyers (already lined up) defend him in the media.
After 4 days he is taken into custody (no unseemly racing from airport to airport with interpol on his trail as with Nick Leeson).
After a brief spell being questioned he is taken in front of a judge who immediately sets him free on bail with a reduced set of charges to be investigated.
We are expected to believe (a) that SocGen did not know what was going on, (b) that SocGen did not use this unwinding to clean out some other dodgy dealing in the equity markets (you unwind a futures contract by buying or selling the future concerned not by selling the underlying stock) and (c) SocGen was quite happy to take the profits and only acted on 21 January when the market crash exposed Kerviel's position. One might also question how management investigators took a fictitious OTC contract at face value. This trader was supposedly acting well out of his authorised limits and in such circumstances they did not check what they were being shown? Complete nonsense - they did not want to find a problem so they did not look.
More to come as the banks position in this rather smelly barrel of pork belly futures is unwound.